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,” “project,” “plan,” “intend,” “believe,” “confident,” “may,” “should,” “can have,” “likely,” “future” 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 and 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:
·
|
demand for our products;
|
·
|
frequency and duration of major power outages;
|
·
|
availability, cost and quality of raw materials and key components used in producing our products;
|
·
|
the impact on our results of the substantial increases in our outstanding indebtedness and related interest expense due to the dividend recapitalization discussed below under “Liquidity and financial condition”;
|
·
|
the possibility that the expected synergies, efficiencies and cost savings of the acquisition of the Magnum Products business will not be realized, or will not be realized within the expected time period;
|
·
|
the risk that the Magnum Products business or other acquisitions that we make will not be integrated successfully;
|
·
|
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; 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 these 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 fiscal year ended December 31, 2011.
Any forward-looking statement made by us in this report speaks only as of the date on which we make it. 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 generators and other engine powered products for the residential, light commercial, industrial and construction markets. 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 the United States and Canada. We design, manufacture, source and modify engines, alternators, transfer switches and other components necessary for our products. Our products are fueled by natural gas, liquid propane, gasoline, diesel and Bi-Fuel™ and are available through a broad network of independent dealers, retailers, wholesalers, and equipment rental companies.
Business drivers and measures
In operating our business and monitoring its performance, we pay attention to a number of industry trends, operational factors and performance measures. The statements in this section are based on our current expectations.
Industry trends
Our performance is affected by the demand for reliable power solutions by our customer base. This demand is influenced by several important trends affecting our industry, including the following:
Increasing penetration opportunity.
The market for residential and light-commercial automatic standby generators is relatively underpenetrated, and many potential customers are not aware of the costs and benefits of backup power solutions. We estimate that penetration rates for residential standby generators are approximately 2.5% of U.S. single-family detached, owner-occupied households with a home value of over one hundred thousand dollars as defined by the U.S. Census Bureau's 2009 American Housing Survey for the United States, and penetration rates of many light-commercial outlets such as restaurants, drug stores, and gas stations are significantly lower than penetration of hospitals and industrial locations. We believe that 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 generators.
Effect of large scale power disruptions.
Power disruptions are an important driver of consumer awareness and have historically influenced demand for generators. Increased frequency and duration of major power outage events caused by the aging U.S. power grid 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 six to twelve months for standby generators. For example, multiple major outage events that occurred over the last five quarters drove strong demand for home standby generators, and the increased awareness of these products contributed to substantial revenue growth for us in 2012. As a result of recent major power outage activity in late October/early November 2012 affecting the east coast, we have seen increased demand for our home standby and portable generators. While the full impact is uncertain, we expect near term results of operations to be positively impacted by this outage activity. While there are power outages every day across all regions of the country, major outage activity is unpredictable by nature and, as a result, our sales levels and profitability may fluctuate from period to period.
Impact of residential investment cycle.
The market for residential generators is affected by the residential investment cycle and overall consumer sentiment. When homeowners are confident of their household income or net worth, they are more likely to invest in their home. These trends can have a material impact on demand for residential generators.
Impact of business capital investment cycle.
The market for commercial and industrial stationary and mobile generators and other power equipment is affected by the capital investment cycle and overall non-residential construction and durable goods spending, as businesses 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 industrial and commercial end markets that we serve (industrial, telecommunications, distribution, retail, health care facilities, data centers, construction, energy and municipal infrastructure, among others). The market for these products is also affected by general economic conditions, credit availability and trends in durable goods spending by businesses.
Operational factors
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 and cost control. Certain operational factors that affect our business include the following:
New product start-up costs.
When we launch new products, we generally experience an increase in start-up costs, including engineering expenses, expediting costs, testing expenses, marketing expenses and warranty costs, resulting in lower gross margins after the initial launch of a new product. Margins on new product introductions generally increase over the life of the product as these start-up costs decline and we focus our engineering efforts on product cost reduction.
Effect of commodity, currency and component price fluctuations.
Industry-wide price fluctuations of key commodities, such as steel, copper and aluminum and other components we use in our products, together with foreign currency fluctuations, 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, 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 borne by our customers and in other cases are paid by us.
