UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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(Mark One)
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ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
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For the fiscal year ended December 31, 2011
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TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
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For the transition period from to
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Commission File Number 001-34627
(Exact name of registrant as specified in its charter)
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DELAWARE
(State or other jurisdiction of incorporation or formation)
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20-5654756
(IRS Employer Identification No.)
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S45 W29290 Hwy. 59, Waukesha, WI
(Address of principal executive offices)
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53189
(Zip Code)
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(262) 544-4811
(Registrant’s telephone number, including area code)
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SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
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Common Stock, $0.01 par value
(Title of class)
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New York Stock Exchange
(Name of exchange on which registered)
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SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT: None
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Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes x No o
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o No x
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 x No o
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 x No o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K o
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 definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
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Large accelerated filer o
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Accelerated filer x
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Non-accelerated filer o
(Do not check if a smaller
reporting company)
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Smaller reporting company o
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Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act) Yes o No x
The aggregate market value of the voting common equity held by non-affiliates of the registrant on June 30, 2011, the last business day of the registrant’s most recently completed second fiscal quarter, was approximately $494,323,000 based upon the closing price reported for such date on the New York Stock Exchange.
As of March 5, 2012, 67,906,706 shares of registrant's common stock were outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant’s Proxy Statement for the 2012 Annual Meeting of Stockholders (the “2012 Proxy Statement”), which will be filed by the registrant on or prior to 120 days following the end of the registrant’s fiscal year ended December 31, 2011, are incorporated by reference into Part III of this Form 10-K.
TABLE OF CONTENTS
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Page
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Forward-Looking Statements
This annual 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 annual 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 annual 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 annual report include estimates regarding:
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our business, financial and operating results and future economic performance;
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proposed new product and service offerings; and
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management's goals, expectations and objectives and other similar expressions concerning matters that are not historical facts.
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Factors that could affect our actual financial results and cause them to differ materially from those anticipated in the forward-looking statements include:
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demand for our products;
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frequency of major power outages;
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availability, cost and quality of raw materials and key components used producing our products;
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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;
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the risk that the Magnum Products business will not be integrated successfully;
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competitive factors in the industry in which we operate;
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our dependence on our distribution network;
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our ability to invest in, develop or adapt to changing technologies and manufacturing techniques;
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our ability to adjust to operating as a public company;
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loss of our key management and employees;
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increase in liability claims; and
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changes in environmental, health and safety laws and regulations.
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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 Item 1A of this Annual Report on Form 10-K.
Any forward-looking statement made by us in this annual 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.
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. We are the only significant market participant focused predominantly on these products, and we have one of the leading market positions in the power equipment markets in the United States and Canada. We design, manufacture, source and modify engines, alternators, automatic 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.
We have what we believe is an industry leading, multi-layered distribution network, and our products are available in thousands of outlets across the United States and Canada. We distribute our products through independent residential and industrial dealers, electrical wholesalers, national accounts, private label arrangements, retailers, catalogs, e-commerce merchants, equipment rental companies, equipment dealers and construction companies. We currently sell our products primarily in North America. We have a significant market share in the residential and light commercial generator markets, which we believe are currently under penetrated. We believe that our leading market position is largely attributable to our strategy of providing a broad product line of high-quality, innovative and affordable products through our extensive and multi-layered distribution network. In addition, through our acquisition of Magnum Products, we are a leading provider of light towers and mobile generators.
We own and operate four manufacturing plants and one distribution facility in Eagle, Wisconsin, Waukesha, Wisconsin, Berlin, Wisconsin and Whitewater, Wisconsin, totaling approximately 1,200,000 total square feet. We also maintain inventory warehouses in the United States that accommodate material storage and rapid response requirements of our customers.
Generac Holdings Inc. (Generac) is a Delaware corporation that was founded in 2006. Generac Power Systems, Inc., or Generac Power Systems, our principal operating subsidiary, is a Wisconsin corporation, which was founded in 1959 to market a line of affordable portable generators that offered superior performance and features. We expanded beyond portable generators in 1980 into the industrial market with the introduction of our first stationary generators that provided up to 200 kW. We entered the residential market in 1989 with a residential standby generator, and expanded our product development and global distribution system in the 1990s, forming a series of alliances that tripled our higher output generator net sales. In 1998, we sold our Generac® portable products business to the Beacon Group, a private equity firm, which eventually sold this business to Briggs & Stratton. Our growth accelerated in 2000 as we expanded our automatic residential standby generator product offering, implemented our multi-layered distribution philosophy, and introduced our quiet-running QT Series generators in 2005, accelerating our penetration in the commercial market. In 2008, we successfully expanded our position in the portable generator market after the expiration of our non-compete agreement with the Beacon Group entered into in connection with the aforementioned Beacon Group transaction. In late 2011, our subsidiary Magnum Power Products, LLC acquired the assets of the Magnum Products business (Magnum or Magnum Products) which is the number one light tower manufacturer in the U.S. and has a growing share of the mobile generator market. Today, we manufacture a full line of power products for a wide variety of applications and markets. Our success is built on engineering expertise, manufacturing excellence and our innovative approaches to the market.
CCMP transactions
In November 2006, affiliates of CCMP Capital Advisors, LLC, or CCMP, together with certain other investors and members of our management, purchased an aggregate of $689 million of our equity capital. In addition, on November 10, 2006, Generac Power Systems borrowed an aggregate of $1.38 billion, consisting of an initial drawdown of $950 million under a $1.1 billion first lien secured credit facility and $430 million under a $430 million second lien secured credit facility. With the proceeds from these equity and debt financings, together with cash on hand at Generac Power Systems, we (1) acquired all of the capital stock of Generac Power Systems and repaid certain pre-transaction indebtedness of Generac Power Systems for $2.0 billion, (2) paid $66 million in transaction costs related to the transaction and (3) retained $3.0 million for general corporate purposes.
We refer to the foregoing transactions collectively as the “CCMP Transactions.”
Initial public offering and corporate reorganization
On February 17, 2010, we completed our initial public offering (IPO) of 18,750,000 shares of our common stock at a price of $13.00 per share. In addition, on March 18, 2010, the underwriters exercised their option and purchased an additional 1,950,500 shares of our common stock from us. We received approximately $224.1 million in net proceeds at the initial closing, and approximately $23.8 million in net proceeds from the underwriters’ option exercise, after deducting the underwriting discount and total expenses related to the offering. The proceeds from the initial closing of the IPO were used entirely to pay down our second lien credit facility in full and to repay a portion of our first lien credit facility. Proceeds from the option exercise were used for general corporate purposes, including additional pre-payment of the first lien credit facility.
Our capitalization prior to the IPO consisted of Series A Preferred Stock, Class B Common Stock and Class A Common Stock. In connection with the IPO, we effected a corporate reorganization in which, after giving effect to a 3.294 for one reverse Class A Common Stock split, our Class B Common Stock and Series A Preferred Stock was converted into Class A Common Stock and our Class A Common Stock was then reclassified as common stock. Following the IPO, we have only one class of common stock outstanding. We refer to these transactions, as the “Corporate Reorganization.” For more information regarding our Corporate Reorganization, see “Item 7 - Management’s Discussion and Analysis of Financial Condition and Results of Operations – Corporate reorganization.”
Our products
We design, engineer and manufacture generators with an output of between 800W and 9mW, as well as other engine powered products such as light towers, pumps and power washers. In the manufacturing process, we design, manufacture, source and modify engines, alternators, transfer switches and other components necessary to production. We classify our products into three classes based on similar range of power output geared for varying end customer uses: residential power products; commercial and industrial power products; and other products. The following summary outlines our portfolio of products, including their key attributes and customer applications.
Residential power products
Our automatic residential standby generators range in output from 6kW to 60kW, with manufacturer's suggested retail prices, or MSRPs, from approximately $1,800 to $15,000. They operate on either natural gas or liquid propane and are permanently installed with an automatic transfer switch, which we also manufacture. Air-cooled residential standby generators range in outputs from 6kW to 20kW, are available in steel and aluminum enclosures and serve as an emergency backup for small to medium homes. Liquid-cooled generators serve as emergency backup for larger homes and small businesses and range in output from 20kW to 60kW. Liquid-cooled brands include the Guardian® Series and the premium Quietsource® Series, which have a quiet, low-speed engine and a standard aluminum enclosure.
We provide portable generators fueled by gasoline that range in size from 800W to 17,500W. These products serve as an emergency home backup and are used for construction and recreational purposes. Following the expiration of a non-compete agreement in 2007, we expanded our portable product offering to introduce portable generators below 12,500W. We currently have four portable product lines: the GP series, targeted at homeowners, ranging from 1,850W to 17,500W; the XG series, targeted at the premium homeowner markets, ranging from 4,000 to 10,000W; the XP series, targeted at the professional contractor market, ranging from 4,000 to 8,000W; and the iX series, targeted at the recreational market, ranging from 800W to 2,000W. With our acquisition of Gen-Tran in February 2012, we now offer manual transfer switches to supplement our portable generator product offering.
Residential power products comprised 63.0%, 62.9% and 62.0%, respectively, of total net sales in 2009, 2010 and 2011.
Industrial and commercial power products
Our light-commercial standby generators include a full range of affordable generators from 22kW to 150kW and related transfer switches, providing three-phase power sufficient for most small and mid-sized businesses including grocery stores, convenience stores, restaurants, gas stations, pharmacies, retail banks and small health care facilities. Our light-commercial generators run on natural gas or liquid propane thereby eliminating the fuel spillages, spoilage, environmental or odor concerns common with traditional diesel units.
We manufacture a broad line of standard and configured standby generators and related transfer switches for industrial applications. Our single-engine industrial generators range in output from 10kW to 600kW with our Modular Power System (MPS) technology extending our product range up to 9mW. We offer four fuel options including diesel, natural gas, liquid propane or Bi-Fuel™. Bi-Fuel™ generators operate on a combination of both diesel and natural gas to allow our customers the advantage of multiple fuel sources and extended run times. These units are primarily used as emergency backup for large healthcare, telecom, datacom, commercial office, municipal and manufacturing customers.
Our MPS technology combines the power of several smaller generators to produce the output of a larger generator, providing our customers with redundancy and scalability in a cost-effective manner. For larger industrial applications, our MPS products offer customers an efficient, affordable way to scale their standby power needs. By offering a series of smaller Generac generators integrated with Generac's proprietary PowerManager control system, we provide a lower cost alternative to traditional large, single-engine generators. The MPS product line also offers superior reliability given its built-in redundancy which allows individual units to be taken off-line for routine maintenance while retaining coverage for critical circuits.
We provide the telecommunications market our full range of generator systems, ranging from 20kW air-cooled generators to 3mW MPS.
Our light towers and mobile generators provide temporary lighting and power for various end markets, such as road and commercial construction, energy, mining, military and special events. We also manufacture mobile pumps which utilize wet and dry-priming pump systems for a wide variety of wastewater applications.
Industrial and commercial power products comprised 31.9%, 31.0% and 31.6%, respectively, of total net sales in 2009, 2010 and 2011.
Other power products
We sell aftermarket service parts to our dealers and proprietary engines to third-party original equipment manufacturers, or OEMs. We also sell RV generators, which are available in gasoline, liquid propane and diesel fuel models, directly to OEMs as well as aftermarket dealers.
Other power products comprise 5.1%, 6.1% and 6.4%, respectively, of total net sales in 2009, 2010 and 2011.
Distribution channels and customers
We distribute our product through several channels to increase awareness of our product categories and the Generac® and Magnum® brands, and to ensure our products reach a broad customer base. This distribution network includes independent residential and industrial dealers, wholesalers, national accounts, private label arrangements, retailers, catalogs, e-commerce merchants, equipment rental companies, equipment dealers and construction companies. We believe our distribution network is a competitive advantage that has strengthened over the last decade by expanding our network from our base of industrial dealers to include other channels of distribution as product offerings have increased. Our network is well balanced with no single sales channel providing more than 25% of our sales and no customer providing more than 8% of our sales in 2011.
Our dealer network, which is located principally in the United States and Canada, is the industry's largest network of independent generator contractors.
Our residential/commercial dealer network sells, installs and services our residential and light-commercial products to end users. We have developed a number of proprietary dealer management programs to evaluate, manage and incentivize our dealers, which we believe has an important impact on the high level of customer service we provide to end customers. These programs include both technical and sales training, under which we train new and existing dealers about our products, service and installation. We regularly perform market analyses to determine if a given market is either under-served or has poor residential dealer representation. Within these locations, we selectively add distribution or invest resources in existing dealer support and training to improve dealer performance.
Our industrial dealer network provides industrial and commercial end-users with on-going, local and nationwide product support. Our industrial dealers maintain the local relationships with commercial electrical contractors, specifying engineers and national account regional buying offices. Our sales group works in conjunction with our industrial dealers to ensure that national accounts receive engineering support, competitive pricing and nationwide service. We promote our industrial generators through the use of product demonstrations, specifying engineer education events, dealer forums and training. In recent years, we have been particularly focused on expanding our dealer network in Latin America in order to expand our international sales opportunities.
Our wholesaler network consists of selling branches of both national and local distribution houses for electrical and HVAC products. Our wholesalers distribute our residential and light-commercial generators and are a key introduction to the standby generator category for electrical and HVAC contractors who may not be Generac dealers.
On a selective basis, we have established private label and licensing arrangements with third party partners to provide residential, light-commercial and industrial generators. The partners include leading home equipment, electrical equipment and construction machinery companies, each of which provides access to incremental channels of distribution for our products. We have agreements in place with these partners having terms of between three and four years and further establishing additional terms and conditions of these arrangements.
Our retail distribution network includes thousands of locations and includes regional and national home improvement chains, retailers, clubs, buying groups and farm supply stores. These physical retail locations are supplemented by a number of catalogue and e-commerce retailers. This network primarily sells our residential standby, portable and light-commercial generators. In some cases, we have worked with our retail partners to create installation programs using our residential dealers to support the sale and installation of standby generator products sold at retail. We also use a combination of display units and advertising through our retail accounts to promote awareness for our products.
The distribution for our mobile products includes international, national and regional equipment rental companies, equipment dealers and construction companies.
Additionally, we sell certain generators and engines directly to OEM manufacturers and after-market dealers for use in the lawn and garden and RV markets.
Manufacturing
Our excellence in manufacturing reflects our philosophy of high standards, continuous improvement and commitment to quality. Our facilities showcase our advanced manufacturing techniques and demonstrate the effectiveness of lean manufacturing.
We continually seek to reduce manufacturing costs while improving product quality. We deliver an affordable product to our customers through our value engineering philosophy, our strategic foreign sourcing, our scale, and adherence to lean manufacturing principles. We believe we have sufficient capacity to achieve our business goals for the near term.
Our product quality is essential to maintaining a leading market position. Incoming shipments from our suppliers are tested to ensure engineering specifications are met. Purchased components are tested for quality at the supplier’s factory and prior to entering production lines and are continuously tested throughout the manufacturing process. Internal product and production audits are performed to ensure a reliable product and process. We test finished products under a variety of simulated conditions at each of our manufacturing facilities.
Research and development and intellectual property
Our primary focus on generators and engine powered equipment drives technological innovation, specialized engineering and manufacturing competencies. Research and development is a core competency and includes a staff of over 150 engineers working on numerous active projects. Our sponsored research and development expense was $10.8 million, $14.7 million and $16.5 million for the years ended December 2009, 2010 and 2011, respectively. Research and development is conducted at each of our manufacturing facilities and additionally at our technical center in Suzhou, China with dedicated teams for each product line. Research and development is focused on developing new technologies and product enhancements as well as maintaining product competitiveness by improving manufacturing costs, safety characteristics, reliability and performance while ensuring compliance with governmental standards. We have had over 30 years of experience using natural gas engines and have developed specific expertise with fuel systems and emissions technology. In the residential and light commercial markets, we have developed proprietary engines, cooling packages, controls, fuel systems and emissions systems. We believe that our expertise in engine powered equipment gives us the capability to develop new products that will allow continued diversification in our end markets.
We rely on a combination of patents and trademarks to establish and protect our proprietary rights. Our commitment to research and development has resulted in a portfolio of approximately 90 U.S. and international patents and patent applications. Our patents expire between 2016 and 2028 and protect certain features and technologies we have developed for use in our products including fuel systems, air flow, electronics and controls, noise reduction and air-cooled engines. U.S. trademark registrations generally have a perpetual duration if they are properly maintained and renewed. New U.S. patents that are issued generally have a life of 20 years from the date the patent application is initially filed. We believe the existence of these patents and trademarks, along with our ongoing processes to register additional patents and trademarks, protect our intellectual property rights and enhance our competitive position. We also use proprietary manufacturing processes that require customized equipment.
Suppliers of raw materials
Our primary raw material inputs are steel, copper and aluminum, all of which are purchased from third parties and, in many cases, as part of machined or manufactured components. We have developed an extensive network of reliable, low-cost suppliers in the United States and abroad. Our strategic global sourcing function continuously evaluates the cost structure of our products and capabilities of our supply chain, and sources components accordingly based on this evaluation. In 2011, we sourced more than half of our components from outside the United States.
Competition
The market for onsite standby generators is competitive. We face competition from a variety of large diversified industrial companies as well as smaller generator manufacturers abroad. However, most of the traditional participants in the standby generator market compete on a more specialized basis, focused on specific applications within their larger diversified product mix. We are the only significant market participant focused predominantly on standby and portable generators with broad capabilities across the residential, industrial and light-commercial generator markets. We believe that our engineering capabilities and core focus on generators provide us with manufacturing flexibility and enable us to maintain a first-mover advantage over our competition for product innovation. We also believe our broad product offering and diverse distribution model provide for additional advantages as well.
In the market for standby commercial and industrial generators, our primary competitors are Caterpillar, Cummins, Kohler and MTU, most of which focus on the market for diesel generators as they are also diesel engine manufacturers. In the market for residential standby generators, our primary competitors include Briggs & Stratton, Cummins (Onan division) and Kohler, which also have broad operations in other manufacturing businesses. In the portable generator market, our primary competitors include Briggs & Stratton, Honda and Techtronics International (TTI), along with a number of smaller domestic and foreign competitors. In the market for mobile generators, our primary competitors are Doosan/IR, Aggreko, Caterpiller and Wacker. Our competitors in the market for light towers include Terex, Allmand and Wacker.
