Generac Holdings Inc. — Q2 2014 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2014. Financial statements are unaudited. Amounts below are in U.S. dollars; financial statement amounts are shown in millions unless noted.
Business context
Generac designs and manufactures power-generation equipment and other engine-powered products for residential, commercial, industrial and construction markets. It reports one operating segment. U.S. sales were approximately 85% of sales in both the quarter and first half. Recent acquisitions included Tower Light and Baldor Generators, in 2013.
Financial performance
| Metric | Q2 2014 | Q2 2013 | Six months 2014 | Six months 2013 |
|---|---|---|---|---|
| Net sales | $362.6 | $346.7 | $704.6 | $746.3 |
| Gross profit | $128.0 | $131.0 | $247.5 | $284.4 |
| Gross margin | 35.3% | 37.8% | 35.1% | 38.1% |
| Operating income | $78.2 | $76.4 | $143.5 | $173.0 |
| Net income | $54.0 | $28.3 | $88.7 | $78.9 |
| Diluted EPS | $0.77 | $0.40 | $1.27 | $1.13 |
| Adjusted EBITDA | $84.5 | $90.1 | $162.0 | $198.9 |
| Adjusted net income | $57.1 | $66.6 | $107.8 | $150.4 |
Quarterly sales rose 4.6%, while first-half sales fell 5.6%. First-half net income increased despite lower sales, but adjusted EBITDA declined 18.5% and adjusted net income declined 28.3%. Management attributed lower margins year over year to acquired businesses and a return to normal seasonal promotional activity.
Q2 residential sales were $179.6 million, down from $196.6 million; the prior-year quarter included about $40 million of shipments related to post-Superstorm Sandy extended lead times. Excluding that benefit, the company reported approximately 15% residential revenue growth, led by home standby generators and power washers. Commercial and industrial sales rose 22.5% in Q2 and 23.2% in the first half, supported mainly by acquisitions, with contributions from oil and gas, stationary generators, light towers and natural-gas products. First-half residential sales were down 24.0% against a prior-year period that included about $140 million of Sandy-related incremental shipments.
Cash, debt and liquidity
- Operating cash flow was $85.3 million for the first half, versus $74.3 million a year earlier. Management cited lower inventory investment compared with the prior-year inventory replenishment.
- Capital expenditures were $13.3 million; investing cash outflow was $13.7 million. Financing cash outflow was $23.8 million, primarily reflecting debt repayments.
- Cash and cash equivalents were $198.0 million at June 30, 2014, up from $150.1 million at year-end 2013. Current assets were $717.2 million and current liabilities $214.0 million.
- Long-term borrowings and capital lease obligations were $1,154.3 million, with $6.5 million of short-term borrowings. The term loan principal was $1,179.0 million. The company made a voluntary $12.0 million debt prepayment in April.
- No borrowings were outstanding under the $150 million ABL facility; availability, net of letters of credit, was $148.5 million. The term loan matures in 2020 and the ABL facility in 2018. The term loan has no financial maintenance covenants; the ABL has a conditional fixed-charge coverage test.
Material changes, outlook and risks
- A leverage-ratio threshold triggered a 25-basis-point term-loan margin reduction effective in Q2. The company recorded a $16.0 million noncash gain representing estimated interest savings over the remaining loan term. Q2 results also included a $4.9 million gain from remeasurement of acquisition-related contingent consideration. These items materially affected reported comparisons; adjusted measures exclude or adjust for them.
- Interest expense declined year over year, reflecting the 2013 refinancing and lower borrowing costs. The effective tax rate for the first half was 35.1%, down from 37.5%.
- No specific financial guidance was provided. Management said operating cash flow, revolver availability, relatively low ongoing capital expenditure needs and tax attributes provide sufficient capital for future growth, while noting expansion may require additional capital.
- Management identified demand and outage variability, residential and business investment cycles, raw-material and component costs, foreign exchange and interest rates, acquisition integration and synergies, competition, distribution dependence, technology, key-personnel retention, product liability and regulatory changes as risks. Major outage timing is unpredictable and can cause sales and profitability to fluctuate.
- Dealer floor-plan financing balances outstanding were approximately $31.7 million; Generac has agreed to repurchase products repossessed by the finance company, subject to the arrangement. Management said ordinary-course litigation was not expected to have a material effect. Product warranty liabilities were $32.2 million. The company reported effective disclosure controls and no material change in internal controls.
Important facts for investors to verify
- How much reported earnings benefited from the $16.0 million borrowing-cost gain and $4.9 million contingent-consideration gain, and how sustainable underlying margins and adjusted results are.
- Whether commercial and industrial growth can offset residential comparisons after the prior-year Sandy-related shipments, including the contribution and integration of acquisitions.
- Debt-service capacity and covenant headroom, given substantial term-loan debt, alongside actual cash generation, revolver availability and future capital needs.
- Exposure to unpredictable outages, commodity and currency movements, dealer repurchase arrangements, warranty claims and the other stated operating risks.