Generac Holdings Inc (GNRC) 2013 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Q3 2013 Generac Holdings Inc.

earnings conference call.

My name is Mark, and I will be your operator for today.

(Operator Instructions)

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

I would now like to turn the conference over to York Ragen, Chief Financial Officer.

Please proceed.

Thank you.

Good morning and welcome to our third-quarter 2013 earnings call.

I would like to thank everyone for joining us this morning.

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

We will begin our call today by commenting on forward-looking statements.

Certain statements made during this presentation, 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 measures during today's call.

Additional information regarding these measures, including reconciliation to comparable US GAAP measures, is available in our earnings release and SEC filings.

I will now turn the call over to Aaron.

Thanks, York.

Good morning, everyone, and thank you for joining us today.

Our third-quarter 2013 results continue to demonstrate the numerous secular growth drivers for our business as well as the ongoing execution of our Powering Ahead strategic plan.

Third-quarter net sales increased 21% over the prior year to $363 million as we once again experienced double-digit organic growth, led by strong shipments of commercial and industrial products as well as home standby generators.

Adjusted EBITDA and adjusted earnings per share increased 31% and 36% respectively in the quarter, with EBITDA margins increasing 210 basis points over the prior year, primarily as a result of ongoing improvements in warranty rates.

Growth in shipments of home standby generators was again strong, as the market adoption for these products continues to grow as a result of a combination of factors, highlighted by the overall additional awareness created from major power outages in recent years, additional distribution, and increased sales and marketing efforts.

Our residential dealer base further expanded as we ended the third quarter with over 5,200 dealers.

We continue to add dealers at a pace above historical rates, with over 400 net dealers added thus far in 2013 and nearly 1,000 net dealer adds since the end of 2011.

Further adding to the growth in home standby generators is our progress on a number of recently-launched sales and marketing initiatives, highlighted by our A.M.P.

targeted marketing process, the PowerPlay in-home selling solution, as well as our Power You Control national advertising campaign.

We believe these factors, including a more favorable environment for residential investment, are driving a new and higher baseline level of demand for home standby generators.

With penetration rates of home standby generators at only approximately 3% of single-family unattached homes in the US, we continue to believe there remains a substantial opportunity for Generac to further grow the market for this emerging product category.

A.M.P., PowerPlay, and the national advertising campaign were fully launched in early 2013 and remain an important corporate focus, as these key initiatives are targeted to further extend the awareness of home standby generators in the quarters ahead.

The number of dealers using PowerPlay continued to grow during the third quarter, and we are on target to achieving an approximately 20% adoption rate by our dealer base by the end of 2013.

We remain encouraged by the rollout of PowerPlay thus far, as we continue to see a notable improvement in our sales closure rates for dealers using this new and innovative sales tool.

In addition, our Power You Control direct-response television advertising, which launched the end of May, is expanding awareness and generating sales leads for the product category at an attractive cost relative to other forms of direct marketing.

Shipments of portable generators declined during the third quarter of 2013 due to less severe power outages relative to the third quarter of 2012, which saw a significant demand from the Derecho windstorm event that impacted the Midwest and mid-Atlantic regions; and to a lesser extent, Hurricane Isaac, which impacted portions of the Gulf Coast region.

Despite the decline in portable generators during the current-year quarter, year-to-date 2013 shipments of these products have been much stronger relative to our initial expectations entering the year.

As commented on during the last quarter, we were encouraged by the robust demand for portable generators during the first half of 2013, following Superstorm Sandy.

Combined with our broad relationships at retail, this has provided us with expanded placement for portable generators.

And as a result, we believe we continue to experience increased market share gains in this product category compared to the prior year.

Our ongoing success in portable generators has further solidified our leading position in providing a full range of backup power products for the residential market and has positioned Generac as being the household name in backup power.

Sales of commercial and industrial products increased at a strong double-digit organic growth rate during the third quarter, as increased awareness of the need for backup power on the part of businesses positively impacted results.

The strong momentum that we experienced during the first half of 2013 from our telecom national account customers continued during the third quarter, as wireless providers in particular looked to further safeguard their networks from future outages.

Additionally, we continue to see attractive revenue growth from shipments of light commercial generators used in smaller footprint retail applications, as market interest in cleaner-burning, more cost-effective natural gas fueled backup generators continues to increase as a result of the exceptional value proposition of these products.

Also contributing to our strong revenue growth in C&I products during the third quarter were the acquisitions of Ottomotores, which closed in December 2012; and Tower Light, which closed in August 2013.

We continued to remain active on the acquisition front by announcing earlier this month the agreement to purchase substantially all of the assets of the generator division of Baldor Electric Company, a wholly-owned subsidiary of ABB Group.

Baldor Generators offers a complete line of standby and prime-rated products ranging from 3 kilowatts to 2.5 megawatts throughout the US and Canada.

The addition of these products significantly expands our industrial product offering and essentially doubles the addressable domestic market that Generac and its distribution partners can serve.

Acquiring the Higher Power product line from Baldor Generators accelerates our organic efforts to increase our share of the commercial and industrial power generation market while also adding a 255,000 square foot, purpose-built facility that provides significant production and testing capacity for future growth.

The integration of Baldor Generators will be a key corporate focus throughout 2014, and we're excited about the opportunity to execute on the potential revenue synergies by further strengthening the combined distribution of the companies.

Additionally, although early in the process, we believe there are meaningful cost synergies to be gained, given our lean product cost structure and increased manufacturing and sourcing scale as we transition the acquired products and facility into the Generac portfolio.

With regards to our EBITDA margin improvements, I want to take a few moments to comment on some very positive trends that we continue to see with declining warranty rates for our products.

We spoke briefly last quarter about warranty rate improvements being a key driver favorably impacting our adjusted EBITDA margins over the prior year, and the momentum on this front continued into the third quarter.

