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Generac Holdings, Inc. (NYSE:GNRC)

Q4 2012 Earnings Call

February 14, 2013 9:00 AM ET

Executives

York Ragen – CFO

Aaron Jagdfeld – CEO

Analysts

Andrew – BMO Capital Markets

Jerry Revich – Goldman Sachs

John Quealy – Canaccord Genuity

Jeff Hammond – KeyBanc Capital Markets

Chris Glynn – Oppenheimer

Operator

Good day, ladies and gentlemen, and welcome to the Fourth Quarter and Full-Year 2012 Generac Holdings Incorporated Earnings Call. My name is Dominic, and I’ll be your operator for today. At this time, all participants are in a listen-only mode. Later, we’ll conduct a question-and-answer session. (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, the Chief Financial Officer. Please proceed.

York Ragen

Good morning, and welcome to our fourth quarter 2012 earnings call. I’d 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 U.S. GAAP measures, is available in our earnings release and SEC filings.

I’ll now turn the call over to Aaron.

Aaron Jagdfeld

Thanks, York. Good morning, everyone, and Happy Valentine’s Day, for joining us today. We’re pleased to report our fourth quarter and full-year 2012 results this morning, which we believe clearly provide further validation of the powerful macro growth drivers for our business and demonstrate the strong execution of our strategy. Our Powering Ahead strategic plan has served as the framework for the significant investments we have made over the past two years to drive penetration of home standby generators and develop new products that strengthen our leadership positions in the residential and C&I markets that we serve.

Additionally, we have made two strategic acquisitions in last 16 months, that have given us access to new products, new markets and new geographies, so the purchase of the Magnum – the Magnum Products business in October 2011 and the Ottomotores business late in the fourth quarter of 2012. The investments we have been making have helped to accelerate our growth and are important part of our transformation of Generac into a more diverse and globally focused company.

In the fourth quarter, our net sales increased 28% over the prior year to a record level of $342 million, with strong and broad-based organic revenue growth across the business. This impressive revenue growth follows a strong prior-year fourth quarter in which we grew 66% over the fourth quarter of 2010. We converted these record shipments during the fourth quarter of 2012 into record levels of adjusted EBITDA and free cash flow.

Our results for the quarter exceeded our previously raised expectations and also exceeded those of the analysts who cover our company as a result of strong operational execution, as demand increased dramatically for home standby and portable generators due to awareness created by Superstorm Sandy and other major outage events in recent years.

In addition to a tremendous quarter for our residential products, our commercial and industrial product net sales were also strong on an organic basis as compared to the prior-year quarter, driven primarily by increased shipments to our national account customers.

On a full-year basis for 2012, we achieved a number of important accomplishments and milestones highlighted by a record level of revenue of $1.176 billion, representing a 49% increase over a very strong 2011 in which we had revenue growth of 34% over 2010.

Similar to our fourth quarter results, we experienced significant growth across all product categories and regions in the United States. The major power outages occurring in 2011 and 2012 continue to demonstrate just how fragile the nation’s electrical grid has become, as a result of significant under investment.

While the outages of the past two years are noteworthy for their scale and impact, the fact remains that over the last two decades severe outages have been increasing at a nearly 20% compounded annual rate, based on data reported by the National American Electric Reliability Council. It’s now estimated that on average between 250,000 and 500,000 people every day across the U.S. lose their power for some period of time. We don’t even have to look further than this year’s Super Bowl, where the component failure resulted in a 34-minute blackout during the game.

These higher profile outages as well as the everyday outages we all experience have created significant awareness for the need for backup power for homes and businesses. This increased level of awareness combined with our greater marketing and distribution efforts have driven higher interest and demand for our home standby and portable generators, as well as our commercial and industrial emergency backup systems. We have worked very hard over the last decade to build the Generac brand in one of the leading names in the backup power space in the U.S. In particular, we have been tremendously successful in making the Generac name synonymous with the home standby generator category, where we hold a dominant 70% share position in this rapidly growing market.

Our ability to satisfy this growth has required us to make major investments in the infrastructure of the company to accommodate what we believe to be a new and higher baseline of sustainable demand for our products. With our improved scale, we’re adding manufacturing capacity to investments and automation, improved utilization and the expansion of our manufacturing footprint.

In addition to more manufacturing capacity, we’ve used the positive momentum in our business to aggressively add engineering and sales resources to drive our strategic growth initiatives forward at an accelerated pace. We believe these investments are a critical and necessary element of our ability to continue to grow successfully into the future.

In 2012, we made important progress in designing and implementing a number of focused residential sales and marketing programs, we believe will allow us to both create and close sales leads more effectively. These programs are the combination of significant research conducted regarding the purchasing process for a home standby generator. At the heart of this project are new sales tools, training improvement and more structured sales processes that are designed to better align our dealer network with Generac and to improve the overall consumer sales process.

Specifically, we have developed an important new proprietary process we call AMP, which is designed to find the most likely purchasers of home standby generators for improved target marketing. This is done through the combination of current owner data regarding the exact location of our installed products, third-party psychographic and demographic data matching nearby households that represent our mostly likely target buyer, and our power outage tracking database. With this highly targeted approach, we are able to deliver marketing contact – content on a direct basis through a number of different vehicles such as direct mail, push e-mail, telemarketing or even door-to-door sales efforts to create sales leads.

We have staffed a new dedicated team at Generac that is tasked with qualifying and scheduling these leads in conjunction with our residential dealers. Once in the hands of our dealers, these leads are then managed through a coordinated and professional in-home sales process that we recently launched called PowerPlay. This tablet-based application allows us to push sales leads down to our dealers as customer appointments and includes professional presentation materials.

Most importantly, the PowerPlay app allows our dealers during an in-home consultation to create a customized backup power plant and detailed proposal for the homeowner. Although just launched a few months ago, we’re very excited about the prospects for both AMP and PowerPlay and expect to have a meaningful percentage of our dealers participating in these programs by the end of 2013.

In addition to developing and delivering cutting-edge tools for our residential and light commercial dealers, we’ve also worked to further expand our industry-leading distribution network ending the fourth quarter with over 4,800 dealers, representing an increase of approximately 600 channel partners over the last 12 months. In addition, we continue to make progress in penetrating the HVAC distribution channel through our Honeywell licensing program.

