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EX-31.1 - EXHIBIT 31.1 - GENERAC HOLDINGS INC.ex31-1.htm


 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

 

FORM 10-Q

 

(Mark One)

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

   
 

For the quarterly period ended June 30, 2017

   

OR

   

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

   
 

For the transition period from      to

 

Commission File Number 001-34627

 

GENERAC HOLDINGS INC.

(Exact name of registrant as specified in its charter)

 

Delaware

20-5654756

(State or other jurisdiction of

(IRS Employer

incorporation or organization)

Identification No.)

   

S45 W29290 Hwy 59, Waukesha, WI

53189

(Address of principal executive offices)

(Zip Code)

 

(262) 544-4811

(Registrant’s telephone number, including area code)

 

Not Applicable

(Former name, former address and former fiscal year, if changed since last report)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☑ No ☐

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ☑ No ☐

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and emerging growth company in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer

Accelerated filer ☐

Non-accelerated filer ☐

Smaller reporting company

    (Do not check if a smaller reporting company) Emerging growth company ☐

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☑

 

As of July 28, 2017, there were 62,151,055 shares of registrant’s common stock outstanding.

 



 

GENERAC HOLDINGS INC.

TABLE OF CONTENTS

 

 

Page

PART I. FINANCIAL INFORMATION

     

Item 1.

Condensed Consolidated Financial Statements (Unaudited)

 
     
 

Condensed Consolidated Balance Sheets as of June 30, 2017 and December 31, 2016

1

     
 

Condensed Consolidated Statements of Comprehensive Income for the Three and Six  Months Ended June 30, 2017 and 2016

2

     
 

Condensed Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2017 and 2016

3

     
 

Notes to Condensed Consolidated Financial Statements

4

     

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

14

     

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

25

     

Item 4.

Controls and Procedures

26

   

PART II. OTHER INFORMATION

     

Item 1.

Legal Proceedings

26

     

Item 1A.

Risk Factors

26

     

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

26

     

Item 6.

Exhibits

26

     
 

Signatures

27

 

 

PART I. FINANCIAL INFORMATION

 

Item 1.           Financial Statements

 

Generac Holdings Inc.

Condensed Consolidated Balance Sheets

(U.S. Dollars in Thousands, Except Share and Per Share Data)

 

   

June 30,

2017

   

December 31,

2016

 

Assets

 

(Unaudited)

   

(Audited)

 

Current assets:

               

Cash and cash equivalents

  $ 67,071     $ 67,272  

Accounts receivable, less allowance for doubtful accounts

    243,285       241,857  

Inventories

    378,110       349,731  

Prepaid expenses and other assets

    9,314       24,649  

Total current assets

    697,780       683,509  
                 

Property and equipment, net

    217,056       212,793  
                 

Customer lists, net

    44,659       45,312  

Patents, net

    44,409       48,061  

Other intangible assets, net

    2,699       2,925  

Tradenames, net

    156,650       158,874  

Goodwill

    716,820       704,640  

Deferred income taxes

    4,261       3,337  

Other assets

    3,196       2,233  

Total assets

  $ 1,887,530     $ 1,861,684  
                 

Liabilities and stockholders’ equity

               

Current liabilities:

               

Short-term borrowings

  $ 22,155     $ 31,198  

Accounts payable

    163,359       181,519  

Accrued wages and employee benefits

    23,765       21,189  

Other accrued liabilities

    93,343       93,068  

Current portion of long-term borrowings and capital lease obligations

    7,700       14,965  

Total current liabilities

    310,322       341,939  
                 

Long-term borrowings and capital lease obligations

    1,007,235       1,006,758  

Deferred income taxes

    37,575       17,278  

Other long-term liabilities

    66,633       61,459  

Total liabilities

    1,421,765       1,427,434  
                 

Redeemable noncontrolling interest

    37,796       33,138  
                 

Stockholders’ equity:

               

Common stock, par value $0.01, 500,000,000 shares authorized, 70,594,648 and 70,261,481 shares issued at June 30, 2017 and December 31, 2016, respectively

    705       702  

Additional paid-in capital

    454,763       449,049  

Treasury stock, at cost

    (293,684 )     (262,402 )

Excess purchase price over predecessor basis

    (202,116 )     (202,116 )

Retained earnings

    495,463       456,052  

Accumulated other comprehensive loss

    (27,209 )     (40,163 )

Stockholders’ equity attributable to Generac Holdings Inc.

    427,922       401,122  

Noncontrolling interests

    47       (10 )

Total stockholders’ equity

    427,969       401,112  

Total liabilities and stockholders’ equity

  $ 1,887,530     $ 1,861,684  

 

See notes to consolidated financial statements.

  

 

Generac Holdings Inc.

Condensed Consolidated Statements of Comprehensive Income

(U.S. Dollars in Thousands, Except Share and Per Share Data)

(Unaudited)

 

   

Three Months Ended June 30,

   

Six Months Ended June 30,

 
   

2017

   

2016

   

2017

   

2016

 
                                 

Net sales

  $ 395,376     $ 367,376     $ 727,190     $ 653,911  

Costs of goods sold

    260,916       243,229       482,244       431,704  

Gross profit

    134,460       124,147       244,946       222,207  
                                 

Operating expenses:

                               

Selling and service

    43,116       42,366       83,300       79,635  

Research and development

    10,567       9,889       20,868       18,086  

General and administrative

    21,361       19,593       42,334       37,426  

Amortization of intangibles

    7,129       8,217       14,312       16,014  

Total operating expenses

    82,173       80,065       160,814       151,161  

Income from operations

    52,287       44,082       84,132       71,046  
                                 

Other (expense) income:

                               

Interest expense

    (10,893 )     (11,380 )     (21,681 )     (22,415 )

Investment income

    38       4       43       36  

Costs related to acquisition

    (136 )           (321 )     (417 )

Other, net

    (1,437 )     158       (1,214 )     545  

Total other expense, net

    (12,428 )     (11,218 )     (23,173 )     (22,251 )
                                 

Income before provision for income taxes

    39,859       32,864       60,959       48,795  

Provision for income taxes

    14,114       11,921       22,365       17,640  

Net income

    25,745       20,943       38,594       31,155  

Net income attributable to noncontrolling interests

    85       55       92       59  

Net income attributable to Generac Holdings Inc.

  $ 25,660     $ 20,888     $ 38,502     $ 31,096  
                                 

Net income attributable to common shareholders per common share - basic:

  $ 0.42     $ 0.32     $ 0.63     $ 0.47  

Weighted average common shares outstanding - basic:

    62,146,393       65,870,714       62,260,170       65,955,455  
                                 

Net income attributable to common shareholders per common share - diluted:

  $ 0.41     $ 0.31     $ 0.63     $ 0.47  

Weighted average common shares outstanding - diluted:

    62,635,437       66,388,581       62,849,877       66,465,770  
                                 

Comprehensive income attributable to Generac Holdings Inc.

  $ 32,577     $ 7,622     $ 48,964     $ 19,076  

 

See notes to consolidated financial statements.

 

 

Generac Holdings Inc.

Condensed Consolidated Statements of Cash Flows

(U.S. Dollars in Thousands)

(Unaudited)

 

   

Six Months Ended June 30,

 
   

2017

   

2016

 

Operating activities

               

Net income

  $ 38,594     $ 31,155  

Adjustment to reconcile net income to net cash provided by operating activities:

               

Depreciation

    11,271       10,429  

Amortization of intangible assets

    14,312       16,014  

Amortization of original issue discount and deferred financing costs

    1,308       2,122  

Deferred income taxes

    17,164       9,072  

Share-based compensation expense

    5,818       5,386  

Other

    377       46  

Net changes in operating assets and liabilities, net of acquisitions:

               

Accounts receivable

    5,362       (9,389 )

Inventories

    (13,981 )     (1,046 )

Other assets

    1,069       2,297  

Accounts payable

    (26,560 )     17,537  

Accrued wages and employee benefits

    1,902       6,166  

Other accrued liabilities

    (559 )     (1,825 )

Excess tax benefits from equity awards

    (403 )     (6,729 )

Net cash provided by operating activities

    55,674       81,235  
                 

Investing activities

               

Proceeds from sale of property and equipment

    45       47  

Expenditures for property and equipment

    (10,030 )     (14,004 )

Acquisitions of businesses, net of cash acquired

    1,160       (60,886 )

Net cash used in investing activities

    (8,825 )     (74,843 )
                 

Financing activities

               

Proceeds from short-term borrowings

    62,435       10,278  

Proceeds from long-term borrowings

    3,069        

Repayments of short-term borrowings

    (72,971 )     (6,327 )

Repayments of long-term borrowings and capital lease obligations

    (9,806 )     (10,652 )

Stock repurchases

    (30,012 )     (34,576 )

Payment of debt issuance costs

    (1,517 )      

Cash dividends paid

          (76 )

Taxes paid related to the net share settlement of equity awards

    (1,958 )     (12,099 )

Proceeds from exercise of stock options

    1,254        

Excess tax benefits from equity awards

          6,729  

Net cash used in financing activities

    (49,506 )     (46,723 )
                 

Effect of exchange rate changes on cash and cash equivalents

    2,456       115  
                 

Net decrease in cash and cash equivalents

    (201 )     (40,216 )

Cash and cash equivalents at beginning of period

    67,272       115,857  

Cash and cash equivalents at end of period

  $ 67,071     $ 75,641  

 

See notes to consolidated financial statements.

 

 

Generac Holdings Inc.
Notes to Condensed Consolidated Financial Statements

(U.S. Dollars in Thousands, Except Share and Per Share Data)

(Unaudited)

 

 

1. Description of Business and Basis of Presentation

 

Founded in 1959, Generac Holdings Inc. (the Company) is a leading designer and manufacturer of a wide range of power generation equipment and other engine powered products serving the residential, light-commercial and industrial markets. Generac’s power products are available globally through a broad network of independent dealers, distributors, retailers, wholesalers and equipment rental companies, as well as sold direct to certain end user customers.

 

Over the years, the Company has executed a number of acquisitions that support its strategic plan (as discussed in Item 1 and Item 8 (Note 1 “Description of Business”) of the Annual Report on Form 10-K for the year ended December 31, 2016). A summary of recent acquisitions include the following:

 

 

In March 2016, the Company acquired a majority ownership interest in PR Industrial S.r.l and its subsidiaries (Pramac). Headquartered in Siena, Italy, Pramac is a leading global manufacturer of stationary, mobile and portable generators primarily sold under the Pramac® brand. Pramac products are sold in over 150 countries through a broad distribution network.

 

In January 2017, the Company acquired Motortech GmbH (Motortech), headquartered in Celle, Germany. Motortech is a leading manufacturer of gaseous-engine control systems and accessories, which are sold globally to gas-engine manufacturers and to aftermarket customers. While the Motortech acquisition was completed in January 2017, it was funded in the fourth quarter of 2016.