There are a number of other standby generator manufacturers located outside North America, but most supply their products mainly to their respective regional markets. In a continuously evolving sector, we believe our size and broad capabilities make us well positioned to remain competitive.
We compete primarily on the basis of brand reputation, quality, reliability, pricing, innovative features, breadth of product and product availability.
Employees
As of December 31, 2011, we had 2,223 employees (2,021 full time and 202 part-time and temporary employees). Of those, 1,364 employees were directly involved in manufacturing at our manufacturing facilities.
We have had an “open shop” bargaining agreement for the past 45 years. Our current agreement is with the Communication Workers of America, Local 4603. The current agreement, which expires October 17, 2016, covers our Waukesha and Eagle facilities. Currently, less than 2% of our workforce is a member of a labor union. Our facilities in Whitewater, Wisconsin and Berlin, Wisconsin are not unionized.
As a manufacturing company, our operations are subject to a variety of foreign, federal, state and local environmental, health and safety laws and regulations including those governing, among other things, emissions to air, discharges to water, noise and the generation, handling, storage, transportation, treatment and disposal of waste and other materials. In addition, our products are subject to various laws and regulations relating to, among other things, emissions and fuel requirements, as well as labeling and marketing.
Our products are regulated by the U.S. Environmental Protection Agency (EPA), California Air Resources Board (CARB) and various other state and local air quality management districts. These governing bodies continue to pass regulations that require us to meet more stringent emission standards, and all of our engines and engine-driven products are regulated within the United States and its territories. Other countries have various degrees of regulation depending upon product application and fuel types. New regulations could require us to redesign our products and could affect market growth for our products.
Segment information
We refer you to Note 2, “Segment Reporting,” of our consolidated financial statements included in Item 8 of this Annual Report on Form 10-K for information about our business segment and geographic areas.
Executive officers
The following table sets forth information regarding our executive officers:
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Position
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Aaron P. Jagdfeld
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Chief Executive Officer and Director
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York A. Ragen
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Chief Financial Officer
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Dawn A. Tabat
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Chief Operating Officer
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Terrence J. Dolan
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Executive Vice President, Industrial Products
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Russell S. Minick
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Executive Vice President, Residential Products
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Allen A. Gillette
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Senior Vice President, Engineering
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Roger W. Schaus, Jr.
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Senior Vice President, Service Operations
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Roger F. Pascavis
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Senior Vice President, Operations
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Aaron P. Jagdfeld has served as our Chief Executive Officer since September 2008 and as a director since November 2006. Prior to becoming Chief Executive Officer, Mr. Jagdfeld worked for Generac for 15 years. He began his career in the finance department in 1994 and became our Chief Financial Officer in 2002. In 2007, he was appointed president and was responsible for sales, marketing, engineering and product development. Prior to joining Generac, Mr. Jagdfeld worked in the audit practice of the Milwaukee, Wisconsin office of Deloitte and Touche. Mr. Jagdfeld holds a Bachelor of Business Administration in Accounting from the University of Wisconsin-Whitewater.
York A. Ragen has served as our Chief Financial Officer since September 2008. Prior to becoming Chief Financial Officer, Mr. Ragen held Director of Finance and Vice President of Finance positions at Generac. Prior to joining Generac in 2005, Mr. Ragen was Vice President, Corporate Controller at APW Ltd., a spin-off from Applied Power Inc., now known as Actuant Corporation. Mr. Ragen began his career in the Audit division of Arthur Andersen's Milwaukee office. Mr. Ragen holds a Bachelor of Business Administration in Accounting from the University of Wisconsin-Whitewater.
Dawn A. Tabat has served as our Chief Operating Officer since 2002. Ms. Tabat joined Generac in 1972 and served as Personnel Manager and Personnel Director before being promoted to Vice President of Human Resources in 1992. During this period, Ms. Tabat was responsible for creating the human resource function within Generac, including recruiting, compensation, training and workforce relations. In her current position, Ms. Tabat oversees manufacturing, logistics, global supply chain, quality, safety and information services.
Terrence J. Dolan began serving as our Executive Vice President of Industrial Products in October 2011. Prior to becoming Executive Vice President of Industrial Products, he served as our Senior Vice President of Sales from January 2010 to October 2011. Prior to joining Generac, Mr. Dolan was Senior Vice President of Business Development and Marketing at Boart Longyear from 2007 to 2008, Vice President of Sales and Marketing at Ingersoll Rand from 2002 to 2007, and Director of Strategic Accounts at Case Corporation from 1991 to 2001. Mr. Dolan holds a B.A. in Management and Communications from Concordia University.
Russell S. Minick joined Generac in August 2011, and was named Executive Vice President of Residential Products in October 2011. Prior to joining Generac, Mr. Minick was President & CEO of Home Care Products for Electrolux from 2006 to 2011, President of The Gunlocke Company at HNI Corporation from 2003 to 2006, Senior Vice President of Sales, Marketing and Product Development at True Temper Sports from 2002 to 2003, and General Manager of Extended Warranty Operations for Ford Motor Company from 1998 to 2002. Mr. Minick is a graduate of the University of Northern Iowa, and holds a degree in marketing.
Allen A. Gillette is our Senior Vice President of Engineering. Mr. Gillette joined Generac in 1998 and has served as Engineering Manager, Director of Engineering and Vice President of Engineering. Prior to joining Generac, Mr. Gillette was Manager of Engineering at Transamerica Delaval Enterprise Division, Chief Engineer—High-Speed Engines at Ajax-Superior Division and Manager of Design & Development, Cooper-Bessemer Reciprocating Products Division. Mr. Gillette holds an M.S. in Mechanical Engineering from Purdue University and a B.S. in Mechanical Engineering from Gonzaga University.
Roger W. Schaus, Jr. serves as our Senior Vice President of Service Operations. Mr. Schaus joined Generac in 1988 and has served as Director of Manufacturing Services, Vice President of Manufacturing Services and Senior Vice President of Operations. Prior to joining Generac, Mr. Schaus was a Manufacturing Area Manager for Harley Davidson Motor Company in Wauwatosa, Wisconsin and a Plant Manager for Custom Products in Menomonee Falls, Wisconsin. Mr. Schaus holds a B.S. in Agricultural Economics from the University of Wisconsin, Madison.
Roger F. Pascavis has served as our Senior Vice President of Operations since January 2008. Mr. Pascavis joined Generac in 1995 and has served as Director of Materials and Vice President of Operations. Prior to joining Generac, Mr. Pascavis was a Plant Manager for MTI in Waukesha, Wisconsin. Mr. Pascavis holds a B.S. in Industrial Technology from the University of Wisconsin, Stout and an M.B.A. from Lake Forest Graduate School of Management.
You should carefully consider the following risks. These risks could materially affect our business, results of operations or financial condition, cause the trading price of our common stock to decline materially or cause our actual results to differ materially from those expected or those expressed in any forward-looking statements made by us or on our behalf. These risks are not exclusive, and additional risks to which we are subject include, but are not limited to, the factors mentioned under “Forward-Looking Statements” and the risks of our businesses described elsewhere in this Report.
Risk factors related to our business and industry
Demand for our products is significantly affected by unpredictable major power-outage events that can lead to substantial variations in, and uncertainties regarding, our financial results from period to period.
Sales of our products are subject to consumer buying patterns, and demand for our products is affected by power outage events caused by thunderstorms, hurricanes, ice storms, blackouts and other grid reliability issues. The impact of these outage events on our sales can vary depending on the location and severity of the outages. Sustained periods without major power disruptions can lead to reduced consumer awareness of the benefits of standby and portable generator products and can result in reduced sales growth rates and excess inventory. The lack of major power-outage events can affect our net sales in the years following a given storm season. Unpredictable fluctuations in demand are therefore part of managing our business, and these fluctuations could have an adverse effect on our net sales and profits. Despite their unpredictable nature, we believe major power outages create awareness and accelerate adoption for our home standby products.
Demand for our products is significantly affected by durable goods spending by consumers and businesses and other macroeconomic conditions.
Our business is affected by general economic conditions, and uncertainty or adverse changes such as the prolonged downturn in U.S. residential investment and the impact of more stringent credit standards could lead to a decline in demand for our products and pressure to reduce our prices. Our sales of light-commercial and industrial generators are affected by conditions in the non-residential construction sector and by the capital investment trends for small and large businesses and municipalities. If these businesses and municipalities cannot access credit markets or do not utilize discretionary funds to purchase our products as a result of the economy or other factors, our business could suffer and our ability to realize benefits from our strategy of increasing sales in the light-commercial and industrial sectors through, among other things, our focus on innovation and product development, including natural gas engine and modular technology, could be adversely affected. In addition, consumer confidence and home remodeling expenditures have a significant impact on sales of our residential products, and prolonged periods of weakness in consumer durable goods spending could have a material impact on our business. Typically, we do not have contracts with our customers, and we cannot guarantee that our current customers will continue to purchase our products. If general economic conditions or consumer confidence were to worsen, or if the non-residential construction sector or rate of capital investments were to decline, our net sales and profits would likely be adversely affected. Additionally, timing of capital spending by our national account customers can vary from quarter-to-quarter based on capital availability and internal capital spending budgets.
Decreases in the availability and quality, or increases in the cost, of raw materials and key components we use could materially reduce our earnings.
The principal raw materials that we use to produce our products are steel, copper and aluminum. We also source a significant number of component parts from third parties that we utilize to manufacture our products. The prices of those raw materials and components are susceptible to significant fluctuations due to trends in supply and demand, transportation costs, government regulations and tariffs, price controls, economic conditions and other unforeseen circumstances beyond our control. We do not have long-term supply contracts in place to ensure the raw materials and components we use are available in necessary amounts or at fixed prices. If we are unable to mitigate raw material or component price increases through product design improvements, price increases to our customers, manufacturing productivity improvements, or hedging transactions, our profitability could be adversely affected. Also, our ability to continue to obtain quality materials and components is subject to the continued reliability and viability of our suppliers, including in some cases, suppliers who are the sole source of certain important components. If we are unable to obtain adequate, cost efficient or timely deliveries of required raw materials and components, we may be unable to manufacture sufficient quantities of products on a timely basis. This could cause us to lose sales, incur additional costs, delay new product introductions or suffer harm to our reputation.
The industry in which we compete is highly competitive, and our failure to compete successfully could adversely affect our results of operations and financial condition.
We operate in markets that are highly competitive. Some of our competitors have established brands and are larger in size or are divisions of large diversified companies and have substantially greater financial resources. Some of our competitors may be willing to reduce prices and accept lower margins in order to compete with us. In addition, we could face new competition from large international or domestic companies with established industrial brands that enter our end markets. Demand for our products may also be affected by our ability to respond to changes in design and functionality, to respond to downward pricing pressure, and to provide shorter lead times for our products than our competitors. If we are unable to respond successfully to these competitive pressures, we could lose market share, which could have an adverse impact on our results. For more information, see “Item 1—Business—Competition.”
Our industry is subject to technological change, and our failure to continue developing new and improved products and to bring these products rapidly to market could have an adverse impact on our business.
New products, or refinements and improvements of existing products, may have technical failures, their introduction may be delayed, they may have higher production costs than originally expected or they may not be accepted by our customers. If we are not able to anticipate, identify, develop and market high quality products in line with technological advancements that respond to changes in customer preferences, demand for our products could decline and our operating results could be adversely affected.
We rely on independent dealers and distribution partners, and the loss of these dealers and distribution partners, or of any of our sales arrangements with significant private label, telecommunications, retail or equipment rental customers, would adversely affect our business.
In addition to our direct sales force and manufacturer sales representatives, we depend on the services of independent distributors and dealers to sell our products and provide service and aftermarket support to our end customers. We also rely upon our distribution channels to drive awareness for our product categories and our brands. In addition, we sell our products to end users through private label arrangements with leading home equipment, electrical equipment and construction machinery companies, arrangements with top retailers and equipment rental companies, and our direct national accounts with telecommunications and industrial customers. Our distribution agreements and any contracts we have with large telecommunications, retail and other customers are typically not exclusive, and many of the distributors and customers with whom we do business offer products and services of our competitors. Impairment of our relationships with our distributors, dealers or large customers, loss of a substantial number of these distributors or dealers or of one or more large customers, or an increase in our distributors' or dealers' sales of our competitors' products to our customers or of our large customers' purchases of our competitors' products could materially reduce our sales and profits. Also, our ability to successfully realize our growth strategy is dependent in part on our ability to identify, attract and retain new distributors at all layers of our distribution platform, and we cannot be certain that we will be successful in these efforts.
Our business could be negatively impacted if we fail to adequately protect our intellectual property rights or if third parties claim that we are in violation of their intellectual property rights.
We view our intellectual property rights as important assets. We seek to protect our intellectual property rights through a combination of patent, trademark, copyright and trade secret laws, as well as licensing and confidentiality agreements. These protections may not be adequate to prevent third parties from using our intellectual property without our authorization, breaching any confidentiality agreements with us, copying or reverse engineering our products, or developing and marketing products that are substantially equivalent to or superior to our own. The unauthorized use of our intellectual property by others could reduce our competitive advantage and harm our business. If it became necessary for us to litigate to protect these rights, any proceedings could be burdensome and costly and we may not prevail. We cannot guarantee that any patents, issued or pending, will provide us with any competitive advantage or will not be challenged by third parties. Moreover, the expiration of our patents may lead to increased competition with respect to certain products.
In addition, we cannot be certain that we do not or will not infringe third parties' intellectual property rights. Any such claim, even if it is without merit, may be expensive and time-consuming to defend, subject us to damages, cause us to cease making, using or selling certain products that incorporate the disputed intellectual property, require us to redesign our products, divert management time and attention and/or require us to enter into costly royalty or licensing arrangements. Furthermore, in connection with our sale of Generac Portable Products to the Beacon Group in 1998, we granted the Beacon Group an exclusive perpetual license for the use of the “Generac Portable Products” trademark in connection with the manufacture and sale of certain engine driven consumer products. This perpetual license was eventually transferred to Briggs and Stratton (Briggs) when the Beacon Group sold that business to Briggs. Currently, this trademark is not being used in commerce. However, in the event that the Beacon Group or Briggs use this trademark in the future, we could suffer competitive confusion and our business could be negatively impacted.
Our operations are subject to various environmental, health and safety laws and regulations, and non-compliance with or liabilities under such laws and regulations could result in substantial costs, fines, sanctions and claims.
Our operations are subject to a variety of foreign, federal, state and local environmental, health and safety laws and regulations including those governing, among other things, emissions to air, discharges to water, noise, the generation, handling, storage, transportation, treatment and disposal of waste and other materials. In addition, under federal and state environmental laws, we could be required to investigate, remediate and/or monitor the effects of the release or disposal of materials both at sites associated with past and present operations and at third-party sites where wastes generated by our operations were disposed. This liability may be imposed retroactively and whether or not we caused, or had any knowledge of, the existence of these materials and may result in our paying more than our fair share of the related costs. Violations of or liabilities under such laws and regulations could result in substantial costs, fines and civil or criminal proceedings or personal injury and workers' compensation claims.
Our products are subject to substantial government regulation.
Our products are subject to extensive statutory and regulatory requirements governing, among other things, emissions and noise, including standards imposed by the federal Environmental Protection Agency, or EPA, state regulatory agencies, such as CARB, and other regulatory agencies around the world. These laws are constantly evolving and many are becoming increasingly stringent. Changes in applicable laws or regulations, or in the enforcement thereof, could require us to redesign our products and could adversely affect our business or financial condition in the future. Developing and marketing products to meet such new requirements could result in substantial additional costs that may be difficult to recover in some markets. In some cases, we may be required to modify our projects or develop new products to comply with new regulations, particularly those relating to air emissions. For example, we were required to modify our spark-ignited air-cooled gaseous engines to comply with the 2011 EPA and CARB regulations, as well as the continued implementation of Tier 4 nonroad diesel engine changes associated with the Magnum acquisition. Typically, additional costs associated with significant compliance modifications are passed on to the market. While we have been able to meet previous deadlines, failure to comply with other existing and future regulatory standards could adversely affect our position in the markets we serve.
We may incur costs and liabilities as a result of product liability claims.
We face a risk of exposure to product liability claims in the event that the use of our products is alleged to have resulted in injury or other damage. Although we currently maintain product liability insurance coverage, we may not be able to obtain such insurance on acceptable terms in the future, if at all, or obtain insurance that will provide adequate coverage against potential claims. Product liability claims can be expensive to defend and can divert the attention of management and other personnel for long periods of time, regardless of the ultimate outcome. A significant unsuccessful product liability defense could have a material adverse effect on our financial condition and results of operations. In addition, we believe our business depends on the strong brand reputation we have developed. If our reputation is damaged, we may face difficulty in maintaining our market share and pricing with respect to some of our products, which could reduce our sales and profitability.
The loss of any key members of our senior management team or key employees could disrupt our operations and harm our business.
Our success depends, in part, on the efforts of certain key individuals, including the members of our senior management team, who have significant experience in the power products industry. If, for any reason, our senior executives do not continue to be active in management, or if our key employees leave our company, our business, financial condition or results of operations could be adversely affected. Failure to continue to attract these individuals at reasonable compensation levels could have a material adverse effect on our business, liquidity and results of operations. Although we do not anticipate that we will have to replace any of these individuals in the near future, the loss of the services of any of our key employees could disrupt our operations and have a material adverse effect on our business.
Disruptions caused by labor disputes or organized labor activities could harm our business.
We may from time to time experience union organizing activities in our non-union facilities. Disputes with the current labor union or new union organizing activities could lead to work slowdowns or stoppages and make it difficult or impossible for us to meet scheduled delivery times for product shipments to our customers, which could result in loss of business. In addition, union activity could result in higher labor costs, which could harm our financial condition, results of operations and competitive position.
We may experience material disruptions to our manufacturing operations.