As the market for home standby and light commercial generators continues to grow, we believe that a larger, more engaged dealer network will be a necessary component in driving the penetration of these products much higher. While we have made significant investments in growing the market for our residential products, we have made equally important investments that we believe will allow us to compete more effectively in the market for commercial and industrial products going forward.

Through the introduction of several new products in 2012, we have further solidified our leadership position in the growing market for cleaner burning, more cost effective natural gas fuel backup power solutions. While still a much smaller portion of the overall C&I market, demand for these products continues to increase at a faster rate than traditional diesel fuel generators, as a result of their lower capital and operating costs.

As the leader in the North American market for natural gas fuel generators for over 30 years, we believe we are in an excellent position to capitalize on the secular shift towards these products. During 2012, we experienced solid year-over-year increases in natural gas generator shipments underpinning an attractive organic growth rate in our C&I products.

Magnum branded light towers and the mobile generators also performed well during 2012, as demand for mobile equipment continue to benefit from a secular shift towards renting versus buying. We substantially completed the integration of Magnum during the year and are extremely pleased with the outcome as we exceeded all of our revenue and cost synergy targets during 2012. We remain excited about the strategic fit of Magnum’s mobile products as they provide additional diversification and cross-selling opportunities to our business.

In addition, opportunities within the traditional (inaudible) market for commercial and industrial products, we believe there is a significant opportunity to provide smaller, more cost effective generators marketed aggressively towards the underpenetrated optional standby market, which include small footprint commercial buildings such as gas stations and convenience stores, restaurants, pharmacies, bank branches, and small healthcare related facilities.

We believe our expertise and scale in these smaller commercial products, our vast distribution capabilities and our national account customer focus will allow us to penetrate these markets by using a targeted marketing approach and funneling opportunities to our distribution partners. We are confident we’ll be able to present a very compelling return on investment for business owners, who are looking to protect their revenue streams as well as their inventories with backup power protection.

2012 was also a year of heavy product development for Generac. New products are the lifeblood of any company and we’ve made significant investments in products associated with growing the market for home standby and commercial backup generators and further diversifying our company with new platforms such as power washers. Innovation has always been a part of Generac’s culture and is a core competency of our company. We believe our ability to innovate something that’s unmatched by competitors whose focus on our markets is generally secondary or tertiary at best.

We’ve used the growth in our business over the past several years to accelerate our product development efforts by more than doubling the size of our engineering team and dramatically expanding our research and development capabilities. As a result, 2013 will bring more new product launches than at any other time in Generac’s 50-plus year history.

New products such as Mobile Link, the industry ‘s only cellular-based OEM developed remote monitoring platform for home standby generators, which provides us an attractive opportunity to develop a future recurring revenue stream, as well as provide a higher level of customer satisfaction by connecting units that require maintenance or service directly with an authorized dealer.

Another exciting new product launching in 2013 is our Protector series; a line of diesel generators developed specifically for residential and light commercial users with the industry’s smallest and most compact footprint at price points well below those of larger more traditional diesel generators. The Protector series products are also an ideal backup power solution for markets outside the U.S. where diesel is the primary or only available fuel source, and where competition from local packagers demands a very competitive cost position.

In addition, we are also working with our team at Magnum as we expect to launch several exciting new mobile products in 2013, including a solar hybrid light tower and towers utilizing LED lighting technology.

Finally bringing some much-needed innovation to the power washer market, we’ve recently secured valuable shelf space for the 2013 selling season with our new OneWash product; the industry’s first and only variable speed power washer aimed at making household outdoor cleaning tasks easier for consumers. In conjunction with diversifying our business with new and innovative products, we’ve been focusing on expanding our market reach into areas outside the U.S. and Canada. For the last several years these efforts have been mostly organic with the creation of a dedicated sales team and the addition of over 80 new distribution points around the globe, with many of those being in Latin America.

To accelerate these efforts and to become a more global player in the markets for backup power, we recently completed acquisition of the Ottomotores businesses late in the fourth quarter of 2012.

The acquisition includes the operations of Ottomotores Mexico, headquartered in Mexico City, and Ottomotores Brazil, located in Curitiba. The combined company is manufacturing and selling diesel generators from 15 kilowatts to 2.5 megawatts with a particular focus on larger kilowatt and containerized gen sets.

With over 500 employees, Ottomotores is a major market share player in the growing Latin American standby power market, and provides us with the essential elements of a local manufacturing presence, access to higher power products and added distribution that we believe are critical for us to compete in the global market for backup power generation.

The integration of Ottomotores is a key corporate initiative for 2013, and we’re excited about the opportunity to execute on the potential revenue and cost synergies of the combined companies.

Although early in the process of exploring opportunities for revenue synergies, the combined sales and marketing teams have already identified the potential to sell our residential and light commercial standby generators, as well as mobile light towers into the Latin American market.

From a cost standpoint, we estimate approximate $2 million of savings exist on an annualized basis, which we will begin to realize towards the second half of 2013 with a potential for additional cost reductions during the second full year of ownership.

Much of the savings we are initially projecting will come primarily as a result of improved purchasing scale with certain components and commodities as well as from improved utilization and efficiencies in the Ottomotores’s operations.

In recent years, we’ve worked hard to diversify Generac’s end markets with new products and services, which is a core objective of our Powering Ahead strategic plan. With the acquisition of the Magnum and Ottomotores businesses, revenues for our C&I products will now total in excess of $500 million on an annualized basis. Additionally our re-entry into the market for power washers provides us with a unique opportunity to gain market share quickly to further diversify our company with the addition of this new platform.

Our execution on our diversification strategy has resulted in a more balanced and more globally focused company. When combined with the powerful macro opportunities in the residential and light commercial backup power market, we believe we have the right strategy in place to drive future growth.

And now, I’d like to turn the call back over to York to discuss fourth quarter results in more detail. York?

York Ragen

Thanks, Aaron. As previously mentioned, net sales for the fourth quarter 2012 were $342 million, a 28% increase as compared to $267.3 million in the fourth quarter of 2011.