Other factors
Other factors that affect our results of operations include the following:
Factors influencing 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 and repayments of indebtedness. Interest expense increased during the first nine months of 2012 compared to the first nine months of 2011, primarily due to an increase in the weighted-average cost of debt associated with the Credit Agreement (defined below), for the period between February 9, 2012 and May 29, 2012, as well as an increase in outstanding debt and the weighted-average cost of debt associated with the Term Loan Credit Agreement (defined below), for the period between May 30, 2012 and September 30, 2012.
On February 9, 2012, Generac Power Systems entered into a new credit agreement (“Credit Agreement”) with certain commercial banks and other lenders. The Credit Agreement provided for borrowings under a $150.0 million revolving credit facility, a $325.0 million tranche A term loan facility and a $250.0 million tranche B term loan facility. The revolving credit facility and tranche A term loan facility were scheduled to mature February 9, 2017, and the tranche B term loan facility was scheduled to mature February 9, 2019. Proceeds received by the Company from loans made under the Credit Agreement were used to repay in full all outstanding borrowings under the former credit agreement, dated November 10, 2006, as amended from time to time. The Company’s former credit agreement was comprised of a revolving credit facility and a first-lien term loan, which were scheduled to mature in November 2012 and November 2013, respectively.
On May 30, 2012, Generac Power Systems amended and restated its existing Credit Agreement by entering into the Term Loan Credit Agreement and the ABL Credit Agreement. The Term Loan Credit Agreement provides for a $900.0 million Term Loan and a $125.0 million uncommitted incremental term loan facility and the ABL Credit Agreement provides for borrowings under a $150.0 million ABL Facility and an uncommitted $50.0 million incremental credit facility. Proceeds from the Term Loan were used to repay the Company’s previous Credit Agreement. The remaining proceeds from the Term Loan were used, along with cash on hand, to pay a special cash dividend of $6.00 per share on the Company’s common stock (dividend recapitalization). Factors influencing interest expense under the new Term Loan Credit Agreement and ABL Credit Agreement are substantially the same factors that influenced interest expense under the previous credit agreements. Future interest expense will be impacted by the higher principal balance and interest rates tied to the Term Loan Credit Agreement.
Factors influencing provision for income taxes and cash taxes paid.
We had $1.2 billion of tax-deductible goodwill and intangible asset amortization remaining as of December 31, 2011 related to our acquisition by CCMP in 2006 that we expect to generate cash tax savings of approximately $470 million through 2021, assuming continued profitability and a 39% tax rate. The amortization of these assets for tax purposes is expected to be $122 million annually through 2020 and $102 million in 2021, which would generate annual cash tax savings of $48 million through 2020 and $40 million in 2021, assuming profitability and a 39% tax rate. Additionally, we had federal net operating loss, or NOL, carry-forwards of approximately $139.2 million as of December 31, 2011, which we expect to generate an additional $48.7 million of federal cash tax savings at a 35% federal rate when utilized. Based on current business plans, we believe that our cash tax obligations through 2021 will be significantly reduced by these tax attributes. In the second quarter of 2012, the dividend recapitalization discussed in “Liquidity and financial condition” was completed. After considering the increased debt and related interest expense, the Company believes it will generate sufficient taxable income to fully utilize these tax attributes. However, any subsequent accumulations of common stock ownership leading to a change of control under Section 382 of the U.S. Internal Revenue Code of 1986, including through sales of stock by large stockholders, all of which are outside of our control, could limit and defer our ability to utilize our net operating loss carry-forwards and other tax assets to offset future federal income tax liabilities.
In addition, as a result of the asset acquisition of the Magnum Products business in the fourth quarter of 2011, we had approximately $55.1 million of incremental tax deductible goodwill and intangible assets remaining as of December 31, 2011. We expect these assets to generate cash tax savings of approximately $21.5 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 $2.9 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.
As a result of the a forementioned tax attributes and federal alternative minimum tax rules, in 2012 we paid $0.5 million of federal income tax related to the 2011 tax year, and anticipate we will pay approximately $1.0 million of federal income tax for the 2012 tax year.
Seasonality.