 

The condensed consolidated financial statements include the accounts of the Company and its subsidiaries that are consolidated in conformity with U.S. generally accepted accounting principles (U.S. GAAP). All intercompany amounts and transactions have been eliminated in consolidation.

 

The condensed consolidated balance sheet as of June 30, 2017, the condensed consolidated statements of comprehensive income for the three and six months ended June 30, 2017 and 2016, and the condensed consolidated statements of cash flows for the six months ended June 30, 2017 and 2016 have been prepared by the Company and have not been audited. In the opinion of management, all adjustments (which include only normal recurring adjustments) necessary for the fair presentation of the financial position, results of operations and cash flows, have been made. The results of operations for any interim period are not necessarily indicative of the results to be expected for the full year.

 

The preparation of the condensed consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the condensed consolidated financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

 

Certain information and footnote disclosure normally included in consolidated financial statements prepared in accordance with U.S. GAAP have been condensed or omitted. These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Annual Report on Form 10-K for the year ended December 31, 2016.

 

New Accounting Standards

 

In May 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2014-09, Revenue from Contracts with Customers. This guidance is the culmination of the FASB’s joint project with the International Accounting Standards Board to clarify the principles for recognizing revenue. The core principal of the guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The guidance provides a five-step process that entities should follow in order to achieve that core principal. ASU 2014-09, as amended by ASU 2015-14, Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date, ASU 2016-08, Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations, ASU 2016-10, Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing, ASU 2016-12, Revenue from Contracts with Customers (Topic 606): Narrow-Scope Improvements and Practical Expedients, and ASU 2016-20, Technical Corrections and Improvements to Topic 606, Revenue from Contracts with Customers, become effective for the Company in 2018. The guidance can be applied either on a full retrospective basis or on a modified retrospective basis in which the cumulative effect of initially applying the standard is recognized at the date of initial application. While the Company is continuing to assess all potential impacts the standard may have on its financial statements, it believes that the adoption will not have a significant impact on its revenue related to equipment and parts sales, which represent substantially all of the revenue for the Company. The Company is currently planning to adopt the standard using the full retrospective method.

 

 

In February 2016, the FASB issued ASU 2016-02, Leases. This guidance is being issued to increase transparency and comparability among organizations by requiring the recognition of lease assets and lease liabilities on the statement of financial position and by disclosing key information about leasing arrangements. The guidance should be applied using a modified retrospective approach and is effective for the Company in 2019, with early adoption permitted. The Company is currently assessing the impact the adoption of this guidance will have on the Company’s results of operations and financial position.

 

In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows: Classification of Certain Cash Receipts and Cash Payments. This guidance is being issued to decrease diversity in practice in how certain cash receipts and cash payments are presented and classified in the statement of cash flows. This guidance should be applied on a retrospective basis and is effective for the Company in 2018, with early adoption permitted. The Company does not believe that the adoption of this guidance will have a significant impact on the presentation of the statement of cash flows.

 

In January 2017, the FASB issued ASU 2017-04, Intangibles – Goodwill and Other: Simplifying the Test for Goodwill Impairment. This guidance is being issued to simplify the subsequent measurement of goodwill by eliminating Step 2 of the goodwill impairment test. Under the new guidance, the recognition of a goodwill impairment charge is calculated based on the amount by which the carrying amount exceeds the reporting unit’s fair value; however, the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. This guidance should be applied on a prospective basis and is effective for the Company in 2020. Early adoption is permitted for goodwill impairment tests performed after January 1, 2017. The Company has early adopted this standard, which did not have a significant impact on its consolidated financial statements.

 

In the first quarter of 2017, the Company adopted ASU 2016-09, Compensation – Stock Compensation: Improvements to Employee Share-Based Payment Accounting. The primary impact of adoption is the prospective recognition of excess tax benefits or deficiencies within the provision for income taxes on the condensed consolidated statement of comprehensive income rather than within additional paid-in capital on the condensed consolidated balance sheet. Further, the Company has elected to continue to estimate forfeitures expected to occur to determine the amount of stock compensation expense recognized each period. The Company also elected to apply the presentation requirements for cash flows related to excess tax benefits or deficiencies prospectively. The presentation requirements for cash flows related to employee taxes paid for withheld shares had no impact to any period presented on the condensed consolidated statements of cash flows as such cash flows have historically been presented as a financing activity. There were no cumulative effect adjustments made to equity as of the beginning of the fiscal period, as those provisions of ASU 2016-09 were not applicable or had no impact to the Company.

 

There are several other new accounting pronouncements issued by the FASB. Each of these pronouncements, as applicable, has been or will be adopted by the Company. Management does not believe any of these other accounting pronouncements has had or will have a material impact on the Company’s consolidated financial statements.

 

2. Pramac Acquisition

 

On March 1, 2016, the Company acquired a 65% ownership interest in Pramac for a purchase price, net of cash acquired, of $60,250. Headquartered in Siena, Italy, Pramac is a leading global manufacturer of stationary, mobile and portable generators primarily sold under the Pramac® brand. Pramac products are sold in over 150 countries through a broad distribution network. The acquisition purchase price was funded solely through cash on hand.

 

The 35% noncontrolling interest in Pramac had an acquisition date fair value of $34,253, and was recorded as a redeemable noncontrolling interest in the condensed consolidated balance sheet, as the noncontrolling interest holder has within its control the right to require the Company to redeem its interest in Pramac. The noncontrolling interest holder has a put option to sell their interests to the Company any time within five years from the date of acquisition. The put option price is either (i) a fixed amount if voluntarily exercised within the first two years after the acquisition, or (ii) based on a multiple of earnings, subject to the terms of the acquisition. Additionally, the Company holds a call option that it may redeem commencing five years from the date of acquisition, or earlier upon the occurrence of certain circumstances. The call option price is based on a multiple of earnings that is subject to the terms of the acquisition. Both the put and call option only provide for the complete transfer of the noncontrolling interest, with no partial transfers of interest permitted.

 

 

The redeemable noncontrolling interest is recorded at the greater of the initial fair value, increased or decreased for the noncontrolling interests’ share of comprehensive income (loss), or the estimated redemption value, with any adjustments to the redemption value impacting retained earnings, but not net income. However, the redemption value adjustments are reflected in the earnings per share calculation, as detailed in Note 11, “Earnings Per Share,” to the condensed consolidated financial statements. The following table presents the changes in the redeemable noncontrolling interest:

 

   

Three Months Ended June 30,

   

Six Months Ended June 30,

 
   

2017

   

2016

   

2017

   

2016

 

Balance at beginning of period

  $ 33,566     $ 35,047     $ 33,138     $ -  

Noncontrolling interest of Pramac

    -       -       -       34,253  

Net income

    92       151       210       167  

Foreign currency translation

    4,433       487       5,357       1,265  

Redemption value adjustment

    (295 )     -       (909 )     -  

Balance at end of period

  $ 37,796     $ 35,685     $ 37,796     $ 35,685  

 

The Company finalized the Pramac purchase price allocation during the first quarter of 2017, based upon its estimates of the fair value of the acquired assets and assumed liabilities. The final purchase price allocation as of the balance sheet date was as follows:

 

   

March 1, 2016

 
         

Accounts receivable, net

  $ 50,716  

Inventories

    39,889  

Property and equipment, net

    19,138  

Intangible assets

    34,471  

Goodwill

    46,775  

Other assets

    7,698  

Total assets acquired

    198,687  
         

Short-term borrowings

    21,741  

Accounts payable

    40,270  

Long-term debt and capital lease obligations (including current portion)

    18,599  

Other liabilities

    23,521  

Redeemable noncontrolling interest

    34,253  

Noncontrolling interest

    53  

Net assets acquired

  $ 60,250  

 

The goodwill ascribed to this acquisition is not deductible for tax purposes. The accompanying condensed consolidated financial statements include the results of Pramac from the date of acquisition through June 30, 2017.

 

The following unaudited pro forma information of the Company gives effect to this acquisition as though the transaction had occurred on January 1, 2016. Consolidated net sales on a pro forma basis for the three and six month periods ended June 30, 2016 were $367,376 and $683,258, respectively. The pro forma impact of this acquisition on net income and earnings per share for both the three and six month periods ended June 30, 2016 is not significant due to amortization related to acquired intangible assets and the fair value step-up of inventory in purchase accounting. This unaudited pro forma information is presented for informational purposes only and is not necessarily indicative of the results of operations that actually would have been achieved had the acquisition been consummated on January 1, 2016.

 

3. Derivative Instruments and Hedging Activities

 

The Company records all derivatives in accordance with Accounting Standards Codification (ASC) 815, Derivatives and Hedging, which requires derivative instruments be reported on the condensed consolidated balance sheets at fair value and establishes criteria for designation and effectiveness of hedging relationships. The Company is exposed to market risk such as changes in commodity prices, foreign currencies and interest rates. The Company does not hold or issue derivative financial instruments for trading purposes.

 

Commodities

 

The Company is exposed to significant price fluctuations in commodities it uses as raw materials, and periodically utilizes commodity derivatives to mitigate the impact of these potential price fluctuations on its financial results and its economic well-being. These derivatives typically have maturities of less than eighteen months. At June 30, 2017, December 31, 2016 and June 30, 2016, the Company had one commodity contract outstanding, covering the purchases of copper.

 

 

Because these contracts do not qualify for hedge accounting, the related gains and losses are recorded in cost of goods sold in the Company’s condensed consolidated statements of comprehensive income. Net pre-tax gains recognized for the three and six months ended June 30, 2017 were $2 and $185, respectively. Net pre-tax gains recognized for the three and six months ended June 30, 2016 were $82 and $76, respectively.

 

Foreign Currencies

 

The Company is exposed to foreign currency exchange risk as a result of transactions denominated in currencies other than the U.S. Dollar. The Company periodically utilizes foreign currency forward purchase and sales contracts to manage the volatility associated with certain foreign currency purchases and sales in the normal course of business. Contracts typically have maturities of twelve months or less. As of June 30, 2017, December 31, 2016 and June 30, 2016, the Company had eighteen, thirty-eight and twelve foreign currency contracts outstanding, respectively.

 

Because these contracts do not qualify for hedge accounting, the related gains and losses are recorded in cost of goods sold in the Company’s condensed consolidated statements of comprehensive income. Net pre-tax gains recognized for the three and six months ended June 30, 2017 were $380 and $179, respectively. Net pre-tax gains (losses) recognized for the three and six months ended June 30, 2016 were $1 and $(178), respectively.