While we seek to operate our facilities in compliance with applicable rules and regulations and take measures to minimize the risks of disruption at our facilities, a material disruption at one of our manufacturing facilities could prevent us from meeting customer demand, reduce our sales and/or negatively impact our financial results. Any of our manufacturing facilities, or any of our machines within an otherwise operational facility, could cease operations unexpectedly due to a number of events, including:
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equipment or information technology infrastructure failure;
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disruptions in the transportation infrastructure including roads, bridges, railroad tracks;
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fires, floods, tornados, earthquakes, or other catastrophes; and
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other operational problems.
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In addition, the vast majority of our manufacturing and production facilities are located in Wisconsin within a 100-mile radius. We could experience prolonged periods of reduced production due to unforeseen events occurring in or around our manufacturing facilities in Wisconsin. In the event of a business interruption at our Wisconsin facilities, we may be unable to shift manufacturing capabilities to alternate locations, accept materials from suppliers or meet customer shipment needs, among other severe consequences. Such an event could have a material and adverse impact on our financial condition and results of our operations.
A significant portion of our purchased components are sourced in foreign countries, exposing us to additional risks that may not exist in the United States.
We source a significant portion of our purchased components overseas, primarily in Asia and Europe. Our international sourcing subjects us to a number of potential risks in addition to the risks associated with third-party sourcing generally. Such risks include:
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inflation or changes in political and economic conditions;
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unstable regulatory environments;
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changes in import and export duties;
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domestic and foreign customs and tariffs;
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currency rate fluctuations;
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trade restrictions;
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labor unrest;
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logistical and communications challenges; and
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other restraints and burdensome taxes.
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These factors may have an adverse effect on our ability to efficiently and cost effectively source our purchased components overseas. In particular, if the U.S. dollar were to depreciate significantly against the currencies in which we purchase raw materials from foreign suppliers, our cost of goods sold could increase materially, which would adversely affect our results of operations.
As a U.S. corporation that sources components in foreign countries, we are subject to the Foreign Corrupt Practices Act. A determination that we violated this act may affect our business and operations adversely.
As a U.S. corporation, we are subject to the regulations imposed by the U.S. Foreign Corrupt Practices Act, or the FCPA, which generally prohibits U.S. companies and their intermediaries from making improper payments to foreign officials for the purpose of obtaining or keeping business. Any determination that we have violated the FCPA could have a material adverse effect on our financial position, operating results and cash flows.
We have significant tax assets, usage of which may be subject to limitations in the future.
As of December 31, 2011, we had approximately $127.1 million of net operating loss carryforwards for U.S. federal income tax purposes. 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 carryforwards to offset future federal income tax liabilities.
Our total assets include goodwill and other indefinite-lived intangibles. If we determine these have become impaired in the future, net income could be materially adversely affected.
Goodwill represents the excess of cost over the fair market value of net assets acquired in business combinations. Indefinite-lived intangibles are comprised of certain trade names. At December 31, 2011, goodwill and other indefinite-lived intangibles totaled $695.9 million, most of which arose from the CCMP Transactions. We review goodwill and other intangibles at least annually for impairment and any excess in carrying value over the estimated fair value is charged to the results of operations. A reduction in net income resulting from the write-down or impairment of goodwill or indefinite-lived intangibles, such as the $9.4 million non-cash charge recorded in the fourth quarter of 2011 primarily related to the write down of a certain trade name as we strategically transition to the Generac brand, could have a material adverse effect on our financial statements.
Goodwill and identifiable intangible assets are recorded at fair value on the date of acquisition. In accordance with FASB ASC (Accounting Standards Codification) Topic 350-20, goodwill and indefinite lived intangibles are reviewed at least annually for impairment and definite-lived intangible assets are reviewed for impairment whenever events or changes in circumstances indicate that their carrying value may not be recoverable. Future impairment may result from, among other things, deterioration in the performance of the acquired business or product line, adverse market conditions and changes in the competitive landscape, adverse changes in applicable laws or regulations, including changes that restrict the activities of the acquired business or product line, and a variety of other circumstances. The amount of any impairment is recorded as a charge to the statement of operations. We may never realize the full value of our intangible assets. Any future determination requiring the write-off of a significant portion of intangible assets would have an adverse effect on our financial condition and results of operations. See “Item 7—Management's Discussion and Analysis of Financial Condition and Results of Operations” for details.
We may need additional capital to finance our growth strategy or to refinance our existing credit facilities, and we may not be able to obtain it on acceptable terms, or at all, which may limit our ability to grow.
We may require additional financing to expand our business. Financing may not be available to us or may be available to us only on terms that are not favorable. The terms of our senior secured credit facilities limit our ability to incur additional debt. In addition, economic conditions, including a downturn in the credit markets, could impact our ability to finance our growth on acceptable terms or at all. If we are unable to raise additional funds or obtain capital on acceptable terms, we may have to delay, modify or abandon some or all of our growth strategies. In February 2012, we completed the planned refinancing of our former credit facility, and the new credit facility is comprised of a $150 million unfunded Revolver, a $325 million Term Loan A and $250 million Term Loan B. The Revolver and Term Loan A both have a five (5) year term, with interest payable on a leveraged-based pricing grid starting at LIBOR plus 2.25%. The Term Loan B matures in seven (7) years and accrues interest at LIBOR plus 2.75% with a LIBOR floor of 1.0%. For more information regarding the refinance of our credit facility see “Item 8 – Financial Statements and Supplementary Data – “16. Subsequent Events.” In the future, if we are unable to refinance such facilities on acceptable terms, our liquidity could be adversely affected.
We are unable to determine the specific impact of changes in selling prices or changes in volumes of our products on our net sales.
Because of the wide range of products that we sell, the level of customization for many of our products, the frequent rollout of new products and the fact that we do not apply pricing changes uniformly across our entire portfolio of products, we are unable to determine with specificity the effect of volume changes or changes in selling prices on our net sales.
We may not realize all of the anticipated benefits of our acquisition of the Magnum Products business or those benefits may take longer to realize than expected. We may also encounter significant unexpected difficulties in integrating the two businesses.
Our ability to realize the anticipated benefits of the Magnum Products acquisition, which was consummated on October 3, 2011, will depend, to a large extent, on our ability to integrate the Magnum Products business with our business. The combination of two independent businesses is a complex, costly and time-consuming process. As a result, we will be required to devote significant management attention and resources to integrating the business practices and operations of the Magnum Products business with ours. The integration process may disrupt our business and, if implemented ineffectively, would preclude realization of the full benefits expected by us. Our failure to meet the challenges involved in integrating the Magnum Products business into our existing operations or otherwise to realize the anticipated benefits of the transaction could cause an interruption of, or a loss of momentum in, our activities and could adversely affect our results of operations.
In addition, the overall integration of the Magnum Products business may result in material unanticipated problems, expenses, liabilities, competitive responses, loss of customer relationships, and diversion of management's attention, and may cause our stock price to decline.
The difficulties of combining the operations of the companies include, among others:
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managing a larger company;
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maintaining employee morale and retaining key management and other employees;
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integrating two business cultures, which may prove to be incompatible;
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the possibility of faulty assumptions underlying expectations regarding the integration process;
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retaining existing customers and attracting new customers;
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consolidating corporate and administrative infrastructures and eliminating duplicative operations;
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the diversion of management's attention from ongoing business concerns and performance shortfalls as a result of the diversion of management's attention to the acquisition;
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unanticipated issues in integrating information technology, communications and other systems;
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unanticipated changes in applicable laws and regulations;
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managing tax costs or inefficiencies associated with integrating the operations of the combined company;
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unforeseen expenses or delays associated with the acquisition;
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difficulty comparing financial reports due to differing financial and/or internal reporting systems; and
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making any necessary modifications to internal financial control standards to comply with the Sarbanes-Oxley Act of 2002 and the rules and regulations promulgated thereunder.
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Many of these factors will be outside of our control and any one of them could result in increased costs, decreases in the amount of expected revenues and diversion of management's time and energy, which could materially impact our business, financial condition and results of operations. In addition, even if the operations of the Magnum Products business are integrated successfully with our operations, we may not realize the full benefits of the transaction, including the synergies, cost savings or sales or growth opportunities that we expect. These benefits may not be achieved within the anticipated time frame, or at all. Or, additional unanticipated costs may be incurred in the integration of our businesses. All of these factors could cause dilution to our earnings per share, decrease or delay the expected accretive effect of the acquisition, and cause a decrease in the price of our common stock. As a result, we cannot assure you that the combination of the Magnum Products business with our business will result in the realization of the full benefits anticipated from the transaction.
Risks related to our common stock
If securities or industry analysts do not publish research or reports about our business, if they adversely change their recommendations regarding our common stock or if our results of operations do not meet their expectations, our common stock price and trading volume could decline.
The trading market for our common stock will be influenced by the research and reports that industry or securities analysts publish about us or our business. If one or more of these analysts cease coverage of our company or fail to publish reports on us regularly, we could lose visibility in the financial markets, which in turn could cause our stock price or trading volume to decline. Moreover, if one or more of the analysts who cover us downgrade recommendations regarding our stock, or if our results of operations do not meet their expectations, our stock price could decline and such decline could be material.
Anti-takeover provisions in our amended and restated certificate of incorporation and by-laws could prohibit a change of control that our stockholders may favor and could negatively affect our stock price.
Provisions in our amended and restated certificate of incorporation and by-laws may make it more difficult and expensive for a third party to acquire control of us even if a change of control would be beneficial to the interests of our stockholders. These provisions could discourage potential takeover attempts and could adversely affect the market price of our common stock. These provisions may also prevent or frustrate attempts by our stockholders to replace or remove our management. For example, our amended and restated certificate of incorporation and by-laws:
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permit our board of directors to issue preferred stock with such terms as they determine, without stockholder approval;
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provide that only one-third of the members of the board are elected at each stockholders meeting and prohibit removal without cause;
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require advance notice for stockholder proposals and director nominations; and
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contain limitations on convening stockholder meetings.
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These provisions make it more difficult for stockholders or potential acquirers to acquire us without negotiation and could discourage potential takeover attempts and could adversely affect the market price of our common stock.
Risks related to our capital structure
We have a significant amount of indebtedness which could adversely affect our cash flow and our ability to remain in compliance with debt covenants and make payments on our indebtedness.
We have a significant amount of indebtedness. As of December 31, 2011, we had total indebtedness of $597.9 million. As of February 9, 2012 our total indebtedness was further reduced to $575.0 million. While we reduced this amount of debt during 2010, 2011 and 2012 through the use of the proceeds of our IPO and of cash on hand, including an additional prepayment of debt of $74.2 million in December of 2010, $24.7 million in April of 2011, $34.6 million in December of 2011 and $22.9 million in February 2012 (as discussed elsewhere in this report under “Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operations”), we still have a significant amount of indebtedness. Our significant level of indebtedness increases the possibility that we may be unable to generate cash sufficient to pay, when due, the principal of, interest on or other amounts due in respect of our indebtedness. Our significant indebtedness, combined with our lease and other financial obligations and contractual commitments could have other important consequences. For example, it could:
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make it more difficult for us to satisfy our obligations with respect to our indebtedness, including financial and other restrictive covenants, which could result in an event of default under the agreements governing our indebtedness;
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make us more vulnerable to adverse changes in general economic, industry and competitive conditions and adverse changes in government regulation;
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require us to dedicate a substantial portion of our cash flow from operations to payments on our indebtedness, thereby reducing the availability of our cash flows to fund working capital, capital expenditures, acquisitions and other general corporate purposes;
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limit our flexibility in planning for, or reacting to, changes in our business and the industry in which we operate;
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place us at a competitive disadvantage compared to our competitors that have less debt; and
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limit our ability to borrow additional amounts for working capital, capital expenditures, acquisitions, debt service requirements, execution of our business strategy or other purposes.
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Any of the above-listed factors could materially adversely affect our business, financial condition, results of operations and cash flows. While we maintain interest rate swaps covering a significant portion of our outstanding debt, our interest expense could increase if interest rates increase because debt under our senior secured credit facilities bears interest at a variable rate. If we do not have sufficient earnings to service our debt, we may be required to refinance all or part of our existing debt, sell assets, borrow more money or sell securities, none of which we can guarantee we will be able to do.
The terms of our senior secured credit facilities restrict our current and future operations, particularly our ability to respond to changes in our business or to take certain actions.
Our former senior secured credit facilities contained, and any future indebtedness of ours or our subsidiaries would likely contain, a number of restrictive covenants that impose significant operating and financial restrictions on us and our subsidiaries, including restrictions on our ability to engage in acts that may be in our best long-term interests. Our new senior secured credit facilities entered into on February 9, 2012 include certain financial covenants.
The new credit facility requires Generac Power Systems to maintain a maximum leverage ratio (as defined in the senior secured credit facility) of 4.00 to 1.00 from the periods June 30, 2012 to September 30, 2012, and 3.75 to 1.00 thereafter. As of December 31, 2011, Generac Power Systems' leverage ratio was 2.83. In addition, the new credit facility requires Generac Power Systems to maintain a minimum interest coverage ratio (as defined in the senior secured credit facility) of 2.50 to 1.00 from June 30, 2012 to September 30, 2012, 2.75 to 1.00 from December 31, 2012 to June 30, 2013, 3.00 to 1.00 from September 30, 2013 to June 30, 2014 and 3.25 to 1.00 thereafter. As of December 31, 2011, Generac Power Systems’ interest coverage ratio was 8.55. Failure to comply with such covenants would result in an event of default under our new senior secured credit facilities unless waived by our lenders.
Our new senior secured credit facilities require us to use a portion of excess cash flow and proceeds of certain asset sales that are not reinvested in our business and other dispositions to repay indebtedness under our senior secured credit facilities.
Our new senior secured credit facilities also include covenants restricting, among other things, our ability to:
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incur liens;
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incur or assume additional debt or guarantees or issue preferred stock;
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pay dividends, or make redemptions and repurchases, with respect to capital stock;
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prepay, or make redemptions and repurchases of, subordinated debt;
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make loans and investments;
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make capital expenditures;
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engage in mergers, acquisitions, asset sales, sale/leaseback transactions and transactions with affiliates;
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change the business conducted by us or our subsidiaries; and
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amend the terms of subordinated debt.
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The operating and financial restrictions and covenants in our new senior secured credit facilities and any future financing agreements may adversely affect our ability to finance future operations or capital needs or to engage in other business activities. A breach of any of the restrictive covenants in our new senior secured credit facilities would result in a default under our new senior secured credit facilities. If any such default occurs, the lenders under our new senior secured credit facilities may elect to declare all outstanding borrowings, together with accrued interest and other fees, to be immediately due and payable, or enforce their security interest, any of which would result in an event of default. The lenders will also have the right in these circumstances to terminate any commitments they have to provide further borrowings.
Our principal stockholder continues to have substantial control over us.
Affiliates of CCMP collectively beneficially own approximately 59.0% of our outstanding common stock. As a consequence, CCMP or its affiliates are able to exert a significant degree of influence or actual control over our management and affairs and will control matters requiring stockholder approval, including the election of directors, a merger, consolidation or sale of all or substantially all of our assets, and any other significant transaction. The interests of this stockholder may not always coincide with our interests or the interests of our other stockholders. For instance, this concentration of ownership may have the effect of delaying or preventing a change in control of us otherwise favored by our other stockholders and could depress our stock price.
Because affiliates of CCMP control more than 50% of the voting power of our common stock, we are a “controlled company” within the meaning of the NYSE's Listed Company Manual. Under the NYSE's Listed Company Manual, a controlled company may elect not to comply with certain NYSE corporate governance requirements, including requirements that: (1) a majority of the board of directors consist of independent directors; (2) compensation of officers be determined or recommended to the board of directors by a majority of its independent directors or by a compensation committee that is composed entirely of independent directors; and (3) director nominees be selected or recommended by a majority of the independent directors or by a nominating committee composed solely of independent directors. Because we have taken advantage of the controlled company exemption to certain NYSE corporate governance requirements, our stockholders do not have the same protections afforded to stockholders of companies that are subject to all of the NYSE corporate governance requirements.
Conflicts of interest may arise because some of our directors are principals of our principal stockholder.
Representatives of CCMP and its affiliates occupy seats on our board of directors. CCMP or its affiliates could invest in entities that directly or indirectly compete with us or companies in which CCMP or its affiliates are currently invested may already compete with us. As a result of these relationships, when conflicts arise between the interests of CCMP or its affiliates and the interests of our stockholders, these directors may not be disinterested. The representatives of CCMP and its affiliates on our board of directors, by the terms of our amended and restated certificate of incorporation, are not required to offer us any transaction opportunity of which they become aware and could take any such opportunity for themselves or offer it to other companies in which they have an investment, unless such opportunity is expressly offered to them solely in their capacity as our directors.
None.
We own and operate manufacturing and distribution facilities located in Eagle, Wisconsin, Waukesha, Wisconsin, Whitewater, Wisconsin and Berlin, Wisconsin, which total approximately 1.2 million square feet. We also operate a dealer training center at our Eagle, Wisconsin facility, which allows us to train new industrial and residential dealers on the service and installation of our products and provide existing dealers with training on product innovations. We also have inventory warehouses in the United States that accommodate material storage and rapid response requirements of our customers.
The following table shows the location and activities of our operations:
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Owned / Leased
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Square Footage
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Activities
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Waukesha, WI
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Owned
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307,250
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Corporate headquarters and manufacturing of liquid-cooled generators and transfer switches and storage
|
|
|
Eagle, WI
|
Owned
|
236,000
|
Manufacturing of liquid-cooled generators and metal fabrication
|
|
|
Eagle, WI
|
Owned
|
6,000
|
Training facility
|
|
|
Whitewater, WI
Berlin, WI
Berlin, WI
|
Owned
Owned
Leased
|
295,000
129,000
122,500
|
Manufacturing of vertically integrated engines and generators
Manufacturing of mobile generators, light towers, pumps and metal fabrication
R&D, shipping, storage facilities, manufacturing
|
|
|
Whitewater, WI
Fort Atkinson, WI
Edgerton, WI
|
Owned
Leased
Leased
|
196,000
183,640
242,100
|
Distribution center
Storage facility
Storage facility
|
|
|
Maquoketa, IA
Nor Cross, GA
Cooler, GA
Alpharetta, GA
|
Owned
Leased
Leased
Leased
|
137,000
12,555
2,500
13,000
|
Inventory warehouse and rental property
Dealer facility, sales, distribution, training
Dealer facility, sales, distribution, training
Manufacturing, sales, distribution, light assembly and packaging
|
As of December 31, 2011, substantially all of our owned properties are subject to mortgages under our senior secured credit facilities.