Although there is demand for our products throughout the year, in each of the past three years approximately 16% to 24% of our net sales occurred in the first quarter, 20% to 25% in the second quarter, 25% to 30% in the third quarter and 26% to 34% in the fourth quarter. However, seasonality can differ depending on the timing of major power outage activity in each year, such as the major outage activity experienced over the last five quarters.
Due to the significant demand and awareness created by these outage events,
our historical seasonality patterns may not apply in 2012.
We maintain a flexible supply chain and production schedule in order to respond to outage-driven peak demand, but typically increase production levels in the second and third quarters of each year.
Results of operations
Three and nine months ended September 30, 2012 compared to three and nine months ended September 30, 2011
The following table sets forth our consolidated statement of operations data for the periods indicated:
|
|
Three months ended September 30,
|
|
|
Nine months ended June 30,
|
|
(Dollars in thousands)
|
|
2012
|
|
|
2011
|
|
|
2012
|
|
|
2011
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net sales
|
|
$
|
300,586
|
|
|
$
|
239,324
|
|
|
$
|
834,284
|
|
|
$
|
524,668
|
|
Cost of goods sold
|
|
|
184,773
|
|
|
|
150,665
|
|
|
|
520,037
|
|
|
|
328,479
|
|
Gross profit
|
|
|
115,813
|
|
|
|
88,659
|
|
|
|
314,247
|
|
|
|
196,189
|
|
Operating expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Selling and service
|
|
|
26,409
|
|
|
|
21,028
|
|
|
|
73,657
|
|
|
|
52,650
|
|
Research and development
|
|
|
6,456
|
|
|
|
4,176
|
|
|
|
17,214
|
|
|
|
11,669
|
|
General and administrative
|
|
|
11,435
|
|
|
|
7,290
|
|
|
|
30,699
|
|
|
|
19,179
|
|
Amortization of intangibles
|
|
|
12,389
|
|
|
|
11,987
|
|
|
|
36,902
|
|
|
|
35,570
|
|
Total operating expenses
|
|
|
56,689
|
|
|
|
44,481
|
|
|
|
158,472
|
|
|
|
119,068
|
|
Income from operations
|
|
|
59,124
|
|
|
|
44,178
|
|
|
|
155,775
|
|
|
|
77,121
|
|
Total other expense, net
|
|
|
(17,257
|
)
|
|
|
(6,673
|
)
|
|
|
(49,105
|
)
|
|
|
(19,303
|
)
|
Income before provision for income taxes
|
|
|
41,867
|
|
|
|
37,505
|
|
|
|
106,670
|
|
|
|
57,818
|
|
Provision for income taxes
|
|
|
16,326
|
|
|
|
126
|
|
|
|
41,734
|
|
|
|
306
|
|
Net income
|
|
$
|
25,541
|
|
|
$
|
37,379
|
|
|
$
|
64,936
|
|
|
$
|
57,512
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Residential power products
|
|
$
|
190,974
|
|
|
$
|
162,091
|
|
|
$
|
489,454
|
|
|
$
|
323,483
|
|
Commercial & industrial power products
|
|
|
93,607
|
|
|
|
63,131
|
|
|
|
299,718
|
|
|
|
164,763
|
|
Other
|
|
|
16,005
|
|
|
|
14,102
|
|
|
|
45,112
|
|
|
|
36,422
|
|
Net sales
|
|
$
|
300,586
|
|
|
$
|
239,324
|
|
|
$
|
834,284
|
|
|
$
|
524,668
|
|
Net sales.
Net sales increased $61.3 million, or 25.6%, to $300.6 million for the three months ended September 30, 2012 from $239.3 million for the three months ended September 30, 2011. Residential product sales increased 17.8% to $191.0 million from $162.1 million for the comparable period in 2011. The growth was primarily driven by increases in shipments for home standby generators as demand increased due to increased awareness following major power outage events. In addition, increased revenue from other residential power products such as our power washer line, which began shipping in the second quarter of 2011, contributed modestly to the year-over-year sales growth in residential products. Industrial and commercial product sales for the third quarter of 2012 increased 48.3% to $93.6 million from $63.1 million for the comparable period in 2011. The increase in net sales was primarily driven by the Magnum Products acquisition.