Over the last five years, our teams have delivered on numerous design and manufacturing improvements in an effort to further enhance product reliability and the ownership experience, to give our customers the peace of mind that they expect when they buy a Generac generator to protect their home or business.

The reduction in warranty rates in the current year is evidence these longer-term efforts are having a positive impact on both customer satisfaction and the profitability of the Company.

Our Powering Ahead strategic plan is focused on driving baseline growth.

And we have been successfully executing on a strategy over the past three years by remaining focused on four key growth objectives -- growing the residential market; gaining commercial and industrial market share; diversifying our end markets; and finally, expanding into new geographies.

When you combine our Powering Ahead strategy with the long-term growth drivers for our business and the potential for further recovery in residential investment and nonresidential construction, we believe Generac is well positioned over the long-term to drive future growth and shareholder value.

I would now like to turn the call the back over to York to discuss third-quarter results in more detail.

York?

Thanks, Aaron.

Net sales for the third quarter 2013 were $363.3 million, a 20.9% increase as compared to $300.6 million in the third quarter of 2012.

Looking at net sales by product class, residential product sales increased to $192.7 million in the third quarter of 2013 as compared to a strong prior-year net sales comparison of $191 million.

During the third quarter, Generac continued to experience solid growth in shipments of home standby generators in comparison to the prior year, as well as continued growth on a sequential quarter-over-quarter basis.

The continued strength in home standby shipments is due to a combination of factors, including the additional awareness created by major power outages in recent years driving the further adoption of the category and expanded distribution broadening the availability of the product.

Other drivers of home standby growth are increased sales and marketing initiatives to create and close the leads more effectively, overall strong operational execution to satisfy the increased demand, and a more favorable environment for residential investment.

The strength in home standby generators was partially offset by a decline in shipments of portable generators due to less severe power outage events in the current year quarter relative to the prior year.

Recall that prior year third-quarter had a number of major outages during the quarter, which did not repeat.

Also contributing to the revenue growth for residential products during the third quarter of 2013 was our growing presence in the market for engine-driven power washers.

Looking at our commercial and industrial products, net sales increased 61.8% to $151.5 million in the third quarter of 2013 from $93.6 million in the third quarter of 2012.

The increase in C&I net sales was primarily driven by a very strong organic increase in shipments to certain national account customers -- in particular, certain customers in the telecom and rental verticals.

As wireless telecom providers continue to harden their networks and as certain national rental companies update their mobile power equipment fleets, we have seen robust growth during the current-year quarter.

As commented on in previous quarters, there can be some variability in our C&I product shipments from quarter to quarter, primarily due to the timing of capital spending by these national account customers.

In addition to growth from our national account customers, we also saw growth coming from natural gas standby generators using light commercial applications, as our commercial teams have been focused on penetrating this significant opportunity.

Supplementing our organic growth, the Ottomotores acquisition, which closed in December 2012; and the Tower Light acquisition, which closed in August 2013; contributed to year-over-year growth in C&I products as well.

Our other product sales category improved to $19.1 million in the third quarter of 2013, an increase of 19% from prior-year third-quarter sales of $16 million.

This growth was primarily due to increased sales of service parts, as the installed base of our products continues to grow with the overall growth of the Company.

Gross margin for the third quarter was 38.4%, which was approximately flat as compared to 38.5% in the prior-year quarter.

Gross margin during the current-year quarter reflects the mix impact from the addition of Ottomotores sales along with a higher mix of organic C&I products.

This was mostly offset by the positive impact from a moderation in commodity costs and continued execution of cost reduction initiatives across the Company.

Operating expenses for the third quarter of 2013 declined $4.5 million or 8% as compared to the third quarter of 2012.

A large contributor to this reduction was the improved overall warranty rates experienced during the current-year quarter, which resulted in a $5.6 million favorable adjustment to warranty reserves, impacting margins by approximately 150 basis points.

A decline in amortization of intangibles also contributed to the reduction in operating expenses.

Partially offsetting these reductions were operating expenses associated with the Ottomotores and Tower Light businesses, as well as increases in sales, engineering, and administrative infrastructure to support the strategic growth initiatives and higher baseline sales levels of the Company.

Excluding non-cash intangible amortization expense, operating expenses as a percentage of net sales during the third quarter of 2013 were 12.4%, representing a 230 basis point decline as compared to 14.7% in the prior-year quarter.

Again, the lower warranty expense was the main driver of this 230 basis point improvement, which includes the reversal of warranty reserves combined with lower overall baseline warranty rates.

Excluding the $5.6 million favorable adjustment in warranty reserves, operating expenses as a percentage of net sales for the third quarter would have been 14%.

Adjusted EBITDA increased 31.2% to $100.1 million, or 27.5% of net sales, in the third quarter of 2013 as compared to $76.3 million or 25.4% of net sales in the same period last year.

This increase in adjusted EBITDA margin is predominantly related to the warranty rate improvements just discussed.

Adjusted EBITDA over the last 12 months as of September 30, 2013, was $382.1 million or 26.3% of net sales during that period.

GAAP net income for the third quarter of 2013 was $47.1 million as compared to $25.5 million for the third quarter of 2012.

Adjusted net income, as defined in our earnings release, increased 36.2% to $73.7 million in the current-year quarter versus $54.1 million in the prior-year third quarter.

This increase is attributable to improved operating earnings during the quarter, resulting from a 20.9% increase in net sales and higher EBITDA margins, as well as $4.4 million in lower interest expense due to a reduction in interest rate from the May 2013 refinancing of our senior secured term loans.

Offsetting these improvements was an $8.4 million increase in cash income tax expense.

Diluted net income per share on a GAAP basis was $0.67 in the third quarter of 2013 compared to $0.37 per share in the third quarter of 2012.

Adjusted diluted net income per share, as reconciled in our earnings release, was $1.06 for the current-year quarter compared to $0.78 per share in the prior-year quarter, a 35.9% year-over-year increase.

With regards to cash income taxes, the third quarter of 2013 includes the impact of a cash income tax expense of $9.5 million as compared to only $1.2 million in the prior-year quarter.