Looking at net sales by product class, residential product sales increased 28.9% to $216 million in the fourth quarter of 2012, relative to a strong prior net sales comparison of $167.5 million, which saw year-over-year sales growth of 67.6% over the fourth quarter of 2010. The growth in the current year was primarily driven by increased demand for portable and home standby generators.

The demand for residential backup power has seen a paradigm shift over the last couple of years as major power outages have accelerated the adoption of standby generators by homeowners.

As the electrical grid continues to age and power outages become more frequent and longer in duration, homeowners have become more aware of the need for a permanently installed automatic backup power solution. As the 70% market share leader in this product category, Generac has been able to satisfy this increased demand through our market-leading distribution, which we continue to expand and develop. In addition, our flexible and lean operations have allowed us to rapidly ramp our supply chain and production to accommodate increased order rates for these products.

With regards to portable generators, we have seen significant increase in the sales for these products as we continue to increase our market share. Our strong relationships with distribution coupled with solid execution have allowed us to capture a leading share of the portable generator market over the last couple of years.

With larger investments in seasonal inventory and expanding shelf space at retail, we’ve been able to satisfy greater demand during major power outages and also increase our baseline portable generator sales significantly. The increase in residential product sales during the fourth quarter was primarily related to increases in portable generator shipments as a result of Super Storm Sandy. As we have discussed in the past, major outage events drive immediate demand for backup power in the form of portable generators. Longer-term, demand for home standby generators typically increases in an area impacted by major outages. This afterglow can last for several quarters thereafter and finally settle into a new and higher baseline of demand due to the awareness and additional distribution points created as a result of the outage.

Looking at our commercial and industrial products, net sales increased 29.4% to $110.6 million in the fourth quarter of 2012 from $85.5 million in the fourth quarter of 2011. The increase in net sales was primarily driven by an increase in shipments to telecommunication and rental national account customers, for both stationary and mobile power equipment.

It’s important to note that the Magnum Products acquisition became annualized as of the fourth quarter of 2012. Accordingly, the full impact of its financial results are reflected in both the current and prior-year quarterly periods.

We have seen solid year-over-year sales growth with Magnum Products as they continue to gain share in the markets that they serve and execute on revenue synergies by selling mobile equipment through Generac’s distribution.

Finally, the fourth quarter of 2012 also includes a modest contribution to C&I product net sales from the Ottomotores acquisition, which closed on December 8, 2012. Our other product sales category improved to $15.4 million in the fourth quarter of 2012, an increase of 8% from prior-year fourth quarter sales of $14.3 million.

As a reminder, this product category is mostly comprised of aftermarket service parts as well as loose engines sold directly to OEMs for use in engine power products across a wide range of applications.

Gross margin as a percent of sales for the fourth quarter of 2012 was 36.9% compared to 36.8% in the prior-year fourth quarter. An increased sales mix of lower margin portable generators was more than offset by a positive impact from improved pricing and moderation in commodity costs during the current year quarter.

Operating expenses for the fourth quarter of 2012 declined by $4.2 million or 6.8% as compared to the prior-year quarter; primarily due to the lower amortization of intangibles over the prior year and a non-cash intangible impairment write-down recorded in the fourth quarter of 2011. Excluding the impact of these items, operating expenses in the fourth quarter of 2012 increased by $8.6 million or 16.2% as compared to the prior year, but declined as a percentage of sales by approximately 180 basis points.

These additional expenses were driven primarily by increased sales, engineering and administrative infrastructure to support the strategic growth initiatives and higher baseline sales levels for the company.

Adjusted EBITDA increased 34% to $83.1 million in the fourth quarter of 2012 as compared to $61.8 million in the same period last year. Adjusted EBITDA for the full-year 2012 was $289.8 million, representing an increase of 53.8% over the prior year. Adjusted EBITDA margins for 2012 were 24.6% of net sales, an 84 basis point improvement over prior-year adjusted EBITDA margins, due to improved operating leverage on higher sales volumes.

GAAP net income for the fourth quarter of 2012 was $28.3 million as compared to $267.1 million for the fourth quarter of 2011. Net income in the current year includes an income tax provision of $21.4 million. Prior-year net income included a net $238 million income tax benefit, largely as a result of the reversal of the full valuation allowance on the company’s net deferred tax assets.

Although we recorded an income tax provision for GAAP purposes in 2012, our current tax attributes resulted in the company only paying nominal cash, cash income taxes throughout the year. In addition to the large income tax benefit recorded in the prior year, fourth quarter 2011 net income also included a $9.4 million pre-tax write-down of certain intangible assets.

Adjusted net income as defined in our earnings release increased 17.1% to $60.7 million in the current year quarter, versus $51.8 million in the prior-year fourth quarter. The increase is attributable to improved operating earnings during the quarter resulting from a 28% increase in net sales, partially offset by the higher interest expense due to the refinancing of the company’s credit facilities in May of 2012, as well as slightly higher in cash – cash income taxes.

Diluted net income per share on a GAAP basis was $0.41 in the fourth quarter of 2012, compared to $3.91 per share in the fourth quarter of 2011. As previously mentioned, the current year quarter included income tax expense, while the prior-year quarter includes a large income tax benefit due to the reversal of the full valuation allowance on the company’s deferred tax assets. As a result, the year-over-year change in income tax provision had a $3.79 per share impact on earnings per share versus prior year.

In addition, prior earnings per share included an $0.08 per share charge related to the intangible asset write-down. Adjusted diluted net income per share as reconciled in our earnings release was $0.87 for the current year quarter, compared to $0.76 per share in the prior-year quarter, a 15.3% year-over-year increase.

The current year adjusted EPS figure includes a $0.17 per share headwind from the combination of higher interest expense and to a lesser extent, higher cash income taxes. For the full year 2012, adjusted diluted net income per share was $3.19, representing a very strong 47% increase compared to 2011, in spite of a $0.40 headwind as a result of the higher interest and taxes.

Free cash flow defined as net cash provided by operating activities plus capital expenditures was $97.4 million in the fourth quarter of 2012 as compared to $73.1 million in the same period last year.

Record levels of shipments during the second half of 2012 helped to significant cash flow in the fourth quarter, which was partially offset by replenishment of inventories.