Net sales increased $309.6 million, or 59.0%, to $834.3 million for the nine months ended September 30, 2012 from $524.7 million for the nine months ended September 30, 2011. Residential product sales increased 51.3% to $489.5 million from $323.5 million for the comparable period in 2011. The growth was primarily due to increased demand for home standby products resulting from the major outage events that occurred since the third quarter of 2011. Increases in distribution and targeted marketing have helped to execute on this increased demand. Industrial and commercial product sales increased 81.9% to $299.7 million from $164.8 million for the comparable period in 2011. The increase in net sales was primarily driven by the additional Magnum Products revenue, and to a lesser extent, increased shipments of natural gas backup generators. Industrial and commercial net sales during the first quarter of 2012 also benefited from the resolution of backlog related to a short-term gap in the supply of certain components sourced overseas.
Gross profit.
Gross profit increased $27.2 million, or 30.6%, to $115.8 million for the three months ended September 30, 2012 from $88.7 million for the three months ended September 30, 2011. Gross profit margin for the third quarter of 2012 was 38.5% compared to 37.0% in the third quarter of 2011. Gross margin increased over the prior year due to a higher mix of home standby generators and the positive impact from price increases, improved manufacturing overhead absorption and moderation in commodity costs relative to the prior year. These margin improvements were partially offset by the mix impact from the addition of Magnum Products sales.
Gross profit increased $118.1 million, or 60.2%, to $314.2 million for the nine months ended September 30, 2012 from $196.2 million for the nine months ended September 30, 2011. Gross profit margin for the first nine months of 2012 was 37.7% compared to 37.4% for the first nine months of 2011. The increase in gross margin is primarily due to the factors affecting gross margin described above.
Operating expenses.
Operating expenses increased $12.2 million, or 27.4%, to $56.7 million for the three months ended September 30, 2012 from $44.5 million for the three months ended September 30, 2011. These additional expenses were driven primarily by operating expenses associated with Magnum, increased sales, engineering and administrative infrastructure to support the strategic growth initiatives and higher baseline sales levels of the Company, increased incentive compensation expenses as a result of the Company’s financial performance during the quarter, and increased variable operating expenses resulting from the increase in organic sales.
Operating expenses increased $39.4 million, or 33.1%, to $158.5 million for the nine months ended September 30, 2012 from $119.1 million for the nine months ended September 30, 2011, primarily due to the factors affecting operating expenses described above.
Other expense.
Other expenses increased $10.6 million, or 158.6%, to $17.3 million for the three months ended September 30, 2012 from $6.7 million for the three months ended September 30, 2011, as a result of higher interest expense of $11.0 million, all due to the dividend recapitalization, completed during the second quarter of 2012. Please refer to "Liquidity and financial condition” for additional details.
Other expenses increased $29.8 million, or 154.4%, to $49.1 million for the nine months ended September 30, 2012 from $19.3 million for the nine months ended September 30, 2011, due to the $14.3 million losses on extinguishment of debt recorded during the first and second quarters of 2012 related to the February 2012 and May 2012 debt refinancing transactions. Interest expense also increased $14.7 million or 82.3%, primarily due to the factors affecting interest expense described above.
Provision for income taxes.
Income tax expense was $16.3 million for the three months ended September 30, 2012 compared to $0.1 million for the three months ended September 30, 2011. Income tax expense was $41.7 million for the nine months ended September 30, 2012 compared to $0.3 million for the nine months ended September 30, 2011. Until the fourth quarter of 2011, a full valuation allowance was recorded on the Company’s net deferred tax assets, resulting in substantially no tax provision. In the fourth quarter of 2011, the Company determined that its deferred tax assets were realizable and a valuation allowance was no longer required. Therefore, the Company began recording an income tax provision at a normalized effective tax rate starting in the first quarter of 2012.
Net income.
As a result of the factors identified above, we generated net income of $25.5 million for the three months ended September 30, 2012 compared to $37.4 million for the three months ended September 30, 2011.
As a result of the factors identified above, we generated net income of $64.9 million for the nine months ended September 30, 2012 compared to $57.5 million for the nine months ended September 30, 2011.
