Generac Holdings Inc (GNRC) 2010 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Second Quarter 2010 Generac Holdings, Inc., earnings conference call.

My name is [Shontalay], and I will be your facilitator for today's call.

At this time, all participants are in a listen-only mode.

We will be facilitating a question-and-answer session towards the end of this conference.

(Operator Instructions).

As a reminder this conference is being recorded for replay purposes.

I would now like to turn the presentation over to your host for today's call, Mr.

York Ragen, CFO of Generac.

Please proceed, sir.

Hello, everyone.

Good morning and welcome to our second quarter 2010 earnings call.

I'd like to thank everyone for joining us today.

With me is Aaron Jagdfeld, our President and Chief Executive Officer.

We will begin by stating that we'll make a number of forward-looking statements on our call today.

Certain statements made during this call as well as other information provided from time to time by Generac or its employees may contain forward-looking statements and involve risks and uncertainties that could cause actual results to differ materially from those in these forward-looking statements.

Please see our earnings release or our SEC filings for a list of words or expressions that identify such statements and the associated Risk Factors.

In addition, we will make reference to certain non-GAAP financial measures as defined by SEC regulations.

In accordance with these regulations, we have provided reconciliations of these measures in our press release issued this morning to what we believe are the most directly comparable GAAP measures.

I will now turn the call over to Aaron Jagdfeld to discuss our Q2 2010 results.

Thank you, York.

During the second quarter of 2010, we were able to achieve strong earnings growth while generating strong cash flows from operations.

Net sales for the second quarter 2010 totaled $140.5 million, a decrease of 6.1% from $149.6 million in the second quarter of 2009.

Although faced with a challenging US economic environment, difficult prior-year comparables in our residential markets, and continued softness in our industrial markets, we saw certain positive trends as our year-over-year sales decline continued to moderate over the last three quarters.

Even during this difficult economic climate, we have continued to execute our growth strategies focused on products, distribution, and awareness for backup power.

Now looking at net sales by product class -- residential product sales declined 3.3% to $87.9 million in the second quarter of 2010 from sales of $90.9 million in the second quarter of 2009.

The consumer continues to be impacted by an uncertain economic environment.

Because of this uncertainty, as well as the limited credit availability, demand for largest discretionary consumer durables purchases, including residential standby generators, has suffered.

In fact, we believe the relative stability and demand for these products over the past two years in the face of this challenging environment further demonstrates the underlying penetration opportunity for residential standby generators.

In addition to the economy, our residential product sales have also been negatively impacted by a reduction in demand from severe power outages in the first half of 2010.

As a comparison, in the first half of 2009, we experienced a positive impact from increased severe power outages occurring in the latter part of 2008 and early part of 2009.

As we have discussed previously, demand for portable generator sales generally increases immediately prior to and after a power outage.

In contrast, demand for residential standby generators generally occurs over a more prolonged period of time following an outage -- sometimes up to 12 months afterwards.

A reduction in the level of severe power outage activity during the latter part of 2009 and the early part of 2010, created a challenging year-over-year comparable when looking at our residential products.

Despite this year-over-year market decline in our residential products, we believe that we have maintained or grown our market share in our residential product categories, and we continue to execute on initiatives to help drive future growth of these products.

During the second quarter 2010, we upgraded our home standby generator product offering with enhanced controls and load-shutting capabilities giving homeowners additional flexibility to manage their backup power needs.

In addition, during the first half of 2010, we expanded our portable generator product line with the introduction of our IX series and XG series of generators, further broadening our product offering.

The XG series is positioned between our entry-level GP series products and our contractor-grade XP series products.

The IX series is an inverter-based portable generator line aimed at the recreational end of the consumer market.

In addition to new products, in the second quarter we continued to add new dealers to our industry-leading dealer network.

We also increased our shelf space with certain retailers, which helped us increase our portable generator market share during the quarter.

Lastly, we continue to focus on several marketing and advertising efforts to promote the awareness of residential standby generators.

In the third quarter of 2010, we will launch our core power series of residential standby generators, which will introduce the industry's lowest opening price point for the category.

Looking at our industrial and commercial products, net sales declined 15.7% to $43.3 million in the second quarter of 2010 from net sales of $51.4 million in the second quarter of 2009.