Free cash flow for the full-year 2012 was $213.2 million, which represents 97% of the adjusted net income reported for the year. Our uses of cash during 2012 included $22 million for capital expenditures, $47 million for the acquisitions of Ottomotores and Gen-Tran, and the payment of $6 per share special dividend in June 2012.

Additionally, as a result of our strong free cash flow generation, earlier this week, we prepaid $80 million of principal on our existing term loan. With regards to primary working capital, the Ottomotores acquisition, which closed in December 2012, added approximately $28 million of primary working capital to our balance sheet as of December 31, 2012. Overall, primary working capital remained at approximately 20% of LTM net sales at December 31, 2012.

At the end of 2012, we had $893.8 million of bank debt outstanding, net of unamortized original issue discount, and $108 million of consolidated cash and cash equivalents on hand, resulting in consolidated net debt of $785.8 million.

Thanks to our strong free cash flow and earnings growth, we were able to end the year with a net debt-to-EBITDA leverage ratio of 2.7 times, at similar levels to where we started the year, despite paying cash for the Ottomotores acquisition and paying a $6 per share special dividend.

Our strong cash flow profile and availability on our undrawn $150 million revolving credit facility gives us significant operating flexibility to further invest in our future organic growth initiatives, pay down debt to our targeted leverage levels, while also executing on potential strategic acquisitions.

I’d now like to walk through some guidance items to help model out our cash flows, and earnings per share for 2013. In 2013, we expect interest expense to be in the range of $60 million to $62 million, which includes $55 million to $57 million of debt service costs at current LIBOR rates, plus approximately $5 million for deferred financing cost and original issue discount amortization for the credit facility.

Our cash income taxes for 2013 are expected to be approximately $9 million to $10 million, as compared to $2.8 million in 2012. This increase in cash income taxes is due to a combination of our NOL carry forward becoming fully utilized during 2013, and to a lesser extent higher overall profitability levels.

Importantly, our favorable tax shield, through annual intangible asset amortization 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 projected 38% to 40% GAAP income tax rate for the foreseeable future.

Depreciation expense in 2013 is forecast to be approximately $10.5 million to $11 million. In 2013, our GAAP intangible amortization expense is expected to decline to $25 million to $26 million, as certain of our definite-lived intangible assets become fully amortized.

Our tax intangible amortization expense, which we can deduct in determining our ultimate cash income tax liability for our corporate tax returns, is expected to approximate $127 million for 2013.

Our stock compensation expense is forecast to increase to approximately $12 million to $13 million.

Finally in 2013, our capital expenditure spending is budgeted to increase to approximately $26 million to $28 million, as we continue to invest in high return product development and cost reduction projects, as well as capacity expansion initiatives and certain other infrastructure expansion projects. Despite this increase, this projected level of capital spending still only represents approximately 2% of our forecasted net sales.

With that, I’d now like to turn the call back Aaron for additional comments for our outlook for 2013.

Aaron Jagdfeld

Thanks, York. We’re initiating guidance for 2013 with expectations for solid revenue growth of approximately 10% over a very strong 2012. Importantly, our outlook assumes no major power outages for the balance of this year.

For residential products, we expect the demand for home standby generators in 2013 will remain strong, as a result of the awareness from major power outage events that have occurred in recent years, combined with a year-over-year improvement in the environment for residential investment and further execution on our initiatives to drive penetration.

With regards to portable generators, although we have built a very strong baseline business for these products, should no major power outage events occur for the balance of 2013, we would expect to see a year-over-year decline in sales for these products.

When excluding the impact of event-driven portable generator sales in 2012, we expect residential product shipments during 2013 to increase in the mid single-digit range over the prior year, as a result of continued demand for home standby generators and increased placement of our power washer product line.

Although important to driving awareness for global – for backup power, major outage events are expected to have a reduced impact on our business going forward as we continue to build a more balanced and diversified company. Based on our historical experience, an average major outage event could provide incremental net sales of between $20 million and $50 million, representing the potential for 2% to 4% additional growth to our forecast depending on several factors. Specifically the impact of any given major outage event is depended on the time of the year, the geographic region impacted, the number of people impacted, our existing distribution in the area, the frequency of prior outages in the affected area and the duration of the event.

With regards to our commercial and industrial products for 2013, we expect net sales to increase at a low 30% year-over-year growth rate through a combination of the Ottomotores acquisition as well as high single-digit organic growth for both stationary and mobile power equipment.

Our 2013 outlook for C&I products assumes a modestly improved non-residential construction market over prior year. Additionally, due to the timing of capital spending by our national account customers, we could experience some variability in product shipments from quarter-to-quarter as has been the case historically.

Summarizing our sales growth assumptions for 2013, total organic year-over-year growth excluding the impact of event-driven portables from 2012, is expected to be between 6% and 8%. Assuming no major outages for the remainder of 2013, this organic growth is expected to be partially offset by an approximate 5% headwind from a decline in portable generator sales. The acquisition of Ottomotores is expected to contribute approximately 7% to 9% growth for a total expected year-over-year net sales increase of approximately 10%.

As previously mentioned, an average major outage event could possibly add another 2% to 4% to our growth depending on the impact. Consolidated gross margins are expected to decline by approximately 80 basis points to a 100 basis points during 2013, as compared to the prior-year primarily as a result of the addition of Ottomotores, partially offset by modest improvement in organic gross margins due to the favorable impact from further cost reduction initiatives.

Operating expenses as a percentage of net sales excluding amortization of intangibles are expected to increase slightly as compared to 2012, as we continue to invest in our infrastructure to support strategic growth initiatives and an overall higher level of baseline sales. As a result of these factors, we expect adjusted EBITDA for full-year 2013 to increase in the mid single-digit percentage range as compared to 2012.

Given our best-in-class margins, capital efficient business model and favorable tax attributes, we expect to continue generating significant free cash flow in 2013. Cash flow conversion is anticipated to remain strong and be consistent with the cumulative average conversion during the past four years of free cash flow representing between 90% to 95% of our adjusted net income.

In closing, we believe the end markets we serve are poised for continued growth as a result of a number of macro drivers. Demand for our residential, commercial and industrial backup generators should remain strong well into the future as we believe that the underinvestment in the electrical grid, and an aging and more electrically-dependent population, combined with more severe and unpredictable weather will continue to increase the frequency and duration of power outages.