Adjusted EBITDA.
Adjusted EBITDA, as defined in the accompanying reconciliation schedules, increased $14.7 million, or 23.9%, to $76.3 million
for the three months ended September 30, 2012
from $61.6 million
for the three months ended September 30, 2011
. Adjusted EBITDA increased $80.0 million, or 63.2%, to $206.7 million for the nine months ended September 30, 2012 from $126.7 million for the nine months ended September 30, 2011.
Adjusted Net Income.
Adjusted net income, as defined in the accompanying reconciliation schedules, of $54.1 million for the three months ended September 30, 2012 increased 7.1% from $50.6 million for the three months ended September 30, 2011. Adjusted net income increased $64.7 million, or 67.9%, to $160.1 million for the nine months ended September 30, 2012 from $95.4 million for the nine months ended September 30, 2011.
See “Non-GAAP measures” for a discussion of how we calculate these non-GAAP measures and 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 operations and, if necessary, borrowings under our revolving credit facility. In November 2006, Generac Power Systems entered into a seven-year $950.0 million first lien term loan, a seven-and-a-half year $430.0 million second lien term loan, and a six-year $150.0 million revolving credit facility. During 2010 and 2011, we used the net proceeds of our initial public offering and a substantial portion of our cash and cash equivalents on hand totaling $493.8 million to pay down our second lien term loans in full and to repay a portion of our first lien term loan. As a result of these pay downs, the outstanding balance on the first lien credit facility was reduced to $597.9 million as of December 31, 2011, and our second lien credit facility was repaid in full and terminated.
On February 9, 2012, Generac Power Systems repaid an additional $22.9 million under its first lien term loan and entered into a new credit agreement. The new credit agreement (“Credit Agreement”) provided for borrowings under a five-year $150.0 million unfunded revolving credit facility, a five-year $325.0 million tranche A term loan facility and a seven-year $250.0 million tranche B term loan facility. Proceeds received by the Company from loans made under the Credit Agreement were used to repay in full all outstanding borrowings under the former credit agreement, dated November 10, 2006, as amended from time to time, and for general corporate purposes.
On May 30, 2012, Generac Power Systems amended and restated its existing Credit Agreement by entering into the Term Loan Credit Agreement and the ABL Credit Agreement. The Term Loan Credit Agreement provides for a $900.0 million Term Loan and a $125.0 million uncommitted incremental term loan facility and the ABL Credit Agreement provides for borrowings under a $150.0 million unfunded ABL Facility. Proceeds from the Term Loan were used to repay the Company’s previous Credit Agreement and related financing fees. The remaining proceeds from the Term Loan were used, along with available cash on hand, to pay a special cash dividend of $6.00 per share on the Company’s common stock (“dividend recapitalization”). As a result of the repayments of debt and refinancing, our net indebtedness, net of unamortized original issue discount, was $882.9 million at September 30, 2012.
For more information regarding the Term Loan Credit Agreement and the ABL Credit Agreement and their potential impact, see Note 8 in Part I, Item 1, “Notes to Condensed Consolidated Financial Statements”.
At September 30, 2012, we had cash and cash equivalents of $58.0 million and $144.7 million of availability under our revolving credit facility, net of outstanding letters of credit.
Long-term liquidity
We believe that our cash flow from operations and our availability under our revolving credit facility, combined with our relatively low ongoing capital expenditure requirements and favorable tax attributes, provides us with sufficient capital to continue to grow our business in the future. We will use a significant portion of our cash flow to pay interest and principal on our outstanding debt, impacting the amount available for working capital, capital expenditures and other general corporate purposes. As we continue to expand our business, we may in the future require additional capital to fund working capital, capital expenditures or acquisitions.