As we commented during recent conference calls, our cash income taxes for 2013 are expected to increase going forward, due to a combination of our NOL carryforward becoming fully utilized during 2013 and higher overall profitability levels.

Cash income taxes for 2013 were previously estimated to be approximately $15.5 million to $16.5 million.

Based on our increase in guidance for full-year 2013, cash income tax expense is now projected to be $23 million to $24 million for the year, which translates into an anticipated full-year 2013 cash income tax rate of 8.5% to 9.5%.

However, you should remember our favorable tax shield through annual intangible asset amortization in our tax return remains intact through 2021, resulting in an approximately $49 million of cash tax savings per year for the next nine years.

As a result, our cash income tax rate is expected to be significantly lower than our current projected 36% to 38% GAAP income tax rate for the foreseeable future.

As we drive higher profitability over time, cash income taxes can be estimated by applying the projected 36% to 38% tax rate on pretax profits going forward, and then deducting the approximately $49 million of annual cash tax savings each year through 2021.

Free cash flow, defined as net cash provided by operating activities less capital expenditures, was $76.7 million in the third quarter of 2013 as compared to $61.6 million in the same period last year.

The increase in free cash flow was primarily the result of strong operating earnings and lower capital spending levels compared to the prior-year quarter, partially offset by a modest overall increase in working capital investment as we were able to monetize seasonal inventory levels during the prior-year quarter.

Free cash flow over the past 12 months was $238.4 million.

As of September 30, 2013, we had a total of $1.21 billion of outstanding debt, net of unamortized original issue discount; and $116.5 million of consolidated cash and cash equivalents on hand, resulting in a consolidated net debt of $1.09 billion.

Our consolidated net debt to LTM adjusted EBITDA leverage ratio at the end of the third quarter was 2.9 times compared to 3.1 times ratio at September 30, 2012.

Given our strong free cash flow profile, we are confident in our ability to continue to invest in the future growth of the business, both organically and through M&A, all through reducing leverage levels over time.

With that, I would now like to turn the call back to Aaron to provide additional comments on our outlook for the remainder of 2013.

Thanks, York.

As a result of the continued strong demand for our home standby generators as well as a modest impact in the expected closing of the Baldor Generators acquisition during the fourth quarter of 2013, we are once again raising our sales guidance.

Full-year net sales are now expected to increase in the low to mid 20% range over the prior year, which is an increase from the low 20% range previously expected.

This guidance continues to assume no major power outage events for the remainder of the year.

As we have discussed, demand for home standby generators continues to benefit from additional awareness and adoption created from the major power outage events in recent years, our expanded distribution, the execution of our current sales and marketing initiatives, and the more favorable environment for residential investment.

This has driven adoption rates for home standby generators even further than previously expected.

As a result, total residential product sales are now expected to increase at a mid- to high teens rate for the full-year 2013 over the prior year, which compares to the high single-digit growth rate previously expected.

As discussed, our guidance for the remainder of the year does not include any assumptions for major power outage events.

However, the prior-year fourth quarter included Superstorm Sandy.

As a result of this strong prior-year comparison, we expect the fourth quarter of 2013 to show a continued decline in shipments of portable generators year over year.

However, we expect shipments of home standby generators will increase during the fourth quarter over the prior year, which we believe further demonstrates the continued adoption of this emerging product category.

Net sales for commercial and industrial products are expected to be in line with the previous guidance of increasing in the low 40% range.

Summarizing our sales growth assumptions for full-year 2013, total Company organic year-over-year growth is now expected to be between 14% to 16%, which represents an increase from our previous guidance of between 11% to 13%.

Acquisitions are expected to contribute between 8% to 9% growth, for a total expected year-over-year net sales increase in the low to mid-20% range.

Consolidated gross margins for 2013 are now expected to increase by approximately 50 basis points as compared to the prior year, which represents an improvement from the previous expectation of approximately flat.

The expected improvement in gross margin is due to a more favorable mix of residential home standby products.

As a result of this increased outlook, we expect full-year gross margins of approximately 38%, representing a nearly 100 basis point improvement relative to two years ago, while continuing to diversify and globalize our business during this time.

Operating expenses as a percentage of net sales, excluding amortization of intangibles, are now expected to decline by approximately 75 to 100 basis points as compared to 2012, which is an improvement from the previous expectation of approximately flat.

This updated outlook is driven primarily by the previously-discussed improvement in our warranty rates; and to a lesser extent, increased operating leverage on higher sales volumes versus previous expectation.

As a result of the higher sales outlook and improved margin guidance, we now expect adjusted EBITDA for full-year 2013 to increase in the low 30% range, which is an increase from the low 20% range previously expected.

In closing this morning, we believe that continued underinvestment in the electrical grid, an aging population, an increased reliance on uninterrupted power and data, and more severe and unpredictable weather will drive strong demand for our residential, commercial, and backup generators well into the future.

In particular, given the relatively low penetration for both home and light commercial standby generators, we believe there is a substantial opportunity for long-term growth as the leader in these emerging product categories.

In addition, we remain very positive about the significant opportunity to provide backup power for critical communications infrastructure, the overall ongoing secular shifts in the market towards natural gas generators, and the rental of mobile power equipment.

These growth drivers are also supplemented by a consensus expectation of an improving macroeconomic environment heading into 2014, with certain indicators, such as single-family housing starts; new single-family home sales; and nonresidential construction all expected to demonstrate some level of improvement.

Additionally, we have been focused on better balancing the overall products that we offer and geographies that we serve.

Much of this diversification has been achieved over the past couple of years through our strategic acquisitions of Magnum Products, Ottomotores, Tower Light, and the pending closing of Baldor Generators.

These acquisitions are an integral part of our Powering Ahead strategic plan and have allowed us to accelerate the diversification and international expansion of our business.

This concludes our prepared remarks.

And at this time, we would like to open up the call for questions.

