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Generac Holdings Inc. (NYSE:GNRC)

Bank of America Merrill Lynch Global Industrials & Materials Conference Call

September 5, 2012 11:45 am ET

Executives

Aaron P. Jagdfeld – President and Chief Executive Officer

Analysts

Andrew Obin – Bank of America Merrill Lynch

Andrew Obin – Bank of America Merrill Lynch

I am Andrew Obin, Bank of America Merrill Lynch machinery analyst, and we have here the management of Generac. We have Aaron Jagdfeld, Company’s President and CEO, and York Ragen, the Company’s CFO.

Generac produces power units. In fact, I was chatting with Aaron about getting one for my in-laws. And the company has experienced rapid growth as due to sort of unforeseen weather events, and increased adoption of the product, and it’s a very interesting story.

And I’ll let Aaron talk about it. Thank you very much for being here.

Aaron P. Jagdfeld

Thanks, Andrew. As Andrew said, I’m Aaron Jagdfeld, President and Chief Executive Officer at Generac. With me is York Ragen, our CFO. I’m not sure how familiar you are with the company, and we can go through these pretty quickly, these slides. We got a prepared deck here, and maybe leave a little more time for Q&A for those of you guys that are in attendance here, and skip lunch to be with us. So one of the downsides of presenting at 11:45 apparently.

But as Andrew said, I think there are a couple of things that from a highlight standpoint make this a very attractive investment. The first of which is just the rapid growth the company has experienced with the adoption of our residential products, and I’ll get into that, the second and that has led to best-in-class organic revenue growth.

We have created the backup power space at the residential market side, what we call the home standby generator market. That’s a category we effectively created about 12 years ago. We’re the market leader in that category, and we’ve created significant barriers to entry that I’ll cover here as well.

We have a financial profile that is pretty unique for a company like ours, and you’ll see that demonstrated in some of the financial information we’ll share with you, but in particular, the free cash flow generation of this company, no pun intended is very dramatic, relative to a company of our size, in terms of the percentage of our EBITDA that we convert to free cash flow. So we’ll cover that as well.

I think one of the last highlights too is that, we have strong market product opportunities outside of the U.S., 99% of our revenues today are generated in the U.S. and Canada. So here we have this kind of homegrown story here in the U.S. and the U.S market, but we’ve got an entire world out there that we’ve only began to scratch the surface on. So those four characteristics we believe are significant in terms of how you want to view this as an investment going forward.

Just a little bit about the business, about the company, was founded in 1959 by an engineer, we’re located just west of Milwaukee, Wisconsin, about 30 minutes west. It was founded as a portable generator manufacturer actually. These are the small gasoline power portable gens that you’d see and they’re very prevalent and typical during widespread outages, people run to Home Depot and Lowe’s to buy these types of products, those are the types of products that the company actually began building back in the late 50s, actually really invented that category as well.

But today we offer a wide range of products, all the way from those, we still offer those small portable generators. Although it’s a very large industrial systems for backup of data centers, hospitals, supermarkets, waste water treatment plants and those types of things.

Our LTM sales here through Q2 is approximately $1.1 billion, and that breaks down about 58% of that being residential, which again are those permanently installed home standby generators as well as the small portable products that we have. And the balance 36% is in the commercial and industrial market where frankly we’re a smaller player, more focused in the niche space of natural gas, which I’ll explain here in a second on why that’s been a good thing to us in the last few years in particular.

We have about 2,200 employees and about 1.2 million square feet of manufacturing, most of that located in Wisconsin. This is a slide that I think, many companies would be envious of relative to the growth trajectory, top line as it were here, about a 15% CAGR over the last 11 years, and that’s on an organic basis.

The last two bars that you see there, the two larger bars, the gold colored piece of those bars actually represent the transaction, the first significant transaction of size from an acquisition standpoint that we did last year in a company called Magnum Products, and I’ll get into that here in a second. But all of the rest of those bars, all the orange portions of those bars are actually organic growth. So, no M&A of significance in the company’s history prior to last year.

And that is really, again, a testament to some of the product categories that we’ve created here in (inaudible) like the home standby generator category. Some of the innovations that we brought to market in natural gas technology, some of the innovations we brought to market in different ways to deploy our industrial systems have also been drivers of growth over that period of time.

And so it’s really a history of innovation that underpins what we do as a company. The company was founded on innovation in 1959, and continues to innovate. And we believe that the innovation is a significant component of and a driver of growth going forward here into the future.

From the product offering standpoint, just graphically represented here, if you look on the left hand side of this graphic on the residential products, you’re going to see at the top the power washer category, which is a new space for us. We’ve only been in that market a little over a year. It was a category that we’re in quite a bit deeper than that. Back in the 1990s, we pioneered the consumerization of that product category of retail. That was packaged up and sold as part of the business in 1998, along with our portable generator business.

So we were number one in North America in power washers and portable generators in 1998. We sold that business to private equity. They in turn sold it to Briggs & Stratton. So today, Briggs & Stratton owns the former Generac portable products business, where we were leaders in that space. We’ve reentered after the expiration of a non-compete, both in the portable generator space as well as the power washer space, and those are the products you see listed there at the top on the left hand side.

The bottom on the left hand is the permanently installed systems. The second from the bottom would be probably our most popular system, those air-cooled home standby generators as they’re referred to. Air-cooled because that is how they are cooled down. They have no radiator. So a liquid-cooled generator will have a radiator much as same as a car or a truck.

And obviously at price points, if you look on the left hand side, they’d kind of climb with those products, with power washers kind of being at the bottom of the price point curve, liquid-cooled home standby generators being at the top of that. Again that represents 58% of our revenues on that side.