Nine months ended September 30, 2012 compared to nine months ended September 30, 2011
The following table summarizes our cash flows by category for the periods presented:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine months ended September 30,
|
|
|
|
|
(Dollars in thousands)
|
2012
|
|
2011
|
|
$ Change
|
% Change
|
|
Net cash provided by operating activities
|
|
$
|
129,224
|
|
|
$
|
89,015
|
|
|
$
|
40,209
|
|
|
|
45.2
|
%
|
Net cash used in investing activities
|
|
$
|
(15,681
|
)
|
|
$
|
(4,457
|
)
|
|
$
|
(11,224
|
)
|
|
|
251.8
|
%
|
Net cash used in financing activities
|
|
$
|
(148,703
|
)
|
|
$
|
(24,421
|
)
|
|
$
|
(124,282
|
)
|
|
|
508.9
|
%
|
Net cash provided by operating activities was $129.2 million for the nine months ended September 30, 2012 compared to $89.0 million for the nine months ended September 30, 2011. This year-over-year increase was primarily driven by strong operating earnings partially offset by increased working capital investments, such as increases in inventory levels to support higher production rates, seasonal build requirements, and rapid response to increased demand, as well as increases in accounts receivable as a result of higher sales, and a decrease in accounts payable.
Net cash used in investing activities was $15.7 million for the nine months ended September 30, 2012, which related to the purchase of property and equipment, and acquisition activity. The increase in purchases of property and equipment was primarily driven by the purchase of a manufacturing facility and expansion of our corporate headquarters. Net cash used in investing activities was $4.5 million for the nine months ended September 30, 2011, a majority of which related to the purchase of property and equipment.
Net cash used in financing activities was $148.7 million for the
nine months
ended September 30, 2012, primarily representing the net cash impact of our refinancing activities and dividend recapitalization transaction during the first half of 2012, including gross proceeds from long-term borrowings of $1,455.6 million offset by $1,172.9 million of long-term borrowing repayments. The Company made $25.7 million of cash payments for transaction fees incurred in connection with these refinancing transactions. Following the refinancing, the Company paid a special cash dividend of $6.00 per share ($404.3 million) on the Company’s common stock during the second quarter of 2012. Net cash used in financing activities was $24.4 million for the nine months ended September 30, 2011, representing a $24.7 million repayment of long-term borrowings in the second quarter of 2011 offset by $0.3 million in proceeds from the exercise of stock options.
Contractual obligations
Except as noted in the Quarterly Reports on Form 10-Q for the quarters ended March 31, 2012 and June 30, 2012, there have been no material changes to our contractual obligations since the March 9, 2012 filing of our Annual Report on Form 10-K for the fiscal year ended December 31, 2011.
Off-balance sheet arrangements
There have been no material changes with regards to off-balance sheet arrangements since the March 9, 2012 filing of our Annual Report on Form 10-K for the fiscal year ended December 31, 2011.
Critical accounting policies
There have been no material changes in our critical accounting policies since the March 9, 2012 filing of our Annual Report on Form 10-K for the fiscal year ended December 31, 2011.
As discussed in our Annual Report on Form 10-K for the fiscal year ended December 31, 2011, in preparing the financial statements in accordance with accounting principles generally accepted in the U.S., 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 accounting principles generally accepted in the U.S., 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, plant and equipment, and other assets. We believe that our most critical accounting estimates and assumptions are in the following areas: goodwill and other indefinite-lived intangible asset impairment assessment, defined benefit pension obligations, estimates of allowance for doubtful accounts, excess and obsolete inventory reserves, product warranty, other contingencies, derivative accounting, income taxes, and share based compensation.
Non-GAAP measures
Adjusted EBITDA
Adjusted EBITDA represents net income before interest expense, taxes, depreciation and amortization, as further adjusted for the other items reflected in the reconciliation table set forth below. This presentation is substantially consistent with the presentation used in our Term Loan Credit Agreement and ABL Credit Agreement. Note that the definitions of EBITDA in the new Term Loan Credit Agreement and ABL Credit Agreement are substantially the same as the definitions of EBITDA in previous credit agreements.