 

Interest Rate Swaps

 

In October 2013, the Company entered into two interest rate swap agreements, and in May 2014, the Company entered into an additional interest rate swap agreement. The Company formally documented all relationships between interest rate hedging instruments and the related hedged items, as well as its risk-management objectives and strategies for undertaking various hedge transactions. These interest rate swap agreements qualify as cash flow hedges, and accordingly, the effective portions of the gains or losses are reported as a component of accumulated other comprehensive loss (AOCL). The cash flows of the swaps are recognized as adjustments to interest expense each period. The ineffective portions of the derivatives’ changes in fair value, if any, are immediately recognized in earnings. For additional details on these interest rate swaps, refer to Item 7A of the Annual Report on Form 10-K for the year ended December 31, 2016.

 

In June 2017, the Company entered into ten additional interest rate swap agreements. These interest rate swap agreements also qualify as cash flow hedges. The following table presents the details of the additional interest rate swaps:

 

Hedged Item

 

Contract Date

 

Effective Date

 

Notional Amount

   

Fixed LIBOR Rate

   

Expiration Date

                             

Interest Rate

 

June 19, 2017

 

July 2, 2018

  $ 125,000       1.6543%    

July 1, 2019

Interest Rate

 

June 19, 2017

 

July 1, 2019

    125,000       1.9053%    

July 1, 2020

Interest Rate

 

June 19, 2017

 

July 1, 2020

    125,000       2.1328%    

July 1, 2021

Interest Rate

 

June 19, 2017

 

July 1, 2021

    125,000       2.3453%    

July 1, 2022

Interest Rate

 

June 19, 2017

 

July 1, 2022

    125,000       2.4828%    

May 31, 2023

Interest Rate

 

June 30, 2017

 

July 2, 2018

    125,000       1.7090%    

July 1, 2019

Interest Rate

 

June 30, 2017

 

July 1, 2019

    125,000       1.9750%    

July 1, 2020

Interest Rate

 

June 30, 2017

 

July 1, 2020

    125,000       2.2170%    

July 1, 2021

Interest Rate

 

June 30, 2017

 

July 1, 2021

    125,000       2.4360%    

July 1, 2022

Interest Rate

 

June 30, 2017

 

July 1, 2022

    125,000       2.5910%    

May 31, 2023

 

Fair Value 

 

The following table presents the fair value of all of the Company’s derivatives:

 

   

June 30,
201
7

   

December 31,
201
6

 

Commodity contracts

  $ 432     $ 623  

Foreign currency contracts

    267       (150 )

Interest rate swaps

    (493 )     (1,739 )

 

The fair value of the commodity and foreign currency contracts are included in other assets, and the fair value of the interest rate swaps are included in other long-term liabilities in the condensed consolidated balance sheets as of June 30, 2017. The fair value of the commodity contract is included in other assets, the fair value of the foreign currency contracts are included in other accrued liabilities, and the fair value of the interest rate swaps are included in other long-term liabilities in the condensed consolidated balance sheets as of December 31, 2016. Excluding the impact of credit risk, the fair value of the derivative contracts as of June 30, 2017 and December 31, 2016 is an asset of $206 and a liability of $1,295, respectively, which represents the amount the Company would either receive or need to pay upon exit of the agreements on those dates.

 

 

The amount of gains recognized in AOCL in the condensed consolidated balance sheets on the effective portion of interest rate swaps designated as hedging instruments for the three and six months ended June 30, 2017 were $324 and $764, respectively. The amount of losses for the three and six months ended June 30, 2016 were $134 and $1,288, respectively.

 

The amount of pre-tax gains recognized in cost of goods sold in the condensed consolidated statements of comprehensive income for commodity and foreign currency contracts not designated as hedging instruments for the three and six months ended June 30, 2017 were $382 and $364, respectively. The amount of pre-tax gains (losses) for the three and six months ended June 30, 2016 were $83 and $(102), respectively.

 

4. Fair Value Measurements

 

ASC 820-10, Fair Value Measurement, defines fair value, establishes a consistent framework for measuring fair value, and expands disclosure for each major asset and liability category measured at fair value on either a recurring basis or nonrecurring basis. ASC 820-10 clarifies that fair value is an exit price, representing the amount that would be received in the sale of an asset or paid to transfer a liability in an orderly transaction between market participants. As such, fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or liability. As a basis for considering such assumptions, the pronouncement establishes a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value as follows: (Level 1) observable inputs such as quoted prices in active markets; (Level 2) inputs, other than quoted prices in active markets, that are observable either directly or indirectly; and (Level 3) unobservable inputs in which there is little or no market data, which require the reporting entity to develop its own assumptions.

 

The Company believes the carrying amount of its financial instruments (cash and cash equivalents, accounts receivable, accounts payable, accrued liabilities, short-term borrowings and ABL facility borrowings), excluding Term Loan borrowings, approximates the fair value of these instruments based upon their short-term nature. The fair value of Term Loan borrowings, which have an aggregate carrying value of $903,294, was approximately $902,730 (Level 2) at June 30, 2017, as calculated based on independent valuations whose inputs and significant value drivers are observable.

 

For the fair value of the assets and liabilities measured on a recurring basis, see the fair value table in Note 3, “Derivative Instruments and Hedging Activities,” to the condensed consolidated financial statements. The fair value of all derivative contracts is classified as Level 2. The valuation techniques used to measure the fair value of derivative contracts, all of which have counterparties with high credit ratings, were based on quoted market prices or model driven valuations using significant inputs derived from or corroborated by observable market data. The fair value of derivative contracts above considers the Company’s credit risk in accordance with ASC 820-10.

 

5. Accumulated Other Comprehensive Loss

 

The following presents a tabular disclosure of changes in AOCL during the three and six months ended June 30, 2017 and 2016, net of tax:

 

   

Foreign

Currency

Translation

Adjustments

   

Defined

Benefit

Pension Plan

   

Unrealized

Gain (Loss) on

Cash Flow

Hedges

   

Total

 
                                 

Beginning Balance – April 1, 2017

  $ (24,447 )   $ (11,040 )   $ (636 )   $ (36,123 )

Other comprehensive income before reclassifications

    8,590       -       324 (1)     8,914  

Amounts reclassified from AOCL

    -       -       -       -  

Net current-period other comprehensive income

    8,590       -       324       8,914  

Ending Balance – June 30, 2017

  $ (15,857 )   $ (11,040 )   $ (312 )   $ (27,209 )

 

   

Foreign

Currency

Translation

Adjustments

   

Defined

Benefit

Pension Plan

   

Unrealized

Loss on Cash

Flow Hedges

   

Total

 
                                 

Beginning Balance – April 1, 2016

  $ (7,102 )   $ (11,362 )   $ (2,765 )   $ (21,229 )

Other comprehensive loss before reclassifications

    (13,132 )     -       (134 ) (2)     (13,266 )

Amounts reclassified from AOCL

    -       -       -       -  

Net current-period other comprehensive loss

    (13,132 )     -       (134 )     (13,266 )

Ending Balance – June 30, 2016

  $ (20,234 )   $ (11,362 )   $ (2,899 )   $ (34,495 )

 

 

   

Foreign

Currency

Translation

Adjustment

   

Defined

Benefit

Pension Plan

   

Unrealized

Gain (Loss) on

Cash Flow

Hedges

   

Total

 
                                 

Beginning Balance – January 1, 2017

  $ (28,047 )   $ (11,040 )   $ (1,076 )   $ (40,163 )

Other comprehensive income before reclassifications

    12,190       -       764 (3)     12,954  

Amounts reclassified from AOCL

    -       -       -       -  

Net current-period other comprehensive income

    12,190       -       764       12,954  

Ending Balance – June 30, 2017

  $ (15,857 )   $ (11,040 )   $ (312 )   $ (27,209 )

 

   

Foreign

Currency

Translation

Adjustments

   

Defined

Benefit

Pension Plan

   

Unrealized

Loss on Cash

Flow Hedges

   

Total

 
                                 

Beginning Balance – January 1, 2016

  $ (9,502 )   $ (11,362 )   $ (1,611 )   $ (22,475 )

Other comprehensive loss before reclassifications

    (10,732 )     -       (1,288) (4)     (12,020 )

Amounts reclassified from AOCL

    -       -       -       -  

Net current-period other comprehensive loss

    (10,732 )     -       (1,288 )     (12,020 )

Ending Balance – June 30, 2016

  $ (20,234 )   $ (11,362 )   $ (2,899 )   $ (34,495 )

 

 

(1)

Represents unrealized gains of $531, net of tax effect of $(207) for the three months ended June 30, 2017.

 

(2)

Represents unrealized losses of $(219), net of tax benefit of $85 for the three months ended June 30, 2016.

 

(3)

Represents unrealized gains of $1,254, net of tax effect of $(490) for the six months ended June 30, 2017.

 

(4)

Represents unrealized losses of $(2,115), net of tax benefit of $827 for the six months ended June 30, 2016.

 

6. Segment Reporting

 

The Company has two reportable segments for financial reporting purposes - Domestic and International. The Domestic segment includes the legacy Generac business and the impact of acquisitions that are based in the United States, all of which have revenues that are substantially derived from the U.S. and Canada. The International segment includes the Ottomotores, Tower Light, Pramac and Motortech acquisitions, all of which have revenues that are substantially derived from outside of the U.S. and Canada. Both reportable segments design and manufacture a wide range of power generation equipment and other engine powered products. The Company has multiple operating segments, which it aggregates into the two reportable segments, based on materially similar economic characteristics, products, production processes, classes of customers and distribution methods. All segment information has been retrospectively adjusted for all periods presented to reflect the current reportable segment structure.

 

   

Net Sales

 
   

Three Months Ended June 30,

   

Six Months Ended June 30,

 

Reportable Segments

 

2017

   

2016

   

2017

   

2016

 

Domestic

  $ 305,907     $ 286,720     $ 554,404     $ 534,736  

International

    89,469       80,656       172,786       119,175  

Total net sales

  $ 395,376     $ 367,376     $ 727,190     $ 653,911  

 

The Company's product offerings consist primarily of power generation equipment and other engine powered products geared for varying end customer uses. Residential products and commercial & industrial products are each a similar class of products based on similar power output and end customer. The breakout of net sales between residential, commercial & industrial, and other products by product class is as follows:

 

   

Net Sales

 
   

Three Months Ended June 30,

   

Six Months Ended June 30,

 

Product Classes

 

2017

   

2016

   

2017

   

2016

 

Residential products

  $ 198,117     $ 181,735     $ 352,973     $ 340,716  

Commercial & industrial products

    170,755       156,730       322,198       259,720  

Other

    26,504       28,911       52,019       53,475  

Total net sales

  $ 395,376     $ 367,376     $ 727,190     $ 653,911  

 

 

Management evaluates the performance of its segments based primarily on Adjusted EBITDA, which is reconciled to Income before provision for income taxes below. The computation of Adjusted EBITDA is based on the definition that is contained in the Company’s credit agreements.