Other macro drivers for our business include a further recovery in residential investment, anticipated increase in infrastructure spending, domestic and global energy development, a rebound in commercial construction, and a continuing secular shift to renting versus buying of construction equipment. Through strong operational execution of our Powering Ahead strategy, we have nearly doubled the size of Generac over the last two years.

We believe the market opportunities in front of us are significant and we will continue to pursue those opportunities with relentless focus. Through market leading innovation and solid execution in 2013, we expect to accelerate the penetration rate for home standby generators, increase our share of the commercial and industrial market, and further diversify our business through new products and geographies. When considering all of these factors, we believe Generac is incredibly well-positioned for growth in 2013 and beyond.

This concludes our prepared remarks. At this time, we’d like to open up the call for questions. Operator?

Question-and-Answer Session

Operator

(Operator Instructions) And your first question comes from the line of Charlie Brady from BMO Capital Markets.

Andrew – BMO Capital Markets

Good morning guys. This is Andrew on for Charley.

York Ragen

Hi, Andrew. How are you doing?

Andrew – BMO Capital Markets

Good. Good. Hey, I had a – I’m sorry if I missed this, but what did you – did you mention what interest expense and what the contribution might be for 2013 and what the contribution for Ottomotores was in the quarter?

York Ragen

So interest expense for 2013, we highlighted as $60 million to $62 million as the expense, and $55 million to $57 million of that is actual cash, debt service costs, with $5 million being amortization and deferred financing costs and original issue discount amortization. And – and the contribution of Ottomotores in the quarter, we...

Aaron Jagdfeld

So it’s very, very minimal

York Ragen

Yeah, we talked as a modest contribution.

Aaron Jagdfeld

And we closed that on December 8, Andrew.

York Ragen

Yeah, some 20 days there.

Aaron Jagdfeld

Yeah, it’s a pretty minor contribution.

Andrew – BMO Capital Markets

Okay. I guess the other question is how much of the increased CapEx is going towards kind of getting like R&D and things situated in – at Ottomotores. I know I think the prior owner might have – wasn’t spending as much on R&D?

Aaron Jagdfeld

Yeah, the R&D, we generally expense, so you’re going to see that in the SG&A line, Andrew. But, as far as obviously, there are hard assets associated with R&D as well with equipment and facilities and things. And you’re right, the previous owner of that business was a holding company based in UK, and I think it was fair to say that there is opportunity there to – for growth based on our level of investment, our appetite to invest. So, there is a piece of our CapEx expense. It’s not huge, but our capital expenditures, we’ve got a couple of million dollars in there for the Ottomotores business for next year for expansion and some R&D efforts as well as – as well as some capacity expansion.

Andrew – BMO Capital Markets

Okay. And it seems like – it seems like you’re making a great push for new products and everything. I was just – I was wondering if there might be any specific one kind of product group that’s most compelling – very compelling opportunity for you guys?

Aaron Jagdfeld

Well, first and foremost we’re a products company, so we love designing and developing new products. It’s kind of at the heart – the core of the company. We were started in 1959 on an innovative idea by our founder and we’ve kind of kept that philosophy, and that core of innovation, really inherent to the company.

So, I were to look across though for 2013 to answer your question, I would see – again as we said in our prepared remarks, probably hands down the broadest offering of new products that we’ve ever done in our history just based on the scale that we’ve gone through over the last couple of years in our engineering and R&D efforts. When I look across it, I’m pretty excited about some of the products that we’re developing that are geared directly towards light commercial opportunity. We talked about this small footprint retail, bank branches, healthcare facilities, those types of things, that today there is really no regulatory reason for them to have backup power, and up until recently there hasn’t been probably a financial reason for them to have it either.

We think that, I’d mentioned in the prepared remarks, we call it our Protector series which is the diesel version of those light commercial products. We also have a very robust gas line of products that we’ve had for a number of years, it’s actually been refreshed this year as well; again all targeted at kind of that light commercial space.

The light commercial space is a lot like, we do kind of a lot like the home standby category a number of years ago, in terms of the under-penetration, the opportunity to get in there and sell on a more direct basis with a broader distribution channel. And you have to have competitive product, because again it’s up for our business, it’s a return on investment calculation, and so we had to redesign these products to make sure that they are very cost effective both in their acquisition cost as well as their operating cost.

Andrew – BMO Capital Markets

Excellent. Thank you, guys.

Aaron Jagdfeld

Thanks, Andrew.

York Ragen

Thank you, Andrew.

Operator

Your next question comes from the line of Jerry Revich of Goldman Sachs.

Jerry Revich – Goldman Sachs

Good morning.

York Ragen

Good morning, Jerry.

Jerry Revich – Goldman Sachs

Can you gentlemen talk about what’s your penetration rate on new homes that are being built today within your target price range is? Can you just give us a sense for your efforts there, and how meaningful of the contribution can we see in your business as the new home-build cycle really picks up steam here?

Aaron Jagdfeld

Yeah, it’s obviously a great question, Jerry, and one that – as we’ve said over the years, the new construction market is short of calling it the Holy Grail of our industry, it could be a really interesting thing for the category because it’s a lot lower in cost to install those products at that point when the walls are open, the trades are on site, permits have been pulled already for everything else if somebody is doing, the cost of the equipment can be rolled into the homeowners’ mortgage. There is a lot of upside to why you want to do this project during new construction. The challenge of course as we’ve said has been getting the builders to promote the category, getting homeowners to understand that it’s available, right, I mean awareness, just, as the category still only in its, frankly in its infancy, 10 years, 12 years old.

We’ve worked very hard with builders over the last three or four years to increase awareness at their level, as well as to increase awareness at the home buyers level. As a result, our penetration rates today, we estimate to be about double what our penetration rates are. The 2.5% we quote of U.S. households, those are single family homes greater than $100,000 in value, we would estimate that penetration rate at new constructions about double that rate, because of the upside of doing it at that point.

So, that has grown from where it was, although we still think it could go higher, in particular in certain regions of the country where and whether it’s replacement homes as a result of Sandy or whether its remodeling or whether it’s just outright new construction in some of the markets where power quality has been poor over the last several years.