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 Term Loan Credit Agreement and ABL Credit Agreement but also because it assists us in comparing our performance across reporting periods on a consistent basis because 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 2012 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 our Company. Management believes that 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 Credit Agreement and ABL Credit Agreement (except where noted in footnote (h) below) 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 impairment and other charges, non-cash gains and 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;
|
•
|
are non-cash in nature, such as share-based compensation; or
|
•
|
were eliminated following the consummation of our initial public offering.
|
We explain in more detail in footnotes (a) through (h) 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 impairment 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;
|
•
|
the adjustments for business optimization expenses, which we believe are appropriate for the reasons set out in note (e) below, represent costs associated with severance and other items which are reflected in operating expenses and income (loss) from continuing operations in our condensed consolidated statements of comprehensive income 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 items that are included as 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 (such as business optimization adjustments) 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 Credit Agreement and ABL Credit Agreement, 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:
|
|
Three months ended September 30,
|
|
|
Nine months ended September 30,
|
|
(Dollars in thousands)
|
|
2012
|
|
|
2011
|
|
|
2012
|
|
|
2011
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
25,541
|
|
|
$
|
37,379
|
|
|
$
|
64,936
|
|
|
$
|
57,512
|
|
Interest expense
|
|
|
16,933
|
|
|
|
5,895
|
|
|
|
32,501
|
|
|
|
17,830
|
|
Depreciation and amortization
|
|
|
14,510
|
|
|
|
14,111
|
|
|
|
43,018
|
|
|
|
41,634
|
|
Income taxes provision
|
|
|
16,326
|
|
|
|
126
|
|
|
|
41,734
|
|
|
|
306
|
|
Non-cash impairment and other charges (a)
|
|
|
(391
|
)
|
|
|
1,402
|
|
|
|
(141
|
)
|
|
|
2,006
|
|
Non-cash share-based compensation expense (b)
|
|
|
2,764
|
|
|
|
1,745
|
|
|
|
8,021
|
|
|
|
5,462
|
|
Loss on extinguishment of debt (c)
|
|
|
-
|
|
|
|
-
|
|
|
|
14,308
|
|
|
|
186
|
|
Transaction costs and credit facility fees (d)
|
|
|
391
|
|
|
|
835
|
|
|
|
1,810
|
|
|
|
1,266
|
|
Business optimization expenses (e)
|
|
|
-
|
|
|
|
(21
|
)
|
|
|
-
|
|
|
|
277
|
|
Letter of credit fees (f)
|
|
|
32
|
|
|
|
12
|
|
|
|
39
|
|
|
|
1
|
|
Other state franchise taxes (g)
|
|
|
182
|
|
|
|
94
|
|
|
|
467
|
|
|
|
236
|
|
Holding company interest income (h)
|
|
|
-
|
|
|
|
(11
|
)
|
|
|
(12
|
)
|
|
|
(49
|
)
|
Adjusted EBITDA
|
|
$
|
76,288
|
|
|
$
|
61,567
|
|
|
$
|
206,681
|
|
|
$
|
126,667
|
|
(a) Represents the following non-cash charges:
•
for the three and nine months ended September 30, 2012, unrealized mark-to-market adjustments on copper forward contracts, loss on disposal of assets and an adjustment to an earn-out obligation in connection with a permitted business acquisition, as defined in our credit agreement;
•
for the three and nine months ended September 30, 2011, unrealized mark-to-market adjustments on copper forward contracts and a loss on disposal of assets;
We believe that adjusting net income for these non-cash charges is useful for the following reasons:
•
The loss on disposals of assets described above results from the sale of assets that are no longer useful in our business and therefore represents losses that are not from our core operations;
•
The adjustments for unrealized mark-to-market gains and losses on copper forward 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 income and cash flows to capture the full effect of these contracts on our operating performance;
(b) Represents share-based compensation expense to account for stock options, restricted stock and other stock awards over their vesting period;
(c) Represents the loss on extinguishment of debt from:
•
for the nine months ended September 30, 2012, represents the loss on extinguishment of debt related to the refinancing transactions that occurred on February 9, 2012 and May 30, 2012;
•
for the nine months ended September 30, 2011, represents the write-off of a portion of deferred financing costs related to the accelerated repayment of debt;
(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 revolving credit facility commitment fees under our senior secured credit facilities, 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;
•
transaction costs relating to the acquisition of a business;
•
other financing costs incurred related to the dividend recapitalization transaction;
(e) Represents severance costs incurred from restructuring-related activities. We do not believe the charges for restructuring-related activities reflect our ongoing operations. Although we have incurred severance costs in the past, it is difficult to predict the amounts of similar costs in the future, and we believe that adjusting for these costs aids in measuring the performance of our ongoing operations. We believe that these costs will tend to be immaterial to our results of operations in future periods.
