Generac Holdings Inc. — Q2 2017 Form 10-Q
Business context and period: Generac designs and manufactures power-generation equipment and other engine-powered products for residential, commercial and industrial markets. This unaudited filing covers the quarter and six months ended June 30, 2017; comparisons are with the corresponding 2016 periods.
Financial performance
- Q2 revenue: $395.4 million, up 7.6%. Gross profit was $134.5 million and gross margin was 34.0%, versus 33.8% reported in Q2 2016. Operating income rose 18.6% to $52.3 million; net income attributable to Generac rose 22.8% to $25.7 million. Basic and diluted EPS were $0.42 and $0.41.
- Six-month revenue: $727.2 million, up 11.2%. Gross margin was 33.7%, compared with 34.0% reported in the prior-year period. Operating income increased 18.4% to $84.1 million; net income attributable to Generac rose 23.8% to $38.5 million. Basic and diluted EPS were both $0.63.
- Cash flow: First-half operating cash flow was $55.7 million, down from $81.2 million. Capital expenditures were $10.0 million. Investing cash outflow was $8.8 million, versus $74.8 million, which included the 2016 Pramac acquisition. Financing cash outflow was $49.5 million; cash ended the period at $67.1 million.
- Margins and adjusted results: Q2 Adjusted EBITDA was $70.2 million, up 9.8%; first-half Adjusted EBITDA was $117.8 million, up 3.6%. First-half Adjusted Net Income attributable to Generac was $69.1 million, down 6.1%. These are non-GAAP measures and should be considered alongside GAAP results.
- Liquidity and debt: Current assets were $697.8 million and current liabilities $310.3 million. Cash was $67.1 million, with $145.9 million available under the ABL facility, net of letters of credit. Balance-sheet short-term borrowings were $22.2 million; current and long-term borrowings and capital lease obligations were $7.7 million and $1,007.2 million, respectively. The ABL had $100.0 million outstanding. The Term Loan matures in May 2023; the company reported covenant compliance and no financial maintenance covenants on that loan.
Material changes versus comparable periods
- Q2 sales increased in both Domestic (+6.7%) and International (+10.9%). Management cited home standby generator and mobile-product shipments domestically, and Motortech acquisition contributions internationally. Residential and commercial/industrial product sales grew; “Other” product sales declined.
- First-half sales growth was led by International (+45.0%), reflecting Pramac and Motortech contributions and organic international growth. Recent acquisitions contributed $50.0 million of first-half sales that were not annualized.
- Management said the first-half gross-margin decline reflected acquisition mix, higher commodity prices and plant-consolidation costs, partly offset by favorable pricing. Prior-year comparisons included Pramac inventory step-up and restructuring charges, so reported margins are not fully like-for-like.
- Q2 Domestic Adjusted EBITDA margin improved to 21.0% from 20.0%; International margin declined to 6.7% from 8.2%. For the first half, Domestic margin was 19.3% versus 19.5%, and International was 6.3% versus 8.0%.
- Operating cash flow fell, which management attributed mainly to working-capital investment, including inventory replenishment after Hurricane Matthew, versus a working-capital benefit in the prior-year period.
- The May 2017 Term Loan amendment reduced applicable margins to 1.25% over base rate or 2.25% over adjusted LIBOR, subject to a 0.75% LIBOR floor. The company repurchased $30.0 million of shares during Q2.
Outlook, risks and unusual items
- The filing gives no specific numerical revenue, earnings or margin guidance. Management said operating cash flow, ABL availability, relatively low capital-expenditure needs and tax attributes provide sufficient capital for continued growth, while noting that expansion may require additional capital.
- Management highlighted demand sensitivity to major outages, residential investment and consumer confidence, and commercial/industrial capital-spending cycles. Sales and profitability may fluctuate with outage activity and seasonality.
- Key risks include commodity and component cost or availability, foreign-exchange and interest-rate movements, acquisition integration and expected synergies, global expansion, competition, distribution-channel dependence, product liability or recalls, and changing regulation.
- The company uses commodity, foreign-currency and interest-rate derivatives to manage exposures. Ten additional interest-rate swaps were entered into in June. The filing reported no material change in risk factors from the 2016 Form 10-K.
- First-half effective tax rate was 36.7%, versus 36.2%; management attributed the increase primarily to non-recurring discrete tax items. Tax examinations were ongoing; management did not expect material taxes or penalties but acknowledged outcomes could affect results.
- Product warranty liabilities were $32.8 million at June 30; extended-warranty deferred revenue was $36.7 million. Dealer floor-plan financing outstanding was approximately $40.9 million, and the company has agreed to repurchase certain repossessed products, subject to stated terms.
- The 35% Pramac noncontrolling-interest holder has a put option that may require Generac to redeem the interest under the acquisition agreement. Routine litigation was not expected by management to have a material effect.
Important facts for investors to verify
- How much reported growth reflects organic demand versus Pramac and Motortech, and whether acquisition-related margin pressure persists.
- Whether inventory and other working-capital investment converts to operating cash flow in subsequent periods.
- How commodity prices, foreign exchange and International segment mix affect margins and earnings.
- Debt service, the effect of the revised Term Loan pricing and the company’s continuing share repurchases on liquidity and leverage.
- Potential Pramac put-option redemption exposure, tax examination outcomes, warranty trends and dealer floor-plan repurchase obligations.