Jerry Revich – Goldman Sachs

And I’m wondering if you could talk about the amount of shelf space that you have on the power washer side in 2013 relative to your 2015 plan? And then also if you could give us an update on how you feel about your portables market share based on the points that you made in the opening remarks?

Aaron Jagdfeld

Yeah, great question. This is kind of – those two product categories are starting to form the core of the portable products business for us, that has done very well over the last four years with the re-entry in the portable generators. We do believe that today we’re number one in brand share in the U.S. in portable gen sets, and that share is somewhere in the mid-to-upper 20% range depending on which data you look at, that has grown obviously from nearly zero rate four years ago.

So, we’ve done – our teams have done tremendously well with that product and that’s come from, again we talk about innovation, we talk about new product introduction cycles, we talk about voice of customer, solving customers’ pain points with products. We’ve done all of that and hit a home run on portable generators.

Now, we try to apply that here to power washers in the last year really in launching those products in 2011, accelerating in 2012. We’re still a small market share player. The market is dominated by a few big players. We do think there is some great opportunities for us, we’ve gotten some great traction in the 2013 selling season here with our product line.

In particular, we mentioned the OneWash product which we debuted at the Lawn & Garden Show in Louisville in the Fall has been very well received. We’ve gotten very good placement for that product at a couple of major retailers here for the spring season. It I think bears out, still we’ve got to see if the sell-through will be or we hope it to be, right, because it’s just being put in stores today.

But we think we have a very compelling value proposition for homeowners there in terms of being the only – the market’s only variable speed power washer to allow them to do a number of different tasks more simply and more easily with that product. So, really excited about that platform, Jerry, and we continue to look at what other products might fit into that platform like that, where we can leverage distribution, leverage our expertise in supply chain and manufacturing capabilities as well as, again our focus on solving customers’ pain points with engine power products.

Jerry Revich – Goldman Sachs

Okay. Thanks, Aaron. And lastly, on York’s point about afterglow continuing for six to nine months post the hurricane, should we expect residential standby sales to be up sequentially into the first quarter? Can you just give us a sense for how that’s shaping out post-Sandy?

York Ragen

Yeah. Jerry, this is York. I think we haven’t given any quarterly guidance. I think there was a number of things in terms of how you can look at that in terms of the magnitude of, say if you flashback to where we were this time last year, we were coming into 2012 after having a hurricane Irene and an October snowstorm. You flash-forward to now and you have a Superstorm Sandy which arguably could be – would be larger than those 2011 events. So, we’re coming into the year with a similar fact pattern here in 2013 as 2012.

And lead times have been extended similarly this year versus last year. So, I think you would expect similar seasonality trends in terms of how, what was provided – from a seasonality perspective you would expect something similar trends as what was provided for our 2012 outlook last year at this time. And, with regards to your comment, is that year-over-year growth, I think maybe just point you to the magnitude of the events, 2011 versus 2012 and how they came into the following year.

Jerry Revich – Goldman Sachs

Thank you.

Aaron Jagdfeld

Thanks, Jerry.

Operator

Your next question comes from the line of John Quealy of Canaccord Genuity.

John Quealy – Canaccord Genuity

Hi, good morning, folks. Congratulation on the good results this year. A couple of questions. First, can you guys talk about distributor adds or what the mix of new distributors was this year? Whether it’s – how quantitative you want to get, it’s fine, but in terms of expectations for next year, obviously Sandy, I imagine added quite a few new potential distributors?

Aaron Jagdfeld

Okay, John. It’s a good question. We were adding on an annualized basis between 300 and 400 net new dealers a year for the last several years. I mean, really for the last decade that’s how we’ve gotten to over 4,000. And I think we quoted – we ended the year just north of 4,800 dealers. We added over 600 channel partners in the last 12 months, which is a higher rate obviously than that 300 to 400, and that obviously is in our minds associated, especially when we look geographically where those partners were added, it’s associated quite heavily with the outage events that occurred in 2011 and 2012 out East. So a lot of these dealers are in the Northeast, but we still had – we continue to have strong growth regionally.

I think one of the things about this company that is amazing to me is, when we look at our regional breakdowns for sales across over the last 12 months, we have no single region that didn’t grow at least 14%; that was our smallest growth region. So – and that’s across the U.S. Obviously, growth in the Northeast has been great with the opportunities that have been created from the events, but even out West, market – regions like that growing 14% plus. So, I think that’s a – it’s pretty amazing and we’re adding channel partners as a result really across the U.S.

John Quealy – Canaccord Genuity

And my second question, more on the C&I side, with national accounts sounded like they came back a little bit in last quarter, can you talk about some of the drivers there, is it competition on the cellular side, are we seeing any movement out of the FCC in terms of trying to get backup power a bit more high-profile, like it was back several years ago with some of those storms?

Aaron Jagdfeld

Yeah, the FCC sure has been talking about it quite a bit more, whether there’ll be any movement out of that talk, is I guess – it remains to be seen. I know that they’ve been holding public hearings in many of the regions that were impacted by power outages, with – all the way down to like local first responders and what not to understand the impact on those types of activities that outages have.

So whether that finally grinds its way to some kind of a mandate, or some type of regulation is yet to be seen. But I can tell you that from our standpoint – the telecom companies, the wireless companies, our customers have been onboard with hardening their networks over the last decade as they built them out. I don’t think that they’re – they’re not doing anything that they don’t believe they should be doing to try and strengthen their network. They certainly don’t want to (inaudible), and their business model is not good to not have – not have it work, right. So, they understand the importance of backup power. I think that we believe there’s still a lot of upside within their network, that being said to continue to grow that out.

And we think the penetration rates in wireless power still – for backup standby generators is still only in the 30 percentile range. So that would – conversely 70% of all towers don’t have some kind of generator as a backup, some have batteries, and other means, but they don’t last quite as long. If you have long-term outage, it can be problematic.

So, I think there’s – I continue to think that that’s going to be a bright spot going forward, we’ve said that. I think – a lot of it depends on the capital spending patterns of those companies and the allocation of those capital dollars to projects such as backup power. But with the drums beating at the FFC on their interest level in this topic that may – that may push forward and at a faster rate some of these plans, I don’t know.