(f) Represents primarily fees on letters of credit outstanding under our senior secured credit facilities, 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.
(g) Represents franchise and business activity taxes paid at the state level. We believe that the inclusion of these taxes in calculating Adjusted EBITDA is similar to the inclusion of income taxes, as set forth in the table above.
(h) Represents interest earned on cash held at Generac Holdings Inc. We exclude these amounts because we do not include them in the calculation of "Covenant EBITDA" under and as defined in our senior secured credit facilities.
Adjusted Net Income is defined as net income before 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 the Company’s debt, losses on extinguishment of the Company’s debt, intangible asset impairment charges (as applicable), transaction costs and other purchase accounting adjustments, and certain non-cash gains and losses as reflected in the reconciliation table set forth below (as applicable).
We believe Adjusted Net Income is used by securities analysts, investors and other interested parties in the evaluation of our company 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 results of operations, our cash flows, 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:
•
|
Adjusted Net Income does not reflect changes in, or cash requirements for, our working capital needs;
|
•
|
although amortization is a non-cash charge, the assets being amortized may have to be replaced in the future, and Adjusted Net Income does not reflect any cash requirements for such replacements;
|
•
|
other companies may calculate Adjusted Net Income differently than we do, limiting its usefulness as a comparative measure.
|
|
|
Three months ended September 30,
|
|
|
Nine months ended September 30,
|
|
(Dollars in thousands)
|
|
2012
|
|
|
2011
|
|
|
2012
|
|
|
2011
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
25,541
|
|
|
$
|
37,379
|
|
|
$
|
64,936
|
|
|
$
|
57,512
|
|
Provision for income taxes
|
|
|
16,326
|
|
|
|
126
|
|
|
|
41,734
|
|
|
|
306
|
|
Income before provision for income taxes
|
|
|
41,867
|
|
|
|
37,505
|
|
|
|
106,670
|
|
|
|
57,818
|
|
Amortization of intangible assets
|
|
|
12,389
|
|
|
|
11,987
|
|
|
|
36,902
|
|
|
|
35,570
|
|
Amortization of deferred financing costs and original issue discount
|
|
|
1,156
|
|
|
|
495
|
|
|
|
2,515
|
|
|
|
1,491
|
|
Transaction costs and other purchase accounting adjustments
|
|
|
(111
|
)
|
|
|
601
|
|
|
|
1,181
|
|
|
|
601
|
|
Loss on extinguishment of debt
|
|
|
-
|
|
|
|
-
|
|
|
|
14,308
|
|
|
|
186
|
|
Adjusted Net Income before provision for income taxes
|
|
|
55,301
|
|
|
|
50,588
|
|
|
|
161,576
|
|
|
|
95,666
|
|
Cash income tax expense
|
|
|
(1,156
|
)
|
|
|
(35
|
)
|
|
|
(1,483
|
)
|
|
|
(315
|
)
|
Adjusted Net Income
|
|
$
|
54,145
|
|
|
$
|
50,553
|
|
|
$
|
160,093
|
|
|
$
|
95,351
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Adjusted Net Income per common share - diluted:
|
|
$
|
0.78
|
|
|
$
|
0.75
|
|
|
$
|
2.32
|
|
|
$
|
1.41
|
|
Weighted average common shares outstanding - diluted:
|
|
|
69,166,501
|
|
|
|
67,646,423
|
|
|
|
68,980,970
|
|
|
|
67,433,740
|
|
New Accounting Standards
On January 1, 2012, the Company adopted Accounting Standards Update (ASU) No. 2011-05, “Comprehensive Income: Presentation of Comprehensive Income,” which requires companies to disclose items of net income, items of other comprehensive income and total comprehensive income either in a single continuous statement or in two separate but consecutive statements. The Company has included a statement of comprehensive income in this Form 10-Q. The adoption of this ASU had no impact on the Company’s financial condition or results of operations.
Except as noted, there have been no material changes since the March 9, 2012 filing of our Annual Report on Form 10-K for the fiscal year ended December 31, 2011.