Continued declines in sales to our industrial national account customers, primarily our telecommunications customers, combined with softness in US non-residential construction spending led to this year-over-year decline.

Our industrial and commercial products are typically purchased in the final stages of the non-residential construction projects.

As a result, recovery in the industrial and commercial standby generator market will generally lag the overall economic recovery.

Although year-over-year sales of these products have declined, we believe we have maintained our share of this market and have seen positive near-term demand trends for these products.

We have focused on several important growth initiatives in this area, which have helped stabilize sales trends for these products.

In the first quarter of 2010, we began shipping our newly redesigned industrial diesel product line.

This product offering is powered by Fiat powertrain engines and includes many improvements resulting from customer feedback and market research.

In addition to new products, over the last year we added new private label accounts, which helped to expand our distribution to the growing natural gas fueled generator market.

Additionally, we increased our efforts to develop international distribution focusing mainly in Latin America in the first half of 2010.

And, finally, we continue to focus on driving demand for our light commercial natural gas-fueled generators by increasing awareness of our lower cost standardized product offerings and by targeting national account customers that are looking for a cost-effective solution to their backup power needs.

We believe these initiatives were an important part of the 13% sequential growth of these products from first quarter 2010 to second quarter 2010.

Underpinning all of our growth initiatives is our consistent and efficient conversion of earnings to cash flow.

At $28.2 million for the second quarter of 2010, our cash flows from operations are 20.1% of net sales, which highlights our advantage operating model, low-cost debt, and favorable tax attributes.

I will now turn the call back over to York, who will discuss margins, capital structure, and cash flows in more detail.

York?

Thanks, Aaron.

Looking at our gross margins, gross margins for the quarter were 39% of net sales compared to 40.2% of net sales in the second quarter of 2009, a year-over-year decline of 120 basis points.

The decrease in gross margin percent is mainly attributable to a sales mix change to our lower kilowatt products, which typically have lower gross margins.

In addition, we are now experiencing higher year-over-year commodity costs in the second quarter primarily from increases in steel and copper.

Turning to operating expenses, operating expenses for the second quarter of 2010 were $35.9 million, a 1.4% increase over the second quarter of 2009 and includes $12.9 million of intangible asset amortization and $1.7 million of share-based compensation expense.

If you recall, the intangible assets on our books relates solely to the CCMP change in control transaction back in November 2006.

As a result, the intangible amortization expense reflected in our income statement relates solely to that CCMP transaction and not any other M&A activity.

The $1.7 million of share-based compensation expense during the quarter relates to stock options, restricted stock, and other stock awards that were granted in conjunction with our February 2010 initial public offering.

US GAAP requires that the value of these share-based compensation awards be expensed over their corresponding vesting periods.

As we indicated on our previous earnings call, for the balance of 2010 we expect to record approximately $1.6 million to $1.7 million in share-based compensation expense per quarter related to these stock awards.

Excluding share-based compensation expense, operating expenses for the quarter decreased $1.2 million, year-over-year, as a result of lower variable operating expenses on lower sales volumes and lower warranty rates.

Partially offsetting this decrease in op expenses were additional investments in engineering, product development, and new public company administrative costs.

As a result of the lower sales volumes and lower gross margins, adjusted EBITDA decreased 10.2% to $36 million in the second quarter of 2010 as compared to $40 million in the second quarter of 2009.

On a sequential quarter-over-quarter basis, adjusted EBITDA margins improved to 25.6% in the second quarter of 2010 as compared to 24.4% in the first quarter of 2010.

Improved operating leverage on higher sales volumes primarily led to the sequential 120 basis-point improvement in adjusted EBITDA margins.

Due to the changes in sales, gross margins, and operating expenses discussed previously, as well as a $12.8 million decrease in interest expense, adjusted net income increased 28.9% to $26.1 million from $20.3 million in the second quarter of 2009.

Net income increased year-over-year by 16.7% to $12.8 million as compared to $11 million for the second quarter of 2009.

A reconciliation of our GAAP net income to adjusted net income is included in our earnings release.

Diluted net income per share was $0.19 per share.