John Quealy – Canaccord Genuity

And my last question, in terms of – I thought you mentioned about $2 million run rate savings in the back half or as we exit 2013 on Ottomotores, can you dive down a little bit about what that is, whether it’s manufacturing on the copper-winding side or if it’s some sort of overhead, can you just give us a little taste of what you’re baking in for cost savings? Thanks, guys.

Aaron Jagdfeld

Yeah. So John, there is a couple of things there. One is that Ottomotores is a – is our most gen set manufacturers. They call themselves manufacturers, but they’re generally packagers. They buy an engine. They buy an alternator. They buy controls. In this case, Ottomotores does quite bit of their own sheet-metal in terms of the structural components of the gen-set, that being closure to the base frame tanks and things like that. But where we see opportunities in that $2 million in synergies is really the result of what we believe our scale as a company, as we’re now $1.1 billion closing in on $1.2 billion, we do have some interesting things from a scale perspective, when we go out shopping for diesel engines as an example. And that’s what Ottomotores servers as a diesel gen-set market down in Latin America.

There are some opportunities there for us to – we believe take some costs out of that process just by using our scale. There is also the opportunity as you pointed out with them. Some of things – we do a lot of vertical manufacturing here at Generac. We wind our own alternators and gas engines. We’re doing our own fuel systems, our own cooling packages, our own emission systems, and the light exhaust systems. We do our own controls, hardware and software. So we think that over time there is opportunities. Some of those opportunities are year one, but our comments also alluded to the fact that there are potential cost reduction opportunities beyond year one that would probably be more befitting of some of the vertically integrated things, like initially that $2 million is going to mainly be in the commodity supply chain space in terms of our using our scale.

Operator

Your next question comes from the line of Jeff Hammond of KeyBanc Capital Markets.

Jeff Hammond – KeyBanc Capital Markets

Hey, good morning, guys.

Aaron Jagdfeld

Good morning, Jeff.

York Ragen

Good morning, Jeff.

Jeff Hammond – KeyBanc Capital Markets

Just a follow-on the seasonal cadence, I think what you’re trying to say, York or maybe just help me out.

York Ragen

Yeah.

Jeff Hammond – KeyBanc Capital Markets

The 4Q to 1Q trend; 4Q 2012 to 1Q 2013 should look similar to last year’s, is that fair?

York Ragen

Correct, in terms of how that seasonality played out with our outlook that we talked about coming into the 2012 year, you’ve given the fact pattern in terms of major outages, lead times being extended. My comment was that you would see a similar type of seasonality in 2013, as what we sort of rolled out in the 2012 outlook at this time last year. So, long way to answer, yes, to your question.

Jeff Hammond – KeyBanc Capital Markets

Okay. And then one is this – is this latest Northeast storm built into your guidance? And how do you frame that versus, quote, this major outage that you – you kind of frame this $20 million to $50 million opportunity?

Aaron Jagdfeld

Yeah, no – it’s a great question and one that – this is where the discussion around what’s a major outage, what’s not, is kind of an inexact science. The outage share with the latest winter storm, I think the peak was 650,000 people out East without power. And it was pretty quickly restored. I mean on balance with some of the other outages, we’ve experienced out East, and to be out of power for only a day or two for most people. I think it was a relief, you didn’t have a backup plan.

So, we shipped obviously some portable generators because that’s what goes first during an event like that. So, we can quantify that and that is included in our guidance to a degree, but because power came on so quickly and frankly the retailers had restocked pretty aggressively after Sandy, later in the year, earlier this year already. So, they were in pretty decent shape. There may be some additional reorders on the backs of that event, but I think that the harder thing to quantify, Jeff, is the – is really the awareness impact of an event like that. You’ve got only 650,000 people without power, but you have 60 million people were in path of that winter storm. And so, although only a small percentage of those 60 million people actually lost power, they were all aware of the fact that they might, that they could have.

And that coupled with some of the other events that have happened out there in the last few years, we call it a tipping point for people. And so, where, what is – where do people hit that tipping point, and is it again the profit – the spectra of another potential outage and people say that’s it, I’m done, I got to be ready for the next one that might happen. It pushes him over the edge to get into purchasing process into that funnel. And then, with some of our new tools, are we more successful at converting those? Time will tell. But we certainly think that it’s a net positive for awareness around home standby generators going forward and so certainly for the light commercial opportunities you talked about as well.

Jeff Hammond – KeyBanc Capital Markets

Okay. Okay. And then just on kind of lead times, can you give us a sense for where lead times are today versus kind of the similar timeframe last year? And then, if you can just kind of qualitatively talk about – you added distribution, I think you talked about stress tests in the supply chain, in your manufacturing capacity. How all that’s playing into how you’re thinking about lead times?

Aaron Jagdfeld

Yeah. It’s a great question. I mean, lead times, I think if you go back, you wind the clock back a year, like York had mention, we were out at the peak eight to 10 weeks. We hit a similar type of peak level this year in terms of backlog, but our production rates were elevated over where they were a year ago. So, we were – we’re already in an elevated production level. So, you kind of have to put that into consideration.

We brought the lead times down now. They’re right around six to seven weeks on most of those products, which I think it’s – it’s not where we want it to be, but we know that that demand ends up being a little bit stickier than say portable generators obviously. You got to have portables there when a storm happens. But with home standbys, because it’s a considered purchase, because it’s an installed product and a project – a home improvement project in most cases, that is the process of pulling permits and lining up contractors and scheduling the entire project, which takes time in and of itself. So, at the front-end, if the contractor or a dealer orders that product, by and large, by the time the products are ready to be delivered, they have everything else lined up and ready to go for the project.

That being said, to your point, we continue to add manufacturing capacity. During 2012, we made some – some significant adds to that capacity, in particular as it relates to our residential business, we put a new factory online, late in the year – this year, and we are changing around some of our production. We’ve added some automation into our – into that particular production of home standby generators that we believe frankly, because of our 70% share and our scale in that category, nobody else could – could automate the way we’re doing at least cost effectively. And so, we think that’s just going to give us further advantage over people and frankly help us bring those lead times down even further.