Operator?

(Operator Instructions) Charley Brady, BMO Capital Markets.

I want to touch on the warranty reserve reversal.

That was the one-off type of thing in this quarter, right?

Obviously, the warranty rates are going down, but as far as the sharp reversal in the rate -- the 6.7% rate, that's kind of a one-off for Q3, right?

And the rate -- kind of on a percentage basis (multiple speakers) back up?

Yes.

The $5.6 million that we refer to in the prepared remarks was really what, I guess what you say as sort of the one-off, maybe non-run-ratable reversal of the warranty reserves.

So that's where I think we tried to recalibrate on a normalized basis, backing that out.

About a 1.5% impact to margins.

Okay.

But going forward, your overall -- I mean, there is some positive impact on a go-forward long-term rate, because your rates have come down on a long-term run rate, correct?

Yes.

I think you can see that, because operating expense improved, what, 230 basis points.

And that impact of that reserve reversal is about 150 basis points.

So that is reflective of -- that delta is reflective of the improved rate going forward.

Okay.

And on the portable, can you quantify how much portables were down in the quarter?

And when you talk about the market share gains, can you put any kind of granularity, or quantify what kind of gains you are getting on the market share in portables?

Yes, Charley, we don't break out portables and home standby, but from a market share gain perspective, we continue to see our share -- I think we spoke publicly last year and on quarterly calls previously -- we felt our share was somewhere in that low 20% to approaching mid-20% range.

And we feel like we are probably gaining -- obviously, the growth in that share has slowed as we approach, maybe, more of a steady-state here of that mid- to upper-20% range of share.

But we have picked up, we believe, a few more points here on the quarter, just year over year.

Okay, and then on the C&I -- I don't know if you mentioned it.

What's the core growth rate on C&I ex-acquisitions?

It was, as I said, very strong organic growth on C&I.

It was probably in that high 30% range.

So we saw strong growth there, highlighted by what I talked about from those national account customers -- seeing significant capital spending from those national account customers.

And just falling on the telecom side of that, can you quantify how much of that C&I growth came out of the telecom market?

Again, we don't break out the different verticals from a competitive standpoint.

But it's obviously an important part of our C&I business and was a driver, as we mentioned in --

Big driver of that growth, yes.

We saw it ramping up kind of Q4 (multiple speakers).

Sorry, Charley?

Did a majority of the C&I growth in the quarter come from telecom?

No, we saw growth -- as we mentioned in our prepared remarks -- even in our -- the light commercial products continue to do very well.

The natural gas products for small-footprint retail.

Those are really not telecom-oriented.

So broadly, we saw also with our Magnum business -- the large national rental accounts were also pretty good purchasers of equipment in the quarter.

So that's something that -- those things were all drivers, basically.

Okay.

Great, thanks.

Ross Gilardi, Bank of America.

I just have a few questions.

First of all, is there any way to look at your standby sales on more of a same-store basis?

And what I'm getting at is -- is your sales growth really due to expanded distribution, or are your existing dealers also seeing year-on-year growth?

We look at all of those figures, and we haven't reported them publicly, but we have seen growth in what I think you would traditionally refer to as a same-store sales type number.

So we are seeing that increase there as well as just raw points of -- as we said -- net dealer adds in general, as well.

So it's really both.

Okay.

And then on the portable side, what is your sense on inventory in the channel now, given that it's been a light hurricane season?

And if that continues -- I realize we've got a few weeks left -- would you expect that you have got a couple of quarters of destocking to go through in portables?

Or does it feel like the inventories are actually pretty balanced in the chain?

Inventories are definitely heavier.

They're seasonally appropriate, ahead of events; but they are, as you indicated, they are having -- it's been a pretty quiet season thus far.

So inventory in the channel for portable generators is at elevated levels; I wouldn't say they are beyond seasonally appropriate, but should we not -- should it remain quiet for the balance of the season here.

We will go through the normal destocking effort.

A couple of quarters is an appropriate way to think about that.

That's the way we think about it when we plan for it.

We plan, not only what we've got in our inventories here, but also in the channel.

We look at it in totality, and then we decide -- we make a call on what we think the season is going to look like, and we plan accordingly.

And if you don't get a season, you just have to burn that off.

Again, per my comments about increased shelf space and market share, we've got the placement to be able to do that.

So it doesn't concern us.

We will monetize the inventory, and we'll adjust our purchases and manufacturing accordingly if the season remains quiet.

Okay.

Thanks, Aaron.

And then I'll just ask -- you referred to the newer and higher baseline a couple of times in your last few quarters.

Is that meant at all to be an initial comment on 2014?

Anything you can say at this point about your level of confidence in growth for the next several quarters, as we head into, perhaps, your toughest comps on the back of Sandy?

The newer and higher baseline comment is actually one we've actually used over the years, because I think it -- as we've said, when you have a category, and I'm referring home standby generators now, when you have a category of product like that, that's really in its infancy, it's an emerging category -- another word we refer to it as, it takes a while to spool that up in terms of penetration rates.

And you can look back at other installed home products as proxies over the years -- whether you're talking about home security, or you're talking about central air-conditioning.

And it takes, frankly, a long period of time to ramp up penetration rates.

In our world, what you will see from time to time is these accelerated points of adoption along the curve.

And that is really the resultant of large-scale, large awareness events or outage events -- things like Sandy or an Irene -- which can accelerate the adoption rates, so make it go faster for a period of time.

And then you kind of fall into a new -- as we refer to it, a new and higher baseline level of demand.

You kind of hold on to that demand, or a good part of that demand.

And the reason for that, as we've talked in the past, it's that distribution that we are expanding, right?

So now you have got distribution points in markets that heretofore hadn't had distribution.

And you've got increased awareness in general.

And in the category, it's still very much word-of-mouth; it's still very much in a viral marketing phase.

So as one person gets one of these products, and there are maybe 5 or 6 or 10 neighbors around them that see that product.

The next time there's an outage in their local neighborhood, their house is the only one that's lit up.

It takes on a the viral type of approach in terms of the next homeowner that buys.

And that's really what is at the heart of our direct-marketing strategies, with our A.M.P.

-- assimilation of our A.M.P.

data and some of the other sales and marketing initiatives we've been working on.

But that's really my comments on the new and higher baseline.

It grows and kind of holds until you get the next catalyst.

There is some seasonality, certainly, in that as well you'll see from quarter to quarter.

But that's really what the comment's about.

Okay.

Thanks.

I'll get back in line.

Brian Drab.

First question -- there's a lot of comments in your prepared remarks around warranty and some questions here in the Q&A.

I just want to make sure that I'm understanding something correctly.

How do you calculate the warranty rate?

And could the recent jump in sales that you've seen over the last three, four quarters have an impact on that, just by virtue of boosting the denominator in that calculation and having a bunch of new equipment in the field?

So we look at warranty rate claims history, and then we bounce that claims history against when we sold those units originally.

So you go back in time to when you sold the units, not to that quarter's sales, per se -- that current quarter's sales.

So the warranty rate is indicative of when you sold the unit back in whatever the sale-to-fail period is.

So I think we are calibrating, and that there isn't an issue -- what you're referring to, where you're just increasing your sales in that particular quarter that would cause sort of an artificial lower warranty rate.

No, it's really the result of a meaningful decline in that experience rate --

The claims --.

Yes, the claims experience rate, as York is indicating.

And the application of that -- there is two pieces to it, right?

There is the application of that lower claims rate, that lower experience rate against future sales, as you accrue warranty dollars in the future.

But then there is the release of the reserves, which is really the adjustment that we talked about here --

Non-run-ratable piece.

-- non-run-ratable piece that we talked about.

And that's -- so there's really two pieces to the move with the warranty.

Yeah, sure.

I understand that there the two pieces.

I'm just trying to make sure that I understood whether the second piece -- going from 150 basis points to 230 -- was more a function of quality.

I guess it sounds like it's exclusively, really, a function of quality improvements rather than math.

Yes.

Correct.

Okay, thanks.

And then can you give us a sense at all for when you think Baldor will close?

Beginning of the quarter, end of the quarter?

I guess we're already end of the quarter.

But closer to the very end of the year or not?

Yes, we've got some things to work through yet towards closing.

So we're kind of in between trying to close here, on just documents and things that need to get buttoned up.

But we would hope within the next 30 days that we're closed on that deal.

Okay, great.

And then just one last question.

Some hurricane activity in Mexico recently.

Have you seen any impact on the Ottomotores business as a result of that?

You know, Ottomotores is much more of a commercial and industrial focused business.

So longer term, you can see impact from outage events on commercial and industrial, but they don't have portable generators that they manufacture or sell in that business at this point.

We are expanding our own distribution of portables and home standbys into Mexico through Ottomotores.

It's part of the synergies that we like about that business.

It gives us a platform.

But obviously, those products are sold mainly through retail, and we have to build those relationships.

So there will be no -- you wouldn't expect any major near-term impact from that.

It would be a longer-term impact on the C&I business in Ottomotores.

Right.

Okay.

Thank you very much.

Mike Halloran, Robert Baird.

First, I just want to get a sense for the puts and takes on the margin line as we head into the fourth quarter here.

Obviously, very strong revenue guidance.

And the EBITDA guidance relative to the revenue guidance seemed to apply some pressure on that margin line going from Q3 to Q4.

I'm sure there's a lot of very understandable reasons, but I just want to make sure I understand some of the puts and takes that would imply some lower margins relative to where we stand in the third quarter, besides, obviously, the warranty expense item that we've already kind of talked about.

I think the warranty non-run-ratable piece -- you've got to factor that out.

And then I think, really, it's a function of once you do all the math on our guidance, you would see a bit of a mix shift between C&I and resi.

So I think that mix shift would have an impact.

And I think that's the biggest piece of it, Mike, to be fair.

Yes, that makes sense.

You're basically implying there the seasonal uptick that you tend to get for fourth-quarter on that piece of business relative to some of the pressure points.

Okay.

That makes sense.

Yes, that is part of that.

And then on the Baldor business, maybe just talk a little bit strategically about that.

The confidence you have going up a little bit more aggressively against some of the larger players on the industrial business; the positioning that Baldor currently has in the market -- I know it's not a large slice of the market today, but confidence in the technology and its ability to go against those guys.

Start there, please.

Yeah, so Mike, this is Aaron.

Strategically, Baldor -- we had made a strategic decision internally as part of Powering Ahead, and as part of our efforts to -- in particular, in Powering Ahead -- to increase our share of the C&I market.

That's really the strategic objective we're after here.

And we were going to do that organically.

And as we looked at the cost of that and the time it takes to do that organically, when this asset became available, we saw an opportunity to accelerate that.

And so, again, they have a purpose-built facility.

It's actually here in Wisconsin, which fits our footprint very well.

But the underpinning of why we even want to get into the higher power ranges and get up against some of the bigger guys in the market -- for us to be, I think -- to have full mindshare with distribution in the commercial and industrial market.

So we've got 42 dealers in the US.

And to get full mindshare from these dealers -- they are generator dealers.

And so they sell all power ranges, because they are generator guys.

They don't just sell up to 600 kilowatts, or approach the over-600 kilowatts market in the way we do with our modular solution, which fits certain applications, but not all.

We saw that, really, the only path for us, if we're going to be serious about C&I going forward, is that we have to be a full-line provider.

We have to have 100% of their mindshare.

Because we couldn't let them buy those higher power-range products from guys like Baldor or others.

Because Baldor has a full line as well, so it's kind of what we refer to as the camel's nose under the tent, in terms of -- you can't allow another OEM into your distribution to sell part of a product line.

So it really takes away from your ability to get that dealer focused on everything that you want them focused on 100%, and invest in a Generac business as opposed to Generac and others.

So that was really the genesis of the strategic thinking behind it.

And then, again, the timing was just accelerated here, with the Baldor asset becoming available.

And if I remember correctly from my days when I covered Baldor, pretty quality assets.

Maybe just compare and contrast what they are bringing to the table.

Obviously, I already referenced the fact that they are not a modular solution the way you guys are.

But from a pure quality of product standpoint, how do you guys look at it and compare it with what you have, and maybe your peer group as well?

You know, again, we did a lot of diligence on this on the front end.

But Baldor has a pretty good name in the marketplace -- in our marketplace relative to the product quality.

They do manufacture not only standby rated machines, but prime duty machines as well.

And that's usually -- where you're going to see a prime duty machine typically would be outside the US.

Now, most of their volume is in the US and Canada.

Where you see prime duty equipment inside the US and Canada is going to be in oilfield services; it's going to be in the energy production sectors, where those pieces of equipment are running either 24/7 or close to it, where utility power is not available.

And so you have to have a quality machine to do that.

And so the engineering effort, the design, the manufacturing that they put into their product to make it that robust extends through also into their standby products.

So what we feel we're getting there is a high-quality product line that we think we can do some things with, both from a revenue synergy -- as I indicated, with combining the distribution in are prepared remarks -- but then on the cost side, we continue to position ourselves as a more significant purchaser from a sourcing standpoint of not only diesel engines, but other components that you would find typical in a generator.

We also have the ability, we think, to extend some of the things that we do vertically, from a vertical integration standpoint, into these products to help lean out the product cost structure for the Baldor product line; and then, again, to play on the back of manufacturing and source and scale.

We think there's some good cost synergy opportunities there once we close.

We're still pretty early, as we indicated in the comments.

But when we get there, hopefully next quarter, we will give people a better steer on what we are thinking about for synergies for that business.

Great stuff.

Appreciate the time.

Jerry Revich, Goldman Sachs.

Aaron, can you talk about your broader portfolio at this point?

A lot of additions, pieces coming together.

What are the next areas that you're focused on?

Just give us a broad sense.

Are you still looking to add additional pieces to the C&I portfolio, or does this pretty much get you what you need in the US?

And then what other regions look interesting to you?

I think from a pure -- it's a great question, Jerry -- but from a pure US and Canada domestic market, if you will, standpoint, as it relates to the one strategic objective that we have, which is to increase our C&I market share, I think the Baldor acquisition certainly puts us on a pathway there.

There could be other ancillary type of products that refer more to the generator space that might be interesting.

But frankly, I think we're closing in on kind of being where we want to be there, from that strategic objective.

From a diversification strategic objective and also expanding geographies, which are two other legs of the stool, there are plenty of other assets and other companies for us to continue to consider.

Our M&A pipeline is still very full.

We think that there opportunities to continue to build that out.

Other products that could fit into the distribution that we have built here, either to the Magnum distribution, or the rental markets, or through our own distribution here on the C&I side -- and then, certainly, internationally there are whole regions of the world where we are really not attacking yet aggressively.

Southeastern Asia -- we've got a toehold in Europe now with Tower Light, but that's really on a -- that's a mobile construction equipment play; we really haven't solved for stationary power generation yet.

So there are a ton of opportunities.

The Western Hemisphere we're getting better with Ottomotores.

We've got Brazil.

We've just reconstituted the Ottomotores Brazil entity.

We combined it with -- Tower Light had a Brazil entity; we've combined those entities and created a Generac Brazil entity, which is a new entity down there.

It's got a facility, and it's got staff.

And then we've got, obviously, our facilities in Mexico through Ottomotores.

But I look out and I see a lot of opportunity yet in our pipeline.

We're being pretty aggressive on that.

And obviously, with our free cash flow characteristics, we think that continuing to put the cash flow to work in this manner to accelerate our Powering Ahead plan is a good use of cash.

And Aaron, can you give us an update on the margin performance on the acquired Tower Light and Ottomotores business?

I know Tower Light you haven't had that long, but perhaps you can give us an update on how that's doing so far?

And what have you seen out of the margin profile in Ottomotores versus the prior owner?

Ottomotores -- I'll focus on that first.

We haven't broken out Tower Light.

But it is -- as we said, I think, publicly, I think it's very good margin business, Tower Light.

Much better than what you would see traditionally here in the US in a mobile equipment company.

But in Ottomotores, as we said before, that was a business we bought that had been underinvested in.

The product cost structure was not as lean as we would have liked to have seen it.

We've done some rationalization of the manufacturing footprint there already.

We're moving in the right direction, I think, to get that -- to lean that out.

And we are bullish on where the synergies could go with that business.

I think we publicly stated $2 million dollars in cost synergies for Ottomotores.

We feel like we're definitely on track with that.

But what we learned, even with Magnum, as an example -- that was an acquisition we did two years ago -- is that when you get in the second and then ultimately the third year, that's where we start to, I think, really sharpen your pencil when it comes to other potential synergies.

And we think that will be the case as well with Ottomotores as we go forward and lean out that cost structure, and really start to use our newfound scale here in purchasing and manufacturing to the benefit of that business from a margin standpoint.

And Aaron, lastly, you mentioned earlier in your comments that there's going to be some seasonality in your residential business over the next couple of quarters.

It's been a while since we've had a typical, seasonal year from a storm standpoint.

Can you just flesh that out for us?

You mentioned, I think, standby should be flat in Q4 versus Q3.

What's a typical seasonal pattern as you see it into the early part of next year?

We mentioned in our remarks that standby is going to be actually up in the fourth quarter.

So we are actually expecting that to be up.

We do expect, again, just from a seasonal standpoint, if it remains a quiet season here for the balance, the fourth quarter from a portable generator standpoint, we would see further declines in the run rates on portable generators in the fourth quarter.

And then we are formulating working through our guidance in 2014 right now.

Pursuant to all my comments, both prepared and here in Q&A, we've got a tremendous amount of initiatives that we have been focused on to drive the Company forward.

You look at the residential, it's that new and higher baseline we talk about.

All the things from A.M.P., to PowerPlay, to our infomercial -- the Power You Control infomercial that launched here in May.

Those things are all having an impact, we believe, on that baseline and on extending the awareness here of portable -- or, excuse me, of standby generators.

But when we get around to the fourth-quarter results, that's we will give a much tighter read on guidance.

Certainly seasonality -- if we get a quiet period, I think the one thing we would say -- if we get a quiet season here, seasonality from a quarterly basis in 2014 would probably look a lot like what it has in the past without storms.

So, you know, last year was different, because are coming right off a storm.

2011 was different, because we were coming off of Irene.

So I don't think you would expect the same type of seasonality with respect to the quarterly numbers as it relates to residential if we have a continued quiet period here this season.

Okay.

Thank you very much.

John Quealy, Canaccord.

The first question -- so on the dealer adds, if you go back trailing four quarters, you've publicly stated you are adding about 100 net per quarter since Q1.

And I think the Q4 2012 to Q1 2013 jump was about 200 dealers.

But can you comment on the gross adds there, or how you're feeling with churn?

And what I mean about churn is -- are the dealers more profitable than they were?

Or can you just comment a little bit more on the dealer metrics?

Thanks.

Yes.

So what we've said with respect to dealer adds -- we've always reported those numbers on a net basis.

I would tell you this, John; we haven't seen anything out of the ordinary with churn that would create an issue for us there that we foresee at this point.

So that's pretty consistent.

But what I would say is -- and we said in our comments -- we have had 1,000 net dealer adds since the end of 2011.

And when you look at that, -- I mean, that is a material increase in our base off of -- you know, we are 5,200 today.

So essentially we were in the low 4,000s at that point, at the end of 2011.

And we do track on a same-store sales basis, as I said previously.

We're seeing improvements in top-line run rate.

From an economic standpoint, the broader the base of product that gets out in the marketplace -- we're at 3% penetration today and headed higher.

There is a lot of product out there from a service standpoint -- service opportunity standpoint, both on an annual service basis, but we are also connecting customers who purchase their products through other non-dealer channels, we are connecting those to our dealers.

Because our dealers are best equipped from a training standpoint, a technical ability standpoint, to repair, service, and maintain products.

So if somebody goes and buys a product from a big-box retailer, or online, or any of the many other channels where they are available, that's great.

We give great accessibility to the product.

But at the end of the day, it is a mechanical product and does need to be serviced.

That's really the economics for the dealer.

And so improving profitability, I think, is going to be a direct result of the increase in base of product that's out there and available to be serviced.

And in terms of margin per standby unit, anecdotally, it sounds like Mobile Link has had a pretty decent uptake, and I've got to imagine that's decent margin as an add-on sort of product to the core stationary.

Can you comment a little bit about how you are feeling with applications like Mobile Link, what you think the uptake -- how it's tracking to your expectations?

Yeah, Mobile Link is -- it's exceeding our expectations here in the first year.

We just launched that product earlier in 2013 here.

And that is a great way for people to interact with product -- text messages; emails; it can go online.

We've got some other development around that product.

That type of remote monitoring is really the class of product that we're talking about there.

And really, it's a revenue model that we haven't had here.

We're dealing directly with end consumers.

We're selling the service, if you will.

In a lot of cases the service in the first year is given away free as a way to entice people to soak into the product here and get used to using it.

But we think there's been a nice take rate so far on it.

We like the product.

We are looking to expand it in other places and do some other things with it going forward.

And we see there's an opportunity to build not only better customer interaction with the product, but also a revenue model there that is a much more recurring revenue stream than we've had in anything we do here, other than maybe service parts.

But it's very much in its infancy.

And as it matures, I'm excited about where that could go.

Perfect.

And then lastly, real quick -- York, I'm sorry if I missed this.

But I couldn't have imagined copper is in your favor.

Can you talk about forward purchasing or hedging that you're doing there?

Thanks, guys.

Yes, we've got some -- I guess what we'd call more opportunist -- we don't have a formal hedging program.

We have some opportunistic hedges out there, but they are more short-term in nature and more modest in nature.

And I guess I wouldn't say that we are locked in on copper at today's levels.

Operator, do we have anyone else left in queue?

Jeffery Hammond.

You mentioned home stand by being up into the fourth quarter, and I think you have talked in the past kind of about a 12-month afterglow on the longer end.

Can you just talk about -- is the resiliency there a function of A.M.P., PowerPlay, and the new dealers?

Or maybe just talk about what you are seeing in terms of momentum on web heads, and registrations, and leads?

Yeah, so Jeff, I think I'm probably not going give you anything new here, other than what's in my prepared remarks, but just the fact that when you combine all those things, right?

I mean, those are all new programs, the things you just mentioned.

And there's a third one, which is the infomercial as well.

So you take A.M.P., you take PowerPlay, you take the infomercial.

Both A.M.P.

and PowerPlay were in testing phase late last year, fully rolled out here at the beginning of the year.

And then the Power You Control infomercial, our direct-response TV campaign, was rolled in May.

When you put all of that together, I think it's having -- everything is in the evidence that we show.

Obviously, we're looking at closure rates on the dealer level, and the impact of those tools that we are giving people in those marketing initiatives, and we're definitely seeing better closure rates as a result, we believe, of those items.

And that's why we're going to continue to focus on those going forward here through the balance of 2013, and actually into 2014 as well.

I think it's not out of the question to see us do some things not only to the aggressive level we are already doing them, but maybe even further with some of those things.

The point here we're trying to make is, obviously, you're going to get events like Sandy; you're going to get events like Irene from time and again.

That's the way it works.

And that's going to accelerate the adoption rate for the category at points in the curve.

But as we build out this base and it becomes a more mainstream category of product, we think we just a -- we've got a great opportunity here to take and extend the awareness from those types of events, but then do some meaningful structural things, like what we're doing in the sales and marketing side, to keep that running forward on a positive basis.

Obviously, we said in our prepared remarks about Q4 -- and you referenced that as well -- and again, I would call out that prior reversion to a more normal seasonality pattern with these types of products, once you get into next year, if the season remains quiet.

But very bullish on the new baseline the we're building at this point.

And what's the new bogey -- as you surpass this 20% dealer on PowerPlay, what's the new bogey to think about in terms of adoption rates there?

That's a great question.

I haven't given a tremendous amount of thought.

We are in the middle of our planning stage right now.

We are having some dialogue back and forth with our team here to make sure that we are aligned on what we do think that is.

But I think it's a meaningful step up.

I think part of it is, you have to look at the 20% that have adopted.

They don't represent just 20% of sales.

Those are generally the dealers who are more heavily involved in the category from a mindshare standpoint, from a staffing standpoint, resource standpoint.

So that 20% of dealers that have adopted, that's -- on a dealer count basis, that represents more than 20% of the dollars.

So, obviously, there's a point of diminishing returns, you push this out and push it out, but you are getting connected to smaller and smaller dealers.

That's one side of the coin.

The other side of the argument that we make, or that I like to make here, is that -- but you don't know where the next great dealer is going to come from.

You sign up a dealer, he gets involved in the category for the first time.

If you give that dealer the right tools to be successful; and they're entrepreneurial enough to promote the category, and promote the business, and they do the things that we are asking them to do; they could have great success with that.

So you can't just say because they are a small dealer today, we shouldn't push it.

They could be a big dealer tomorrow as a result of pushing it.

So it's really -- I don't want to quote a number at this point, but I would think we're going to be pushing hard to get a number.

And we'll quote you something on that when get to next year.

And just a couple of housekeeping items, kind of on the acquisitions.

Can you quantify what the acquired revenue was in the quarter?

Well, we talked about organic growth for C&I in that high 30% range.

So if we grew 62% for C&I, the delta there would be acquisitions, Jeff.

And you had two months of Tower Light?

We had really one, if you think about it.

Yes, really one.

Unfortunately, it really kind of shuts down for the month of August.

You buy a company and it closes.

Okay.

That's probably why it seems like a lower number.

You've got to think about that in terms of the run rate.

Correct.

Is there any way to kind of give us a rough size, trailing 12 months sales, on Baldor?

And kind of where -- any profitability metrics in terms of where they stand relative to your other businesses?

Yes; we haven't disclosed revenues for some pretty competitive reasons there.

But I think -- obviously, as we said, the current business is not optimized.

So when you look at the profitability of that business today, I think we really believe that there is an opportunity to take our scale, to take our manufacturing capabilities, to really go after leaning out that product cost structure and doing some things there.

There's also some great revenue synergies that -- this is a product line that our dealers don't have access to directly from Generac.

They do from others, but not all of our dealers are in this market, because we don't offer it.

And we'll have some nice synergies with that.

There's some great connection of synergies between the Magnum business and the Baldor business relative to the rental markets and the oil and gas markets.

We are really excited about that.

We think that there is an opportunity there to do something that is pretty cool.

But the other thing I would mention -- this is a carveout of a much bigger business, right?

And we are buying assets.

So it's a little hard to really look at the true profitability.

You can do as much as you can do in diligence to try and figure out what it would run rate to.

But at the end of the day, until you really get it in-house and we assimilate it into our portfolio, both on a facility basis and the way we do manufacturing; as well as from a product basis, in the way we design products, I think we'll probably have a better glimpse of it once we get the thing closed and get into the next quarter.

Jeff, we may be able to make some more comments on it then.

Okay, thanks guys.

Christopher Glynn, Oppenheimer.

I don't know what happened.

I don't know if he disconnected and if he wants to press star one again?

He is in the call?

He is back in.

Hold on one moment.

Okay, Christopher Glynn.

So we've been talking about the new higher resi baseline, and for my question, I don't think there's any possibility of an empirical answer.

But wondering if you had any gut thoughts on how much of what we're seeing right now is the new baseline versus some elements of extended afterglow?

Obviously, what gets really hard to parse apart on this -- and we talked about this on other calls -- so if you go back, right, we had not only Sandy; but you had Irene; you had the snowstorm in October -- Snowtober, as I think it was referred to; had other numerous outages on the East Coast, smaller to larger.

They all build on each other.

And so to try and parse apart baseline versus what is coming off of which outage, I mean, what do you point to?

We tried to do that scientifically; we tried to do it from a gut perspective; and both ways.

What we continue to focus on, Chris, is expanding distribution and focusing on the programs and the tools that we are putting in the hands of those dealers that we are putting out on the street to sell our products.

And then some of the more, I would say, national level and regional level marketing campaigns that we've been ramping up here to get the product category in front of more people and explain it to more people -- to create our own awareness, if you will; to create our own storm, if you will.

But that's really what we're focused on here going forward, because it's a really bad strategy to sit around and watch the Weather Channel.

That's not a strategy for a business.

It's not.

Okay.

And then if we look at the mix in the margin impact in the fourth quarter, understand -- but will that be probably a good proxy to start thinking about 2014 as things have kind of calmed down a little on the residential side?

Yeah, Chris, this is York.

We are pulling those numbers together now, so we haven't commented on 2014 margins at this point.

We haven't given any guidance on 2014.

We're still pulling that together ourselves, so it would be premature to comment on 2014 margins.

Fair enough.

Thanks.

There is no further questions in queue.

And I would now like to turn the call over to Aaron Jagdfeld for closing remarks.

Thank you.

We want to thank everyone this morning for joining us.

And we look forward to discussing our fourth-quarter and full-year 2013 earnings results, which will be out sometime in February of next year.

So with that, we thank you.

Thank you very much.

This concludes today's conference.

Thank you for your patience, your participation.

You may now disconnect.

Have a great day.