Business context and reporting period
Generac Holdings Inc. filed this Form 10-K for the fiscal year ended December 31, 2017. Generac designs and manufactures power-generation equipment and other engine-powered products, serving residential, commercial and industrial markets. It reports Domestic and International segments and sells through a broad dealer, distributor, retail and rental network; no customer represented more than 6% of 2017 sales.
Demand for backup generators is influenced by power-outage activity. Management said major outages in the second half of 2017, including Hurricanes Harvey, Irma and Maria, increased awareness and contributed to strong revenue growth.
Key financial metrics
Amounts below are in U.S. dollars; financial results are for the year ended December 31 unless otherwise noted.
| Metric | 2017 | 2016 | Change |
|---|---|---|---|
| Net sales | $1,672.4 million | $1,444.5 million | +15.8% |
| Gross profit / margin | $582.1 million / 34.8% | $514.1 million / 35.6% | Profit +13.2%; margin down 0.8 percentage point |
| Operating income | $251.1 million | $204.6 million | +22.7% |
| Net income attributable to Generac | $159.4 million | $98.8 million | +61.3% |
| Diluted earnings per share | $2.56 | $1.50 | Up $1.06 |
| Operating cash flow | $261.1 million | $253.4 million | +3.0% |
| Capital expenditures | $33.3 million | $30.5 million | +$2.8 million |
| Cash and cash equivalents at year-end | $138.5 million | $67.3 million | +$71.2 million |
Year-end total indebtedness was $928.7 million, including $20.6 million of short-term borrowings. The $250 million revolving ABL facility had $249.7 million of availability, net of letters of credit, and no ABL balance outstanding. The term loan matures in May 2023; the ABL facility matures in May 2020. The company reported compliance with credit-facility covenants and no financial maintenance covenant on the term loan.
Adjusted EBITDA attributable to Generac, a non-GAAP measure, was $311.7 million versus $274.6 million, up 13.5%; total segment Adjusted EBITDA before noncontrolling interests was $317.7 million. Adjusted net income attributable to Generac was $212.9 million versus $198.3 million, up 7.4%. These measures are supplemental and are not substitutes for GAAP earnings or cash flow.
Fourth-quarter 2017 sales were $488.0 million, operating income was $94.1 million, net income attributable to Generac was $81.2 million and diluted EPS was $1.30. The quarter included a $28.4 million one-time, non-cash tax benefit from the Tax Act.
Material changes versus the prior comparable period
- Domestic sales rose 10.5% to $1,296.6 million; International sales rose 38.8% to $375.9 million, reflecting acquisitions and organic growth. Non-annualized acquisitions contributed $69.7 million of 2017 sales.
- Residential product sales increased 12.7% to $870.4 million; commercial and industrial sales increased 22.9% to $685.1 million. Residential products accounted for 52.0% of sales and C&I products for 41.0%.
- Gross margin declined to 34.8% from 35.6%. Management cited lower-margin sales mix, including International and mobile products, acquisition mix and higher commodity prices; pricing and manufacturing leverage partially offset these pressures.
- Operating expenses increased 7.0%, to $331.1 million, with acquisition-related costs, personnel and incentive compensation contributing to the increase. Interest expense declined modestly, aided by debt repricing and lower borrowings, partly offset by higher LIBOR and foreign-currency transaction losses.
- The effective tax rate fell to 21.3% from 36.8%, principally reflecting the Tax Act benefit and excess tax benefits from share-based compensation. The 2017 reported earnings increase therefore includes a material tax-related benefit.
- Operating cash flow increased slightly. Investing cash outflow fell to $31.9 million from $105.8 million, as 2016 included acquisition payments. Financing cash outflow was $160.1 million; 2017 included $30.0 million of share repurchases and substantial debt repayments.
Outlook, risks, contingencies and unusual items
- Management expected the combined federal and state effective tax rate in 2018 to be approximately 25%–26%, with lower cash taxes. It described a preliminary favorable overall Tax Act impact, but said its accounting assessment remained incomplete; adjustments to provisional tax amounts could affect future results. No specific 2018 revenue or earnings guidance is provided in the filing.
- Management views the roughly 4% penetration of its defined U.S. addressable home-standby-generator market as a growth opportunity. Strategy priorities include expanding residential standby adoption, gaining C&I share, growing gaseous-fueled products and leveraging international operations.
- Key risks include unpredictable outages and resulting demand swings; economic and capital-spending cycles; competition; commodity and component costs, including reliance on some single-source suppliers; dependence on distribution partners; foreign-exchange and floating-rate exposure; acquisition integration and synergy execution; manufacturing or IT disruption; product liability and regulatory requirements; and cybersecurity threats.
- Interest-rate swaps covered a portion of floating-rate exposure. Management estimated that a 100-basis-point LIBOR change would alter annual cash interest expense by approximately $6.3 million after swaps, or $9.3 million without them.
- Goodwill and indefinite-lived intangible assets totaled $849.8 million at year-end. Annual impairment tests found no impairment in 2017; future impairment remains possible if assumptions or business conditions deteriorate.
- Management stated that pending ordinary-course litigation was not expected to have a material effect. Dealer floor-plan financing carried a repurchase obligation for certain repossessed inventory; $36.5 million remained financed at year-end.
- On February 13, 2018, after year-end, Generac signed an agreement to acquire Selmec, a Mexico-based industrial generator maker with approximately 300 employees. The filing does not state that the acquisition had closed.
- The auditor issued an unqualified opinion on the financial statements and internal control over financial reporting; management also concluded disclosure controls were effective.
Most important facts for investors to verify
- How much of 2017 growth and fourth-quarter results was driven by outage-related demand, and whether that demand persists absent further major outages.
- Whether gross-margin pressure from product, geographic and acquisition mix and higher commodity prices continues, and how much pricing or productivity can offset it.
- The sustainability of earnings after separating the $28.4 million non-cash Tax Act benefit and other non-GAAP adjustments from recurring performance.
- Current debt balances, interest-rate exposure, covenant terms and the availability of the ABL facility, alongside planned debt repayment and share repurchases.
- The completion and terms of the Selmec acquisition, and evidence that Generac can integrate acquisitions and realize expected growth or cost benefits.
- The eventual effects of the Tax Act and the company’s expected cash-tax savings; the filing’s estimates depend on continued profitability and assumptions about tax rates.