 

   

Adjusted EBITDA

 
   

Three Months Ended June 30,

   

Six Months Ended June 30,

 
   

2017

   

2016

   

2017

   

2016

 

Domestic

  $ 64,157     $ 57,352     $ 107,003     $ 104,212  

International

    6,034       6,574       10,846       9,523  

Total adjusted EBITDA

  $ 70,191     $ 63,926     $ 117,849     $ 113,735  
                                 

Interest expense

    (10,893 )     (11,380 )     (21,681 )     (22,415 )

Depreciation and amortization

    (12,986 )     (13,650 )     (25,583 )     (26,443 )

Non-cash write-down and other adjustments (1)

    (1,710 )     (2,909 )     (1,876 )     (2,782 )

Non-cash share-based compensation expense (2)

    (3,186 )     (2,901 )     (5,818 )     (5,386 )

Transaction costs and credit facility fees (3)

    (420 )     (237 )     (736 )     (760 )

Business optimization expenses (4)

    (1,346 )     -       (1,446 )     (7,106 )

Other

    209       15       250       (48 )

Income before provision for income taxes

  $ 39,859     $ 32,864     $ 60,959     $ 48,795  

 

 

(1)

Includes gains/losses on disposal of assets, unrealized mark-to-market adjustments on commodity contracts, and certain foreign currency and purchase accounting related adjustments.

 

(2)

Represents share-based compensation expense to account for stock options, restricted stock and other stock awards over their respective vesting periods.

 

(3)

Represents transaction costs incurred directly in connection with any investment, as defined in our credit agreement; equity issuance, debt issuance or refinancing; together with certain fees relating to our senior secured credit facilities.

 

(4)

Represents charges relating to business optimization and restructuring costs.

 

The Company’s sales in the United States represented approximately 73% and 74% of total sales for the three months ended June 30, 2017 and 2016, respectively, and represented approximately 72% and 78% of total sales for the six months ended June 30, 2017 and 2016, respectively. Approximately 85% and 87% of the Company’s identifiable long-lived assets are located in the United States at June 30, 2017 and December 31, 2016, respectively.

 

7. Balance Sheet Details

 

Inventories consist of the following:

 

   

June 30,
2017

   

December 31,

2016

 
                 

Raw material

  $ 225,472     $ 218,911  

Work-in-process

    4,448       2,950  

Finished goods

    148,190       127,870  

Total

  $ 378,110     $ 349,731  

 

Property and equipment consists of the following:

 

   

June 30,
2017

   

December 31,

2016

 
                 

Land and improvements

  $ 12,696     $ 12,079  

Buildings and improvements

    127,167       122,747  

Machinery and equipment

    87,647       81,687  

Dies and tools

    24,222       23,269  

Vehicles

    1,702       1,474  

Office equipment and systems

    69,166       66,929  

Leasehold improvements

    2,397       2,319  

Construction in progress

    7,060       8,654  

Gross property and equipment

    332,057       319,158  

Accumulated depreciation

    (115,001 )     (106,365 )

Total

  $ 217,056     $ 212,793  

 

 

8. Product Warranty Obligations

 

The Company records a liability for product warranty obligations at the time of sale to a customer based upon historical warranty experience. The Company also records a liability for specific warranty matters when they become known and are reasonably estimable. Additionally, the Company sells extended warranty coverage for certain products. The sales of extended warranties are recorded as deferred revenue, which is recognized over the lives of the contracts.

 

The following is a tabular reconciliation of the product warranty liability, excluding the deferred revenue related to extended warranty coverage:

 

   

Three Months Ended June 30,

   

Six Months Ended June 30,

 
   

2017

   

2016

   

2017

   

2016

 

Balance at beginning of period

  $ 32,008     $ 31,904     $ 31,695     $ 30,197  

Product warranty reserve assumed in acquisition

    -       -       43       840  

Payments

    (4,285 )     (4,900 )     (8,845 )     (8,552 )

Provision for warranty issued

    4,086       4,220       8,246       7,702  

Changes in estimates for pre-existing warranties

    1,004       (489 )     1,674       548  

Balance at end of period

  $ 32,813     $ 30,735     $ 32,813     $ 30,735  

 

The following is a tabular reconciliation of the deferred revenue related to extended warranty coverage:

 

   

Three Months Ended June 30,

   

Six Months Ended June 30,

 
   

2017

   

2016

   

2017

   

2016

 

Balance at beginning of period

  $ 31,451     $ 28,830     $ 31,080     $ 28,961  

Deferred revenue contracts issued

    6,898       1,619       8,867       2,763  

Amortization of deferred revenue contracts

    (1,632 )     (1,367 )     (3,230 )     (2,642 )

Balance at end of period

  $ 36,717     $ 29,082     $ 36,717     $ 29,082  

 

Product warranty obligations and extended warranty related deferred revenues are included in the condensed consolidated balance sheets as follows:

 

   

June 30,

2017

   

December 31,

2016

 

Product warranty liability

               

Current portion - other accrued liabilities

  $ 20,582     $ 20,763  

Long-term portion - other long-term liabilities

    12,231       10,932  

Total

  $ 32,813     $ 31,695  
                 

Deferred revenue related to extended warranties

               

Current portion - other accrued liabilities

  $ 7,635     $ 6,728  

Long-term portion - other long-term liabilities

    29,082       24,352  

Total

  $ 36,717     $ 31,080  

 

9. Credit Agreements

 

Short-term borrowings included in the condensed consolidated balance sheets consist of the following:

 

   

June 30,

2017

   

December 31,

2016

 

ABL facility

  $ -     $ -  

Other lines of credit

    22,155       31,198  

Total

  $ 22,155     $ 31,198  

 

 

Long-term borrowings in the condensed consolidated balance sheets include the following:

 

   

June 30,

2017

   

December 31,

2016

 

Term loan

  $ 929,000     $ 929,000  

Original issue discount and deferred financing costs

    (26,800 )     (26,677 )

ABL facility

    100,000       100,000  

Capital lease obligation

    4,845       4,647  

Other

    7,890       14,753  

Total

    1,014,935       1,021,723  

Less: current portion of debt

    7,038       14,399  

Less: current portion of capital lease obligation

    662       566  

Total

  $ 1,007,235     $ 1,006,758  

 

The Company’s credit agreements originally provided for a $1,200,000 term loan B credit facility (Term Loan) and currently include a $300,000 uncommitted incremental term loan facility. In November 2016, the Company amended its Term Loan to extend the maturity date from May 31, 2020 to May 31, 2023. The Term Loan is guaranteed by all of the Company’s wholly-owned domestic restricted subsidiaries, and is secured by associated collateral agreements which pledge a first priority lien on virtually all of the Company’s assets, including fixed assets and intangibles, other than all cash, trade accounts receivable, inventory, and other current assets and proceeds thereof, which are secured by a second priority lien. The Term Loan initially bore interest at rates based upon either a base rate plus an applicable margin of 1.75% or adjusted LIBOR rate plus an applicable margin of 2.75%, subject to a LIBOR floor of 0.75%. Beginning in the second quarter of 2014, and measured each quarterly period thereafter, the applicable margin related to base rate loans is reduced to 1.50% and the applicable margin related to LIBOR rate loans is reduced to 2.50%, in each case, if the Borrower’s net debt leverage ratio, as defined in the Term Loan, falls below 3.00 to 1.00 for that measurement period.

 

In May 2017, the Company amended its Term Loan, modifying the pricing of the facility by reducing certain applicable margin rates; base rate plus a fixed applicable margin of 1.25% or adjusted LIBOR rate plus a fixed applicable margin of 2.25%. Further, the amendment removed the pricing grid that would reduce the applicable margin if a net debt leverage ratio of 3.00 to 1.00 was achieved. The amended Term Loan pricing is still subject to the 0.75% LIBOR floor. In connection with this amendment and in accordance with ASC 470-50, Debt Modifications and Extinguishments, the Company capitalized $1,432 of fees as deferred financing costs on long-term borrowings and expensed $85 of transaction fees in the second quarter of 2017. As of June 30, 2017, the Company was in compliance with all covenants of the Term Loan. There are no financial maintenance covenants on the Term Loan.

 

The Company’s credit agreements also provide for a $250,000 senior secured ABL revolving credit facility (ABL Facility). The maturity date of the ABL Facility is May 29, 2020. Borrowings under the ABL Facility are guaranteed by all of the Company’s wholly-owned domestic restricted subsidiaries, and are secured by associated collateral agreements which pledge a first priority lien on all cash, trade accounts receivable, inventory, and other current assets and proceeds thereof, and a second priority lien on all other assets, including fixed assets and intangibles of the Company and certain domestic subsidiaries. ABL Facility borrowings bear interest at rates based upon either a base rate plus an applicable margin of 0.50% or adjusted LIBOR rate plus an applicable margin of 1.50%, in each case, subject to adjustments based upon average availability under the ABL Facility.

 

In May 2015, the Company borrowed $100,000 under the ABL Facility, the proceeds of which were used as a voluntary prepayment towards the Term Loan. As of June 30, 2017, there was $100,000 outstanding under the ABL Facility, leaving $145,876 of availability, net of outstanding letters of credit.

 

As of June 30, 2017 and December 31, 2016, short-term borrowings consisted of borrowings by our foreign subsidiaries on local lines of credit, which totaled $22,155 and $31,198, respectively.

 

10. Stock Repurchase Program

 

In August 2015, the Company’s Board of Directors approved a $200,000 stock repurchase program, which the Company completed in the third quarter of 2016. In October 2016, the Company’s Board of Directors approved an additional $250,000 stock repurchase program. Under the program, the Company may repurchase $250,000 of its common stock over the following 24 months. The Company may repurchase its common stock from time to time, in amounts and at prices the Company deems appropriate, subject to market conditions and other considerations. The repurchases may be executed using open market purchases, privately negotiated agreements or other transactions. The actual timing, number and value of shares repurchased under the program will be determined by management at its discretion and will depend on a number of factors, including the market price of the Company’s common stock and general market and economic conditions, applicable legal requirements, and compliance with the terms of the Company’s outstanding indebtedness. The repurchases may be funded with cash on hand, available borrowings or proceeds from potential debt or other capital markets sources. The stock repurchase program may be suspended or discontinued at any time without prior notice. During the three months ended June 30, 2017, the Company repurchased 844,500 shares of its common stock for $30,012. Since the inception of both programs, the Company has repurchased 8,116,706 shares of its common stock for $279,891, all funded with cash on hand.