From time to time, we are involved in legal proceedings primarily involving product liability and employment matters and general commercial disputes arising in the ordinary course of our business. As of December 31, 2011, we believe that there is no litigation pending that would have a material effect on our results of operations or financial condition.
Not Applicable.
Price Range of Common Stock
Shares of our common stock are traded on the NYSE under the symbol “GNRC.” The following table sets forth the high and low sales prices reported on the NYSE for our common stock by fiscal quarter during 2011 and 2010, respectively.
|
2011
|
||||||||
|
High
|
Low
|
|||||||
|
Fourth Quarter
|
$ | 29.06 | $ | 18.29 | ||||
|
Third Quarter
|
$ | 21.41 | $ | 15.41 | ||||
|
Second Quarter
|
$ | 21.10 | $ | 17.10 | ||||
|
First Quarter
|
$ | 20.85 | $ | 14.72 | ||||
|
2010
|
||||||||
|
High
|
Low
|
|||||||
|
Fourth Quarter
|
$ | 16.51 | $ | 13.04 | ||||
|
Third Quarter
|
$ | 15.08 | $ | 11.99 | ||||
|
Second Quarter
|
$ | 15.40 | $ | 10.65 | ||||
|
First Quarter (beginning February 11, 2010)
|
$ | 15.40 | $ | 12.84 | ||||
Stock Performance Graph
The line graph below compares the cumulative total stockholder return on our common stock with the cumulative total return of the Standard & Poor’s S&P 500 Index and S&P 500 Industrials Index for the year ended December 31, 2011. The graph and table assume that $100 was invested on February 11, 2010 (first day of trading) in each of our common stock, the S&P 500 Index, S&P 500 Industrials Index, and that all dividends were reinvested. Cumulative total stockholder returns for our common stock, the S&P 500 Index, and the S&P 500 Industrials Index are based on our fiscal year.
ASSUMES $100 INVESTED ON FEBRUARY 11, 2010
ASSUMES DIVIDEND REINVESTED
FISCAL YEAR ENDING DECEMBER 31, 2011
|
Company/
Market/
Peer Group
|
2/11/2010
|
3/31/2010
|
6/30/2010
|
9/30/2010
|
12/31/2010
|
3/31/2011
|
6/30/2011
|
9/30/2011
|
12/31/2011
|
|||||||||||||||||||||||||||
|
Generac Holdings Inc.
|
$ | 100.00 | $ | 109.11 | $ | 109.11 | $ | 106.23 | $ | 125.93 | $ | 158.02 | $ | 151.09 | $ | 146.50 | $ | 218.30 | ||||||||||||||||||
|
S&P 500 Index
|
$ | 100.00 | $ | 108.73 | $ | 96.31 | $ | 107.18 | $ | 118.71 | $ | 125.73 | $ | 125.85 | $ | 108.40 | $ | 121.21 | ||||||||||||||||||
|
S&P 500 Industrials Index
|
$ | 100.00 | $ | 113.00 | $ | 99.09 | $ | 113.27 | $ | 126.65 | $ | 137.74 | $ | 136.82 | $ | 108.06 | $ | 125.90 | ||||||||||||||||||
Holders
As of February 17, 2012, there were approximately 107 registered holders of record of Generac’s common stock. A substantially greater number of holders of Generac common stock are “street name” or beneficial holders, whose shares are held of record by banks, brokers, and other financial institutions.
Dividends
We did not declare or pay cash dividends in 2011. We currently do not have plans to pay any dividends on our common stock in the near term. However, in the future, subject to factors such as general economic and business conditions, our financial condition and results of operations, our capital requirements, our future liquidity and capitalization and such other factors that our board of directors may deem relevant, we may change this policy and choose to pay dividends. Our ability to pay dividends on our common stock is currently restricted by the terms of our senior secured credit facilities and may be further restricted by any future indebtedness we incur. Our business is conducted through our principal operating subsidiary, Generac Power Systems. Dividends from, and cash generated by Generac Power Systems will be our principal sources of cash to repay indebtedness, fund operations and pay dividends. Accordingly, our ability to pay dividends to our stockholders is dependent on the earnings and distributions of funds from Generac Power Systems.
Securities Authorized for Issuance Under Equity Compensation Plans
The information required by this item will be included in our 2012 Proxy Statement and is incorporated herein by reference.
Recent Sales of Unregistered Securities
None.
Use of Proceeds from Registered Securities
Not applicable.
The following table sets forth our selected historical consolidated financial data for the periods and at the dates indicated. The selected historical consolidated financial data for the years ended December 31, 2009, 2010 and 2011 are derived from our audited consolidated financial statements included elsewhere in this annual report. The selected historical consolidated financial data for the years ended December 31, 2007 and December 31, 2008 are derived from our audited historical financial statements not included in this annual report.
The results indicated below and elsewhere in this annual report are not necessarily indicative of our future performance. You should read this information together with “Item 7—Management's Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and related notes included in Item 8 of this Annual Report on Form 10-K.
|
(Dollars in thousands, except per share data)
|
Year ended December 31, 2007
|
Year ended December 31, 2008
|
Year ended December 31, 2009
|
Year ended December 31, 2010
|
Year ended December 31, 2011
|
|||||||||||||||
|
Statement of operations data:
|
||||||||||||||||||||
|
Net sales
|
$ | 555,705 | $ | 574,229 | $ | 588,248 | $ | 592,880 | $ | 791,976 | ||||||||||
|
Costs of goods sold
|
333,428 | 372,199 | 352,398 | 355,523 | 497,322 | |||||||||||||||
|
Gross profit
|
222,277 | 202,030 | 235,850 | 237,357 | 294,654 | |||||||||||||||
|
Operating expenses:
|
||||||||||||||||||||
|
Selling and service
|
52,652 | 57,449 | 59,823 | 57,954 | 77,776 | |||||||||||||||
|
Research and development
|
9,606 | 9,925 | 10,842 | 14,700 | 16,476 | |||||||||||||||
|
General and administrative
|
17,581 | 15,869 | 14,713 | 22,599 | 30,012 | |||||||||||||||
|
Amortization of intangibles (1)
|
47,602 | 47,602 | 51,960 | 51,808 | 48,020 | |||||||||||||||
|
Goodwill and trade name impairment charge and trade name write-down (2)
|
— | 583,486 | — | — | 9,389 | |||||||||||||||
|
Total operating expenses
|
127,441 | 714,331 | 137,338 | 147,061 | 181,673 | |||||||||||||||
|
Income (loss) from operations
|
94,836 | (512,301 | ) | 98,512 | 90,296 | 112,981 | ||||||||||||||
|
Other income (expense):
|
||||||||||||||||||||
|
Interest expense
|
(125,366 | ) | (108,022 | ) | (70,862 | ) | (27,397 | ) | (23,718 | ) | ||||||||||
|
Gain on extinguishment of debt (3)
|
18,759 | 65,385 | 14,745 | — | — | |||||||||||||||
|
Write-off of deferred financing costs related to debt extinguishment
|
— | — | — | (4,809 | ) | (377 | ) | |||||||||||||
|
Investment income
|
2,682 | 600 | 2,205 | 235 | 110 | |||||||||||||||
|
Costs related to acquisition
|
— | — | — | — | (875 | ) | ||||||||||||||
|
Other, net
|
(1,196 | ) | (1,217 | ) | (1,206 | ) | (1,105 | ) | (1,155 | ) | ||||||||||
|
Total other expense, net
|
(105,121 | ) | (43,254 | ) | (55,118 | ) | (33,076 | ) | (26,015 | ) | ||||||||||
|
Income (loss) before provision (benefit) for income taxes
|
(10,285 | ) | (555,555 | ) | 43,394 | 57,220 | 86,966 | |||||||||||||
|
Provision (benefit) for income taxes (4)
|
(571 | ) | 400 | 339 | 307 | (237,677 | ) | |||||||||||||
|
Net income (loss)
|
$ | (9,714 | ) | $ | (555,955 | ) | $ | 43,055 | $ | 56,913 | $ | 324,643 | ||||||||
|
Income (loss) per share - diluted:
|
||||||||||||||||||||
|
Class A Common Stock (5)
|
(34,994 | ) | (357,628 | ) | (41,111 | ) | (1.65 | ) | 4.79 | |||||||||||
|
Class B Common Stock (5)
|
3,462 | 3,780 | 4,171 | 505 | n/a | |||||||||||||||
|
Statement of cash flows data:
|
||||||||||||||||||||
|
Depreciation
|
6,181 | 7,168 | 7,715 | 7,632 | 8,103 | |||||||||||||||
|
Amortization
|
47,602 | 47,602 | 51,960 | 51,808 | 48,020 | |||||||||||||||
|
Expenditures for property and equipment
|
(13,191 | ) | (5,186 | ) | (4,525 | ) | (9,631 | ) | (12,060 | ) | ||||||||||
|
Other financial data:
|
||||||||||||||||||||
|
Adjusted EBITDA (6)
|
158,148 | 129,858 | 159,087 | 156,249 | 188,476 | |||||||||||||||
|
Adjusted Net Income (7)
|
21,931 | 13,758 | 83,643 | 115,954 | 147,176 | |||||||||||||||
|
(Dollars in thousands)
|
As of December 31, 2007
|
As of December 31, 2008
|
As of December 31, 2009
|
As of December 31, 2010
|
As of December 31, 2011
|
|||||||||||||||
|
Balance sheet data:
|
||||||||||||||||||||
|
Current assets
|
$ | 217,750 | $ | 274,997 | $ | 345,017 | $ | 272,519 | $ | 383,265 | ||||||||||
|
Property, plant and equipment, net
|
78,982 | 76,674 | 73,374 | 75,287 | 84,384 | |||||||||||||||
|
Goodwill
|
1,029,068 | 525,875 | 525,875 | 527,148 | 547,473 | |||||||||||||||
|
Other intangibles and other assets
|
582,859 | 448,668 | 392,977 | 334,929 | 537,671 | |||||||||||||||
|
Total assets
|
$ | 1,908,659 | $ | 1,326,214 | $ | 1,337,243 | $ | 1,209,883 | $ | 1,552,793 | ||||||||||
|
Total current liabilities
|
$ | 94,690 | $ | 127,981 | $ | 131,971 | $ | 86,685 | $ | 165,390 | ||||||||||
|
Long-term debt, less current portion
|
1,280,750 | 1,121,437 | 1,052,463 | 657,229 | 575,000 | |||||||||||||||
|
Other long-term liabilities
|
27,439 | 43,539 | 17,418 | 24,902 | 43,514 | |||||||||||||||
|
Redeemable stock (8)
|
747,070 | 843,451 | 878,205 | — |
—
|
|||||||||||||||
|
Total liabilities, redeemable stock and stockholders' equity (8)
|
$ | 1,908,659 | $ | 1,326,214 | $ | 1,337,243 | $ | 1,209,883 | $ | 1,552,793 | ||||||||||
(1) Our amortization of intangibles expenses include the straight-line amortization of customer lists, patents and other finite-lived intangibles assets.
(2) As of October 31, 2008, as a result of our annual goodwill and tradename impairment test, we determined that an impairment of goodwill and trade names existed, and we recognized a non-cash charge of $583.5 million in 2008. During the fourth quarter of 2011, the Company decided to strategically transition certain products to their more widely known Generac brand. Based on this decision, the Company recorded a $9.4 million non-cash charge which primarily related to the write down of the impacted trade name to net realizable value. In addition, the Company performed its annual goodwill and tradename impairment test as of October 31, 2011. Except as noted, no impairment was indicated.
(3) During 2007, affiliates of CCMP acquired $80.3 million principal amount of second lien term loans for approximately $60.0 million. CCMP's affiliates exchanged this debt for additional shares of our Class B Common Stock. The fair value of the shares exchanged was $60.0 million. We recorded this transaction as additional Class B Common Stock of $60.0 million based on the fair value of the debt contributed by CCMP's affiliates, which approximated the fair value of shares exchanged. The debt was held in treasury at face value. Consequently, we recorded a gain on extinguishment of debt of $18.8 million, which includes a write-off of deferred financing fees and other closing costs in the consolidated statement of operations for the year ended December 31, 2007.
During 2008, affiliates of CCMP acquired $148.9 million principal amount of second lien term loans for approximately $81.1 million. CCMP's affiliates exchanged this debt for additional shares of our Class B Common Stock and Series A Preferred Stock. The fair value of the shares exchanged was $81.1 million. We recorded this transaction as Series A Preferred Stock of $62.9 million and Class B Common Stock of $18.2 million based on the fair value of the debt contributed by CCMP's affiliates, which approximated the fair value of shares exchanged. The debt was held in treasury at face value. Consequently, we recorded a gain on extinguishment of debt of $65.4 million, which includes a write-off of deferred financing fees and other closing costs in the consolidated statement of operations for the year ended December 31, 2008.
During 2009, affiliates of CCMP acquired $9.9 million principal amount of first lien term loans and $20.0 million principal amount of second lien term loans for approximately $14.8 million. CCMP's affiliates exchanged this debt for 1,475.4596 shares of Series A Preferred Stock. The fair value of the shares exchanged was $14.8 million. We recorded this transaction as additional Series A Preferred Stock of $14.8 million based on the fair value of the debt contributed by CCMP's affiliates, which approximated the fair value of shares exchanged. The debt was held in treasury at face value. Consequently, we recorded a gain on extinguishment of debt of $14.7 million, which includes a write-off of deferred financing fees and other closing costs, in the consolidated statement of operations for the year ended December 31, 2009.
(4) The 2011 net tax benefit of $237.7 million includes a tax benefit of $271.4 million recorded due to the reversal of valuation allowances recorded on the Company’s net deferred tax assets. See discussion in Item 8 – Financial Statements and Supplementary Data – Note 9 for additional information.
(5) Diluted earnings per share reflects the impact of the reverse stock split which occurred immediately prior to the initial public offering as discussed in “Item 8 – Financial Statements and Supplementary Data – Note 1”. At the time of the IPO on February 17, 2010, all shares of Class B common stock were converted into shares of Class A common stock, and the Class A common stock became the one class of outstanding common stock. See discussion of the IPO in Part 1, Item 1 – Initial Public Offering and Corporate Reorganization.
(6) Adjusted EBITDA represents net income (loss) 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 senior secured credit facilities (Covenant EBITDA), except that we do not give effect to certain additional adjustments that are permitted under those facilities which, if included, would increase the amount reflected in this table. For a description of the additional adjustments permitted for Covenant EBITDA under our senior secured credit facilities, see "Item 7 - Management's discussion and analysis of financial condition and results of operations—Liquidity and capital resources—Senior secured credit facilities—Covenant compliance." The definition of Adjusted EBITDA in the new February 2012 credit agreement is substantially the same as the definition in the previous 2006 credit agreement.
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 senior secured credit facilities 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 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 senior secured credit facilities (except where noted in footnote (j) 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, transaction costs relating to the CCMP Transactions and repurchases of our debt by affiliates of CCMP, non-cash gains 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, such as sponsor fees.
We explain in more detail in footnotes (a) through (j) 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 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 (f) below, represent costs associated with severance and other items which are reflected in operating expenses and income (loss) from continuing operations in our consolidated statements of operations 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 and sponsor 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 that 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 senior secured credit facilities, 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.
Our former senior secured credit facility required Generac Power Systems, Inc. to maintain a leverage ratio of consolidated total debt, net of unrestricted cash and marketable securities, to Covenant EBITDA at a level that varied over time. As of December 31, 2011, Generac Power Systems, Inc.’s ratio was 2.83 to 1.00, which was below the covenant requirement of 4.75 to 1.00. Generac Holdings Inc. net debt to adjusted EBITDA ratio as of December 31, 2011 was 2.65x. Our credit agreement does not permit us to net cash and cash equivalents held by the Generac Holdings Inc. entity against our debt balance for covenant purposes. Our new senior secured credit facilities entered into on February 9, 2012 also include certain financial covenants. The new credit facility requires Generac Power Systems to maintain a maximum leverage ratio (as defined in the senior secured credit facility) of 4.00 to 1.00 from the periods June 30, 2012 to September 30, 2012, and 3.75 to 1.00 thereafter. In addition, the new credit facility requires Generac Power Systems to maintain a minimum interest coverage ratio (as defined in the senior secured credit facility) of 2.50 to 1.00 from June 30, 2012 to September 30, 2012, 2.75 to 1.00 from December 31, 2012 to June 30, 2013, 3.00 to 1.00 from September 30, 2013 to June 30, 2014 and 3.25 to 1.00 thereafter. Failure to comply with this covenant would result in an event of default under our new senior secured credit facility unless waived by our lenders. An event of default under our new senior secured credit facility could result in the acceleration of our indebtedness under the facility, and we may be unable to repay the amounts due.