Adjusted diluted net income per common share was $0.39 per share, both of which included $0.03 per share of share-based compensation expense.

Now looking at our cash flows for the second quarter of 2010, cash flows from operations were $28.2 million in the second quarter of 2010 compared to $20.7 million in the second quarter of 2009.

This net increase in cash flows is attributable to a $10.9 million decrease in cash interest paid partially offset by a decline in income from operations.

Cash interest expense declined year-over-year during the second quarter of 2010 due to lower LIBOR rates, the termination of certain interest rate swap agreements at the beginning of 2010, and the debt repayments we made in the first quarter of 2010.

For the balance of 2010, we anticipate GAAP interest expense to be approximately $6 million to $6.5 million per quarter.

As you recall, following our initial public offering in February 2010, the outstanding balance on our first lien credit facility had been reduced to $731.4 million, and the second lien term loan had been terminated.

The first lien credit facility bears interest at LIBOR + 250 basis points and comes due in November 2013.

It is also prepayable without any penalties.

In addition, we currently have a total of $300 million notional amount of interest rate swaps in place.

That swap LIBOR fixed at a blended rate of 1.5% for two years.

Our ratio of consolidated debt less consolidated cash versus our last 12 months adjusted EBITDA was 4.0 times at June 30, 2010, a significant reduction from the 5.8 times ratio as of December 31, 2009.

Our strong cash flow generation and IPO contributed to the significant reduction in leverage.

Additionally, we have no borrowings outstanding under our revolver, which has approximately $147 million of availability net of outstanding letters of credit.

Continuing on with cash flows, as previously discussed, we currently do not pay federal income taxes and expect cash taxes to remain minimal for the balance of 2010.

Capital expenditures of $1.5 million for the second quarter of 2010 were comparable year-over-year and quarter-over-quarter.

Looking at the second half of 2010, we expect our CapEx spending run rate to pick up as we execute on certain product development and cost reduction initiatives.

We estimate second half 2010 CapEx run rate to be approximately double the first-half run rate.

With that, I'd like to turn the call back over to Aaron to provide some additional comments on outlook.

Thanks, York.

On a macro level, we continue to believe that the aging and under-invested electrical grid has become increasingly susceptible to power outages.

In addition, residential and light commercial standby generators remain at low penetration levels.

As a result, we believe the emergency backup generators for all applications will continue to grow in popularity.

We are currently executing on a number of initiatives aimed at growing the market for residential and light commercial standby generators through targeted marketing campaigns and other awareness-related activities.

We also believe the development of innovative products and the further expansion of our distribution are key contributors to maintaining our leading share of the residential and light commercial markets and also serve as important drivers in increasing our share of the industrial standby and portable generator markets.

In the near term, we continue to see positive trends in end-market demand for our industrial and commercial products relative to recent quarters.

While we are cautious about forecasting the timing of a recovery in non-residential construction, we believe demand for these products has bottomed.

Given this trend for our industrial and commercial products, our distribution and marketing initiatives and assuming the impact of normalized power outage activity through the balance of the year on our residential products, we are optimistic about our second-half financial results.

As a result of our strong operating model, low-cost debt and favorable tax attributes, we expect to generate strong cash flows, which will help us drive our strategic growth initiatives and continue to delever our balance sheet resulting in increased value for our shareholders.

Longer term, we are confident that with the return of a more robust US economic environment coupled with the continued under-investment in the aging power grid and an aging and more electrically dependent population, we will continue to see increased demand for our backup power products.

As a market leader for natural gas-fueled generators for residential and light commercial applications, we believe we are well positioned to capitalize on the increasing demand for these products.

This concludes our prepared remarks.

At this time, we would like to open up the call to any questions.

Operator?

(Operator Instructions) Jerry Revich, Goldman Sachs.

Aaron, can you talk about what drove the sharp increase in the loose engine and other product sales?

Any new products that you've been able to distribute?

Or can you give us, just, some more detail there?

Thanks.

Yes, absolutely, Jerry.

What you're speaking to is the other sales category that we break out.

We did see a nice increase in that category in the current quarter, and have seen a nice increase year-to-date primarily drive by both the loose engine sales, which go to the OEM lawn and garden industry.

And so that is basically a restocking and a recovery in that market.