 

 

11. Earnings Per Share

 

Basic earnings per share is calculated by dividing net income attributable to the common shareholders of the Company by the weighted average number of common shares outstanding during the period, exclusive of restricted shares. Except where the result would be anti-dilutive, diluted earnings per share is calculated by assuming the vesting of unvested restricted stock and the exercise of stock options. The following table reconciles the numerator and the denominator used to calculate basic and diluted earnings per share:

 

   

Three Months Ended June 30,

   

Six Months Ended June 30,

 
   

2017

   

2016

   

2017

   

2016

 

Numerator

                               

Net income attributable to Generac Holdings Inc.

  $ 25,660     $ 20,888     $ 38,502     $ 31,096  

Redeemable noncontrolling interest redemption value adjustment

    295       -       909       -  

Net income attributable to common shareholders

  $ 25,955     $ 20,888     $ 39,411     $ 31,096  
                                 

Denominator

                               

Weighted average shares, basic

    62,146,393       65,870,714       62,260,170       65,955,455  

Dilutive effect of stock compensation awards (1)

    489,044       517,867       589,707       510,315  

Diluted shares

    62,635,437       66,388,581       62,849,877       66,465,770  
                                 

Net income attributable to common shareholders per share

                               

Basic

  $ 0.42     $ 0.32     $ 0.63     $ 0.47  

Diluted

  $ 0.41     $ 0.31     $ 0.63     $ 0.47  

 

(1) Excludes approximately 279,200 stock options and 7,000 shares of restricted stock for the three month period ended June 30, 2017, and 193,200 stock options for the six month period ended June 30, 2017, as the impact of such awards was anti-dilutive. Excludes approximately 189,500 stock options and 3,000 shares of restricted stock for the three month period ended June 30, 2016, and 215,800 stock options and 3,400 shares of restricted stock for the six month period ended June 30, 2016, as the impact of such awards was anti-dilutive.

 

12. Income Taxes

 

The effective income tax rates for the six months ended June 30, 2017 and 2016 were 36.7% and 36.2%, respectively. The increase in the effective income tax rate in 2017 was primarily due to non-recurring discrete tax items.

 

The Company files U.S. federal, U.S. state, and foreign jurisdiction tax returns that are subject to examination up to the expiration of the statute of limitations. We believe the tax positions taken on our returns would be sustained upon an exam, or where a position is uncertain, adequate reserves have been recorded.

 

The Company is currently under examination in multiple jurisdictions and is working to address all matters. While the Company does not believe any material taxes or penalties are due, there is a possibility that the ultimate tax outcome of an examination may result in differences from what was recorded. Such differences may affect the provision for income taxes in the period in which the determination is made, and could impact the company’s financial results.

 

13. Commitments and Contingencies

 

The Company has an arrangement with a finance company to provide floor plan financing for certain dealers. The Company receives payment from the finance company after shipment of product to the dealer. The Company participates in the cost of dealer financing up to certain limits and has agreed to repurchase products repossessed by the finance company, but does not indemnify the finance company for any credit losses it incurs. The amount financed by dealers which remained outstanding under this arrangement at June 30, 2017 and December 31, 2016 was approximately $40,900 and $33,900, respectively.

 

In the normal course of business, the Company is named as a defendant in various lawsuits in which claims are asserted against the Company. In the opinion of management, the liabilities, if any, which may result from such lawsuits are not expected to have a material adverse effect on the financial position, results of operations or cash flows of the Company.

 

 

Item 2.          Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

This quarterly report contains forward-looking statements that are subject to risks and uncertainties. Forward-looking statements give our current expectations and projections relating to our financial condition, results of operations, plans, objectives, future performance and business. You can identify forward-looking statements by the fact that they do not relate strictly to historical or current facts. These statements may include words such as “anticipate,” “estimate,” “expect,” “forecast,” “project,” “plan,” “intend,” “believe,” “confident,” “may,” “should,” “can have,” “likely,” “future”, “optimistic” and other words and terms of similar meaning in connection with any discussion of the timing or nature of future operating or financial performance or other events.

 

The forward-looking statements contained in this quarterly report are based on assumptions that we have made in light of our industry experience and on our perceptions of historical trends, current conditions, expected future developments and other factors we believe are appropriate under the circumstances. As you read and consider this report, you should understand that these statements are not guarantees of performance or results. They involve risks, uncertainties (some of which are beyond our control) and assumptions. Although we believe that these forward-looking statements are based on reasonable assumptions, you should be aware that many factors could affect our actual financial results and cause them to differ materially from those anticipated in the forward-looking statements. The forward-looking statements contained in this quarterly report include estimates regarding:

 

 

our business, financial and operating results, and future economic performance; 

 

proposed new product and service offerings; and 

 

management's goals, expectations, objectives and other similar expressions concerning matters that are not historical facts.

 

Factors that could affect our actual financial results and cause them to differ materially from those anticipated in the forward-looking statements include:

 

 

frequency and duration of power outages impacting demand for our products;

 

availability, cost and quality of raw materials and key components used in producing our products; 

 

the impact on our results of possible fluctuations in interest rates and foreign currency exchange rates;

 

the possibility that the expected synergies, efficiencies and cost savings of our acquisitions will not be realized, or will not be realized within the expected time period;

 

the risk that our acquisitions will not be integrated successfully;

 

difficulties we may encounter as our business expands globally;

 

competitive factors in the industry in which we operate;

 

our dependence on our distribution network; 

 

our ability to invest in, develop or adapt to changing technologies and manufacturing techniques; 

 

loss of our key management and employees; 

 

increase in product and other liability claims or recalls; and

 

changes in environmental, health and safety laws and regulations.

 

Should one or more of these risks or uncertainties materialize, or should any of these assumptions prove incorrect, our actual results may vary in material respects from those projected in any forward-looking statements. A detailed discussion of these and other factors that may affect future results is contained in our filings with the Securities and Exchange Commission, including in Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2016. Stockholders, potential investors and other readers should consider these factors carefully in evaluating the forward-looking statements.

 

Any forward-looking statement made by us in this report speaks only as of the date on which it is made. Factors or events that could cause our actual results to differ may emerge from time to time, and it is not possible for us to predict all of them. We undertake no obligation to update any forward-looking statement, whether as a result of new information, future developments or otherwise, except as may be required by law.

 

 

Overview

 

We are a leading designer and manufacturer of a wide range of power generation equipment and other engine powered products serving the residential, light commercial and industrial markets. Power generation is our primary focus, which differentiates us from our primary competitors that also have broad operations outside of the power equipment market. As the only significant market participant focused predominantly on these products, we have one of the leading market positions in the power equipment market in North America and an expanding presence internationally. We believe we have one of the widest ranges of products in the marketplace, including residential, commercial and industrial standby generators, as well as portable and mobile generators used in a variety of applications. Other engine powered products that we design and manufacture include light towers which provide temporary lighting for various end markets; commercial and industrial mobile heaters used in the oil & gas, construction and other industrial markets; and a broad product line of outdoor power equipment for residential and commercial use.

 

Over the past several years, we have executed a number of acquisitions that support our strategic plan. A summary of the recent acquisitions can be found in Note 1, “Description of Business and Basis of Presentation,” to the condensed consolidated financial statements in Item 1 of this quarterly report on Form 10-Q, and in Item 8 (Note 1 “Description of Business”) of the Annual Report on Form 10-K for the year ended December 31, 2016.

 

Business Drivers and Operational Factors

 

In operating our business and monitoring its performance, we pay attention to a number of business drivers and trends as well as operational factors. The statements in this section are based on our current expectations.

 

Business Drivers and Trends

 

Our performance is affected by the demand for reliable power generation products, mobile product solutions and other engine powered products by our customer base. This demand is influenced by several important drivers and trends affecting our industry, including the following:

 

Increasing penetration opportunity.    Many potential customers are not aware of the costs and benefits of automatic backup power solutions. We estimate that penetration rates for home standby generators are only approximately 4.0% of U.S. single-family detached, owner-occupied households with a home value of over $100,000, as defined by the U.S. Census Bureau's 2015 American Housing Survey for the United States. The decision to purchase backup power for many light-commercial buildings such as convenience stores, restaurants and gas stations is more return-on-investment driven and as a result these applications have relatively lower penetration rates as compared to buildings used in code-driven or mission critical applications such as hospitals, wastewater treatment facilities, 911 call centers, data centers and certain industrial locations. The emergence of lower cost, cleaner burning natural gas fueled generators has helped to increase the penetration of standby generators in the light-commercial market. We believe by expanding our distribution network, continuing to develop our product line, and targeting our marketing efforts, we can continue to build awareness and increase penetration for our standby and mobile generators for residential, commercial and industrial purposes.

 

Effect of large scale and baseline power disruptions.    Power disruptions are an important driver of customer awareness and have historically influenced demand for generators, both in the United States and internationally. Increased frequency and duration of major power outage events, that have a broader impact beyond a localized level, increases product awareness and may drive consumers to accelerate their purchase of a standby or portable generator during the immediate and subsequent period, which we believe may last for nine to twelve months following a major power outage event for standby generators. Major power disruptions are unpredictable by nature and, as a result, our sales levels and profitability may fluctuate from period to period. In addition, there are smaller, more localized power outages that occur frequently across the United States that drive the baseline level of demand for back-up power solutions. The level of baseline power outage activity occurring across the United States can also fluctuate, and may cause our financial results to fluctuate from year to year.

 

Impact of residential investment cycle.    The market for residential generators is also affected by the residential investment cycle and overall consumer confidence and sentiment. When homeowners are confident of their household income, the value of their home and overall net worth, they are more likely to invest in their home. These trends can have an impact on demand for residential generators. Trends in the new housing market highlighted by residential housing starts can also impact demand for our residential generators. Demand for our outdoor power equipment is also impacted by several of these factors, as well as weather precipitation patterns.

 

Impact of business capital investment cycle.   The global market for our commercial and industrial products is affected by different capital investment cycles, which can vary across the numerous regions around the world in which we participate. These markets include non-residential building construction, durable goods and infrastructure spending as well as investments in the exploration and production of oil & gas, as businesses or organizations either add new locations or make investments to upgrade existing locations or equipment. These trends can have a material impact on demand for these products. The capital investment cycle may differ for the various commercial and industrial end markets that we serve including light commercial, retail, telecommunications, industrial, data centers, healthcare, construction, oil & gas and municipal infrastructure, among others. The market for these products is also affected by general economic and geopolitical conditions as well as credit availability in the geographic regions that we serve. In addition, we believe demand for our mobile power products will continue to benefit from a secular shift towards renting versus buying this type of equipment.

 

 

Factors Affecting Results of Operations

 

We are subject to various factors that can affect our results of operations, which we attempt to mitigate through factors we can control, including continued product development, expanded distribution, pricing, cost control and hedging. Certain operational and other factors that affect our business include the following:

 

Effect of commodity, currency and component price fluctuations.    Industry-wide price fluctuations of key commodities, such as steel, copper and aluminum, along with other components we use in our products, can have a material impact on our results of operations. Also, with the Pramac acquisition in 2016, we have further expanded our commercial and operational presence outside of the United States. This acquisition, along with our existing international presence, exposes us to fluctuations in foreign currency exchange rates that can have a material impact on our results of operations.