The following table presents a reconciliation of net income (loss) to Adjusted EBITDA:
|
(Dollars in thousands)
|
Year ended December 31, 2007
|
Year ended December 31, 2008
|
Year ended December 31, 2009
|
Year ended December 31, 2010
|
Year ended December 31, 2011
|
|||||||||||||||
|
Net income (loss
|
$ | (9,714 | ) | $ | (555,955 | ) | $ | 43,055 | $ | 56,913 | $ | 324,643 | ||||||||
|
Interest expense
|
125,366 | 108,022 | 70,862 | 27,397 | 23,718 | |||||||||||||||
|
Depreciation and amortization
|
53,783 | 54,770 | 59,675 | 59,440 | 56,123 | |||||||||||||||
|
Income taxes provision (benefit)
|
(571 | ) | 400 | 339 | 307 | (237,677 | ) | |||||||||||||
|
Non-cash impairment and other charges (income)(a)
|
5,328 | 585,634 | (1,592 | ) | (361 | ) | 10,400 | |||||||||||||
|
Non-cash share-based compensation expense(b)
|
— | — | — | 6,363 | 8,646 | |||||||||||||||
|
Write-off of deferred financing costs related to debt extinguishment(c)
|
— | — | — | 4,809 | 377 | |||||||||||||||
|
Transaction costs and credit facility fees(d)
|
1,044 | 1,319 | 1,188 | 1,019 | 1,719 | |||||||||||||||
|
Non-cash gains(e)
|
(18,759 | ) | (65,385 | ) | (14,745 | ) | — | — | ||||||||||||
|
Business optimization expenses(f)
|
1,944 | 971 | — | 108 | 277 | |||||||||||||||
|
Sponsor fees(g)
|
500 | 500 | 500 | 56 | — | |||||||||||||||
|
Letter of credit fees(h)
|
335 | 169 | 135 | (26 | ) | (33 | ) | |||||||||||||
|
Other state franchise taxes(i)
|
— | 53 | 72 | 317 | 342 | |||||||||||||||
|
Holding company interest income(j)
|
(1,108 | ) | (640 | ) | (402 | ) | (93 | ) | (59 | ) | ||||||||||
|
Adjusted EBITDA
|
$ | 158,148 | $ | 129,858 | $ | 159,087 | $ | 156,249 | $ | 188,476 | ||||||||||
(a) Represents the following non-cash charges:
• for the year ended December 31, 2007, primarily a $3.9 million charge for the step-up in book value of inventory as a result of the application of purchase accounting in connection with the CCMP Transactions. Also includes $1.4 million of other charges, including a write-off of a pre-CCMP Transactions receivable, stock compensation expense, unsettled mark-to-market losses on copper forward contracts and losses on disposals of assets;
• for the year ended December 31, 2008, primarily $503.2 million in goodwill impairment charges and $80.3 million in trade name impairment charges described in "Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations—Critical accounting policies—Goodwill and other intangible assets." $1.6 million of the amount is comprised of unsettled mark to market losses on copper forward contracts, a write-off of pre-CCMP Transactions bad debts and losses on disposals of assets. Separately, the amount also includes a write-off of certain inventory;
• for the years ended December 31, 2010 and 2009, primarily unrealized mark-to-market adjustments on copper and Euro forward contracts and loss on disposal of assets;
• for the years ended December 31, 2011, primarily $9.4 million trade name write-down described in "Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations—Critical accounting policies—Goodwill and other intangible assets." Also includes unrealized mark-to-market adjustment on copper forward contracts and loss on disposal of assets;
We believe that adjusting net income for these non-cash charges is useful for the following reasons:
• The losses on disposals of assets in several periods described above result from the sale of assets that are no longer useful in our business and therefore represent losses that are not from our core operations;
• The write-offs of certain pre-CCMP Transaction bad debts in the years ended December 31, 2007 and 2008 are non-cash charges that we believe do not reflect cash outflows after our acquisition by CCMP;
• The adjustments for unrealized mark-to-market gains and losses on copper forward and Euro contracts represent non-cash items to reflect changes in the fair value of forward contracts that have not been settled or terminated. We believe that 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 operations and cash flows to capture the full effect of these contracts on our operating performance;
• The goodwill and trade name impairment charges recorded in the year ended December 31, 2008 and the trade name write-down recorded in the year ended December 31, 2011 are one-time items that we believe do not reflect our ongoing operations. These charges are explained in greater detail in "Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting Policies—Goodwill and Other Intangible Assets";
• The small amount of stock compensation expense recorded in the year ended December 31, 2007 was a non-cash charge for compensation under our 2006 Management Equity Incentive Plan. We do not believe that equity awards and the related expense under our 2006 Management Equity Incentive Plan, which terminated in connection with our initial public offering, will be useful in predicting stock compensation expense that we will incur under the new equity incentive plan that we adopted in connection with the IPO. However, we do expect to incur stock compensation expense under the new plan, and you should see our Proxy Statement under captions "Compensation discussion and analysis—Components of compensation—Equity-based compensation" and "Executive compensation—2010 Equity incentive plan" for more information about that plan; and
• The write-off of certain pre-CCMP Transaction excess inventory recorded in the year ended December 31, 2008 was a non-cash charge that we believe does not reflect cash outflows after our acquisition by CCMP.
(b) Represents share-based compensation expense to account for stock options, restricted stock and other stock awards over their vesting period.
(c) Represents the write-off of a portion of deferred financing costs related to the repayment of debt.
(d) Represents the following transaction costs and fees relating to our senior secured credit facilities:
• 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;
• before 2011, transaction costs relating to repurchases of debt under our first and second lien credit facilities by affiliates of CCMP, which CCMP's affiliates contributed to our company in exchange for the issuances of securities, which repurchases we do not expect to recur;
• in the year ended December 31, 2011, transaction costs relating to the acquisition of the Magnum Products business
(e) represents the following non-cash gains:
• for all periods before 2010, represents non-cash gains on the extinguishment of debt repurchased by affiliates of CCMP, as described in note (d) above, which we do not expect to recur.
(f) Primarily represents severance costs incurred from restructuring-related activities. For the year ended December 31, 2007, consists of $1.4 million of severance costs and $0.6 million of other restructuring-related costs. We do not believe the charges for restructuring-related activities in the year ended December 31, 2007 reflect our ongoing operations. Although we have incurred severance costs in most of the periods set forth in the table above, 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.
(g) Represents management, consulting, monitoring, transaction and advisory fees and related expenses paid or accrued to affiliates of CCMP and certain other investors (related parties) under an advisory services and monitoring agreement. This agreement automatically terminated upon consummation of our initial public offering, and, accordingly, we believe that these expenses do not reflect the expenses of our ongoing operations.
(h) Represents 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.
(i) Represents franchise and business activity taxes paid at the state level. We believe the inclusion of these taxes in calculating Adjusted EBITDA is similar to the inclusion of income taxes, as set forth in the table above.
(j) 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.
(7) Adjusted Net Income is defined as net income before provision (benefit) for income taxes adjusted for the following items: cash income tax expense, amortization of intangible assets, amortization and write-offs of deferred loan costs related to the Company’s debt, intangible asset impairment charges, transaction costs and purchase accounting adjustments, and non-cash gains reflected in the reconciliation table set forth below.
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 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, such as amortization costs, and non-cash gains and write-offs relating to the retirement of debt. We also make adjustments to present cash taxes paid.
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.
The following table presents a reconciliation of net income (loss) to Adjusted Net Income:
|
(Dollars in thousands)
|
Year ended December 31, 2007
|
Year ended December 31, 2008
|
Year ended December 31, 2009
|
Year ended December 31, 2010
|
Year ended December 31, 2011
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|||||||||||||||
|
Net income (loss)
|
$ | (9,714 | ) | $ | (555,955 | ) | $ | 43,055 | $ | 56,913 | $ | 324,643 | ||||||||
|
Provision (benefit) for income taxes
|
(571 | ) | 400 | 339 | 307 | (237,677 | ) | |||||||||||||
|
Income (loss) before provision (benefit) for income taxes
|
(10,285 | ) | (555,555 | ) | 43,394 | 57,220 | 86,966 | |||||||||||||
|
Amortization of intangible assets
|
47,602 | 47,602 | 51,960 | 51,808 | 48,020 | |||||||||||||||
|
Amortization of deferred loan costs
|
4,225 | 3,905 | 3,417 | 2,439 | 1,986 | |||||||||||||||
|
Write-off of deferred financing costs related to debt extinguishment
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— | — | — | 4,809 | 377 | |||||||||||||||
|
Intangible impairment charge
|
— | 583,486 | — | — | 9,389 | |||||||||||||||
|
Transaction costs and purchase accounting adjustments
|
3,925 | — | — | — | 875 | |||||||||||||||
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Gain on extinguishment of debt
|
(18,759 | ) | (65,385 | ) | (14,745 | ) | — | — | ||||||||||||
|
Adjusted net income before income taxes
|
26,708 | 14,053 | 84,026 | 116,276 | 147,613 | |||||||||||||||
|
Cash income tax expense
|
(4,777 | ) | (295 | ) | (383 | ) | (322 | ) | (437 | ) | ||||||||||
|
Adjusted net income
|
$ | 21,931 | $ | 13,758 | $ | 83,643 | $ | 115,954 | $ | 147,176 | ||||||||||
(8) Includes our Series A Preferred Stock and Class B Common Stock. See Note 7 to our audited consolidated financial statements included in Item 8 of this Annual Report on Form 10-K.
The following discussion and analysis of our financial condition and results of operations should be read together with “Item 6 - Selected Financial Data” and the consolidated financial statements and the related notes included in Item 8 of this Annual Report on Form 10-K. This discussion contains forward-looking statements, based on current expectations and related to future events and our future financial performance, that involve risks and uncertainties. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of many factors, including those set forth under “Item 1A - Risk Factors.”
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 commercial 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, automatic transfer switches and other components necessary for our products. Our generators and other products are fueled by natural gas, liquid propane, gasoline, diesel and Bi-Fuel™ and are available through a broad network of independent dealers, retailers and 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, performance measures and operational factors. 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. Although there have been recent increases in product costs for installed standby generators in the residential and light-commercial markets (driven in the last two years by raw material costs), these costs have declined overall over the last decade, and many potential customers are not aware of the costs and benefits of backup power solutions. We estimate that penetration rates for residential products are approximately 2.5% 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 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.
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.
Effect of large scale power disruptions. Power disruptions are an important driver of consumer awareness and have historically influenced demand for generators. Disruptions in the aging U.S. power grid and other outage activity increase 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. While there are power outages every year 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 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, 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. The 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 decreased in 2011 compared to 2010, primarily due to approximately $134 million of debt pre-payments made over the last thirteen months.
Factors influencing provision for income taxes. Because we made a Section 338(h)(10) election in connection with the CCMP Transactions, we have $1.2 billion of tax-deductible goodwill and intangible asset amortization remaining as of December 31, 2011 that we expect to generate cash tax savings of $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 generates annual cash tax savings of $48 million through 2020 and $40 million in 2021, assuming profitability and a 39% tax rate. Additionally, we have federal net operating loss, or NOL, carry-forwards of $127.1 million as of December 31, 2011, which we expect to generate an additional $44 million of federal cash tax savings at a 35% rate when and if utilized. Based on current business plans, we believe that our cash tax obligations through 2021 will be significantly reduced by 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 carryforwards to offset future federal income tax liabilities.
In addition, as a result of the asset acquisition of Magnum, we have approximately $57.0 million of tax deductible goodwill and intangible assets remaining as of December 31, 2011. We expect these assets to generate tax savings of $22.2 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.
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, with different seasonality depending on the timing of outage activity in each year, such as the outage activity experienced in the third and fourth quarters of 2011. Due to the significant demand and awareness created by these outage events in the second half of 2011, we expect growth rates during 2012 to be heavily weighted toward the first half of the year, assuming no material improvement in the macroeconomic environment and no comparable outage events in 2012. Because of this, our historical seasonality patterns may not apply in 2012.
We maintain a flexible 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.
Transactions with CCMP
In November 2006, affiliates of CCMP, together with certain other investors and members of our management, purchased an aggregate of $689 million of our equity capital. In addition, on November 10, 2006, Generac Power Systems borrowed an aggregate of $1.38 billion, consisting of an initial drawdown of $950 million under a $1.1 billion first lien secured credit facility and $430 million under a $430 million second lien secured credit facility. With the proceeds from these equity and debt financings, together with cash on hand at Generac Power Systems, we (1) acquired all of the capital stock of Generac Power Systems and repaid certain pre-transaction indebtedness of Generac Power Systems for $2.0 billion, (2) paid $66 million in transaction costs related to the transaction and (3) retained $3 million for general corporate purposes. For additional information concerning these and other historical transactions with CCMP, see “Item 1—Business—History—CCMP transactions.”
During 2007, affiliates of CCMP acquired $80.3 million principal amount of second lien term loans for approximately $60.0 million. CCMP's affiliates exchanged this debt for additional shares of Class B Common Stock. The fair value of the shares exchanged was $60.0 million. We recorded this transaction as additional Class B Common Stock of $60.0 million based on the fair value of the debt contributed by CCMP's affiliates, which approximated the fair value of shares exchanged. The debt was held in treasury at face value. Consequently, we recorded a gain on extinguishment of debt of $18.8 million, which includes the write-off of deferred financing fees and other closing costs, in the consolidated statement of operations for the year ended December 31, 2007.
During 2008, affiliates of CCMP acquired $148.9 million principal amount of second lien term loans for approximately $81.1 million. CCMP's affiliates exchanged $24.0 million principal amount of this debt for additional shares of Class B Common Stock and $124.9 million principal amount of this debt for shares of our Series A Preferred Stock. The fair value of the shares of our Class B Common Stock and Series A Preferred Stock so exchanged was $18.2 million and $62.9 million, respectively. We recorded this transaction as Series A Preferred Stock of $62.9 million and Class B Common Stock of $18.2 million based on the fair value of the debt contributed by CCMP's affiliates, which approximated the fair value of shares exchanged. The debt was held in treasury at face value. Consequently, we recorded a gain on extinguishment of debt of $65.4 million, which includes the write-off of deferred financing fees and other closing costs, in the consolidated statement of operations for the year ended December 31, 2008.
As of September 30, 2008, we failed to satisfy the leverage ratio in our senior secured credit facilities. As permitted by the credit agreement, in November, 2008, this violation was remedied by an equity contribution of $15,500,000 from affiliates of CCMP, in exchange for 1,550 shares of Series A Preferred stock.
During 2009, affiliates of CCMP acquired $9.9 million principal amount of first lien term loans and $20.0 million principal amount of second lien term loans for approximately $14.8 million. CCMP's affiliates exchanged this debt for 1,475.4596 shares of Series A Preferred Stock. The fair value of the shares exchanged was $14.8 million. We recorded this transaction as additional Series A Preferred Stock of $14.8 million based on the fair value of the debt contributed by CCMP's affiliates, which approximated the fair value of shares exchanged. The debt was held in treasury at face value. Consequently, we recorded a gain on extinguishment of debt of $14.7 million, which includes a write-off of deferred financing fees and other closing costs, in the consolidated statement of operations for the year ended December 31, 2009.
In connection with such issuances of our Class B Common Stock to affiliates of CCMP in connection with debt exchanges in 2007 and 2008 and the satisfaction of preemptive rights under the shareholders' agreement that arose from such issuances, affiliates of CCMP sold some of the shares of our Class B Common Stock they were issued in connection with such debt exchanges to an entity affiliated with CCMP, certain other investors and certain members of our management and board of directors. In addition, in connection with such issuances of our Series A Preferred Stock to affiliates and CCMP in connection with debt exchanges in 2008 and 2009 and the satisfaction of preemptive rights under the shareholders' agreement that arose from such issuances, during the year ended December 31, 2009, we issued 2,000 shares of Series A Preferred Stock for an aggregate purchase price of $20.0 million in cash to an entity affiliated with CCMP and certain members of management and our board of directors, and affiliates of CCMP sold some of the shares of Series A Preferred Stock they were previously issued in connection with such debt exchanges to an entity affiliated with CCMP and a member of the board of directors at the same price.
Corporate reorganization
Our capitalization prior to the initial public offering consisted of Series A Preferred Stock, Class B Common Stock and Class A Common Stock. Our Series A Preferred Stock was entitled to a priority return preference equal to a 14% annual return on the amount originally paid for such shares and equity participation equal to 24.3% of the remaining equity value of the Company. Our Class B Common Stock was entitled to a priority return preference equal to a 10% annual return on the amount originally paid for such shares. In connection with the initial public offering, we undertook a corporate reorganization which gave effect to the conversion of our Series A Preferred Stock and Class B Common Stock into the same class of our common stock that was sold in our initial public offering while taking into account the rights and preference of those shares, including the priority returns of our Series A Preferred Stock and our Class B Common Stock and the equity participation rights of the Series A Preferred Stock. A reverse stock split was needed to reduce the number of shares to be issued to holders of our Class A and Class B Common Stock to the number that correctly reflected the proportionate interest of such stockholders in our company, taking into account the number of shares of common stock to be issued upon the conversion of our Series A Preferred Stock and the number and value of shares of common stock to be issued and sold to new investors in the initial public offering. We refer to these transactions as the “Corporate Reorganization.” The specific steps in the Corporate Reorganization were as follows:
Treatment of Class B Common Stock
Our certificate of incorporation prior to the offering provided for the mandatory conversion of our Class B Voting Common Stock to Class A Common Stock in the event of an initial public offering, so that our Class B Common Stock is converted into the same class of our common stock that is to be offered in an initial public offering taking into account of the value, rights and preferences of our Class B Common Stock. In accordance with the terms of our certificate of incorporation prior to the offering, at the time we entered into an underwriting agreement with respect to the initial public offering, each share of our Class B Common Stock automatically converted into a number of shares of our Class A Common Stock equal to one plus the quotient obtained by dividing (i)(x) the amount paid for such share of Class B Common Stock plus (y) an increase to such amount equal to 10% per annum calculated and compounded quarterly on the basis of a 360-day year of twelve 30-day months and which increased amount shall be deemed to have accrued on a daily basis (i.e., the “Class B Return”), by (ii) the public offering price (net of underwriting discounts and commissions). We refer to this as the “Class B Conversion.” Each share of our Class B Common Stock converted into 1,118.440 shares of our Class A Common Stock (i.e., the “Class B Conversion Ratio”). As a result of the Class B Conversion, we issued an aggregate of 88,484,700 shares of our Class A Common Stock.
Reverse stock split
Immediately following the Class B Conversion, we effected a 3.294 for one reverse stock split of our then outstanding shares of Class A Common Stock, including those shares of our Class A Common Stock issued as part of the Class B Conversion, which decreased the number of shares of our Class A Common Stock immediately after the Class B Conversion from 88,490,028 shares to 26,861,523 shares. We refer to this as the “Reverse Stock Split.”