Those products were off quite a bit last year.

Additionally, what goes in that category is RV.

Our RV generator market we serve with a full product line.

We are seeing some recovery in RV, although I will tell you that we believe that recovery was probably related more to restocking here initially as we are getting intel from our RV customers and OEMs that the dealer lots are beginning to fill back up, and the sell-through rates have not been what they anticipated.

So we believe that trend will moderate here on the other category in the second half.

That's helpful.

And on the balance sheet side, obviously, good free cash flow generation in the quarter.

Can you talk about your debt reduction targets perhaps over the balance of the year?

And why we didn't see more of that paydown this quarter?

We'll be evaluating exactly how much cash on our balance sheet will be used to pay down debt.

I think we've said that, as we grow our cash balance on our balance sheet, we'll continue to fund the growth of our business -- the growth strategies of our business -- but we'll also continue to pay down debt, and that's obviously something that we'll be looking at over the second half of the year.

We have had targets out there over the next couple of years, two to three years, to get to that two to three times leverage.

So I know that we've got those long-term targets out there.

And, lastly, what kind of production increase are you looking for in the third quarter, which is a big production quarter for your residential standby markets.

I'm wondering if you could just step us through the trends that you're seeing there.

Thanks.

Sure.

Typically, we try to level out our production volumes as much as we can, obviously, to run the plants efficiently.

But, certainly, starting here in the second quarter and continuing on in the third quarter we do see historically there's a rampup from the seasonality standpoint -- our production rates.

We believe that should give us a favorable impact on things like absorption variance in the second half of the year.

That's normal seasonality, though, and in terms of what those rates are, I would tell you that they are consistent with our expectations for a more average storm season here for the second half of the year.

Steve Sanders, Stephens, Inc.

First, Aaron, I think you made some comments about some positive recent trends on the C&I side.

Were you talking specifically about the diesel product, or were you making a broader comment that includes the natural gas products?

It is a broader comment, Steve, relative to, really, all of our C&I type products.

And, certainly, we believe that the introduction of our industrial product offering based around the diesel side and based around that Fiat powertrain agreement, we believe that has given us a new layer of differentiation in the market.

We'll be the only North American volume manufacturer using those engines here in North America.

It's a well-known brand in terms of Fiat and some of the Iveco brand, which is a truck engine brand, probably more prominently known in Europe than here in North America, but a very good engine platform.

But the natural gas side of our business, we've also seen a nice stabilization of demand on that side as well.

Again, I think it's very consistent with my comments on the last call -- when you break that down vertically into some of the drivers in those end markets, you look at things like health care, government spending on things like wastewater treatment plants and whatnot.

Those verticals within the C&I business have seemed to stabilize quicker than maybe what I would call the retail non-residential construction market and in those spaces.

Okay, and then, York, on the commodity side, obviously, everyone is seeing some pressure there.

So how should we think your ability to recoup some of those higher costs through pricing or other actions, given what you're seeing on the competitive side?

From a pricing standpoint, obviously, we'll evaluate pricing as commodity levels fluctuate.

And, obviously, [as it combines for a while] there, we're headed down below -- the top level was below $3.

Steel is heading downward, but, like I said, we evaluate that continually, and when we feel top combines will stick at a higher level, we'll evaluate our pricing strategies.

I would say, Steve, that, to be frank, we focus -- I think we're cautious to use the pricing lever, in particular, in the fragile economic recovery that's going on here.

And also I think, in particular, on the residential side where we believe that as evidenced by the introduction or our core power series coming up here in the third quarter, we believe that lower pricing is the key to expanding this product offering to a more mass market.

But I would tell you that we have other levers to pull as well, in particular, on the cost reduction side -- cost out.

We focus very hard as a company day in and day out in taking cost out of our products and making sure that we're optimizing.

That works maybe even moreso as a lever for us than I think as an effective lever than pricing can.

Okay, and that really leads into the next question.

You mentioned in your prepared remarks some cost reduction initiatives, and I think maybe they were tied to some of the increased capital spending in the back half.

Can you provide any additional color on that?

And then, York, I just wanted to make sure I understood correctly the sequential step-up in the interest expense from 5.6, 5.7 to 6 to 6.5.