 

We have historically attempted to mitigate the impact of rising commodity, currency and component prices through improved product design and sourcing, manufacturing efficiencies, price increases and select hedging transactions. Our results are also influenced by changes in fuel prices in the form of freight rates, which in some cases are accepted by our customers and in other cases are paid by us.

 

Seasonality.    Although there is demand for our products throughout the year, in each of the past five years approximately 23% to 27% of our net sales occurred in the first quarter, 20% to 25% in the second quarter, 24% to 27% in the third quarter and 25% to 29% in the fourth quarter, with different seasonality depending on the occurrence, timing and severity of major power outage activity in each year. Major outage activity is unpredictable by nature and, as a result, our sales levels and profitability may fluctuate from period to period. The seasonality experienced during a major power outage, and for the subsequent quarters following the event, will vary relative to other periods where no major outage events occurred. We maintain a flexible production and supply chain infrastructure in order to respond to outage-driven peak demand.

 

Factors influencing interest expense and cash interest expense. Interest expense can be impacted by a variety of factors, including market fluctuations in LIBOR, interest rate election periods, interest rate swap agreements, credit facility pricing grids, and repayments or borrowings of indebtedness. Cash interest expense decreased during the six months ended June 30, 2017 compared to the six months ended June 30, 2016, primarily due to the $25 million voluntary prepayment of Term Loan debt in November 2016 and decreased borrowings at other foreign subsidiaries, partially offset by an increase in the LIBOR rate. Refer to Note 9, “Credit Agreements,” to the condensed consolidated financial statements included in Part 1, Item 1 of this Quarterly Report on Form 10-Q for further information.

 

Factors influencing provision for income taxes and cash income taxes paid.   We had approximately $592 million of tax-deductible goodwill and intangible asset amortization remaining as of December 31, 2016 related to our acquisition by CCMP in 2006 that we expect to generate aggregate cash tax savings of approximately $231 million through 2021, assuming continued profitability and a 39% tax rate. The recognition of the tax benefit associated with these assets for tax purposes is expected to be $122 million annually through 2020 and $102 million in 2021, which generates annual cash tax savings of $48 million through 2020 and $40 million in 2021, assuming profitability and a 39% tax rate. As a result of the asset acquisition of the Magnum business in the fourth quarter of 2011, we had approximately $38.0 million of incremental tax deductible goodwill and intangible assets remaining as of December 31, 2016. We expect these assets to generate aggregate cash tax savings of $14.9 million through 2026 assuming continued profitability and a 39% tax rate. The amortization of these assets for tax purposes is expected to be $3.8 million annually through 2025 and $2.8 million in 2026, which generates an additional annual cash tax savings of $1.5 million through 2025 and $1.1 million in 2026, assuming profitability and a 39% tax rate. Based on current business plans, we believe that our cash tax obligations through 2026 will be significantly reduced by these tax attributes. Other domestic acquisitions have resulted in additional tax deductible goodwill and intangible assets that will generate tax savings, but are not material to our consolidated financial statements.

 

 

Results of Operations

 

Three months ended June 30, 2017 compared to the three months ended June 30, 2016

 

The following table sets forth our consolidated statement of operations data for the periods indicated:

 

   

Three Months Ended June 30,

                 

(U.S. Dollars in thousands)

 

2017

   

2016

   

$ Change

   

% Change

 
                                 

Net sales

  $ 395,376     $ 367,376     $ 28,000       7.6 %

Cost of goods sold

    260,916       243,229       17,687       7.3 %

Gross profit

    134,460       124,147       10,313       8.3 %

Operating expenses:

                               

Selling and service

    43,116       42,366       750       1.8 %

Research and development

    10,567       9,889       678       6.9 %

General and administrative

    21,361       19,593       1,768       9.0 %

Amortization of intangible assets

    7,129       8,217       (1,088 )     -13.2 %

Total operating expenses

    82,173       80,065       2,108       2.6 %

Income from operations

    52,287       44,082       8,205       18.6 %

Total other expense, net

    (12,428 )     (11,218 )     (1,210 )     10.8 %

Income before provision for income taxes

    39,859       32,864       6,995       21.3 %

Provision for income taxes

    14,114       11,921       2,193       18.4 %

Net income

    25,745       20,943       4,802       22.9 %

Net income attributable to noncontrolling interests

    85       55       30       54.5 %

Net income attributable to Generac Holdings Inc.

  $ 25,660     $ 20,888     $ 4,772       22.8 %

 

The following table sets forth our reportable segment information for the periods indicated:

 

   

Net Sales

                 
   

Three Months Ended June 30,

                 

(U.S. Dollars in thousands)

 

2017

   

2016

   

$ Change

   

% Change

 

Domestic

  $ 305,907     $ 286,720     $ 19,187       6.7 %

International

    89,469       80,656       8,813       10.9 %

Total net sales

  $ 395,376     $ 367,376     $ 28,000       7.6 %

 

   

Adjusted EBITDA

                 
   

Three Months Ended June 30,

                 
   

2017

   

2016

   

$ Change

   

% Change

 

Domestic

  $ 64,157     $ 57,352     $ 6,805       11.9 %

International

    6,034       6,574       (540 )     -8.2 %

Total Adjusted EBITDA

  $ 70,191     $ 63,926     $ 6,265       9.8 %

 

The following table sets forth our product class information for the periods indicated:

 

   

Three Months Ended June 30,

                 

(U.S. Dollars in thousands)

 

2017

   

2016

   

$ Change

   

% Change

 

Residential products

  $ 198,117     $ 181,735     $ 16,382       9.0 %

Commercial & industrial products

    170,755       156,730       14,025       8.9 %

Other

    26,504       28,911       (2,407 )     -8.3 %

Total net sales

  $ 395,376     $ 367,376     $ 28,000       7.6 %

 

Net sales.    The increase in Domestic sales for the three months ended June 30, 2017 was primarily due to strong growth in shipments of home standby generators and mobile products, which was partially offset by a decline in residential portable sales due to excess levels of field inventory during the current-year quarter along with new product placement with certain retail customers in the prior-year quarter.

 

The increase in International sales for the three months ended June 30, 2017 was primarily due to the contribution from the recent acquisition of Motortech.

 

 

The total net sales contribution from non-annualized recent acquisitions to the three months ended June 30, 2017 was $9.5 million.

 

Gross profit.    Gross profit margin for the second quarter of 2017 was 34.0% compared to 33.8% in the prior-year second quarter. The prior-year included $3.4 million of expense relating to the purchase accounting adjustment for the step-up in value of inventories relating to the Pramac acquisition. Excluding the impact of these expenses, gross margin in the prior year was 34.7%. The pro-forma decline in gross margin as compared to the prior year was due to a number of factors including higher commodity prices seen in prior quarters and, to a lesser extent, certain plant consolidation costs.

 

Operating expenses.    The increase in operating expenses was primarily driven by the addition of recurring operating expenses associated with the Motortech acquisition.

 

Other expense.    The increase in other expense was primarily due to an increase in foreign currency transactional losses partially offset by a decrease in interest expense due to the $25 million voluntary prepayment of Term Loan debt in November 2016 and decreased borrowings at other foreign subsidiaries.

 

Provision for income taxes.    The effective income tax rates for the three months ended June 30, 2017 and 2016 were 35.4% and 36.4%, respectively. The decrease in the effective income tax rate year-over-year is partially attributable to an increase in the Company’s federal domestic production activity deduction due to higher pre-tax income during the first half of 2017 compared to the first half of 2016.

 

Net income attributable to Generac Holdings Inc.    The increase in net income attributable to Generac Holdings Inc. was primarily due to the factors outlined above.

 

Adjusted EBITDA.    Adjusted EBITDA margins for the Domestic segment for the three months ended June 30, 2017 were 21.0% of net sales compared to 20.0% in the prior-year second quarter. Adjusted EBITDA margin in the current year was positively impacted by improved overall leverage of fixed operating expenses on the organic increase in sales, partially offset by the unfavorable impact from higher commodity prices seen in prior quarters.

 

Adjusted EBITDA margins for the International segment, before deducting for noncontrolling interests, for the three months ended June 30, 2017 were 6.7% of net sales compared to 8.2% in the prior-year second quarter. The decline was primarily due to unfavorable foreign currency impacts and sales mix, along with higher commodity prices and increased overall operating expenses including the expansion of branch operations. These impacts were partially offset by the addition of the Motortech acquisition.

 

Adjusted Net Income.    Adjusted Net Income of $43.3 million for the three months ended June 30, 2017 increased 1.4% from $42.7 million for the three months ended June 30, 2016, due to the factors outlined above together with an increase in cash income tax expense.

 

See “Non-GAAP Measures” for a discussion of how we calculate Adjusted EBITDA and Adjusted Net Income and the limitations on their usefulness.

 

 

Six months ended June 30, 2017 compared to the six months ended June 30, 2016

 

The following table sets forth our consolidated statement of operations data for the periods indicated:

 

   

Six Months Ended June 30,

                 

(U.S. Dollars in thousands)

 

2017

   

2016

   

$ Change

   

% Change

 
                                 

Net sales

  $ 727,190     $ 653,911     $ 73,279       11.2 %

Cost of goods sold

    482,244       431,704       50,540       11.7 %

Gross profit

    244,946       222,207       22,739       10.2 %

Operating expenses:

                               

Selling and service

    83,300       79,635       3,665       4.6 %

Research and development

    20,868       18,086       2,782       15.4 %

General and administrative

    42,334       37,426       4,908       13.1 %

Amortization of intangible assets

    14,312       16,014       (1,702 )     -10.6 %

Total operating expenses

    160,814       151,161       9,653       6.4 %

Income from operations

    84,132       71,046       13,086       18.4 %

Total other expense, net

    (23,173 )     (22,251 )     (922 )     4.1 %

Income before provision for income taxes

    60,959       48,795       12,164       24.9 %

Provision for income taxes

    22,365       17,640       4,725       26.8 %

Net income

    38,594       31,155       7,439       23.9 %

Net income attributable to noncontrolling interests

    92       59       33       55.9 %

Net income attributable to Generac Holdings Inc.