Treatment of Series A Preferred Stock
The certificate of designations for our Series A Preferred Stock prior to our initial public offering provided for the mandatory conversion of the Series A Preferred Stock to Class A Common Stock in the event of an initial public offering, so that our Series A Preferred Stock is converted into the same class of our common stock that is to be offered in an initial public offering taking into account of the value, rights and preferences of our Series A Preferred Stock. In accordance with the terms of the certificate of designations to our Series A Preferred Stock and our certificate of incorporation prior to the offering, promptly following the time we entered into an underwriting agreement with respect to the initial public offering, each share of our Series A Preferred Stock automatically converted into a number of shares of our Class A Common Stock equal to the sum of (A) the quotient obtained by dividing (i)(w) the amount paid for such share of Series A Preferred Stock plus (x) an increase to such amount equal to 14% per annum calculated and compounded quarterly on the basis of a 360-day year of twelve 30-day months and which increased amount shall be deemed to have accrued on a daily basis (the “Series A Preferred Return”), by (ii) the public offering price (net of underwriting discounts and commissions), plus (B) the product of (y) a fraction, the numerator of which is one and the denominator of which is the number of shares of our Series A Preferred Stock outstanding at such time, and (z) an additional number of shares of our Class A Common Stock that, when added to the number of shares of our Class A Common Stock outstanding at such time, including after giving effect to the Class B Conversion and the Reverse Stock Split, equaled 24.3% of the number of shares of our Class A Common Stock outstanding at such time (excluding the shares issued pursuant to clause (A) above). We refer to this as the “Series A Preferred Conversion.” Each share of our Series A Preferred Stock converted into 1,724.976 shares of our Class A Common Stock (i.e., the “Series A Preferred Conversion Ratio”). As a result of the Series A Preferred Conversion, we issued an aggregate of 19,511,018 shares of our Class A Common Stock.
Reclassification of Class A Common Stock
After giving effect to the Class B Conversion, the Reverse Stock Split and the Series A Preferred Conversion, there were 46,372,541 shares of Class A Common Stock which were reclassified as common stock.
Initial public offering
On February 17, 2010, the Company completed its initial public offering of 18,750,000 shares of its common stock at a price of $13.00 per share. In addition, the underwriters exercised their option and purchased an additional 1,950,500 shares of the Company’s common stock from the Company on March 18, 2010. We received a total of approximately $247.9 million in net proceeds from the initial public offering and underwriters’ option exercise, after deducting the underwriting discounts and expenses. Immediately following the Corporate Reorganization, the IPO and underwriters’ option exercise, we had 67,529,290 total shares of common stock outstanding.
Repayment of debt
In February 2010, we used $221.6 million in net proceeds from the initial closing of the IPO to pay down our second lien term loan in full and to pay down a portion of our first lien term loan. In addition, in March 2010, December 2010, April 2011 and December 2011, we used $138.5 million, $74.2 million, $24.7 million and $34.6 million, respectively, of cash and cash equivalents on hand to further pay down our first lien term loan. As a result of these debt repayments, the outstanding balance on the first lien credit facility has been reduced to $597.9 million as of December 31, 2011, and our second lien credit facility has been repaid in full and terminated. This reduction in debt will have a significant impact on cash flows as a result of lower interest expense in future periods, based on current LIBOR rates.
Additionally, in connection with our refinancing on February 9, 2012, we used $22.9 million of cash and cash equivalents on hand to further pay down our first lien term loan. We classified this portion of debt as a current liability in our consolidated balance sheet at December 31, 2011.
Components of net sales and expenses
Net sales
Substantially all of our net sales are generated through the sale of our generators and other engine powered products to the residential, commercial and industrial markets. We also sell engines to certain customers and service parts to our dealer network. Net sales are recognized upon shipment of products to our customers. Net sales also includes shipping and handling charges billed to customers which are recognized at the time of shipment of products to our customers. Related freight costs are included in cost of sales. Our generators and other products are fueled by natural gas, liquid propane, gasoline, diesel or Bi-Fuel™ systems with power output from 800W to 9mW. Our products are primarily manufactured and assembled at our Wisconsin facilities and distributed through thousands of outlets across the United States and Canada. Our smaller kW generators for the residential, portable and commercial markets are typically built to stock, while our larger kW products for the industrial markets are generally customized and built to order.
Our net sales are affected primarily by the U.S. economy as sales outside of the United States represent only approximately 5% of total net sales.
We are not dependent on any one channel or customer for our net sales, with no single customer representing more than 8% of our net sales for the year ended December 31, 2011 and our top ten customers representing less than 30% of our net sales for the same period.
Costs of goods sold
The principal elements of costs of goods sold in our manufacturing operations are component parts, raw materials, factory overhead and labor. Component parts and raw materials comprised over 80% of costs of goods sold for the year ended December 31, 2011. The principal component parts are engines and alternators. We design and manufacture air-cooled engines for certain of our products smaller than 20kW. We source engines for some of our smaller products and all of our products larger than 20kW. We design all the alternators for our units and manufacture alternators for certain of our units. We also manufacture other generator components where we believe we have a design and cost advantage. We source component parts from an extensive global network of reliable, low-cost suppliers.
The principal raw materials used in our manufacturing processes and in the manufacturing of the components we source are steel, copper and aluminum. We are susceptible to fluctuations in the cost of these commodities, impacting our costs of goods sold. We seek to mitigate the impact of commodity prices on our business through a continued focus on product design improvements and price increases in our products. However, there is typically a lag between raw material price fluctuations and their effect on our costs of goods sold.
Other sources of costs include our manufacturing facilities, which require significant factory overhead, labor and shipping costs. Factory overhead includes utilities, support personnel, depreciation, general supplies and support and maintenance. Although we maintain a low-cost, largely non-union workforce and flexible manufacturing processes, our margins can be impacted when we cannot promptly decrease labor and manufacturing costs to match declines in net sales.
Operating expenses
Our operating expenses consist of costs incurred to support our marketing, distribution, engineering, information systems, human resources, finance, purchasing, risk management, legal and tax functions. All of these categories include personnel costs such as salaries, bonuses, employee benefit costs and taxes. We typically classify our operating expenses into four categories: selling and service, research and development, general and administrative, and amortization of intangibles.
Selling and service. Our selling and service expenses consist primarily of personnel expense, marketing expense, warranty expense and other sales expenses. Our personnel expense recorded in selling and services expenses includes the expense of our sales force responsible for our national accounts and other personnel involved in the marketing and sales of our products. Warranty expense, which is recorded at the time of sale, is estimated based on historical trends. Our marketing expenses include direct mail costs, printed material costs, product display costs, market research expenses, trade show expenses and media advertising. Marketing expenses generally increase as our sales efforts increase and are related to the launch of new product offerings and opportunities within selected markets or associated with specific events such as awareness marketing in areas impacted by storms, participation in trade shows and other events.
Research and development. Our research and development expenses support over 130 active research and development projects. We currently operate four advanced facilities and employ over 150 engineers who focus on new product development, existing product improvement and cost reduction. Our commitment to research and development has resulted in a significant portfolio of approximately 90 U.S. and international patents and patent applications. Our research and development costs are expensed as incurred.
General and administrative. Our general and administrative expenses include personnel costs for general and administrative employees, accounting and legal professional services fees, information technology costs, insurance, travel and entertainment expense and other corporate expense.
Amortization of intangibles. Our amortization of intangibles expenses include the straight-line amortization of customer lists, patents and other intangibles assets.
Goodwill and trade name. Goodwill primarily represents the excess of the amount paid to acquire us over the estimated fair value of the net tangible and intangible assets acquired as of the November 2006 date of the CCMP Transactions.
Other indefinite-lived intangible assets consist of trade names. The fair value of trade names is measured using a relief-from-royalty approach, which assumes the fair value of the trade name is the discounted cash flows of the amount that would be paid had we not owned the trade name and instead licensed the trade name from another company.
In 2011, we recorded a non-cash charge which primarily related to the write down of a certain trade name. Please see “Critical accounting policies—Goodwill and other intangible assets” for additional detail on this charge.
Other income (expense)
Our other income (expense) includes the interest expense on the outstanding balances of our $950.0 million first lien term loan, $430.0 million second lien term loan and $150.0 million revolving credit facility entered into in November 2006, and the amortization of debt financing costs. In February 2010, we used the net proceeds from the initial closing of the initial public offering to pay down our second lien term loan in full and to pay down a portion of our first lien term loan. In addition, in March 2010, December 2010, April 2011 and December 2011, we used cash and cash equivalents on hand to further pay down our first lien term loan principal. No amounts were outstanding under the revolving credit facility at December 31, 2011 and December 31, 2010. The amounts borrowed under our term loans bear interest at rates based upon either a base rate or LIBOR, plus an applicable margin. We also earn interest income on our cash and cash equivalents, which is included in other income (expense). We also recorded expenses related to interest rate swap agreements, which had a notional amount of $300.0 million outstanding at December 31, 2010 at an average rate of 1.5%, and a notional amount of $300.0 million outstanding at December 31, 2011 at an average rate of 1.5%. Other income (expense) may also include other financial items such as extinguishment of debt.
Costs related to acquisition. In 2011, our other expenses include one-time transaction-related expenses related to the acquisition of the Magnum business.
Results of operations
Year ended December 31, 2011 compared to year ended December 31, 2010
The following table sets forth our consolidated statement of operations data for the periods indicated:
|
Year ended December 31,
|
||||||||
|
(Dollars in thousands)
|
2010
|
2011
|
||||||
|
Net sales
|
$ | 592,880 | $ | 791,976 | ||||
|
Costs of goods sold
|
355,523 | 497,322 | ||||||
|
Gross profit
|
237,357 | 294,654 | ||||||
|
Operating expenses:
|
||||||||
|
Selling and service
|
57,954 | 77,776 | ||||||
|
Research and development
|
14,700 | 16,476 | ||||||
|
General and administrative
|
22,599 | 30,012 | ||||||
|
Amortization of intangibles
|
51,808 | 48,020 | ||||||
|
Trade name write-down
|
- | 9,389 | ||||||
|
Total operating expenses
|
147,061 | 181,673 | ||||||
|
Income from operations
|
90,296 | 112,981 | ||||||
|
Total other expense, net
|
(33,076 | ) | (26,015 | ) | ||||
|
Income before provision for income taxes
|
57,220 | 86,966 | ||||||
|
Provision for income taxes
|
307 | (237,677 | ) | |||||
|
Net income
|
$ | 56,913 | $ | 324,643 | ||||
|
Year ended December 31,
|
||||||||
|
(Dollars in thousands)
|
2010
|
2011
|
||||||
|
Residential power products
|
$ | 372,782 | $ | 491,016 | ||||
|
Commercial & Industrial power products
|
183,555 | 250,270 | ||||||
|
Other
|
36,543 | 50,690 | ||||||
|
Net sales
|
$ | 592,880 | $ | 791,976 | ||||
Net sales. Net sales increased $199.1 million, or 33.6%, to $792.0 million for the year ended December 31, 2011 from $592.9 million for the year ended December 31, 2010. This increase was driven by a $118.2 million, or a 31.7%, increase in residential product sales largely driven by demand created by the major power outages in the third and fourth quarters of 2011. The frequency and duration of these major outages in certain regions of the country led to a surge in demand for portable generators as well as increased awareness and accelerated adoption of home standby generators. Commercial and industrial product sales increased $66.7 million, or 36.3%. Magnum Products contributed $36.5 million during the fourth quarter of 2011. In addition, overall capital spending from our national account customers and strong demand for our large industrial systems also contributed to increased commercial and industrial sales. Other product sales increased $14.1 million mainly due to stronger service parts sales as a result of the major power outage events during the second half of 2011. Magnum Products also contributed $2.3 million to service parts sales during the fourth quarter of 2011.
Costs of goods sold. Costs of goods sold increased $141.8 million, or 39.9%, to $497.3 million for the year ended December 31, 2011 from $355.5 million for the year ended December 31, 2010. This increase was mainly driven by the increase in sales volume and the addition of Magnum Products during the fourth quarter.
Gross profit. Gross profit increased $57.3 million, or 24.1%, to $294.7 million for the year ended December 31, 2011 from $237.4 million for the year ended December 31, 2010, primarily due to the factors affecting net sales and cost of goods sold described above. As a percent of net sales, gross profit margin for the year ended December 31, 2011 decreased to 37.2% from 40.0% for the year ended December 31, 2010. This decline is primarily attributable to a higher sales mix of lower margin portable generators during 2011 and the mix impact from the addition of the Magnum Products business during the fourth quarter of 2011. To a lesser extent, higher commodity costs versus the prior year also contributed to the year-over-year gross margin decline.
Operating expenses. Operating expenses increased $34.6 million to $181.7 million for the year ended December 31, 2011 from $147.1 million for the year ended December 31, 2010. Selling and service expenses increased $19.8 million due to higher variable operating expenses and incentive compensation as a result of higher sales experienced during 2011. General and administration costs increased $7.4 million mainly due to increased incentive compensation and incremental stock-based compensation expense. Operating expenses also increased as a result of investments made in infrastructure in 2011 to support the strategic growth initiatives of the Company. In addition, in the fourth quarter of 2011 the Company recorded a $9.4 million non-cash charge which primarily related to the write down of a certain trade name as we strategically transition to the Generac brand.
Other expense. Other expense decreased $7.1 million, or 21.3%, to $26.0 million for the year ended December 31, 2011 from $33.1 million for the year ended December 31, 2010. This decrease was driven by a decline in interest expense of $3.7 million as a result of approximately $134 million of debt pre-payments made over the last thirteen months. In addition, there was a $4.4 million decrease in the write-off of deferred financing costs related to debt extinguishment. Partially offsetting the aforementioned decreases are transaction costs related to the Magnum Products acquisition totaling $0.9 million.
Income tax expense. Income tax expense decreased $238.0 million to a benefit of $237.7 million for the year ended December 31, 2011 from $0.3 million for the year ended December 31, 2011 due to a reversal of the full valuation allowance on net deferred tax assets. See discussion in Item 8 – Financial Statements and Supplementary Data – Note 9 for additional information.
Net income. As a result of the factors identified above, we generated net income of $324.6 million for the year ended December 31, 2011 compared to a net income of $56.9 million for the year ended December 31, 2010. The increase in net income is due to the items previously described.
Adjusted EBITDA. Adjusted EBITDA increased to $188.5 million, compared to $156.2 million in 2010, due to the factors previously discussed.
Adjusted net income. Adjusted Net Income increased to $147.2 million in 2011 compared to $116.0 million in 2010, due to the factors discussed above.
Year ended December 31, 2010 compared to year ended December 31, 2009
The following table sets forth our consolidated statement of operations data for the periods indicated:
|
Year ended December 31,
|
||||||||
|
(Dollars in thousands)
|
2009
|
2010
|
||||||
|
Net sales
|
$ | 588,248 | $ | 592,880 | ||||
|
Costs of goods sold
|
352,398 | 355,523 | ||||||
|
Gross profit
|
235,850 | 237,357 | ||||||
|
Operating expenses:
|
||||||||
|
Selling and service
|
59,823 | 57,954 | ||||||
|
Research and development
|
10,842 | 14,700 | ||||||
|
General and administrative
|
14,713 | 22,599 | ||||||
|
Amortization of intangibles
|
51,960 | 51,808 | ||||||
|
Total operating expenses
|
137,338 | 147,061 | ||||||
|
Income (loss) from operations
|
98,512 | 90,296 | ||||||
|
Total other expense, net
|
(55,118 | ) | (33,076 | ) | ||||
|
Loss before provision for income taxes
|
43,394 | 57,220 | ||||||
|
Provision for income taxes
|
339 | 307 | ||||||
|
Net loss
|
$ | 43,055 | $ | 56,913 | ||||
|
Year ended December 31,
|
||||||||
|
(Dollars in thousands)
|
2009
|
2010
|
||||||
|
Residential power products
|
$ | 370,740 | $ | 372,782 | ||||
|
Commercial & Industrial power products
|
187,323 | 183,555 | ||||||
|
Other
|
30,185 | 36,543 | ||||||
|
Net sales
|
$ | 588,248 | $ | 592,880 | ||||
Net sales. Net sales increased $4.6 million, or 0.8%, to $592.9 million for the year ended December 31, 2010 from $588.2 million for the year ended December 31, 2009. This increase was driven by a $2.0 million, or a 0.6%, increase in sales to the residential markets due to continued expansion of the Company’s distribution network and successful new product launches, offset by continued weakness in U.S. residential investment. This residential product sales increase was offset by a $3.8 million, or 2.0%, decline in industrial and commercial product sales as a result of market declines in non-residential construction and reduced capital spending by national account customers. Although a decrease for the full year, industrial and commercial product sales displayed strong momentum in the second half of fiscal 2010 as end markets recovered. Other product sales increased $6.4 million as a result of stronger RV, OEM engine and service parts sales.
Costs of goods sold. Costs of goods sold increased $3.1 million, or 0.9%, to $355.5 million for the year ended December 31, 2010 from $352.4 million for the year ended December 31, 2009. This increase was driven by a $4.4 million increase in materials cost, primarily due to higher steel, copper and aluminum costs, as well as by the increase in sales volume, partially offset by lower manufacturing overhead costs.
Gross profit. Gross profit increased $1.5 million, or 0.6%, to $237.4 million for the year ended December 31, 2010 from $235.9 million for the year ended December 31, 2011, primarily due to the factors affecting net sales and cost of goods sold described above. As a percentage of net sales, gross profit decreased slightly to 40.0% for the year ended December 31, 2010 from 40.1% for the year ended December 31, 2009.
Operating expenses. Operating expenses increased $9.7 million to $147.1 million for the year ended December 31, 2010 from $137.3 million for the year ended December 31, 2009. This increase is due to incremental research and development costs of $3.9 million related to ongoing product development. In addition, general and administrative expenses increased $7.9 million, of which $6.4 million was related to non-cash stock compensation expense recorded for the time vesting of equity awards granted in connection with the IPO. The remaining increase in administrative costs was associated with additional costs to operate as a public company.
Other expense. Other expense decreased $22.0 million, or 40.0%, to $33.1 million for the year ended December 31, 2010 from $55.1 million for the year ended December 31, 2009. This decrease was driven by a decline in interest expense of $43.5 million as a result of our reduction in indebtedness, lower LIBOR rates and the termination of certain interest rate swap agreements. Offsetting this interest expense decline in 2010, there was a prior year gain on extinguishment of debt of $14.7 million that did not occur in 2010, as well as the current year write-off of deferred financing costs related to debt extinguishment of $4.8 million.
Income tax expense. Income tax expense was $0.3 million for the year ended December 31, 2010, unchanged from the year ended December 31, 2009. Income tax expense primarily relates to certain state income taxes based on profitability measures other than net income.