If you could just let us know what's behind that?

Well, I'll tackle the -- I think my comments on the cost reductions related to the second half -- we do have some cost-reduction projects that are tied to some further automation that we're doing in our facilities around some of our core processes.

And as we continue to do that, we believe that obviously the idea there is that we know how to make to take costs out.

That's really what those are related to.

There are plenty of other cost reduction opportunities that center around sourcing and other optimization and manufacturing and design that we continue to push on.

Then, York, are you going to tackle the second one?

Interest rates side, when we initially rolled out estimates for the year on interest expense, we didn't have the interest rate swaps in place at the time.

Now, as I mentioned, we've got $300 million notional of interest rate swaps now in place that rolled in here over the last, roughly, four months.

And that's going to swap 41% of our debt fixed at a LIBOR of 1.5%.

So in that original estimate there was a lower swap fixed percentage on our interest expense estimate.

Mike Halloran, Robert W.

Baird.

Back on the commodity side, just piggybacking on that question -- so when you think about the relationship between the price and the cost side on commodities, this second quarter, the impact on your P&L versus, say, maybe, in the third quarter, are you expecting much of a sequential difference there?

Second quarter versus third quarter there will be, based on my estimates, a slight -- yes, there will be a slight increase incremental from Q2 to Q3, yes.

But, remember, Mike, I think the important thing is there that it takes about three to six months from a lagging standpoint for movements in the price of those commodities.

So working our way through and into from a realization standpoint.

And coupled then, what we said before, is in terms of improved overhead absorption will help offset that.

Right.

I understand the other moving parts.

I was just curious.

And then on the sequential trends through the quarter, could you maybe talk a little bit about what you saw on the residential standby side as well as the commercial industrial side?

Did you see a pickup through the quarter that was pretty consistent with normal seasonality or was it something a little bit different?

It was primarily more related to normal seasonality, in particular, on the residential side, which is a more seasonal business as opposed to C&I, which, typically doesn't have the level of seasonality.

We believe that the sequential improvement in C&I was really more related to what we felt was kind of a bottoming of that market back in Q1.

And we think that that's really the result of baseline improved demand.

Again, earlier -- my comments on certain verticals within that in certain markets that are recovering.

And then from a normal seasonality standpoint, could you talk a little bit about what the normal seasonal (inaudible) would be 2Q to 3Q and 3Q to 4Q from a revenue standpoint?

I'm trying to back out the portable market from that, since there is more variability there?

Yes, obviously, it can vary.

I know, over the last three years, looking at the second quarter, that's average, roughly, 22% to 25% of our sales where you look over the last three years, the third quarter has been about 25% to 30% of our sales.

So that's historical average seasonality, which, obviously, can move --

That does have some portables in it, as well, I think, in fairness.

If you have it broken out right between the two.

But certainly that's -- on a high level, that's how it looks.

And the fourth quarter?

It can be relatively consistent with the third quarter, again, depending on certain outage activity that happens during the third quarter.

There can be some resell in the fourth quarter that helps to spur demand in the fourth quarter as well.

So we've seen, historically, fourth quarter can have similar seasonality as the third quarter.

And then similar comments on the margin line -- or similar question on the margin line.

I know, earlier, we were talking about the absorption patterns through the year -- how you get a ramp from first to second, obviously, and then a little bit of a ramp from second to third, and maybe fourth is consistent with 3Q.

Is that the trend on the margin line from a margin -- operating margin perspective?

Yes, I'd say that.

Obviously, it depends on mix and whatnot, but I would say, in general, that's a true statement.

Phil Gresh, JP Morgan.

The callout there on the mix impact on the residential side -- you haven't mentioned that before.

Is that something that's been happening or is that something new you saw this quarter?

No, that's -- I think we've said, at least maybe not as direct as that, but we've said in the past that typically lower KW residential products have lower margins than do higher KW residential products.

It sounds like you have seen a trend towards sales being towards the lower end in the quarter.

Has that been happening or -- ?

Seasonality-wise we typically will see in the winter months and satisfying some of the winter demand as well as some of the early-season demand.

In the Northeast and the Midwest, in particular, those KW output generators are generally smaller.