  $ 38,502     $ 31,096     $ 7,406       23.8 %

 

The following table sets forth our reportable segment information for the periods indicated:

 

   

Net Sales

                 
   

Six Months Ended June 30,

                 

(U.S. Dollars in thousands)

 

2017

   

2016

   

$ Change

   

% Change

 

Domestic

  $ 554,404     $ 534,736     $ 19,668       3.7 %

International

    172,786       119,175       53,611       45.0 %

Total net sales

  $ 727,190     $ 653,911     $ 73,279       11.2 %

 

   

Adjusted EBITDA

                 
   

Six Months Ended June 30,

                 
   

2017

   

2016

   

$ Change

   

% Change

 

Domestic

  $ 107,003     $ 104,212     $ 2,791       2.7 %

International

    10,846       9,523       1,323       13.9 %

Total Adjusted EBITDA

  $ 117,849     $ 113,735     $ 4,114       3.6 %

 

The following table sets forth our product class information for the periods indicated:

 

   

Six Months Ended June 30,

                 

(U.S. Dollars in thousands)

 

2017

   

2016

   

$ Change

   

% Change

 

Residential products

  $ 352,973     $ 340,716     $ 12,257       3.6 %

Commercial & industrial products

    322,198       259,720       62,478       24.1 %

Other

    52,019       53,475       (1,456 )     -2.7 %

Total net sales

  $ 727,190     $ 653,911     $ 73,279       11.2 %

 

Net sales.    The increase in Domestic sales for the six months ended June 30, 2017 was primarily due to strong growth in shipments of mobile products and home standby generators, as well as increased shipments of C&I stationary and specialty outdoor power equipment products. This strength was largely offset by a decline in residential portable sales due to excess levels of field inventory during the current year along with new product placement with certain retail customers in the prior year.

 

The increase in International sales for the six months ended June 30, 2017 was primarily due to the contribution from the recent acquisitions of Pramac and Motortech. The growth was also due to increased organic shipments of stationary products, most notably within the European and Latin American regions.

 

The total net sales contribution from non-annualized recent acquisitions to the six months ended June 30, 2017 was $50.0 million.

 

 

Gross profit.    Gross profit margin for the first half of 2017 was 33.7% compared to 34.0% in the prior-year first half. The prior year included $2.7 million of business optimization and restructuring costs classified within cost of goods sold to address the significant and extended downturn for capital spending within the oil & gas industry, as well as $3.4 million of expense relating to the purchase accounting adjustment for the step-up in value of inventories relating to the Pramac acquisition. Excluding the impact of these charges, gross margin in the prior-year was 34.9%. The pro-forma decline in gross margin as compared to the prior year was due to the mix impact from the Pramac and Motortech acquisitions, higher commodity prices seen in prior quarters and certain plant consolidation costs. These impacts were partially offset by net favorable pricing impacts.

 

Operating expenses.    Operating expenses increased $9.7 million, or 6.4%, as compared to the first half of 2016. The prior-year included $4.4 million of business optimization and restructuring costs classified within operating expenses to address the downturn for capital spending within the oil & gas industry. Excluding the impact of these charges, operating expenses increased $14.1 million, or 9.6%, as compared to the prior year. The increase was primarily driven by the addition of recurring operating expenses associated with the recent acquisitions of Pramac and Motortech.

 

Other expense.    The increase in other expense was primarily due to an increase in foreign currency transactional losses partially offset by a decrease in interest expense due to the $25 million voluntary prepayment of Term Loan debt in November 2016 and decreased borrowings at other foreign subsidiaries.

 

Provision for income taxes.    The effective income tax rates for the six months ended June 30, 2017 and 2016 were 36.7% and 36.2%, respectively. The increase in the effective income tax rate in 2017 was primarily due to non-recurring discrete tax items.

 

Net income attributable to Generac Holdings Inc.    The prior-year net income attributable to Generac Holdings Inc. includes $7.1 million of pre-tax business optimization and restructuring costs to address the downturn for capital spending within the oil & gas industry. Excluding the impact of these charges, net income attributable to the Company was flat, based on the factors outlined above.

 

Adjusted EBITDA.    Adjusted EBITDA margins for the Domestic segment for the six months ended June 30, 2017 were 19.3% of net sales compared to 19.5% for the six months ended June 30, 2016. Adjusted EBITDA margins decreased due to overall unfavorable product mix and the unfavorable impact from higher commodity prices seen in prior quarters, mostly offset by improved overall leverage of fixed operating expenses on the organic increase in sales and net favorable pricing impacts.

 

Adjusted EBITDA margins for the International segment, before deducting for noncontrolling interests, for the six months ended June 30, 2017 were 6.3% of net sales compared to 8.0% for the six months ended June 30, 2016. The decline was primarily due to the Pramac acquisition, unfavorable foreign currency impacts and sales mix, higher commodity prices and increased overall operating expenses including the expansion of branch operations. These impacts were partially offset by the addition of the Motortech acquisition.

 

Adjusted Net Income.    Adjusted Net Income of $69.1 million for the six months ended June 30, 2017 decreased 6.1% from $73.6 million for the six months ended June 30, 2016, due to the factors outlined above and an increase in cash income tax expense.

 

See “Non-GAAP Measures” for a discussion of how we calculate Adjusted EBITDA and Adjusted Net Income and the limitations on their usefulness.

 

Liquidity and Financial Condition

 

Our primary cash requirements include payment for our raw material and component supplies, salaries & benefits, operating expenses, interest and principal payments on our debt and capital expenditures. We finance our operations primarily through cash flow generated from operating activities and, if necessary, borrowings under our ABL Facility.

 

Our credit agreements originally provided for a $1.2 billion Term Loan and currently include a $300.0 million uncommitted incremental term loan facility. The Term Loan matures on May 31, 2023. Following the amendment in May 2017, the Term Loan bears interest at rates based upon either a base rate plus a fixed applicable margin of 1.25% or adjusted LIBOR rate plus a fixed applicable margin of 2.25%, subject to a LIBOR floor of 0.75%. As of June 30, 2017, we were in compliance with all covenants of the Term Loan. There are no financial maintenance covenants on the Term Loan.

 

Our credit agreements also provide for the $250.0 million ABL Facility. The maturity date of the ABL Facility is May 29, 2020. In May 2015, we borrowed $100.0 million under the ABL Facility, the proceeds of which were used as a voluntary prepayment of Term Loan borrowings. As of June 30, 2017, there was $100.0 million outstanding under the ABL Facility, and we were in compliance with all of its covenants.

 

 

At June 30, 2017, we had cash and cash equivalents on hand of $67.1 million and $145.9 million of availability under our ABL Facility, net of outstanding letters of credit.

 

In August 2015, our Board of Directors approved a $200.0 million stock repurchase program, which we completed in the third quarter of 2016. In October 2016, our Board of Directors approved another stock repurchase program, under which we may repurchase an additional $250.0 million of common stock over 24 months from time to time, in amounts and at prices we deem appropriate, subject to market conditions and other considerations. For the three months ended June 30, 2017, the Company repurchased 844,500 shares of its common stock for $30.0 million. Since the inception of both programs, we have repurchased 8,116,706 shares of our common stock for $$279.9 million, all funded with cash on hand.

 

See Note 9, “Credit Agreements” to the condensed consolidated financial statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q.

 

Long-term Liquidity

 

We believe that our cash flow from operations and availability under our ABL Facility, combined with relatively low ongoing capital expenditure requirements and favorable tax attributes (which result in a lower cash tax rate as compared to the U.S. statutory tax rate) provide us with sufficient capital to continue to grow our business in the future. We will use a portion of our cash flow to pay principal on our outstanding debt as well as repurchase shares of our common stock, impacting the amount available for working capital, capital expenditures and other general corporate purposes. As we continue to expand our business, we may require additional capital to fund working capital, capital expenditures or acquisitions.

 

Cash Flow

 

Six months ended June 30, 2017 compared to the six months ended June 30, 2016

 

The following table summarizes our cash flows by category for the periods presented:

 

   

Six Months Ended June 30,

                 

(U.S. Dollars in thousands)

 

2017

   

2016

   

$ Change

   

% Change

 
                                 

Net cash provided by operating activities

  $ 55,674     $ 81,235     $ (25,561 )     -31.5 %

Net cash used in investing activities

    (8,825 )     (74,843 )     66,018       -88.2 %

Net cash used in financing activities

    (49,506 )     (46,723 )     (2,783 )     6.0 %

 

The decrease in net cash from operating activities was primarily driven by a working capital investment during the current year as compared to a benefit from the working capital reduction in the prior year as we replenished inventory levels in the first quarter of 2017 following Hurricane Matthew. This decrease is partially offset by an increase in operating income.

 

Net cash used in investing activities for the six months ended June 30, 2017 primarily represents cash payments for the purchase of property and equipment. Net cash used in investing activities for the six months ended June 30, 2016 primarily represents cash payments of $60.9 million related to the acquisition of Pramac and $14.0 million for the purchase of property and equipment. The Motortech acquisition was completed in the first quarter of 2017, but was funded in the fourth quarter of 2016.

 

Net cash used in financing activities for the six months ended June 30, 2017 primarily represents $82.8 million of debt repayments ($73.0 million of short-term borrowings and $9.8 million of long-term borrowings) and $30.0 million of payments for the repurchase of the Company’s common stock. These payments were partially offset by $65.5 million cash proceeds from borrowings ($62.4 million short-term and $3.1 million long-term).

 

Net cash used in financing activities for the six months ended June 30, 2016 primarily represents $34.6 million of payments for the repurchase of the Company’s common stock, $17.0 million of debt repayments ($10.7 million of long-term borrowings and $6.3 million of short-term borrowings) and $12.1 million related to the net share settlement of equity awards. These payments were partially offset by $10.3 million cash proceeds from short-term borrowings and a $6.7 million cash inflow related to excess tax benefits of equity awards.

 

Contractual Obligations

 

In May 2017, the Company amended its Term Loan, which reduces future interest payments on the Term Loan. Refer to Note 9, “Credit Agreements,” to the condensed consolidated financial statements for further information. Other than the Term Loan amendment, there have been no material changes to our contractual obligations since the February 24, 2017 filing of our Annual Report on Form 10-K for the year ended December 31, 2016.

 

 

Off-Balance Sheet Arrangements

 

There have been no material changes to off-balance sheet arrangements since the February 24, 2017 filing of our Annual Report on Form 10-K for the year ended December 31, 2016.

 

Critical Accounting Policies

 

There have been no material changes in our critical accounting policies since the February 24, 2017 filing of our Annual Report on Form 10-K for the year ended December 31, 2016.

 

As discussed in our Annual Report on Form 10-K for the year ended December 31, 2016, in preparing the financial statements in accordance with U.S. GAAP, we are required to make estimates and assumptions that have an impact on the asset, liability, revenue and expense amounts reported. These estimates can also affect our supplemental information disclosures, including information about contingencies, risk and financial condition. We believe, given current facts and circumstances, that our estimates and assumptions are reasonable, adhere to U.S. GAAP and are consistently applied. Inherent in the nature of an estimate or assumption is the fact that actual results may differ from estimates and estimates may vary as new facts and circumstances arise. We make routine estimates and judgments in determining net realizable value of accounts receivable, inventories, property and equipment, and prepaid expenses. We believe that our most critical accounting estimates and assumptions are in the following areas: goodwill and other intangible asset impairment assessment; business combinations and purchase accounting; defined benefit pension obligations; estimates of product warranty and other contingencies; income taxes and share based compensation.