Net income. As a result of the factors identified above, we generated net income of $56.9 million for the year ended December 31, 2010 compared to a net income of $43.1 million for the year ended December 31, 2009. The increase in net income is due to the items previously described.
Adjusted EBITDA. Adjusted EBITDA decreased to $156.2 million, compared to $159.1 million in 2009, as modest sales growth and consistent gross margins were more than offset by increased investment in the business. Adjusted EBITDA margins declined slightly in fiscal 2010 to 26.4% compared to 27.0% in fiscal 2009.
Adjusted net income. Adjusted Net Income increased to $115.9 million in 2010 compared to $83.6 million in 2009. The increase in adjusted net income was attributable to lower interest expense versus prior year
offset by non-cash stock compensation expenses and reduced Adjusted EBITDA compared to fiscal 2009.
Liquidity and financial position
Our primary cash requirements include the payment of our raw material and components suppliers, 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 has been reduced to $597.9 million as of December 31, 2011, and our second lien credit facility has been repaid in full and terminated.
At December 31, 2011, we had cash and cash equivalents of $93.1 million and $144.2 million of availability under our revolving credit facility. Our total indebtedness was $597.9 million at December 31, 2011.
On February 9, 2012, Generac Power Systems repaid an additional $22.9 million against its first lien term loan and entered into a new credit agreement. The new credit agreement provides for borrowings under a new five-year $150.0 million 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 new credit agreement were used to repay in full all outstanding borrowings under the former credit agreement, dated as of November 10, 2006, as amended from time to time, and for general corporate purposes. As a result of the repayments of debt and refinancing, our total indebtedness was $575.0 million at February 9, 2012.
Long-term liquidity
We believe that our cash flow from operations, our availability under our revolving credit facility, combined with our low ongoing capital expenditure requirements and favorable tax attributes, will provide us with sufficient capital to continue to grow our business in the next twelve months and beyond. However, even with our reduced leverage, we will use a portion of our cash flow to pay interest 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.
Cash flow
Year ended December 31, 2011 compared to year ended December 31, 2010
The following table summarizes our cash flows by category for the periods presented:
|
Year ended December 31,
|
||||||||||||||||
|
(Dollars in thousands)
|
2010
|
2011
|
Change
|
% Change
|
||||||||||||
|
Net cash provided by operating activities
|
$ | 114,481 | $ | 169,712 | $ | 55,231 | 48.2 | % | ||||||||
|
Net cash used in investing activities
|
$ | (11,204 | ) | $ | (95,953 | ) | $ | (84,749 | ) | -756.4 | % | |||||
|
Net cash used in financing activities
|
$ | (186,001 | ) | $ | (59,216 | ) | $ | 126,785 | 68.2 | % | ||||||
Net cash provided by operating activities was $169.7 million for 2011 compared to $114.5 million in 2010. This increase of $55.2 million, or 48.2%, is primarily attributable to increased sales volume during 2011 and to a lesser extent favorable net cash inflows from working capital in 2011 compared to net cash flow outflows from working capital in 2010.
Net cash used for investing activities for the year ended December 31, 2011 was $96.0 million. This included $12.1 million used for the purchase of property and equipment and $83.9 million for the acquisition of the Magnum Products business. Net cash used for investing activities for the year ended December 31, 2010 was $11.2 million and included $9.6 million used for the purchase of property and equipment and $1.6 million for a business acquisition, net of cash acquired.
Net cash used in financing activities was $59.2 million for the year ended December 31, 2011, a decrease of $126.8 million in net cash outflows from 2010 due to higher levels of debt payments made in 2010 totaling $434.3 million which were offset by $248.3 million of proceeds from the issuance of common stock. In 2011, $59.4 million of payments on debt were made.
Year ended December 31, 2010 compared to year ended December 31, 2009
The following table summarizes our cash flows by category for the periods presented:
|
Year ended December 31,
|
||||||||||||||||
|
(Dollars in thousands)
|
2009
|
2010
|
Change
|
% Change
|
||||||||||||
|
Net cash provided by operating activities
|
$ | 74,607 | $ | 114,481 | $ | 39,874 | 53.4 | % | ||||||||
|
Net cash used in investing activities
|
$ | (4,351 | ) | $ | (11,204 | ) | $ | (6,853 | ) | -157.5 | % | |||||
|
Net cash provided (used) by financing activities
|
$ | 9,822 | $ | (186,001 | ) | $ | (195,823 | ) | -1,993.7 | % | ||||||
Net cash provided by operating activities was $114.5 million for 2010 compared to $74.6 million in 2009. This increase of $39.9 million represents a 53.4% increase over prior year mainly due to the reduction of cash paid for interest expense of $38.8 million. A reduction in working capital usage also contributed to the full year 2010 cash flow improvement as well.
Net cash used for investing activities for the year ended December 31, 2010 was $11.2 million and included $9.6 million used for the purchase of property and equipment and $1.6 million for a business acquisition, net of cash acquired. Net cash used for investing activities for the year ended December 31, 2009 was $4.4 million and included $4.5 million used for the purchase of property and equipment. The increase in property and equipment purchases in 2010 relates to certain product development and cost reduction projects.
Net cash provided (used) by financing activities was $(186.0) million for the year ended December 31, 2010, a decrease of $195.8 million from 2009, due mainly to $248.3 million of proceeds from the issuance of common stock, offset by payments on debt of $434.3 million. Net cash provided by financing activities was $9.8 million for the year ended December 31, 2009 due to a $20.0 million capital contribution in exchange for shares of our Series A Preferred Stock, offset by principal payments on our first lien term loan of $9.5 million and $0.7 million of payments incurred in advance of our IPO.
Senior secured credit facilities
In November 2006, as part of the CCMP Transactions, Generac Power Systems entered into (i) a first lien credit facility with Goldman Sachs Credit Partners L.P., as administrative agent, composed of (x) a $950.0 million term loan, which was scheduled to mature in November 2013 and (y) a $150 million revolving credit facility, which was scheduled to mature in November 2012, and (ii) a second lien credit facility with JP Morgan Chase Bank, N.A., as administrative agent, composed of a $430.0 million term loan, which was scheduled to mature in May 2014. The effective interest rate on the first lien credit facility term loan on December 31, 2011 was 3.2%. The effective interest rate, excluding the effect of interest rate swaps in place on the first lien credit facility term loan on December 31, 2011, was 2.8%.
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 loans. 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. Additional information on this credit facility can be found in the Notes to Consolidated financial Statements – Note 6 Credit Agreements.
On February 9, 2012, Generac Power Systems repaid an additional $22.9 million against its first lien term loan and entered into new senior secured credit facilities. The new credit facilities include a new five-year $150.0 million 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 from loans made under the new credit facilities were used to repay in full all first lien term loans outstanding under our former first lien credit facility, and for general corporate purposes. As a result of the repayments of debt and refinancing, our total indebtedness was $575.0 million and there were no borrowings on the revolving credit facility at February 9, 2012.
The new revolving credit facility and tranche A term loan facility initially bear interest at rates based upon either a base rate plus an applicable margin of 1.25% or adjusted LIBOR rate plus an applicable margin of 2.25%. The tranche B term loan facility bears interest at rates based upon either a base rate (which, with respect to such tranche B term loan facility, will not be less than 2.00%) plus an applicable margin of 1.75% or adjusted LIBOR rate (which, with respect to such tranche B term loan facility, will not be less than 1.00%) plus an applicable margin of 2.75%. In subsequent periods, the new revolving credit facility and the tranche A term loan facility will bear interest at rates based upon either a base rate plus an applicable margin ranging from 0.75% to 1.50% or adjusted LIBOR rate plus an applicable margin ranging from 1.75% to 2.50%, each determined based on a leverage ratio.
Amounts under the new revolving credit facility can be borrowed and repaid, from time to time, at our option, provided there is no default or event of default under the new credit facilities.
The principal amount of the tranche A term loan amortizes in equal installments of $4.063 million on the first day of each fiscal quarter commencing on July 1, 2012 through April 1, 2014, then equal installments of $8.125 million on the first day of each fiscal quarter commencing July 1, 2014 through April 1, 2015, then equal installments of $10.156 million on the first day of each fiscal quarter commencing July 1, 2015 through January 1, 2017, with a final payment of $188.906 million on February 9, 2017. The principal amount of the tranche B term loan amortizes in equal installments of $0.625 million on the first day of each fiscal quarter commencing on July 1, 2012 through January 1, 2019, with a final payment of $233.125 million on February 9, 2019. Any amounts outstanding under the revolving credit facility are due on February 9, 2017.
The new credit facilities restrict the circumstances in which distributions and dividends can be paid by Generac Power Systems, as the borrower. Payments can be made by Generac Power Systems to us for certain expenses such as operating expenses in the ordinary course and dividends can be used to repurchase equity interests, subject to limitation in certain circumstances. Additionally, the new credit facilities restrict the aggregate amount of dividends and distributions that can be paid and, in certain circumstances, requires the maintenance of certain leverage ratios in order to pay certain dividends or distributions.
The new credit facilities permit Generac Power Systems to prepay its borrowings under the tranche A term loan facility, the tranche B term loan facility and the revolving credit facility, subject to the procedures set forth in the new credit agreement applicable to the new credit facilities. In certain circumstances, Generac Power Systems may be required to make prepayments on its outstanding borrowings under the new credit facilities if it receives proceeds as a result of certain asset sales, debt issuances, casualty or similar events of loss or if Generac Power Systems has excess cash flow (as defined in the new credit facilities).
The new credit agreement contains customary events of default, including, among others, nonpayment of principal, interest or other amounts, failure to perform covenants, inaccuracy of representations or warranties in any material respect, cross-defaults with other material indebtedness, certain undischarged judgments, the occurrence of certain ERISA or bankruptcy or insolvency events or the occurrence of a change in control (as defined in the new credit agreement). Upon an event of default under the new credit agreement, the lenders may declare the loans and all other obligations under the new credit agreement immediately due and payable and require Generac Power Systems to cash collateralize the outstanding letter of credit obligations. A bankruptcy or insolvency event of default causes such obligations to automatically become immediately due and payable.
The borrowings under the new credit facilities are secured by associated collateral agreements which pledge virtually all assets of Generac Power Systems and the guarantors of the new credit facilities. The new credit agreement requires Generac Power Systems, among other things, to meet certain financial and nonfinancial covenants and maintain a consolidated net leverage ratio not exceeding certain agreed levels and an interest coverage ratio not to decline below certain agreed levels.
Covenant compliance
The first lien credit facility in place at December 31, 2011 required Generac Power Systems to maintain a leverage ratio of consolidated total debt, net of unrestricted cash and marketable securities, to EBITDA (as defined in such first lien credit facility). We refer to the calculation of EBITDA under and as defined in such first lien credit facility in this annual report as “Covenant EBITDA.” Covenant EBITDA and the leverage ratio were calculated based on the four most recently completed fiscal quarters of Generac Power Systems. Based on the formulations set forth in the first lien credit facility, Generac Power Systems was required to maintain a maximum leverage ratio of 4.75 to 1.00 as of December 31, 2011 and for the remainder of the term of such first lien credit agreement. As of December 31, 2011, Generac Power Systems’ leverage ratio was 2.83 to 1.00. Failure to comply with this covenant would have resulted in an event of default under the first lien credit facility unless waived by the lender thereunder. Generac Power Systems was in compliance with the financial covenants under the first lien credit facility as of December 31, 2009, December 31, 2010 and December 31, 2011. Additional information on the first lien credit facility can be found in the Notes to Consolidated financial Statements – Note 6 Credit Agreements.
The new credit facilities, effective February 9, 2012, requires Generac Power Systems to maintain a leverage ratio of consolidated total debt, net of unrestricted cash and marketable securities, to EBITDA (as defined in the new credit agreement) and an interest coverage ratio of EBITDA to cash interest expense (as defined in the new credit agreement). The calculation of EBITDA under and as defined in the new credit agreement is referred to in this annual report as “Covenant EBITDA.” Covenant EBITDA, the leverage ratio and interest coverage ratio are calculated based on the four most recently completed fiscal quarters of Generac Power Systems. Based on the formulations set forth in the new credit agreement, Generac Power Systems is required to maintain a maximum leverage ratio of 4.00 to 1.00 from the periods June 30, 2012 to September 30, 2012, and 3.75 to 1.00 thereafter. Additionally, Generac Power Systems is required to maintain a minimum interest coverage ratio of 2.50 to 1.00 from June 30, 2012 to September 30, 2012, 2.75 to 1.00 from December 31, 2012 to June 30, 2013, 3.00 to 1.00 from September 30, 2013 to June 30, 2014 and 3.25 to 1.00 thereafter.
Our compliance with the financial covenants and satisfaction of certain leverage based ratios are used in determining, among other things, the interest rate applicable to the outstanding loans under the new credit facilities, the ability to undertake business acquisitions, the ability to incur certain types of indebtedness and the amount of dividends and distributions that are permitted to be paid to our stockholders, subject to certain exceptions.
An event of default under the new credit facilities could result in the acceleration of our indebtedness under such facilities, and we may be unable to repay or finance the amounts due. If there were an event of default as a result of a failure to maintain our required leverage ratio or otherwise, it would have an adverse effect on our financial condition and liquidity, including preventing us from utilizing our revolving credit facility. In addition, the new credit facilities restrict our ability to take certain actions, such as incur additional debt or make certain acquisitions, if we are unable to meet our leverage ratio.
In addition to the financial covenant described above, the new credit facilities contain certain other affirmative and negative covenants that, among other things, provide limitations on the incurrence of additional indebtedness, liens on property, sale and leaseback transactions, investments, loans and advances, merger or consolidation, asset sales, acquisitions, transactions with affiliates, prepayments of any other indebtedness and modifications of Generac Power Systems’ organizational documents.
As of December 31, 2011, $597.9 million of borrowings were outstanding under the first lien credit facility. As of December 31, 2010, $657.2 million of borrowings were outstanding under the first lien credit facility. As previously disclosed, on February 9, 2012, Generac Power Systems repaid an additional $22.9 million against its first lien credit facility and entered into new credit facilities. As of February 9, 2012, a total of $575.0 million were outstanding under the new credit facilities.
Contractual obligations
The following table summarizes our expected payments for significant contractual obligations as of December 31, 2011:
|
Payment due by period
|
||||||||||||||||||||
|
(Dollars in thousands)
Contractual obligations
|
Total
|
Less than
1 year
|
2-3 years
|
4-5 years
|
After 5
years
|
|||||||||||||||
|
Long-term debt, including current portion (1)
|
$ | 597,874 | $ | -- | $ | 597,874 | $ | -- | -- | |||||||||||
|
Interest on long-term debt(2)
|
31,665 | 17,043 | 14,622 | -- | -- | |||||||||||||||
|
Operating leases
|
1,325 | 479 | 818 | 28 | -- | |||||||||||||||
|
Total contractual cash obligations(3)
|
$ | 630,864 | $ | 17,522 | $ | 613,314 | $ | 28 | $ | -- | ||||||||||
(1) On February 9, 2012, a subsidiary of the Company entered into a new credit agreement with certain commercial banks and other lenders. The new credit agreement provides for borrowings under a new $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 new revolving credit facility and tranche A term loan facility mature February 9, 2017, and the tranche B term loan facility matures February 9, 2019.
(2) Assumes all debt will remain outstanding until maturity and using the interest rates in effect for our senior secured credit facilities as of December 31, 2011.
(3) Pension obligations are excluded from this table as we are unable to estimate the timing of payment due to the inherent assumptions underlying the obligation. However, the Company estimates we will contribute $2.9 million to our pension plans in 2012.
Capital expenditures
Our operations require capital expenditures for technology, tooling, equipment, capacity expansion and upgrades. Capital expenditures were $12.1 million for the year ended December 31, 2011, and were funded through cash from operations. Capital expenditures were $9.6 million for the year ended December 31, 2010, and were also funded through cash from operations.
Off-balance sheet arrangements
We have an arrangement with a finance company to provide floor plan financing for selected dealers. This arrangement provides liquidity for our dealers by financing dealer purchases of products with credit availability from the finance company. We receive payment from the finance company after shipment of product to the dealer and our dealers are given a longer period of time to pay the finance provider. If our dealers do not pay the finance company, we may be required to repurchase the applicable inventory held by the dealer.
Total inventory financed accounted for approximately 7% of net sales for the year ended December 31, 2010 and approximately 6% of net sales for the year ended December 31, 2011. The amount financed by dealers which remained outstanding was $9.8 million and $10.0 million as of December 31, 2010 and 2011, respectively.
Critical accounting policies
In preparing the financial statements in accordance with accounting principles generally accepted in the U.S., management is required to make estimates and assumptions that have an impact on the asset, liability, revenue and expense amounts reported. These estimates can also affect supplemental information disclosures of the Company, including information about contingencies, risk and financial condition. The Company believes, given current facts and circumstances, that its 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. The Company makes routine estimates and judgments in determining net realizable value of accounts receivable, inventories, property, plant and equipment, and prepaid expenses. Management believes the Company’s 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.
Goodwill and other intangible assets
We perform an annual impairment test for goodwill and trade names and more frequently if an event or circumstances indicate that an impairment loss has been incurred. Conditions that would trigger an impairment assessment include, but are not limited to, a significant adverse change in legal factors or business climate that could affect the value of an asset. The analysis of potential impairment of goodwill requires a two-step process. The first step is the estimation of fair value of the applicable reporting unit. Estimated fair value is based on management judgments and assumptions with the assistance of a third-party valuation firm, and those fair values are compared with our aggregate carrying value of the respective reporting unit. If our fair value is greater than the carrying amount, there is no impairment. If our carrying amount is greater than the fair value, then the second step must be completed to measure the amount of impairment, if any.
The second step calculates the implied fair value of the goodwill, which is compared to its carrying value. The implied fair value of goodwill is calculated by valuing all of the tangible and intangible assets of the reporting unit at the hypothetical fair value, assuming the reporting unit had been acquired in a business combination. The excess of the fair value of the entire reporting unit over the fair value of its identifiable assets and liabilities is the implied fair value of goodwill. If the implied fair value of goodwill is less than the carrying value of goodwill, an impairment loss is recognized equal to the difference.
The Company performed the required annual impairment tests for goodwill as of October 31, 2011, 2010 and 2009, and found no impairment of goodwill.