You don't have the air conditioning loads that you have in the South Central, Southeastern markets of the US and the Western markets of the US.

So, typically, as the outage activity shifts from those Northeast and Midwest markets down to the Southern markets going from Q1 through the year, we'll see lower KW units earlier in the year.

Then going to higher KW units, and then generally returning back to lower KW units by the back half of the year as you get into Q4.

Okay, got you, that's helpful.

And then can you talk about your inventory situation with the portables as you head into the summer storm season?

I know, coming out of those winter storms, they were elevated enough that you didn't see a big benefit.

So how are you positioned at this point?

We actually -- our finished good inventory levels, we feel pretty good relative to where they were a year ago.

We think the retailers as well based on all the information we have, we feel the retailers believe they are fairly set for a normal season.

Obviously, what everybody is forecasting is quite a bit above that.

But I would tell you that at least at this point, we are comfortable that we're set for the season.

I don't think there are any major differences between where we were at this point in time last year nor is there any major difference where the retailers are at going into the season.

Okay.

And then on the non-res side, obviously, you sound more optimistic there.

Is that a business that you think can be up year-over-year in the second half at this point?

You're obviously down, kind of mid-teens.

Do you have some easier comps?

Is that how you're looking at it or -- ?

Again, we're cautious about it.

The economic recovery there in non-res, if government spending drops off, if more stimulus is -- as stimulus continues to run out here, what that will do to -- as I said before, the government segment there is -- you know, as a piece of that vertical that's improving -- health care, data centers -- we do remain optimistic about it because we like the fact that we think we've seen a bottom.

Everything from that point in Q1 has been improving.

We do think that if these trends continue, we're going to remain optimistic about that business for the second half of the year.

Jeff Hammond, Keybanc Capital Markets.

I know you guys have been a little reticent to talk in too much detail about the forward look, but if we look back on the first half, I just want to understand, as you look at your first couple of quarters as a public company, how those lined up relative to your expectations, where you might have seen better trends, and where you might have been disappointed.

I would tell you that, Jeff, actually, it's in line with our expectations.

So we know that as we've said, I think we're pleased that we're seeing a bottom in C&I.

That continued to be a little bit touch and go.

We were off 15% in both quarters.

And so there was some concern that would this trend continue.

Where we've seen the biggest pullback there, again, as we've said, is in our national account customers.

They have not recovered yet, and I think that any real improvements in demand for the back half of this year are going to be somewhat dependent on their decisions to improve their CapEx spending.

But I wouldn't say -- the only surprise -- there was a pleasant one -- we think we found the bottom.

On the residential side, we've got a lot of initiatives going on there as we do on the C&I side as well, but I think our expectations for the residential standby, in particular, are coming right in line.

I think on the portable generator side, we've been very pleased with the success we've had in reentering this market.

If you recall, we've only been in it for two years now -- back in it -- and we are pleased with our performance to date.

We continue to expand the product line, as I mentioned in my prepared remarks, but kind of fleshing it out with some additional product offering to cover the entire spectrum of market.

But I would tell you that I am pleasantly surprised -- not surprised as much as I am pleased with our development in portables.

I think that continues to be a good area, and I think that the home standby side is in line with expectations and is a market that, for us, I think we're very pleased with that performance over the last couple of years.

Obviously, as a big-ticket consumer durable, a discretionary one at that, we had concerns going into the housing downturn.

The downturn in residential investment, the crunch that the consumer has been under here, whether you're talking unemployment or their lack of access to capital, or home equity lines and such -- we were concerned about that market.

But our initiatives, I think, have been very strong and have helped us bull our way through that and really demonstrate to us the potential success in that marketplace that can be in the future here.

Okay, good, and then just a follow-on to that.

The national account, is that constraint been isolated to telcom?

Or are you seeing that across the board?

Because we are hearing on the retail side, at least on the HVAC, in particular, that people are starting to come back to planned replacement and a little bit of new store growth.

It's primarily our telecommunications customers.

And you have to remember, the products that we're in, when, in particular, you speak to the proxy there on HVAC, generators -- it's not a huge replacement cycle market yet, still very low penetration rates especially when we're talking about the commercial side of our business, light commercial side.