Our standard lead times, we’d like to see that down to one to two weeks on those types of products. So we’ve got a little bit of work to do. We’ve ramped up our production. We’ve got – we’re at levels that we’ve not been at before, in terms of production today. Our supply chain, thankfully we pressure tested that last year with Irene in the snowstorm. That has worked out really well for us. We think that we’ve put a challenge out there for our supply chain to go even higher, should we experience additional demand surges going forward. But it’s clear to us that the investments in automation, the investments in capacity, these are all – we believe important long-term investments as this category continues to grow out. We just think categories got a tremendous amount of runway in it.

Jeff Hammond – KeyBanc Capital Markets

Okay great, and just final question. Can you, the 80 basis to 100 basis point gross margin headwind, is that all Ottomotores? And how should we think about mix given that portables are kind of expected to be down and residential home standby up?

York Ragen

Yeah I think if – in our comments we had talked about organically gross margins, we expect to be slightly up as a result of the number of cost reduction issues, we’ve been working on that, will roll into our product costs in 2013. But when you layer on Ottomotores, then it brings back down to that 80 basis point to 100 basis point year-over-year decline. So, I think most of the organic move on gross margin would be more of those cost reduction initiatives when price costs from pricing and commodity cost standpoint would be relatively neutral.

Jeff Hammond – KeyBanc Capital Markets

Okay, but why wouldn’t we get a benefit from mix, if we’re growing home standby 6% to 8%, and portables are down 5%, or portables?

York Ragen

You’ve got C&I running in there, so at a high single-digit organic. So...

Aaron Jagdfeld

We’ve got some pretty good cost reduction programs also, Jeff, that we’ve been working on here, that we believe are going to be meaningful in terms of their impact on margins next year and going forward.

Jeff Hammond – KeyBanc Capital Markets

Okay, great thanks guys.

Aaron Jagdfeld

You bet. Thanks, Jeff.

Operator

Your next question comes from the line of Christopher Glynn.

Chris Glynn – Oppenheimer

Thanks, good morning. You’d mentioned, really to the competitors, that the residential standby markets, that secondary or tertiary at best, but we have seen a paradigm shift here. So I’m just wondering what your thoughts are on some of those competitors giving it more attention or given who they are and the scale of some of their other businesses, if you don’t see any changed kind of attention to the space?

Aaron Jagdfeld

Yeah, and that’s a great question, Chris. They – these guys – the guys we compete with – there is only – frankly there is only three of us, and the other two guys have been very focused on this space in the last five or six years. I think, since we frankly become a public company and since we started talking about the category and the growth opportunities in the category, I think they’ve seen and they’ve seen growth I’m sure in their own numbers. They’re not – all the competitors created equal I will say though; some of them focus more on the premium segment of the market, which where they believe their brand can extract additional price although the product is not premium.

You’ve got other guys that I think are good competitors in this space that have a better cost position than others. But in the end I think what this comes down to is that, we believe over time that if this is going to truly become a commoditized type of and a democratized, if you will, from a word standpoint, type of product category whether like HVAC or some other installed product, there is going to be other people jumping in, but we’ve got such a head-start with distribution, with product, with some of the things we mentioned here on the sales and marketing side with our AMP – our AMP process and our PowerPlay sales tablet-based selling application, the distribution network we’ve got is two-fold greater than the next closest guy.

And so we think we’ve got some really good things that – and there is some solid barriers to entry that should help us keep our share where it’s at. Frankly, our share has been at 70% for some time now. And if these guys were going to get serious about and every indication we have, if they are serious about it, you think that they would have nibbled away at our share, that’s not the case. And so, we think we can continue to maintain that going forward and we like our position, we like the fact that the market is growing. That’s – I think that’s the key thing here, we’re all trying to grow the market. And that’s – that’s what we’re focused on.

Chris Glynn – Oppenheimer

Okay. So, you think the degree of seriousness had been real enough that there is a not a new inflection, given the drama of the past two years?

Aaron Jagdfeld

Yeah. I don’t think anything more than what they’ve already been experiencing. The growth in this category is been great for not longer than two years. Right, so, and I think we have all seen that in your own businesses, and based on comments they’ve made publically, it’s clear that they are focused on that. And one of those company is a public company, the other one is not, the other one is a private company, but all indications that we see in the marketplace is – is that they are very focused on it.

York Ragen

And there has been no new entrants.

Aaron Jagdfeld

And there’s been or has been no new major entrants in the category in a long time.

Chris Glynn – Oppenheimer

Okay, thanks. And one follow-up, just in terms of, if we look at your process for identifying new power tool extensions like the power washer, just – you probably don’t want to identify what they are, but, maybe some comments on the degree of scope of what you’re considering, and how they might stack up with, how you view the power washer opportunity?

Aaron Jagdfeld

Yeah. We have a pretty interesting selection criteria process here, as we look to develop new product platforms like washers. And for us, we look at engine power tools in particular, washers was kind of at the top of our radar screen in terms of the new category to get into a couple of years ago. Because that was one of the larger potential segments, it was frankly dominated by one player, one or two players.

And we thought that there was – there was an opportunity there to innovate, and to move the price points up in a meaningful way that we could create more customer enjoyment and frankly make some money out of it. So that popped out of that filtering process. There are other categories beyond that. I won’t mention them directly, but there are some product categories underneath that that we’re evaluating today on whether or not we think we would go into them.

And Maybe that could come organically. It could come through an acquisition, we don’t – we have a pretty robust M&A pipeline that we continue to look at, but from an organic standpoint, power washers for us is probably a shorter pipe because we have done it before, and we are a little more comfortable with it. Anything beyond that is going to get to be a little bit longer pipe. But we think that, as I said before being able to leverage our scale, our supply chain, our manufacturing prowess and our distribution relationships, I do believe there are other products we can plug into that and be successful with. So we’re going to continue to evaluate that and push forward.

Chris Glynn – Oppenheimer

Thanks a lot.

Aaron Jagdfeld

Thank you.

Operator

This concludes today’s question-and-answer session. I would like to hand the call back over for any closing remarks.

Aaron Jagdfeld

Thank you, Dominic. We appreciate again everybody’s attention this morning and your time, and we look forward to reporting out our first quarter earnings to you on the next call. Thank you again.

Operator

Thank you for your participation in today’s conference. This concludes the presentation. You may now disconnect and have a wonderful day.

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