During the fourth quarter of 2011, the Company decided to strategically transition certain products to their more widely known Generac brand. Based on this decision, the Company recorded a $9.4 million non-cash charge which primarily related to the write down of the impacted trade name to net realizable value. In addition, the Company performed its annual fair value-based impairment test as of October 31, 2011. Except as noted, no impairment was indicated.
The Company performed its annual fair value-based impairment test on indefinite lived trade names as of October 31, 2010 and 2009. No impairment was indicated.
We can make no assurances that remaining goodwill or trade names will not be impaired in the future. When preparing a discounted cash flow analysis, we make a number of key estimates and assumptions. We estimate the future cash flows of the business based on historical and forecasted revenues and operating costs. This, in turn, involves further estimates, such as estimates of future growth rates and inflation rates. In addition, we apply a discount rate to the estimated future cash flows for the purpose of the valuation. This discount rate is based on the estimated weighted average cost of capital for the business and may change from year to year. Weighted average cost of capital includes certain assumptions such as market capital structures, market betas, risk-free rate of return and estimated costs of borrowing. Changes in these key estimates and assumptions, or in other assumptions used in this process, could materially affect our impairment analysis for a given year. Additionally, since our measurement also considers a market approach, changes in comparable public company multiples can also materially impact our impairment analysis.
In the long term, our remaining goodwill and trade name balances could be further impaired in future periods. A number of factors, many of which we have no ability to control, could affect our financial condition, operating results and business prospects and could cause actual results to differ from the estimates and assumptions we employed. These factors include:
|
·
|
a prolonged global economic crisis;
|
|
·
|
a significant decrease in the demand for our products;
|
|
·
|
the inability to develop new and enhanced products and services in a timely manner;
|
|
·
|
a significant adverse change in legal factors or in the business climate;
|
|
·
|
an adverse action or assessment by a regulator; and
|
|
·
|
successful efforts by our competitors to gain market share in our markets.
|
Our cash flow assumptions are based on historical and forecasted revenue, operating costs and other relevant factors. If management's estimates of future operating results change or if there are changes to other assumptions, the estimate of the fair value of our business may change significantly. Such change could result in impairment charges in future periods, which could have a significant impact on our operating results and financial condition.
Defined benefit pension obligations
The funded status of our pension plans is more fully described in Note 9 to our audited consolidated financial statements included in Item 8 of this annual report. As discussed in Note 9, the pension benefit obligation and related pension expense or income are calculated in accordance with ASC 715-30, Defined Benefit Plans—Pension, and are impacted by certain actuarial assumptions, including the discount rate and the expected rate of return on plan assets.
Rates are evaluated on an annual basis considering such factors as market interest rates and historical asset performance. Actuarial valuations for fiscal year 2011 used a discount rate of 5.22% and an expected rate of return on plan assets of 7.62%. Our discount rate was selected using a methodology that matches plan cash flows with a selection of Moody's Aa or higher rated bonds, resulting in a discount rate that better matches a bond yield curve with comparable cash flows. In estimating the expected return on plan assets, we study historical markets and preserve the long-term historical relationships between equities and fixed-income securities. We evaluate current market factors such as inflation and interest rates before we determine long-term capital market assumptions and review peer data and historical returns to check for reasonableness and appropriateness. Changes in the discount rate and return on assets can have a significant effect on the funded status of our pension plans, stockholders' equity and related expense. We cannot predict these changes in discount rates or investment returns and, therefore, cannot reasonably estimate whether the impact in subsequent years will be significant.
The funded status of our pension plans is the difference between the projected benefit obligation and the fair value of its plan assets. The projected benefit obligation is the actuarial present value of all benefits expected to be earned by the employees' service adjusted for future potential wage increases.
Our funding policy for our pension plans is to contribute amounts at least equal to the minimum annual amount required by applicable regulations. Given this policy, we expect to make $2.9 million in contributions to our pension plans in 2012.
Allowance for doubtful accounts, excess and obsolete inventory reserves, product warranty reserves and other contingencies
The reserves, if any, for customer rebates, product warranty, product liability, litigation, excess and obsolete inventory and doubtful accounts are fact-specific and take into account such factors as specific customer situations, historical experience, and current and expected economic conditions. These reserves are reflected under Notes 2, 4, 5 and 15 to our audited consolidated financial statements included in Item 8 of this Annual Report on Form 10-K.
Derivative accounting
We have interest rate swap contracts, or the Swaps, in place to fix a portion of our variable rate indebtedness. For 2007 and 2008, the Swaps were deemed highly effective per ASC 815 and therefore, any changes in fair value of these Swaps is recorded in accumulated other comprehensive income (loss). As of January 3, 2009, in accordance with the terms of our senior secured credit facilities, we changed the interest rate election from three-month LIBOR to one-month LIBOR. As a result, we concluded that as of January 3, 2009, the Swaps no longer met hedge effectiveness criteria under ASC 815. Future changes in the fair value of the Swaps was immediately recognized in our statement of operations as interest expense, while the effective portion of the Swaps prior to the change remained in accumulated other comprehensive income (loss) and was amortized as interest expense over the period of the originally designated hedged transactions which ended on January 4, 2010. New interest rate swap contracts entered into in fiscal 2010 are deemed highly effective per ASC 815.
As required by ASC 815 Derivatives and Hedging, we record the Swaps at fair value pursuant to ASC 820 Fair Value Measurements and Disclosures, which 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. When determining the fair value of the Swaps, we considered our credit risk in accordance with ASC 820. The fair value of the Swaps, including the impact of credit risk, at December 31, 2011 and 2010 was a liability of $5.3 million and $4.1 million, respectively.
Income taxes
We account for income taxes in accordance with ASC 740 Income Taxes. Our estimate of income taxes payable, deferred income taxes and the effective tax rate is based on an analysis of many factors including interpretations of federal and state income tax laws, the difference between tax and financial reporting bases of assets and liabilities, estimates of amounts currently due or owed in various jurisdictions, and current accounting standards. We review and update our estimates on a quarterly basis as facts and circumstances change and actual results are known.
We have generated significant deferred tax assets as a result of goodwill and intangible asset book versus tax differences as well as significant net operating loss carryforwards. In assessing the realizability of these deferred tax assets, we consider whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the years in which those temporary differences become deductible. We consider the scheduled reversal of deferred tax liabilities, projected future taxable income and tax planning strategies in making this assessment. As of September 30, 2011, we were in a three year cumulative loss position and had a full valuation allowance recorded against our net deferred tax assets. In the fourth quarter of 2011, we came out of a three-year cumulative loss position and, as part of the normal assessment of the future realization of our net deferred tax assets, determined that a valuation allowance was no longer required. As a result, the valuation allowance previously recorded was reversed in the fourth quarter of 2011 and was recorded as a component of the income tax provision.
Share based compensation
Under the fair value recognition provisions of ASC 718 Compensation – Stock Compensation, share based compensation cost is measured at the grant date based on the fair value of the award and is recognized as expense over the requisite service period. Determining the fair value of share based awards at the grant date requires judgment, including estimating expected dividends and market volatility of our stock. In addition, judgment is also required in estimating the amount of share based awards that are expected to be forfeited. If actual results differ significantly from these estimates, share based compensation expense and our results of operations could be impacted.
New Accounting Standards
For information with respect to new accounting pronouncements and the impact of these pronouncements on our consolidated financial statements, see Note 2 to the consolidated financial statements in Item 8 of this annual report on Form 10-K.
We are exposed to market risk from changes in foreign currency exchange rates, commodity prices and interest rates. To reduce the risk from changes in certain foreign currency exchange rates and commodity prices, we use financial instruments from time to time. We do not hold or issue financial instruments for trading purposes.
Foreign currency
We are exposed to foreign currency exchange risk as a result of purchasing from suppliers in other countries. Periodically, we utilize foreign currency forward purchase and sales contracts to manage the volatility associated with foreign currency purchases in the normal course of business. Contracts typically have maturities of one year or less. Realized and unrealized gains and losses on transactions denominated in foreign currency are recorded in earnings as a component of cost of goods sold. At December 31, 2011 and December 31, 2010, we had no foreign exchange contracts outstanding.
On February 18, 2010, we entered into a ten-month foreign currency average rate option transaction for Euros with a total notional amount of $2.5 million and a termination date of December 31, 2010. Total losses recognized in the statement of operations for foreign currency contracts were $100,000. The primary objective of this hedging activity is to mitigate the impact of potential price fluctuations of the Euro on our financial results.
Commodity prices
We are a purchaser of commodities and of components manufactured from commodities, including steel, aluminum, copper and others. As a result, we are exposed to fluctuating market prices for those commodities. While such materials are typically available from numerous suppliers, commodity raw materials are subject to price fluctuations. We generally buy these commodities and components based upon market prices that are established with the supplier as part of the purchase process. Depending on the supplier, these market prices may reset on a periodic basis based on negotiated lags. To the extent that commodity prices increase and we do not have firm pricing from our suppliers, or our suppliers are not able to honor such prices, we may experience a decline in our gross margins to the extent we are not able to increase selling prices of our products or obtain manufacturing efficiencies to offset increases in commodity costs.
Periodically, we engage in certain commodity risk management activities. The primary objectives of these activities are to understand and mitigate the impact of potential price fluctuations on our financial results. Generally, these risk management transactions will involve the use of commodity derivatives to protect against exposure resulting from significant price fluctuations.
We primarily utilize commodity contracts with maturities of one year or less. These are intended to offset the effect of price fluctuations on actual inventory purchases. The primary objective of the hedge is to mitigate the impact of potential price fluctuations of copper on our financial results. As of December 31, 2011, we had the following commodity forward contracts outstanding with the fair value gains losses shown (in thousands):
|
Hedged Item
|
Number of Contracts Outstanding
|
Effective Date
|
Aggregate Notional Amount
|
Losses recognized in consolidated statement of operations for the year ended December 31, 2011
|
|||||||||
|
Copper
|
2 |
October 1, 2011 to June 30, 2012
|
$ | 6,468 | $ | 861 | |||||||
Interest rates
As of December 31, 2011, a portion of the outstanding debt under our term loans was subject to floating interest rate risk. As of this date, we had the following interest rate swap contracts outstanding (in thousands):
|
Hedged Item
|
Contract Date
|
Effective Date
|
Notional Amount
|
Fixed LIBOR Rate
|
Expiration Date
|
||||||
|
Interest rate
|
April 1, 2011
|
October 1, 2012
|
$ | 100,000 | 2.22 | % |
October 1, 2013
|
||||
|
Interest rate
|
April 1, 2011
|
July 1, 2012
|
$ | 200,000 | 1.905 | % |
July 1, 2013
|
||||
|
Interest rate
|
June 29, 2010
|
October 1, 2010
|
$ | 100,000 | 1.025 | % |
October 1, 2012
|
||||
|
Interest rate
|
January 21, 2010
|
July 1, 2010
|
$ | 200,000 | 1.73 | % |
July 1, 2012
|
||||
At December 31, 2011, the fair value of the swaps reduced for our credit risk and excluding related accrued interest was a liability of $5.3 million. For further information on these swaps, see Note 6 to our audited consolidated financial statements included in Item 8 of this Annual Report on Form 10-K. Even after giving effect to these swaps, we are exposed to risks due to changes in interest rates with respect to the portion of our term loans that are not covered by the swaps. A hypothetical change in the LIBOR interest rate of 100 basis points would have changed annual cash interest expense by approximately $3.0 million (or, without the swaps in place, $6.0 million).
We expect to maintain our existing swaps as highly effective in accordance with ASC 815 and, therefore, any changes in the fair value of the swap would be recorded in accumulated other comprehensive income (loss).
To the Board of Directors and Stockholders of Generac Holdings Inc.
We have audited Generac Holdings Inc.’s internal control over financial reporting as of December 31, 2011, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). Generac Holdings Inc.’s management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the company’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions or that the degree of compliance with the policies or procedures may deteriorate.
As indicated in the accompanying Management’s Report on Internal Control Over Financial Reporting, management’s assessment of and conclusion on the effectiveness of internal control over financial reporting did not include the internal controls of Magnum Products LLC, which is included in the December 31, 2011 consolidated financial statements of Generac Holdings Inc. and constituted 7% and 12% of total and net assets, respectively, as of December 31, 2011 and 5% and 1% of revenues and net income, respectively, for the year then ended. Our audit of internal control over financial reporting of Generac Holdings Inc. also did not include an evaluation of the internal control over financial reporting of Magnum Products LLC.
In our opinion, Generac Holdings Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2011, based on the COSO criteria.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets as of December 31, 2011 and 2010, and the related consolidated statements of operations, redeemable stock and stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2011 of Generac Holdings Inc. and our report dated March 9, 2012 expressed an unqualified opinion thereon.
/s/ Ernst & Young LLP
Milwaukee, Wisconsin
March 9, 2012
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Stockholders of Generac Holdings Inc.
We have audited the accompanying consolidated balance sheets of Generac Holdings Inc. (the Company) as of December 31, 2011 and 2010, and the related consolidated statements of operations, redeemable stock and stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2011. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Generac Holdings Inc. and subsidiaries at December 31, 2011 and 2010, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2011, in conformity with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company's internal control over financial reporting as of December 31, 2011, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 9, 2012 expressed an unqualified opinion thereon.
/s/ Ernst & Young LLP
Milwaukee, Wisconsin
March 9, 2012
|
Consolidated Balance Sheets
|
||||||||
|
(Dollars in Thousands, Except Share and Per Share Data)
|
||||||||
|
December 31,
|
||||||||
|
2011
|
2010
|
|||||||
|
Assets
|
||||||||
|
Current assets:
|
||||||||
|
Cash and cash equivalents
|
$ | 93,126 | $ | 78,583 | ||||
|
Accounts receivable, less allowance for doubtful accounts of $789 in 2011 and $723 in 2010
|
109,705 | 63,154 | ||||||
|
Inventories
|
162,124 | 127,137 | ||||||
|
Deferred income taxes
|
14,395 | – | ||||||
|
Prepaid expenses and other assets
|
3,915 | 3,645 | ||||||
|
Total current assets
|
383,265 | 272,519 | ||||||
|
Property and equipment, net
|
84,384 | 75,287 | ||||||
|
Customer lists, net
|
72,897 | 96,944 | ||||||
|
Patents, net
|
78,167 | 84,933 | ||||||
|
Other intangible assets, net
|
7,306 | 6,483 | ||||||
|
Deferred financing costs, net
|
3,459 | 5,822 | ||||||
|
Trade names
|
148,401 | 140,050 | ||||||
|
Goodwill
|
547,473 | 527,148 | ||||||
|
Deferred income taxes
|
227,363 | – | ||||||
|
Other assets
|
78 | 697 | ||||||
|
Total assets
|
$ | 1,552,793 | $ | 1,209,883 | ||||
|
Liabilities and stockholders’ equity
|
||||||||
|
Current liabilities:
|
||||||||
|
Accounts payable
|
$ | 81,053 | $ | 41,809 | ||||
|
Accrued wages and employee benefits
|
14,439 | 6,833 | ||||||
|
Other accrued liabilities
|
47,024 | 38,043 | ||||||
|
Current portion of long-term debt
|
22,874 | – | ||||||
|
Total current liabilities
|
165,390 | 86,685 | ||||||
|
Long-term debt
|
575,000 | 657,229 | ||||||
|
Other long-term liabilities
|
43,514 | 24,902 | ||||||
|
Total liabilities
|
783,904 | 768,816 | ||||||
|
Stockholders’ equity:
|
||||||||
|
Common stock (formerly Class A non-voting common stock), par value $0.01, 500,000,000 shares authorized, 67,652,812 and 67,524,596 shares issued at December 31, 2011 and 2010, respectively
|
676 | 675 | ||||||
|
Additional paid-in capital
|
1,142,701 | 1,133,918 | ||||||
|
Excess purchase price over predecessor basis
|
(202,116 | ) | (202,116 | ) | ||||
|
Accumulated deficit
|
(157,015 | ) | (481,658 | ) | ||||
|
Accumulated other comprehensive loss
|
(15,357 | ) | (9,752 | ) | ||||
|
Total stockholders’ equity
|
768,889 | 441,067 | ||||||
|
Total liabilities and stockholders’ equity
|
$ | 1,552,793 | $ | 1,209,883 | ||||
|
See notes to consolidated financial statements.
|
||||||||
|
Consolidated Statements of Operations
|
||||||||||||
|
(Dollars in Thousands, Except Share and Per Share Data)
|
||||||||||||
|
Year Ended December 31,
|
||||||||||||
|
2011
|
2010
|
2009
|
||||||||||
|
Net sales
|
$ | 791,976 | $ | 592,880 | $ | 588,248 | ||||||
|
Costs of goods sold
|
497,322 | 355,523 | 352,398 | |||||||||
|
Gross profit
|
294,654 | 237,357 | 235,850 | |||||||||
|
Operating expenses:
|
||||||||||||
|
Selling and service
|
77,776 | 57,954 | 59,823 | |||||||||
|
Research and development
|
16,476 | 14,700 | 10,842 | |||||||||
|
General and administrative
|
30,012 | 22,599 | 14,713 | |||||||||
|
Amortization of intangibles
|
48,020 | 51,808 | 51,960 | |||||||||
|
Trade name write-down
|
9,389 | – | – | |||||||||
|
Total operating expenses
|
181,673 | 147,061 | 137,338 | |||||||||
|
Income from operations
|
112,981 | 90,296 | 98,512 | |||||||||
|
Other (expense) income:
|
||||||||||||
|
Interest expense
|
(23,718 | ) | (27,397 | ) | (70,862 | ) | ||||||
|
Gain on extinguishment of debt
|
– | – | 14,745 | |||||||||
|
Write-off of deferred financing costs related to debt extinguishment
|
(377 | ) | (4,809 | ) | – | |||||||
|
Investment income
|
110 | 235 | 2,205 | |||||||||
|
Costs related to acquisition
|
(875 | ) | – | – | ||||||||
|
Other, net
|
(1,155 | ) | (1,105 | ) | (1,206 | ) | ||||||
|
Total other expense, net
|
(26,015 | ) | (33,076 | ) | (55,118 | ) | ||||||