 

Non-GAAP Measures

 

Adjusted EBITDA

 

The computation of Adjusted EBITDA attributable to Generac Holdings Inc. is based on the definition of EBITDA contained in our credit agreement dated as of May 31, 2013, as amended. To supplement our condensed consolidated financial statements presented in accordance with U.S. GAAP, we provide the computation of Adjusted EBITDA attributable to the Company, taking into account certain charges and gains that were recognized during the periods presented.

 

We view Adjusted EBITDA as a key measure of our performance. We present Adjusted EBITDA not only due to its importance for purposes of our credit agreements but also because it assists us in comparing our performance across reporting periods on a consistent basis as it excludes items that we do not believe are indicative of our core operating performance. Our management uses Adjusted EBITDA:

 

 

for planning purposes, including the preparation of our annual operating budget and developing and refining our internal projections for future periods;

 

to allocate resources to enhance the financial performance of our business;

 

as a benchmark for the determination of the bonus component of compensation for our senior executives under our management incentive plan, as described further in our 2017 Proxy Statement;

 

to evaluate the effectiveness of our business strategies and as a supplemental tool in evaluating our performance against our budget for each period; and

 

in communications with our Board of Directors and investors concerning our financial performance.

 

We believe Adjusted EBITDA is used by securities analysts, investors and other interested parties in the evaluation of the Company. Management believes the disclosure of Adjusted EBITDA offers an additional financial metric that, when coupled with U.S. GAAP results and the reconciliation to U.S. GAAP results, provides a more complete understanding of our results of operations and the factors and trends affecting our business. We believe Adjusted EBITDA is useful to investors for the following reasons:

 

 

Adjusted EBITDA and similar non-GAAP measures are widely used by investors to measure a company's operating performance without regard to items that can vary substantially from company to company depending upon financing and accounting methods, book values of assets, tax jurisdictions, capital structures and the methods by which assets were acquired;

 

investors can use Adjusted EBITDA as a supplemental measure to evaluate the overall operating performance of our company, including our ability to service our debt and other cash needs; and

 

by comparing our Adjusted EBITDA in different historical periods, our investors can evaluate our operating performance excluding the impact of items described below.

 

 

The adjustments included in the reconciliation table listed below are provided for under our Term Loan and ABL Facility, and also are presented to illustrate the operating performance of our business in a manner consistent with the presentation used by our management and Board of Directors. These adjustments eliminate the impact of a number of items that:

 

 

we do not consider indicative of our ongoing operating performance, such as non-cash write-downs and other charges, non-cash gains, write-offs relating to the retirement of debt, severance costs and other restructuring-related business optimization expenses;

 

we believe to be akin to, or associated with, interest expense, such as administrative agent fees, revolving credit facility commitment fees and letter of credit fees; or

 

are non-cash in nature, such as share-based compensation.

 

We explain in more detail in footnotes (a) through (e) below why we believe these adjustments are useful in calculating Adjusted EBITDA as a measure of our operating performance.

 

Adjusted EBITDA does not represent, and should not be a substitute for, net income or cash flows from operations as determined in accordance with U.S. GAAP. Adjusted EBITDA has limitations as an analytical tool, and you should not consider it in isolation, or as a substitute for analysis of our results as reported under U.S. GAAP. Some of the limitations are:

 

 

Adjusted EBITDA does not reflect our cash expenditures, or future requirements for capital expenditures or contractual commitments;

 

Adjusted EBITDA does not reflect changes in, or cash requirements for, our working capital needs;

 

Adjusted EBITDA does not reflect the significant interest expense, or the cash requirements necessary to service interest or principal payments on our debt;

 

although depreciation and amortization are non-cash charges, the assets being depreciated and amortized will often have to be replaced in the future, and Adjusted EBITDA does not reflect any cash requirements for such replacements;

 

several of the adjustments that we use in calculating Adjusted EBITDA, such as non-cash write-downs and other charges, while not involving cash expense, do have a negative impact on the value of our assets as reflected in our consolidated balance sheet prepared in accordance with U.S. GAAP; and

 

other companies may calculate Adjusted EBITDA differently than we do, limiting its usefulness as a comparative measure.

 

Furthermore, as noted above, one of our uses of Adjusted EBITDA is as a benchmark for determining elements of compensation for our senior executives. At the same time, some or all of these senior executives have responsibility for monitoring our financial results, generally including the adjustments in calculating Adjusted EBITDA (subject ultimately to review by our Board of Directors in the context of the Board's review of our quarterly financial statements). While many of the adjustments (for example, transaction costs and credit facility fees), involve mathematical application of items reflected in our financial statements, others involve a degree of judgment and discretion. While we believe all of these adjustments are appropriate, and while the quarterly calculations are subject to review by our Board of Directors in the context of the Board's review of our quarterly financial statements and certification by our Chief Financial Officer in a compliance certificate provided to the lenders under our Term Loan and ABL Facility credit agreements, this discretion may be viewed as an additional limitation on the use of Adjusted EBITDA as an analytical tool.

 

Because of these limitations, Adjusted EBITDA should not be considered as a measure of discretionary cash available to us to invest in the growth of our business. We compensate for these limitations by relying primarily on our U.S. GAAP results and using Adjusted EBITDA only supplementally.

 

 

The following table presents a reconciliation of net income to Adjusted EBITDA attributable to Generac Holdings Inc.:

 

   

Three Months Ended June 30,

   

Six Months Ended June 30,

 

(U.S. Dollars in thousands)

 

2017

   

2016

   

2017

   

2016

 
                                 

Net income attributable to Generac Holdings Inc.

  $ 25,660     $ 20,888     $ 38,502     $ 31,096  

Net income attributable to noncontrolling interests (a)

    85       55       92       59  

Net income

    25,745       20,943       38,594       31,155  

Interest expense

    10,893       11,380       21,681       22,415  

Depreciation and amortization

    12,986       13,650       25,583       26,443  

Provision for income taxes

    14,114       11,921       22,365       17,640  

Non-cash write-down and other adjustments (b)

    1,710       2,909       1,876       2,782  

Non-cash share-based compensation expense (c)

    3,186       2,901       5,818       5,386  

Transaction costs and credit facility fees (d)

    420       237       736       760  

Business optimization expenses (e)

    1,346       -       1,446       7,106  

Other

    (209 )     (15 )     (250 )     48  

Adjusted EBITDA

    70,191       63,926       117,849       113,735  

Adjusted EBITDA attributable to noncontrolling interests

    1,455       1,623       2,411       2,307  

Adjusted EBITDA attributable to Generac Holdings Inc.

  $ 68,736     $ 62,303     $ 115,438     $ 111,428  

 

(a)   Includes the noncontrolling interests' share of expenses related to Pramac purchase accounting, including the step-up in value of inventories and intangible amortization, of $1.1 million and $2.2 million for the three and six months ended June 30, 2017, respectively, and $4.3 million and $5.5 million for the three and six months ended June 30, 2016, respectively.

 

(b)   Represents the following non-cash charges: gains/losses on disposals of assets, unrealized mark-to-market adjustments on commodity contracts, transactional foreign currency gains/losses and certain purchase accounting related adjustments. We believe that adjusting net income for these non-cash charges is useful for the following reasons:

 

 

The gains/losses on disposals of assets result from the sale of assets that are no longer useful in our business and therefore represent gains or losses that are not from our core operations;

 

The adjustments for unrealized mark-to-market gains and losses on commodity contracts represent non-cash items to reflect changes in the fair value of forward contracts that have not been settled or terminated. We believe it is useful to adjust net income for these items because the charges do not represent a cash outlay in the period in which the charge is incurred, although Adjusted EBITDA must always be used together with our U.S. GAAP statements of comprehensive income and cash flows to capture the full effect of these contracts on our operating performance; and

 

The purchase accounting adjustments represent non-cash items to reflect fair value at the date of acquisition, and therefore do not reflect our ongoing operations.

 

(c)  Represents share-based compensation expense to account for stock options, restricted stock and other stock awards over their respective vesting period.

 

(d) Represents transaction costs incurred directly in connection with any investment, as defined in our credit agreement, equity issuance or debt issuance or refinancing, together with certain fees relating to our senior secured credit facilities, such as administrative agent fees and credit facility commitment fees under our Term Loan and ABL Facility, which we believe to be akin to, or associated with, interest expense and whose inclusion in Adjusted EBITDA is therefore similar to the inclusion of interest expense in that calculation.

 

(e) For the three and six months ended June 30, 2017, represents severance and other non-recurring plant consolidation costs. For the six months ended June 30, 2016, primarily represents charges relating to business optimization and restructuring costs to address the significant and extended downturn for capital spending within the oil & gas industry. These charges represent expenses that are not from our core operations and do not reflect our ongoing operations.

 

Adjusted Net Income

 

To further supplement our condensed consolidated financial statements in accordance with U.S. GAAP, we provide the computation of Adjusted Net Income attributable to the Company, which is defined as net income before noncontrolling interest and provision for income taxes adjusted for the following items: cash income tax expense, amortization of intangible assets, amortization of deferred financing costs and original issue discount related to our debt, intangible impairment charges, certain transaction costs and other purchase accounting adjustments, losses on extinguishment of debt, business optimization expenses, certain other non-cash gains and losses, and adjusted net income attributable to noncontrolling interests, as set forth in the reconciliation table below.

 

We believe Adjusted Net Income is used by securities analysts, investors and other interested parties in the evaluation of our company’s operations. Management believes the disclosure of Adjusted Net Income offers an additional financial metric that, when used in conjunction with U.S. GAAP results and the reconciliation to U.S. GAAP results, provides a more complete understanding of our ongoing results of operations, and the factors and trends affecting our business.

 

 

The adjustments included in the reconciliation table listed below are presented to illustrate the operating performance of our business in a manner consistent with the presentation used by investors and securities analysts. Similar to the Adjusted EBITDA reconciliation, these adjustments eliminate the impact of a number of items we do not consider indicative of our ongoing operating performance or cash flows, such as amortization costs, transaction costs and write-offs relating to the retirement of debt. We also make adjustments to present cash taxes paid as a result of our favorable tax attributes.

 

Similar to Adjusted EBITDA, Adjusted Net Income does not represent, and should not be a substitute for, net income or cash flows from operations as determined in accordance with U.S. GAAP. Adjusted Net Income has limitations as an analytical tool, and you should not consider it in isolation, or as a substitute for analysis of our results as reported under U.S. GAAP. Some of the limitations are: