Generac Holdings Inc (GNRC) 2014 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the second quarter 2014 Generac earnings conference call. My name is (Inaudible), and I'll be the operator for today. (Operator Instructions). I would now like to turn the conference over your host for to Mr. York Ragen, Chief Financial Officer. Please proceed.

Thank you. Good morning, and welcome to our second quarter 2014 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 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'll 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.

Thank you, York. Good morning everyone, and thank you for joining us today. Our second quarter results reflect seasonally higher shipments as compared to the first quarter of 2014, driven by the expected sequential increase in residential products.

In addition, our results -our results further demonstrate the ongoing diversification of our business, as shipments of commercial and industrial products continue to represent a growing portion of our sales, as we have increased our exposure to new markets, such as oil and gas, broadened our industrial product line, and strengthened our industrial distribution network. Second quarter net sales increased 5% to $363 million, as compared to $347 million in the second quarter of 2013. C&I product sales increased 23% during the second quarter, due to a combination of recent acquisitions and strength in the oil and gas market.

As expected, residential products faced a strong prior year comparison, as sales were $180 million, compared to $197 million in the prior year quarter, which benefited from elevated demand due to Superstorm Sandy. Excluding this prior year benefit, residential product sales increased at a solid rate over the prior year, primarily as a result of strong shipments of home standby generators. The strong year-over-year growth in home standby generators was achieved in spite of the backdrop of the power outage environment that has been trending well below normalized baseline levels in recent quarters.

As we have previously mentioned, we monitor power outage activity internally, and over the last six quarters, outage severity has declined considerably as compared to a previous normalized period, which excludes impacts of major outage events. We believe the growth experience in home standby generators during the second quarter, despite this lower power outage environment, supports our position that permanently installed standby generators are an emerging category as a backup to homes with an install base that continues to grow. In addition, we believe our sales growth in the second quarter points to gains in valuable market share in the category as we continue to benefit from our broad distribution, innovative sales and marketing processes, and new product introductions.

We expect that the long-term trend of an increasing level of power outages driven by an aging and under invested electrical grid, and coupled with the proliferation of digital electronics, favorable demographics, and increasingly severe weather will continue well into the future. We continue to remain particularly focused on additional opportunities to increase the awareness of home standby generators using our unique sales and marketing tools, including our A.M.P. targeted marketing process, and our direct response television campaign, along with our digital and traditional advertising efforts.

The sales leads generated from these sources are directed to our Generac lead team for qualification and scheduling of an in-home consultation to our PowerPlay in-home selling solution. Many of these sales and marketing tools only became fully operational within the past year and a half, and form an innovative and cost-effective approach to identifying and qualifying sales leads. During the second quarter and entering into the second half of 2014, we are increasing our media spend for the Power You Control infomercial campaign, which has been contributing to notable increase in in-home consultation in recent months.

Also during the second half, we will have an increased focus on improving sales closure rates for home standby generators by further optimizing these tools, including new and improved training programs for our dealers, (Inaudible) leveraging the recent availability of new financing options within PowerPlay, and further enhancements to the PowerPlay application itself. With only approximately 3% of US households owning a stationary backup generator, there is a substantial opportunity to grow the residential standby category in the -- in the long-term.

We also wanted to discuss an exciting new addition to our home standby product line this morning. Our new 22 kilowatt Guardian Series air-cooled standby generator launched July 1, provides the highest output in an air-cooled generator currently available in the marketplace. This new power [node] dramatically improves the affordability for those homeowners requiring a larger generator for carrying higher amperage power loads. Previously, these homeowners would have had to step up to a liquid-cooled product solution, which costs thousands of dollars more. We are excited about this product, as we believe it gives us a further advantage over our competitors, as this new unit expands on the breadth of our industry-leading line.

Also contributing to the year-over-year sales growth in residential products in the second quarter was an increase in revenue from power washers. With the successful roll-out of several new products, as well as the increased placement of our consumer and prosumer units at certain retail channel partners, we believe we continue to make good progress in growing our market share in the power washer category. Sales of our commercial and industrial products during the current quarter increased at a strong rate, driven primarily by the Tower Light and Baldor Generator acquisitions, as well as strong shipments of [gaseous] generators for oil and gas applications, partially offset by a decline in sales within certain Latin American markets.

We continue to see some notable strength in the quarter from rental equipment customers in the US, as a result -- as a result of strong demand in the oil and gas market. As we've been discussing recently, we are particularly excited about the increased exposure of this particular vertical market that the combined Baldor and Magnum acquisitions give us. Through these two acquisitions, we now have a broad product line of mobile and stationary gaseous fuel generators, that are capable of running on well gas generated at the drilling site. Advances in drilling techniques over the past several years has created access to a significant supply of shale gas, which has created an attractive secular opportunity for both mobile and stationary equipment demand, including the need for support equipment such as light towers, generators, and pumps that are essential at these drilling sites.

The oil and gas market is expected to be an important end-market vertical for Generac going forward, and we are further evaluating the opportunity to better determine the appropriate levels of investment and resources needed as we position ourselves to participate in this potential long-term upcycle.

With regards to Baldor Generators, the integration of this recent acquisition and the buildout of our industrial distribution network both remain key corporate focal points during the second half of 2014. As a reminder, Baldor offers a broad line of higher power output standby and prime rated products throughout the US and Canada. The addition of these products significantly expands our industrial product offering and manufacturing footprint, and essentially doubles the addressable domestic market that we and our distribution partners can serve.

We continue to make good progress in strengthening our distribution as we work to combine the Generac and Baldor industrial networks, and we are particularly focused on increasing our sales bandwidth to better enable our distribution partners to sell the larger generators and systems now available to them. This includes a greater level of interfacing with the engineering firms responsible for specifying these products in an effort to improve their knowledge of our recently expanded product offering. In addition to our sales efforts, we've identified some meaningful product cost synergies, given our increased manufacturing and sourcing scale, as we transition the acquired products and facility into the Generac portfolio.

Our Tower Light acquisition that closed in August 2013 continues to perform well. Headquartered outside Milan, Italy, this acquisition positions -- positions Generac as the global leader in the light tower product category, and allows us to participate in the growing rental market outside the US. Their broad global distribution and innovative products, that are tailored to serve local markets, are key contributors to an established history of profitable growth. We continue to evaluate additional revenue and cost synergy opportunities as we further integrate Tower Light into the Company.

Our Ottomotores business, based in Mexico, experienced a decline in sales within Latin America during the second quarter 2014. This decline was primarily driven by a combination of a difficult prior-year comparison related to certain large projects that shipped in the second quarter of 2013 which did not repeat, as well as overall softness in Latin American markets, which has been negatively impacting infrastructure spending in the region. Although the market has been recently challenging, we have continued to make good progress in our integration efforts with Ottomotores, and this acquisition remains an essential platform for our international expansion efforts, by providing a local manufacturing presence, and access to the important Latin American market for power generation and other engine-powered equipment.

We continue to be focused on executing our Powering Ahead strategic plan, which includes growing the overall residential standby generator market, gaining industrial market share, diversi -- diversifying our end markets, and expanding internationally. This strategic plan serves as a foundation for the investments we make to drive the penetration of our products, create a new and higher baseline of demand, and resulting in a more diversified Company with improved global scale.

Combining this strategy with the long-term growth drivers for our business, and the potential for future recovery and key macro economic indicators, 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 back over to York to discuss second quarter results in more detail. York?

Thank you, Aaron. Net sales for the second quarter 2014 increased 4.6% to $362.6 million, as compared to $346.7 million in the second quarter of 2013, with the prior year benefiting from elevated demand from Superstorm Sandy. Looking at net sales by product class; residential product sales were $179.6 million in second quarter of 2014, as compared to $164 million in the first quarter of 2014, a 9.5% sequential increase over last quarter. Compared to the prior year quarter, residential product sales declined from the $196.6 million that was shipped in the second quarter of 2013.

Shipments of residential products during the prior year second quarter of 2014 were positively impacted by approximately $40 million, as we continue ramp production levels to satisfy the extended lead times that existed during the quarter. By contrast, lead times during 2014 have been at more normalized levels. Excluding this $40 million of benefit during the prior year quarter, residential product sales increased approximately 15% year-over-year, driven mainly by strong shipments of home standby generators.

Demand for these products benefited from both normal pre-season patterns, as well as numerous initiatives to drive a new and higher baseline for the category. In addition to home standby generators, we also saw a significant year-over-year percentage increase in sales of our power washer products, as we continue to gain market share and brand recognition in this product category. Partially offsetting this strength was a year-over-year decline in sales of portable generators due to a combination of lower power outage severity over recent quarters, coupled with the prior year second quarter still benefiting from elevated demand and replenishment following Superstorm Sandy.

Looking at our commercial industrial products, net sales increased 22.5% to $163.5 million in the second quarter of 2014, as compared to $133.4 million in the second quarter of 2013. The increase in C&I net sales was driven -- was driven primarily by the acquisitions of Tower Light, which closed in August 2013, and Baldor Generators, which closed in November 2013. Additionally, we are seeing positive momentum in the oil and gas markets, as demand for certain stationary and mobile products have increased significantly through our rental customer base. Also contributing to the year-over-year sales growth from C&I products, were increased sales of natural gas generators using light commercial and retail applications. Partially offsetting these increases was a decline in sales in certain Latin American markets as Aaron previously discussed.

Our other product sales category improved to $19.6 million in the second quarter of 2014, an increase of 17.5% from the prior year second quarter sales of $16.6 million. This growth is due to increase in sales of service parts as the install base of our product overall growth of the Company, and to a lesser extent, the contribution from recent acquisitions.

Gross margin for the second quarter was 35.3%, compared to 37.8% in the prior year's second quarter. This 250 basis point decline in gross margin was due to a combination of the Baldor Generators acquisition, along with a return to regular promotional activities consistent with a period of normal seasonality. Operating expenses for the second quarter 2014 declined $4.7 million, or 8.6%, as compared to the second quarter of 2013.

Included in operating expense for the current year quarter is a $4.9 million gain relating to a remeasurement of a contingent earn-out obligation from a recent acquisition. Excluding this gain, operating expenses for the second quarter of 2014 were flat as compared to the previous year, despite the addition of operating expenses from recent acquisitions.

Adjusted EBITDA margins came in slightly ahead of our expectation at 23.3% of net sales in the second quarter of 2014, as compared to 26% of net sales in the same period last year. Compared to prior year, adjusted EBITDA margins were primarily impacted by the overall decline in gross profit margin, as previously discussed. Adjusted EBITDA over the last 12 months as of June 30, 2014 was $365.7 million, or 25.3% of net sales.

GAAP net income for the second quarter of 2014 was $54 million, as compared to $28.3 million for the second quarter of 2013. Included in other income expense in the current year quarter was a $16 million non-cash gain associated with a 25 basis point reduction in our term loan interest rate, resulting from our credit agreement leverage ratio stepping below three times at the beginning of the second quarter. As a result of our elected GAAP accounting method related to the amortization of deferred financing costs and original issue discount on debt, the entire $16 million future benefit from the 25 basis point interest rate reduction over the remaining term of the loan is required to be fully recognized as a gain in the current quarter.

Similarly, included in other income expense in the prior year second quarter was a $13.5 million loss on extinguishment of debt as a result of our May 2013 credit agreement refinancing and other debt prepayments that were made during the prior year quarter. Updating our interest expense guidance, our cash debt service costs are now projected to be between $41 million to $42 million for the full year 2014, while amortization of deferred financing costs and original issue discounts are now expected to be approximately $7 million during 2014, for a full year 2014 GAAP interest expense total of $48 million to $49 million. Adjusted net income as defined in our earnings release was $57.1 million in the current year quarter, versus $66.6 million in the prior year second quarter.

This decline over the prior year is the result of the previously-discussed lower gross margins, along with a $9 million increase in cash income tax expense over the prior year quarter. These reductions were partially offset by $2.8 million in lower interest expense due to a reduction -- due to a reduction in interest rate from the May 2013 refinancing of our senior secured term loans.

Diluted net income per share on a GAAP basis was [$0.77] in the second quarter of 2014, compared to $0.40 per share in the second quarter of 2013. Adjusted diluted net income per share, as reconciled in our earnings release, was $0.82 for the current year quarter, compared to $0.95 per share in the prior year quarter. With regards to cash income taxes, the second quarter of 2014 includes the impact of a cash income tax expense of $11.7 million, as compared to $2.7 million in the prior year quarter.

As we have commented -- as we have commented during recent earnings calls, our cash income taxes for 2014 are expected to increase over the prior year due to a combination of our NOL carryforwards, and certain tax credit carryforwards becoming fully utilized during 2013, as well as certain discreet tax deductions that were taken in 2013 that will not repeat in 2014. Our cash income tax rate for the full year 2014 is now anticipated to be 17% to 18%, versus our previous expectation of 19% to 20%, due to higher level of benefit than previously expected from certain tax credits.

As a reminder, even though we are now starting to pay income taxes, our favorable tax shield through our -- through annual and tangible asset amortization in our tax return remains intact through 2021, resulting in approximately $49 million of cash tax savings per year for the next eight years. As a result, our cash income tax rate is expected to be significantly lower than our currently projected 34% to 36% GAAP income tax rate in 2014.

As we drive higher profitability over time, cash income taxes can be estimated by applying a projected longer-term GAAP income tax rate of approximately 36% on pre-tax profits going forward, and then deducting the approximately $49 million of annual cash tax savings from the tax shield each year through 2021. Precash flow, defined as net cash provided by operating activities less capital expenditures, was $40.5 million in the second quarter of 2014, as compared to $30.3 million in the same period last year. The year-over-year decline in operating earnings during the current year quarter was more than offset by less investment and working capital, compared to the prior year second quarter.

The prior year included a significant use of cash to replenish finished goods inventory levels that had been depleted from Superstorm Sandy. Precash flow over the last twelve months was $236.9 million. As we have mentioned during our last earnings call, we made a voluntary prepayment of debt totalling $12 million in April 2014 that will be applied against our excess cash flow payment requirement in our credit facility, as well as against future term loan principle amortizations for the next 12 months.

As of June 30, 2014, we had a total of [$1.16 billion] of outstanding debt, net of unamortized original issue discount, and $198 million of consolidated cash and cash equivalents on hand, resulting in consolidated net debt of $963.3 million. Our consolidated net debt to LTM adjusted EBITDA leverage ratio at the end of the second quarter was 2.6 times, a level within our targeted range of 2 times to 3 times. With that, I would now like to turn the call back over to Aaron to provide additional comments on our outlook for 2014.

Thank you, York. We are reaffirming our prior guidance this morning for 2014, in terms of revenue growth, EBITDA margins, and free cash flow. For the full year 2014, net sales are still expected to increase in the mid single-digit range, as compared to the prior year. This sales outlook assumes an increased level of power outage severity in the second half of 2014 as compared to recent quarters, returning to a more normalized annual baseline level. Additionally, as we have previously discussed, the timing of CapEx spending for certain telecom and other national account customers can vary from quarter to quarter, which may have an impact on our previously guided seasonality.

Our current sales outlook does not assume a material deferral in CapEx spending with these customers, and contemplates a sequential sales increase from the third quarter to the fourth quarter. In summarizing, our sales growth assumptions for 2014 - excluding the impact of the $140 million headwind related to the first half 2013 production ramp in residential products to normalize lead times - we still expect total organic year-over-year growth to be between 9% and 11%. When including the prior year headwind, we still expect organic growth to be approximately flat year-over-year in 2014.

The acquisitions of Tower Light and Baldor Generators are still expected to contribute approximately 5% growth, resulting in an overall year-over-year net sales increase in the mid single-digit range. With regards to gross margins, we are expecting sequential improvement in the second half of 2014 of approximately 150 basis points as a result of a higher mix of residential product sales, and price cost improvements expected in the second half of the year.

We are also reaffirming our adjusted EBITDA margin guidance for 2014, as we continue to see adjusted EBITDA margins remaining in the mid 20% range, which is consistent with the average level experienced during the past four years. Adjusted EBITDA margins during the fourth quarter are expected to increase approximately 150 basis points as compared to the third quarter. Furthermore, we expect that we will continue to generate significant free cash flow in 2014, given our superior margin profile, capital efficient operating model, low cost of debt, and favorable tax attributes. For full year 2014, we still expect our conversion of adjusted net income of free cash flow to be approximately 90%.

In closing this morning, as we continue to execute on our Powering Ahead strategic plan, and capitalize on our long-term secular growth drivers for our business, we believe we will continue to generate strong free cash flow for the foreseeable future. As a result, we are confident in our ability to continue to invest in the future growth of the business, both organically and through M&A, while also evaluating other priority uses of cash to enhance shareholder value. This concludes our prepared remarks, and at this time, we would like to open up the call for questions. Operator.

(Operator Instructions). Your first question will come from the line of Jerry Revich from Goldman Sachs. Please proceed.

Good afternoon, York and Aaron, it's -- it's Matt on behalf of Jerry. I wanted to start on the residential standby side, and maybe, Aaron, you could talk a little bit about the order levels and (Inaudible), seeing as we -- as we start off the third quarter and -- and how those are tracking versus expectations.

Our comments are -- I'll talk about it a couple of ways, Matt. The thing we watch, we watch some indicators as we look at this residential business, it used to be that we didn't have a tremendous amount of visibility to it. It was a tough business to predict -- I'm talking about the standby business, now, of course -- in terms of -- of future thoughts around that, it was really related just to what was going on with the order book currently today, because lead time's are pretty short on those products. What's really interesting is over the last year and a half, as we've introduced some of these new tools that we've got and driving leads into our call centers here, we not only obviously track lead volume, but we track what we call in-home consultations -- or IHCs -- that we create on a go-forward basis coming out of those -- those inbound calls.

And so what we have seen, both closing out the second quarter, and as we start the third quarter here, is we have seen a nice improvement in the IHC rate. And again, this is on the backdrop in our comments -- our prepared remarks this morning -- overall outage events have been pretty quiet in the last six quarters since Sandy, and in fact pretty down, compared to the historical longer-term averages if you look back to the last couple of years, even if you exclude any major events like Sandy or Irene or anything like that, the outage activity has been pretty weak. We see those cycles from time to time, we are in one of those cycles now.

It's our -- our guidance contemplates a reversion to the mean, basically, from an -- from an annual baseline level of outage activity that we believe needs to happen here in '14 in order for us to -- to realize our guidance on the residential side. That being said, we are coming into our season now, third quarter is where we would see that, so we've seen a nice pickup coming out of the second quarter, you see that in our second quarter results with home standby as we get the channel ready for the season. That's the cadence for this business when you get a year following a year without storms, so everything is falling in line the way we see it, and we like where we see some of these leading indicators, like IHCs.

That's very helpful, and then if I can just switch gears briefly, and turn to the commercial business. Can you quantify the headwind in Latin America that you're seeing, and talk a little bit more about how you expect that business to progress for you over the rest of the year?

I'm not going to quantify it directly, though, but I will -- but I will talk about that business, because I think it's an important discussion point. Ottomotores was -- we have talked about Ottomotores a lot as a company, and we talked about it to investors. Great business, a great business down in Mexico City, they're located down there. A couple of plants in Mexico City, and distribution throughout Mexico, they sell a lot of the product on a direct basis within the Mexican City area. Obviously Mexico City is a almost a little bit of a different entity unto itself from Mexico, in terms of its dependence on what goes on in -- in -- in the government there in Mexico, that -- in terms of ebbs and flows of spending, in particular CapEx spending -- as it relates to infrastructure. There was a -- there's been a fairly notable pull back with the change in administration that happened a year ago.

There was a -- there's been a fairly notable pull back with the change in administration that happened a year ago. I think -- due to a couple of things. One, I think everybody was expecting CapEx (Inaudible) to pick up, not pull back, but what happened is the administration is, I think, doing the right things for the long-term, but unfortunately, it's impacting things negatively in the short-term.

For the longer-term, they're trying to open up the energy markets there to private investment, and in doing so -- obviously that's been a -- been a bit of a slog for them, politically. But I think they've gotten to a point now where there's a quasi-public / private approach to that, and I think that's going to be good long-time for the energy sector in Mexico, good for the economy in Mexico, good for people who are investing in Mexico, like Generac, and we view this as an investment in our future in Latin America, because I think it's going to open up a lot of opportunity. In the meantime, it look a while to write all the rules, and to get things through the political environment there, and so those rules have only recently come out around that quasi-public / private investment structure. So we think that going forward here in Mexico, the -- the economic environment, it's our belief, will improve off of what has been a fairly dismal performance.

I think all the economic forecasts for Mexico have started out at the beginning of the year the last two years has started out robust and moved down, I believe it was just north of 1% GDP last year for Mexico. That business, just to -- to frame the backdrop for you, Matt, has -- has been challenging, just from a macro-environment standpoint, and then obviously the rest of Latin America has been somewhat challenged. We had a fair amount of exposure through Ottomotores to the Venezuelan market, and obviously Venezuela has -- has -- has been very challenging with the change in guard there.

There's -- there's some things there in terms of big projects that go on in Venezuela that haven't happened over the course of the last year and a half. We do have a business in Brazil that came with the Ottomotores acquisition in Curitiba, that business has done quite well. Now, it's off of a fairly small base. It's kind of a greenfield startup about four years ago, and that business is -- but it has performed well in spite of a Brazilian economy that hasn't, so we like what we see down there. It's a great springboard for us as the first acquisition outside the US to get our feet wet with.

Now, the other thing I'll give you as a backdrop, this was a business that we bought that was owned by a -- basically an industrial holding company and it was somewhat ignored, unfortunately under-invested in. So we had some investment catch-up, we've been doing that, the integration efforts have been ongoing over the last year, year and a half. We are pleased with the results on the integration side, we would just like to see the market pick up so that we can realize some commercial -- some additional commercial success there. By and large, it's going to be -- this is going to be a home run for us in the long run, and we are -- we are still very excited and very bullish on it.

Your next question will come from the line of Ross Gilardi from Bank of America. Please proceed.

Good morning, thank you, guys.

Good morning, Ross.

Good morning. Aaron, I just was wondering if you could flesh out your outlook statement a little bit more, and maybe give more color on what specifically you need to happen in the second half of the year, with respect to power outage activity to deliver your full year outlook. So, in your outlook statement, are you saying that the level of power outage activity in the first half was subnormal and therefore you need a greater number of outages to return to a normalized baseline for the full year, or are you just saying that you need normal seasonal power outage activity to pick up in Q3 and you'll be fine?

It -- It's the -- it's the former, not the latter. So what we saw in the first half of the year outages were down considerably, down 65% in fact, to the average prior to Sandy, and that's something that we track internally. We watch -- we watch outages, and watch duration of outages, frequency of outages, and number of people impacted and outage activity has been soft. As a generator manufacturer, as our primary product category, I made reference to it before; Outages ebb and floor -- ebb and flow.

The reversion to the mean comment that I made is exactly what we need to have happen, which means, in your words, an elevated level in the second half over the lower level that we had in the first half, to return to that normal annual cadence that we would see in outages for the baseline level, and that excludes major events. Now, that return to the mean can happen in a major event, it could happen in a series of smaller events. We have seen a much reduced volume here, it's just been pretty quiet the last few, the last several quarters.

And if you just see this continued lull in power outage activity despite the seasonality, can you give us a sense as to what your full year outlook would look like?

Yes, we are going to stick to our guidance, because we believe in the reversion to the mean. Everything reverts to the mean over time, and again, because of our history and we've seen this before, an outage can happen tomorrow, an outage can happen today, it could happen ten minutes from now, it could happen four quarters from now. There is no exact science to it. All that we can say is that we -- we continue to look at the long-term macro thesis of the business in terms of the quality of power, i.e., major power outages, or power outages affecting large amounts of people continue to increase, and that has been on the rise for more than a decade.

Again, we believe that that's tied to all the things we talk about, Ross, in terms of underinvestment in the grid, the age of the components of the grid, our dependence on electricity as a society. The aging in place concept that we talked about a lot in terms of people wanting to stay in their homes as long as possible. Automatic power generation, backup power generation gives people that independence to do that.

All those trends are in place, those haven't materially changed. It is just some of this quarter-to-quarter stuff, in terms of what outages can do over the long haul. So, again, it's a -- it's a -- our view is that we are going to have a reversion to the mean in the second half.

Okay. With respect to residential and the15% gain (Inaudible) the $40 million in the base, here, is it possible to say how much power washers contributed to that, because you -- you -- you'd mentioned that you had a higher than historical mix there, and if you excluded power washers give a better -- would your standby generator business have been up more or less than that 15%?

The overwhelming majority, Ross, is that it's standby generators. Power washers are -- it's a -- it's an important category for us, a growing category, but we are still a small player in that. So it's a -- the overwhelming majority was -- was home standby generators.

Okay. And how about your dealer count? What would your dealer count look like in the second quarter, and are you still confident you can get 300 to 500 net adds this year, and are you seeing any abnormal levels of attrition, or are you having to incentivize new dealers with stronger promotions to get them to come on board?

Good question. Our dealer count was roughly flat with the first quarter, so we think that that's -- we've hit the bottom of losses on the dealer count side. Worked around the corner there, if you will, in terms of what the cycle goes like with those -- with dealer adds and -- and -- and losses over the course of post outage event like we've experienced here. So we like the fact we've flattened out a bit there.

As far as guidance for the rest of the year, as we have said on previous calls, we are going to be at the low end of that 300 to 400 that we normally add on a net basis. So that's -- we are still holding in there on that guidance. We think that the second half of the year again, in particular with our comments about reversion of the mean and outage events, obviously you tend to get more inbound traffic and outbound traffic on dealer acquisition, as we refer to it, a new dealer adds when you have an environment that has more power outages. We would anticipate, if all of that holds together, that we would still achieve the low end of that range at the very least.

As far as what we have had to do to bring on new dealers. We have got a pretty consistent pipeline that we work on that. Obviously, when you don't have as many outages as your backdrop, you work harder to bring those dealers into the fold. We still have a tremendous amount of interest in the category, and it's not real hard to sell people on the idea of adding this to an electrical contractor or an HVAC contractor's business. It's a -- it starts out being kind of an ancillary part of their business, and for those that really get it over time, you look at a -- you look at that dealer progression, on a vintage analysis basis over time.

There is a percentage of those dealers that go on to shed their contracting businesses and become generator dealers all by themselves, and that's a progression that we continue to look for. We always are out there -- our Honeywell program is all about adding new distribution in the HVAC space, and that's been a nice place for us to focus on here in the -- not only the back half of last year, but in the front half of this year. We are getting into the cooling season right now, so you lose a little bit of their focus and attention as they focus on air conditioning, but those areas we believe there's still a tremendous opportunity, with 70,000 electrical contractors in the US, and 100,000 HVAC contractors out there, there is a tremendous pool from us -- from which to pull from for new distribution.

Okay. Great, Aaron. And my last one on telecom; are you actually seeing any -- do you have any reasons to be concerned about order delays right now? Are you seeing anything in your business today, or are you just highlighting that in the past when there's been consolidation activity, that you can see some shifting around. I think you were saying that telecom activity deliveries would be more weighted to Q4 than Q3, but I'm not sure if I heard that correctly.

You -- you did hear that correctly, Ross. In terms of the telecom business, as much as I say we've been -- we've been fortunate enough to improve our visibility as it relates to residential, our visibility on the telecom side is still really -- is really challenging for us as a business, and that's why we call it out as a risk. Basically on every call, we say that that business in particular can be somewhat lumpy from quarter to quarter.

I -- our expanded comments there this morning are really related to the fact that we -- we have witnessed in the past, when some of the major customers that we have there do acquisitions, or announce other major deals -- as has been announced by one of these customers recently -- that can create a deferral in CapEx spending. We have not been notified directly of any such deferral, but at the same time, there is always a caution around these guys in terms of what they can do with that CapEx, and take their CapEx budget. Recently, one of those customers came out and did reaffirm their CapEx guidance for the year, so that, for us, we read that as somewhat of a positive sign.

It wasn't a reduction in the CapEx spend that they were forecasting, but we'll see how it translates into spend on generators, right? I mean that -- unfortunately, that level of detail is not given to us and not given to the public market. There is still a fair amount of uncertainty in timing. It's a great market long-term, 300,000 sell sites, only about 30% of those sites having backup power today, and we think that that is a -- in terms of a long-term secular opportunity for us just given the amount of critical voice and data that -- that is going through wireless lines today, and the conversion to 4G from 3G,

There's just a whole host of reasons why these sites should have a generator, why 100% of the sites should have a generator on them. Whether that ultimately gets legislated or not is not up to us. But what is up to us is to continue to serve those customers with the right product offering, and to be able to react quickly when they do want to change course, up or down, in terms of CapEx spending.

Thank you. Best of luck. I'll jump back in queue.

Your next question will come from the line of Jeff Hammond from KeyBanc Capital Markets. Please proceed.

This is James (Inaudible) filling in for Jeff. Can you just provide more color on the oil and gas space, particularly with respect to the natural gas flaring, what you are seeing there, and how close Generac is to having a viable product?

Yes, so actually, we have products today, we have products to run off of wellhead gas. We are continuing to evaluate what the product mix needs to be as these go forward. A lot of is on the fly, both for the -- the producers, the E&P producers themselves, the rental companies, and ourselves. Trying to figure out what's the best way to utilize that flare gas. And flare gas, as you mentioned, James, is the leading -- is one of the leading drivers there in the shift that's going on, not only at the state level, but also at the federal level.

There is a lot of discussion right night now on flare gas, there's new regulations being proposed, some of those regulations take place beginning of next year. And so, there is a lot of discussion between ourselves, and our channel partners, and our end customers on what kinds of ways can that flare gas be consumed, either to produce power or light or pumping. There's a whole host of applications. In particular, I think what we like is that, through the acquisitions we have made -- both at Magnum and at Baldor -- it's -- it's really positioned us quite well in terms of a relationship standpoint with the rental companies that serve those customers, both the large national rental companies, as well as the specialty power rental companies that serve the oil and gas markets.

But those -- those acquisitions have given us a great starting point for a product platform, great relationships as I mentioned, and it's helped us congeal our thoughts around what we need to do to be successful in this going forward. So, we've had a taste of it here over the last couple of quarters, we've called that out in terms of success of oil and gas. We look at it as a secular opportunity going forward. We think that the flaring of that wellhead gas is going to continue to play a role. Obviously, that's a bit of a regional thing, it happens --- flaring is a bit of a more of a --a something that happens in the Bakken rather than down in the Eagle Ford, and some of the shale plays in the south. But we're learning a lot, we're quick studies, and we think that we are well-positioned to capitalize on that.

That's helpful, thank you. Then, just as a point of clarity in telecom, did I hear correctly that your top line forecast bakes in sequential second half improvement in that space, or were you speaking to the broader consolidated revenue?

Actually, it's sequential improvement from third quarter to fourth quarter, is what our reference was.

Okay, and that is in line with seasonality or do you have something in the backlog that gives you confidence with that?

No, there is not a lot of seasonality with the telecom business. It's a -- that CapEx spending kind of comes and goes. The ebbs and flows of that are -- there's purse strings somewhere in a corporate office, and that's -- unfortunately, as I said before, our visibility is fairly limited, but we do see it shaping up more a back half of the second half then more of a fourth quarter event than third quarter event.

Okay, thanks, I'll get back in queue.

Your next question will come from the line of Charley Brady of BMO Capital Markets. Please proceed.

Hello guys, this is actually Patrick Woo standing in for Charley. Just -- on the residential side, can you maybe add a little bit more flavor as to how much each of the -- how much standby, power washers and portables breaks down, in terms of revenue for --?

Patrick, we don't -- we don't break down the categories of product, I mean that's a -- just from a competitive standpoint. Again, the preponderance of the increase that we saw in Q2 was -- was mainly driven by the -- overwhelmingly driven by home standby.

And all of our -- all of our residential products, a vast majority is home standby products that's what -- that's the key point.

Okay. Perfect. And I think you mentioned that there was standby market is still only really at 3% penetration. What do you think is the realistic improvement there, and -- and is there an overall, I guess industry trend of improving the awareness for that category, or is Generac doing a lot of the heavy lif -- heavy lifting there for improving that awareness to drive that number up?

We are doing all the heavy lifting. Our competitors are so small in the space, that we -- we're driving that market. It's our bus and we're in the front seat, there. In terms of where it could go, ultimately penetration rate, and we have made -- a lot of discussion around this -- we've had a lot of discussion. We look at the first -- first fence post in the penetration curve there, Patrick, is really the -- when we look at portable generator penetration rates, which are in the low teens in terms of household penetration -- and that is all households -- and remember, we subset the number of households that we think is our addressable market at about 50 million for that 3%.

So about 1.5 million households of the 50 million have a permanently installed backup generator today. That's a -- that's something that we think -- at the very least, we think that the first fence post in the penetration curve is those portable generator owners. Because this is overwhelmingly step up type of category of product in terms of when we look at the buyers of our automatic systems, over half of those buyers either own or owned a portable generator. So you look at the product life cycle of a portable generator, the normal replacement cycle there is between 10 and 12 years.

The category for home standby generators is only about12 to 14 years old, so the awareness levels still remain in that 30% to 40% range. We have a lot of work to do, even though we have been doing a lot of the heavy lifting. A lot of that -- there's still a lot of opportunity there, and a lot of work to be done just to get the awareness levels up to something more respectable in the 70%, 80% range. So, we think all the things that we are doing with our in-home selling solution, which we call PowerPlay -- it's an iPad-based solution -- the infomercial that we do that we've been running, we call it Power You Control.

Our A.M.P. direct marketing process, where we combine third-party household data with our activation data with power outage data. Those are all very unique things that nobody else in our industry is doing, because they don't have the scale to do it, nor do they have the data, or I think the stomach to probably spend the kind of capital that we are spending on it. It's one of the things we mentioned, is the ability -- the free cash flow that we generate, this company has given us a great opportunity to invest in some pretty meaningful things to try and move the needle on awareness, and to move the needle on this category more quickly than it would do on its own in the absence of our efforts.

Your next question will come from the line of Mike Halleron from Robert Baird. Please proceed.

Good morning, guys. So when you think about the rental demand side of things today, what are you seeing from your trajectory there, obviously some positive commentary from some of the public rental guys and some of our contacts, what are you seeing in your business, what's the outlook there as well.

The rental market for us has been a great market. I mean, the Magnum acquisition has -- has been -- has performed very, very well over the roughly two and a half years of our -- almost coming up on three years here in October -- of our tenure of ownership, and all of that we believe, or lot of that, there is a couple of underlying trends, I mean certainly oil and gas we'd call it out, Mike, here more recently, but longer term the secular trend of renting versus buying underpins that, and you -- you see that, as you said in the rental companies that you guys cover or that you watch out there.

Those rental trends, in terms of CapEx -- now the CapEx can be somewhat lumpy, but -- and there are cycles to fleet refresh there, that we continue to learn about, but they are pretty staggered in terms of how the customers come and go. We are pretty excited, we have got some new products that we are launching there, particularly in Light Tower side -- that's the one we haven't talk much about, probably should have to give the guys at Magnum their due on this, but they've done a fantastic job.

We are the number one light tower provider to the global market -- and really number one here in the U.S., and we want to hold that position. We've got some -- some pretty cool product coming down the line to kind of change the game a little bit on light towers. There is a -- there is a lot of discussion around, the -- the compactness of those products, the affordability of those products. I think a lot of the rental companies would tell you that probably one of the better performing pieces of equipment, from an ROIC standpoint, on their a lot would be a light tower, and there is, it is a good piece of equipment, we've got some great scale in manufacturing there. We've been able to do some neat things with Tower Light on the light tower side.

But we like the rental trends. We like the rental trends in Europe, actually. We are starting to see some signs there that the current economic malaise that has gone on in Europe is resulting in a heightened interest in renting versus buying of, again, those types of pieces of support equipment like light towers, generators, and pumps. So, we are anticipating that over time, the European market will -- will follow some of the same growth curves that have occurred domestically here. So, we are pretty bullish on that.

And then could you update us again on the capital deployment side, obviously very strong cash generation expected again this year. Any change to what the prioritization is from your perspective?

Mike, this is York. No, I -- we pretty much hold firm on our prior (Inaudible) cash capital that we've been talking about ever since we went public, and like everybody, you want to grow organically. We've talked about paying down debt, but where our leverage is today at 2.6 times, we are in our target range, so you pretty quickly go to M&A as our -- as our third priority, and we've talked at length as well on these calls about our M&A pipeline, and we are fostering that pipeline and we've (Inaudible) our relationships, and I think we have demonstrated we can -- when something becomes actionable, we can move on the M&A side. So those are the top three priorities, and then once we get through that, then at that point, the board would evaluate the return of capital to shareholders at that point, but there is -- there is other some priorities above it

I think Mike, just I have a couple of comments to that. I think we generated a lot of cash, we had almost $200 million of cash on our balance sheet at the end of the quarter, and obviously we didn't announce any M&A deals in the first half. So although we have a robust pipeline, a lot of -- sometimes M&A is about the timing of things, and certainly about being disciplined in terms of the prices you pay for assets and so, if there were to be a situation where M&A activity would not occur, I mean obviously I think we would owe it to ourselves and our shareholders to continue to evaluate the best uses of that cash, with respect to creating shareholder value.

So, you can anticipate that our board will continue to monitor that very closely. And as we move through the rest of the year here, if we -- if we don't see the right kind of activity from an M&A standpoint that we want to see, or we can't get a deal done for the price we want to get a deal done for, then we'll have to -- we'll have to do something else with that cash.

Yes, we'll monitor excess liquidity, and the board will evaluate it.

Yes, exactly.

Thanks, guys, appreciate the time as always.

(Multiple Speakers) Thanks, Mike.

Your next question will come from the line of John Quealy from Canaccord Genuity. Please proceed.

Hey, good morning, folks.

Hey John, how are you doing?

I'm doing alright, how are you? So, first question. Back to this reversion of the mean. In -- in -- can we quantify that a little bit more? So, for example, are -- are you looking for two or three events of 100,000 outages? How do we gauge this? What moves the needle for you guys when you say reversion of the mean? There is government data that we all track about outages, but how do we sensitize this to your comments?

Yes John, again, we track outages internally, and we look at -- so instead of just raw outages, and this is the problem with some of the public data that is available, it doesn't -- most of the public data is really a patchwork quilt of just available reporting from utility companies around the U.S., and we've actually developed some pretty cool proprietary indexes that we track internally here, that measure combined -- not only the frequency of outages, but also the severity or the duration of those outages, and so to answer your question, I can't tell you with a high degree of specificity on this call what that means in terms of whether that's one big outage for seven days --

It also regionally is important, right, so you get these echo effects that happen. If I -- if we had an outage, even a small one in, maybe, the northeast -- because that market has gone through a number of outages over the last couple of years -- the impact of that small outage in that market could have a greater impact than it would be, may in the midwest, or maybe in the southwest.

So it's -- there -- it's an imprecise science, although we are trying to put more science to it, it's still -- there is not a -- there's not a great answer to the question. Reversion to the mean comment, and that concept, is that on the long-term average in terms of what the number of people impacted by outages, we were down against that long-term average in the first half of this year, and have been down against that long-term average for the last six quarters, as we mentioned.

And so the reversion to the mean here, for the full year 2014, would mean some kind of increased outage activity in the back half of the year. So, again I can't -- I can't put my finger on exactly whether that's four small outages, or one big one, or where it is. But that's -- that's how I have to answer the question.

Okay, that's -- that's -- that's fair. You mentioned some increased informercials and training and maybe some PowerPlay financing. I assume that is baked in your guidance. Can you talk about how much of a drag that is? Is it 20 BPS, or 10 BPS, or not even? How do we think about the monetary aspects of the increased demand activities?

Yes, I don't have that number directly in front of me. That increased spending level, though, has been pretty much baked in our rate here, if you look at, in particular in Q2. I think Q2 is probably a pretty solid indicator there, although you -- you -- you could see as it relates to the from an infomercial spend standpoint, we are kind of evaluating right now, how far do we want to go with that.

Some of that depends on this reversion of the mean, right? If -- you don't want to -- you don't want to go overboard advertising if you don't have a lot of eyeballs that you're hitting that haven't experienced some kind of an outage event. I mean that is not as effective advertising for us in this business.

So we can be very pinpoint and very accurate where we advertise, but at the end of the day, you do want to advertise in markets where there has been outage activity. So, I think that what we are seeing there, I think the run rate is -- from Q2 is probably a pretty good approximate, so I don't --

Which is a lot more than what we did last year, that's the key.

A lot more than what we did at this point last year which was the key to the comment. But you're right, it includes training, it includes a lot of the advertising infomercial spend, continues to -- spending on the PowerPlay platform, that is --- it's not cheap platform. I mean, you put those applications together and all the back end -- the iPad app is one thing, but all of the subsystems that go around it to take the leads, to schedule the leads, to improve the -- the -- that process and the metric-ing that comes out of that process, the amount of data that we are getting out of that process is phenomenal. And shifting through that to help us direct what -- what we need to focus on next is what we're spending a lot of time and money on doing.

Alright, great. Thank you, guys.

(Multiple Speakers) Thanks, John

Your last question will come from Tim Mulrooney from William Blair. Please proceed.

Good morning, guys.

Morning, Tim.

Just a couple of clarification questions on the call, here. First of all, can you guys tell us -- may be you did -- can you tell us exactly how much recent acquisitions contributed to C&I in the quarter?

We didn't, necessarily, in prepared comments. I can give you more color, there. Looking at organic C&I in the second quarter, that was up year-over-year in the low single-digits. So of the 22% growth, the vast majority of that was acquisition-driven, low single-digit organic growth.

Okay, so around $25 million, is that a fair estimate for the acquisition revenue in the second quarter?

Roughly.

Roughly, okay. Okay, and then secondarily, do you guys still expect adjusted EBITDA margin to expand 400 basis points in the second half from the first half?

Actually, in the outlook statement actually, we alluded to gross margins. So, we anticipate gross margins will go up about 150 basis points from first half to second half, and that's a [resi] -- a higher [resi] mix, some price cost improvements, and then you're going to leverage your SG&A in the second half moreso than -- moreso than the first half. So that would play out in terms of -- around that level of increase first half, second half.

Okay, great. And then just lastly, I was wondering if you guys could provide any more color on the oil and gas opportunity. I know there have been a lot of questions about that so far, but could you maybe just talk about how large this market is for your C&I business today, or maybe how big of an opportunity you think this could be within the next several years? Thank you.

Thanks, Tim. So we don't break specific verticals in detail, but I can tell you that in terms of trying to frame the discussion on how big it could be, that's exactly what we're in the middle of right now. It's just getting our arms around some pretty detailed research and analysis around go-to-market strategies, resources needed, size of the market obviously being a component of the research. We -- we think there's a large opportunity there, we just haven't been able to quantify how large.

Looking at how the market moves and what's important to that, we're starting to understand a bit of where generators and other supporting equipment are important to the customer, and how they are used on the site or in the process, whether it be upstream or downstream or midstream. So we're starting to get a much better feel for that, and I think in the quarters to come, we'll be able to comment with a higher degree of confidence in terms of just quantifying the market size and the opportunity, but -- and for that matter, our efforts to go after it. But at this point, we are still in the early innings of what we believe to be a high-growth secular trend here towards opportunities in oil and gas for us.

Alright, ladies and gentlemen, that will conclude the Q&A portion of the conference. I would like to turn it over to Aaron Jagfeld for any closing remarks.

Thank you. We want to thank everyone for joining us this morning and we look forward to our third quarter 2014 earnings release, which we anticipate will be sometime in late October. Thank you again for your time this morning.

Ladies and gentlemen, that will conclude today's conference. Thank you for your participation, you may now disconnect. Have a great day.