That's about growing that market, and because it's a discretionary item, because businesses are still watching their spend very closely, I think that there is pressure, in particular, on those large national accounts.

But to answer your question, that's primarily the result of our telecommunications customers.

Okay, and then portables -- last quarter you had mentioned that inventories were coming in a little bit higher.

Has that cleared out or are inventories still a little bit high there?

Actually, we've been pleased with our ability to sell down, kind of, you know, again, in a bit of a challenging environment from an outage activity standpoint, the first half of 2010 was not as active as 2009.

But we've actually been, again, because I think we've been picking up some share, our own numbers demonstrate that additional shelf space.

And so on an everyday basis, we believe we've been -- we are very pleased with our selldown of that inventory to levels that we find more acceptable here going into the season.

Baseline level of business has been --

Yes, baseline level of business has been doing quite well.

Okay, and then final question -- you mentioned the mix down, and it was helpful to kind of give the seasonality of that, but I guess as you introduce some of these lower-end products, and I think the hope there -- or the strategy -- was to push more penetration.

What do you see as the risk that, in a tough economic environment, we don't necessarily see more penetration, but we just see people buying down in the near term?

It's a great question, and obviously one we're focused on.

Anytime you introduce products, which are on the lower end of a spectrum, that can happen.

You can have some cannibalization of your existing products, the higher KW products.

And while we do have some of that baked in our math, the idea here is, as you mentioned, it's more about sparking increased demand.

But it's really less about -- in our view -- less about the cannibalization of residential standby that we're selling today and more about the cannibalization of portable generators as people trade up.

As we compress the price difference that exists -- that arbitrage in price between the portable generator market and the residential standby, we believe we can get more people interested in trading up rather than trading down.

Now, will people trade down?

To an extent, they will and, obviously, we'll watch that very closely during this product launch.

But one of the things that's a tenet of our hypothesis here in introducing this lower entry-level price point is that we want to get people interested in the category.

And oftentimes, when people get interested in the category at an opening price point, it's our job to merchandise people to the next level of product.

Either through better feature set offerings, higher kilowatt output.

The other generators will do more and have better features for our customers.

But we will watch that very closely because, obviously, that's something that is going to be important for us to stay on top of.

Andrew Obin, Merrill Lynch.

The question on longer-term growth initiatives.

Could you talk about the ability to attract more customers for private label and also where we are in terms of international growth strategy?

Thank you.

On the private label side, as we mentioned in our prepared remarks, we did sign a couple of new deals last year, which we believe have helped us go after some additional markets and improve our distribution in certain markets with those labels.

As far as future private labels, we'll continue to look at those programs where we believe it makes sense.

And, in particular, there are segments of potential market opportunity out there that we believe are under-addressed today and that may not be best addressed by the Generac label, either in terms of brand recognition or just in terms of the best way to approach those opportunities, maybe with a different brand.

We continue to evaluate that.

We believe there are some opportunities out there and, in fact, a few that we are looking at today.

But, again, we're only going to do that where it makes sense in terms of increasing distribution.

We have very much focused on consolidating our brands as much as we can down onto the Generac platform as we continue to try and make Generac a name that's synonymous with backup power solutions.

And this is really about increasing the pie with very low penetration rates.

There are potential market verticals there that still are, we believe, underserved and maybe best served by a different brand other than Generac.

So that's on the private label side.

From an international standpoint, as I mentioned in my prepared remarks, we've focused our initial efforts here, at least in the first half of 2010, somewhat in the back half of 2009, on Latin America -- South Central America.

We actually have a growing distribution base down there now of over 16 dealers in those markets, and, in fact, we are currently in the process of onboarding that distribution.

When you bring what are primarily C&I dealers on board, there is generally a fairly good cycle that exists there to turning them into productive assets in your distribution.

And what I mean by that is certainly those products in C&I have longer lead time sales cycles in terms of quoting activity and follow-up activity as well as turning those into orders and then satisfying those orders with shipments.

But there's a sales education process, a learning curve, if you will, that we need to get those dealers up to.

And right now it's really evaluating with those new distribution partners what are the right products that we need to have for their local markets.

So we're doing a lot of learning as well on our side, but we are pleased with our progress, to date, at least as it relates to Latin America.

