Generac Holdings Inc. — Q3 2017 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2017; unaudited. Generac designs and manufactures power-generation equipment and other engine-powered products for residential, commercial and industrial markets. Comparisons are with the corresponding 2016 periods. Dollar amounts below are USD millions unless otherwise stated.
Financial performance
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Net sales | $457.3 | $373.1 | $1,184.4 | $1,027.0 |
| Gross profit | $157.5 | $137.8 | $402.4 | $360.0 |
| Gross margin | 34.4% | 36.9% | 34.0% | 35.1% |
| Operating income | $72.9 | $56.3 | $157.0 | $127.4 |
| Net income attributable to Generac | $39.7 | $26.2 | $78.2 | $57.3 |
| Diluted EPS | $0.64 | $0.40 | $1.26 | $0.87 |
| Adjusted EBITDA | $88.8 | $72.8 | $206.6 | $186.6 |
| Operating cash flow | Not presented by quarter | Not presented by quarter | $122.7 | $129.5 |
Q3 sales rose 22.5%, operating income 29.3%, and attributable net income 51.7%. Nine-month sales increased 15.3% and attributable net income 36.5%. Adjusted net income attributable to Generac, a non-GAAP measure, was $57.8 million for Q3 (up 8.6%) and $126.9 million for nine months (up 0.1%).
Drivers and material changes
- Q3 domestic sales grew 21.8%; international sales grew 25.5%. Residential product sales rose 30.6%, commercial and industrial sales 16.6%.
- Management attributed domestic growth partly to increased portable-generator shipments following Hurricanes Harvey, Irma and Maria, as well as continued mobile-product growth. International results benefited from Motortech, organic growth and a stronger euro. Recent acquisitions contributed $10.1 million of non-annualized Q3 sales and $60.1 million for the nine-month period.
- Gross margin contracted in Q3, mainly because portable-generator and mobile-product sales—both lower-margin than the company average—made up a larger share of sales. For nine months, management also cited acquisition mix, commodity costs and plant-consolidation costs; higher pricing and manufacturing leverage partly offset these pressures.
- Q3 adjusted EBITDA increased 21.9%; Domestic adjusted EBITDA margin was 22.8% versus 23.2%, while International margin was 6.1% versus 4.8%. Nine-month adjusted EBITDA increased 10.7%.
Cash, debt and liquidity
- Cash and equivalents were $128.8 million at September 30, versus $67.3 million at December 31, 2016. Nine-month operating cash flow was $122.7 million, down $6.8 million year over year, principally due to greater working-capital investment. Capital expenditures were $16.7 million; operating cash flow less capital expenditures was approximately $106.1 million.
- Cash used in investing activities was $15.3 million, compared with $80.9 million in 2016, which included the Pramac acquisition. Cash used in financing was $48.8 million, including $30.0 million of share repurchases.
- Reported borrowings and capital-lease obligations totaled approximately $1,039 million, including $26.2 million of short-term borrowings; cash netted against that total was $128.8 million. The term loan had $929.0 million principal outstanding and matures May 2023. The ABL facility had $100.0 million outstanding, with $142.2 million available after letters of credit.
- In May 2017, the term-loan amendment reduced pricing to a fixed margin of 2.25% over adjusted LIBOR (subject to a 0.75% floor), or 1.25% over base rate. The company reported covenant compliance and no term-loan financial maintenance covenants. In October 2017, after quarter-end, it repaid $90.0 million of ABL borrowings.
- Current assets were $810.1 million and current liabilities $458.7 million. The company said operating cash flow, ABL availability, low capital-expenditure requirements and tax attributes should provide sufficient capital for planned growth, while noting possible future needs for working capital, capital expenditures or acquisitions.
Outlook, risks and unusual items
- The filing gives no specific revenue, earnings or margin guidance. Management’s discussion is forward-looking and identifies outage frequency and duration as unpredictable demand drivers; seasonality and major outage events can cause period-to-period volatility.
- Other cited risks include raw-material and component availability, costs and quality; interest rates and foreign exchange; acquisition integration and realization of expected synergies; global expansion, competition and distribution dependence; product liability or recalls; and changing environmental, health and safety requirements.
- The nine-month effective tax rate was 35.3%, versus 36.7% in 2016, reflecting favorable nonrecurring discrete tax items. Management stated tax attributes were expected to reduce cash taxes, subject to continued profitability and stated assumptions. The company was under examination in multiple tax jurisdictions; management did not expect material taxes or penalties but noted outcomes could differ from recorded amounts.
- The 35% Pramac noncontrolling interest is redeemable under a put option, generally exercisable within five years of the March 2016 acquisition; the balance was $41.8 million at quarter-end. Dealer floor-plan financing outstanding was approximately $40.5 million; Generac participates in financing costs and agreed to repurchase repossessed products, but does not indemnify the finance company for credit losses.
- Product warranty liabilities were $33.2 million, and deferred revenue for extended warranties was $47.2 million. Management said ordinary-course lawsuits were not expected to have a material adverse effect. Disclosure controls were deemed effective; the company continued integrating Pramac controls and updating controls in connection with an ERP rollout.
- Non-GAAP measures exclude selected items and have limitations; the filing cautions that Adjusted EBITDA is not a substitute for GAAP income or operating cash flow and does not capture working-capital needs, capital expenditures or debt service.
Key investor verification points
- How much of the sales surge tied to hurricane-related portable-generator demand persists, and how does product mix affect margins?
- What portion of growth reflects organic demand versus Motortech and other acquisition contributions, and are international margins improving?
- Can operating cash flow keep pace with working-capital needs, debt service, repurchases and potential investment or acquisitions?
- Verify the post-quarter $90.0 million ABL repayment and resulting debt, cash and borrowing availability in subsequent filings.
- Review tax examination developments, the Pramac put-option terms and redemption exposure, warranty trends, and the assumptions underlying non-GAAP adjustments and cash-tax expectations.