ColdFusion Developer Center

Generac Earnings Discontinued Due to Customer Bankruptcy and Product Warranty Issues

Generac Holdings (GNRC -7.84%), which makes emergency power generators and other energy technology solutions, closed Wednesday’s trading session down 7.8% after posting a weak third-quarter report. Much of this drop was likely due to market momentum, as the broader market was down as well.

The higher and lower results for the quarter and the company’s significantly reduced full-year guidance were in line with preliminary results released on October 19. In other words, the key figures did not surprise investors following the company. Wednesday’s report contained much more data, however.

Generac key figures

Metric

Q3 2021

Q3 2022

To change

Revenue

$943 million

$1.09 billion

15%

GAAP net income

$132 million

$58 million (56%)

Adjusted net income

$151 million $112 million (26%)

Earnings per share (EPS) GAAP

$1.93 $0.83 (57%)

Adjusted EPS

$2.35 $1.75 (26%)

Data source: Generac. GAAP = generally accepted accounting principles.

Core sales, a measure that excludes the impact of acquisitions and foreign currencies, were up about 10%.

Adjusted numbers exclude pre-tax charges totaling $55.3 million – $17.9 million in bad debt related to a larger clean energy products customer that filed for bankruptcy, and $37.3 million of clean energy product warranty issues.

That’s a huge total charge – it’s almost half of the company’s adjusted net profit. And this last issue, in particular, suggests that enterprise risk management controls may need to be strengthened.

Cash flow was negative during the quarter. The company spent $56 million on operations in the third quarter, compared to cash generation of $74.4 million a year earlier. And free cash flow was negative $73.5 million, compared to positive $42.1 million in the third quarter of 2021.

A cash outflow of $73.5 million in a single quarter is huge compared to the company’s cash position. Generac ended the quarter with cash and cash equivalents of $229.9 million. It also has long-term debt of around $1.3 billion.

Breakdown of sales by product class and geography

Product class:

  • Home product sales increased 9% year-over-year to $664 million.
  • Sales of commercial and industrial products increased 20% to $311 million. (Generac also has a relatively small “other” category.)

Geographic segment:

  • Domestic sales increased 18% year-over-year to $946.6 million, with acquisitions made over the past year contributing about 8% of that growth.
  • International sales (which consist primarily of commercial and industrial products) increased 14% to $182.5 million, and base growth was approximately 22%. Currency headwinds have been significant as the US dollar has strengthened significantly over the past year against most other currencies. (Both categories include inter-segment sales, so their total is slightly more than total company revenue.)

What the CEO had to say

In the earnings release, CEO Aaron Jagdfeld summarized why third quarter results fell short of management’s past expectations:

Sales of commercial and industrial products continued to experience strong growth in the quarter, but sales of residential products began to slow as installation capacity constraints in our distribution network led to an increase in inventory of home backup generators. This resulted in lower than expected orders from our channel partners, although we saw sequential improvements in several key metrics for the home standby category. In addition, during the quarter, clean energy product shipments were negatively impacted by a large clean energy product customer which ceased operations during the quarter.

Jagfeld said headwinds from its channel partners in the home watch product category are expected to persist through the first half of 2023.

Orientation 2022 lowered

Metric

Guidance prior to 2022

2022 Guidance Update

Revenue increase

36% to 40%

22% to 24%
Net profit margin before deduction of non-controlling interests 13% to 14% 9% to 10%

Data source: Generac.

Updated revenue guidance includes a net favorable impact of approximately 5% to 7% from acquisitions and foreign currencies.

A dismal quarter, but long-term growth potential remains promising

In short, Generac had a disappointing third quarter, and all signs point to continued challenges in its home standby generator business through the first half of 2023. Beyond that, much will depend on the state of the economy. A deep or prolonged recession would hurt the business.

That said, Generac’s long-term growth potential remains bright, but whether it will realize that potential remains to be seen. The company’s backup power business should continue to benefit from the growing number of climate changeextreme weather events, which in turn increase the frequency and severity of power outages.

As Jagfeld noted in the earnings release, “As dependence on electricity increases and imbalances between supply and demand grow further, Generac will continue to invest in technologies and solutions to drive the evolution to the next-generation network.”

Investors should watch Generac’s cash flow closely, as its cash outflows were very strong in the third quarter.

Beth McKenna holds (long) positions in Generac Holdings. The Motley Fool has no position in the stocks mentioned. The Motley Fool has a disclosure policy.