We continue to look at other parts of the globe.

In fact, we are fleshing out more of an [EAME] type of approach and structure to our international sales efforts here, and we believe, as we've said before, in the longer term we've got our eyes on that as a way to grow.

So could you share with us revenue targets for Latin America for the next 12 months?

Andrew, I don't have discrete numbers to share with you at this time.

Again, as we've said, we don't anticipate our international sales efforts being material.

Today it's only 2%, roughly, of our business.

We look at everything that's not in North America.

As we've said, from a longer-term perspective, we believe that there's obviously a lot of upward mobility to that number, over time, but it's really something -- it's really about building the distribution, which does take time.

And so we're being, I think, very conservative and very cautious in understanding those markets, learning those markets and understand which products need to go into them.

So I'm not comfortable enough to put a number on that for any particular region in the next 12 months.

(Operator Instructions) Corey Tobin.

A couple of quick ones, if I could.

Can you talk about the linearity in the quarter and I guess specifically I'm looking for the trend in year-over-year growth for the three months, the April, May, and June months in the quarter.

And also what you've seen through July?

We won't comment specifically on particular months.

I guess we have said we saw positive trends so --

And, again, I think probably the key there is that we do typically see that from a seasonal standpoint for or residential products.

We see improvement generally building throughout the second quarter on the C&I business.

We like what we saw sequentially.

There's not as much seasonality in that business, so we believe that's better geared around a return of some demand in certain markets.

And, again, we're not in a position to comment on where we're at in July, but we remain optimistic about the second half based on what we've seen, to date, here not only in Q2 but in the first half in some of those trends.

Okay, and just to clarify this -- on the residential side, when you say you're optimistic about the trends you're seeing, you're not speaking sequentially but actually in the year-over-year growth trends?

Yes, that's fair, exactly.

Okay, great.

And then the second question on the new residential product -- can you just give us some feeling for margins on that product?

I understand the lower price point, as you mentioned, but have you figured out the manner in which to take cost out since the margins are going to be consistent with the prior products?

Yes, that's the right way to look at it.

Obviously, that's a product that, as an entry-level product, has been somewhat de-contented from the existing product line that we have out there.

It's a bit different in terms of configuration.

It's a step down in terms of feature sets for the consumer.

It's less KW.

It starts at 7,000 watts as opposed to the bottom rung of the existing product line is at 8,000 watts.

So you're talking about 16% less output there.

So that's certainly an impacting cost.

So what we've done in terms of positioning is really tried to position the product such that we can test the US [system] and demand at this new price point and not see a degradation in our margins should we have a shift down from the low end of the current product line to that product.

Mike Halloran, Robert W.

Baird.

Just a quick follow-up on the stock-based comp expense.

You gave good guidance for of the rest of the year.

I know you commented on the expense exists as long as the vesting period does.

How long is that vesting period?

Three years for the restricted stock and five years ratably over -- for the options.

Michael Plancey, UBS.

Most of my questions have been answered, but I just was wondering, with the business that throws off as much cash as you guys do, do you have a sense for what the right cash balance is?

I think we've talked in terms of targeted leverage ratios, which is what we've at least targeted over the next coming years here.

Yes, it's a great question.

The fact that the business is low CapEx, the fact that we don't pay any taxes, frankly, working capital needs -- we estimate about $0.20 for every $1 of sales that we increase.

So there's not a reason to have a huge cash balance on this business at any one point in time with, in particular, $150 million revolver out there as well that's primarily untapped.

But as we've said, to effectively finance our growth initiatives, we've also mentioned in the past that there may be some opportunities for -- in the M&A space relative to some small bolt-on acquisitions and what not.

So, obviously, we want to keep a cash balance on hand that would accommodate opportunistically, not only the financing of additional growth initiatives but a potential to use that cash for other opportunities.

Does the current credit agreement allow you to return any of that cash to shareholders?

There's baskets.

At this time, there are no further questions in the queue, and I would like to turn the call back over to management for closing remarks.

All right.

Well, we'd like to thank everybody for their time today, and we look forward to speaking with you again at the next quarter.

Thank you very much.

Thank you for your participation in today's conference.

This concludes the presentation.

You may now disconnect.

Have a wonderful day.