On the right hand side, those would be representative graphics of the products that we sell for our C&I markets. The first three products there are pictures of products that we acquired from the Magnum Products Company last year in October. So that’s a construction light tower that you see at the top there, that company is number one in North America in light tower sales.

These are the types of, basically it’s a fixed application generator. It’s used in road construction, as more road construction goes over the night time. It’s used in oil and gas patch type of anywhere the extraction or exploration is going on, there isn’t a permanent source of electricity or lighting, that’s where you’re going to see light towers. You’re also going to see them in commercial construction as well.

Mobile generators, another product category that they brought to us, with that purchase. Again wherever you’d need temporary power, you’re going to see those types of products; mobile pumps, de-watering, removal of flood waters or de-watering a construction site.

And then the bottom two products here on the right hand side will be pictures of what our permanently installed commercial and industrial set look like. Again, you are going to see these in small footprint retail type installations, convenient stores, small bank branches; that’s going to be on the commercial side. And then on the bottom there, the industrial sets, which are more primarily diesel power gensets. You’re going to see those in hospitals and data centers in larger applications.

Just stepping back for a second, if you are a generator manufacturer, I think it’s important to point out a few kind of macro drivers for the demand side of power generation. And that really is the grid; the age of the grid, the tremendous underinvestment in the grid over the last three decades.

It’s been great for homeowners like everybody in this room, kept your utility rates low but the way that’s been accomplished is by the 3200 different independent grid operators that are out there under-investing in the big-ticket items such as transmission and distribution. So that’s how we’ve been able to keep your rates low, which has been fantastic for us personally, but unfortunately where we’ve suffered is in reliability.

And you can see that bar chart there on the left hand side really, I think points out that it’s the best graphic that we can give people that this is a real issue, it’s not an issue that obviously we have mistaken it being an issue because we are a generator manufacturer. But frankly, these are statistics accumulated by the North American Reliability Council, which is a government entity, and that government entity tracks the number of outages that happen across the U.S.

This bar graph represents the number of major outages, those outages that impact more than 50,000 people at a time. And you can see that, that’s growing and at a compounded annual growth rate of 17% since 1993. And we don’t have the data from NRRC, it’s not available yet for 2011, otherwise we’d put that up there. But we suspect based on other independent sources that we use that number is going to go quite a bit higher even in 2011.

So it continues to demonstrate, and we think that this is highly correlated; the reliability issue here is highly correlated to the age of the grid. The average grid components are over 40 years in age, that’s poles, lines, transformers, all the actual hard infrastructure around the grid is aging very quickly and it’s leading to some significant issues.

The other macro item that we would point to, it’s not just the aging grid, but in particular as it relates to the opportunity on our residential market, is the aging population. There are – the 80% of the buyers of these systems are over age 50. And that is one of the largest segments of the population in terms of growth going forward. But why is that? Why are 80% of the buyers of home standby generators over age 50? Well, frankly, homeownership skews to over age 50, disposable income level skew to over age 50, people who appreciate insurance like homeowners insurance skews older in society.

And so you can think of a home standby generator as a basic extension for most people of that homeowners’ insurance policy. It’s for property protection, but even as you get older, it goes beyond property protection and it starts to get into areas of life safety. So things that you probably wouldn’t think about, but there are quite a few more home medical devices being brought into the home. People want to stay in their home as long as possible.

So and this is what we were talking with Andrew about with his in-laws is that people want to extend their independence, right, they want to stay in the house that they raise their kids in, now they’re going to retire and the homes paid off, but to live in that house, okay, and if power reliability is an issue, you compromise your independence very quickly. If you can’t control whether it’s home medical devices, whether it’s refrigeration of medications, whether it’s climate control, which is the big one, right, if it’s cold outside, you can’t turn on the heat when the power is out, or if it’s hot outside, you can’t put on the air; that’s a real problem as you age. Basic mobility within the house, when it’s dark, that becomes a problem as well.

So again, the category skews older and we think that the demographic shift in the U.S. plays favorably into this market over the long-term. So aging grid, aging population, the confluence of those two things and those are kind of big large macro driving forces that are not going to change very quickly here in the next 10, 20, 30 years, right.

The baby boomers are going to continue to retire at an amazing rate over the next 20 years. That’s when people will clearly realize that, that is a tremendously long cycle. And as they age and they want to stay in those homes longer, they’re going to need to extend their independence by having appliances like a home standby generator.

The other part of this graphic and the reason we spent so much time on this slide is really on the second half here is the penetration story of those home standby generators. And we did some proxy to other installed home systems on what might this penetration rate be? Today, it’s only 2.5% of U.S. households that actually have a home standby generator installed. And for us, the addressable market is only 50 million U.S. homes. It’s single family, unattached housing stock greater than $100,000 in value.

So we take out all the multi-tenant buildings, we take out all the intercity housing stock or the stock where, frankly you’re just not going to find somebody to invest in a product like this in a home that’s less than $100,000 in value.

That subset of the 120 million homes in the U.S. is 50 million homes. Of that 50 million, 2.5% of those homes have a home standby generator installed. Every 1% of penetration is a $2 billion market opportunity. We own 70% market share in home standby generator space. So we believe that, that is an incredibly attractive opportunity relative to improving the adoption rates for these products. They suffer from low adoption rates today because it’s still a relatively new category.

We invented the category about 12 years ago. And so there’s just, frankly, not enough people who know that what this product does, where they can find it, how much it costs. And so, the low awareness level, we believe, is something that is our focal point going forward to increase this penetration rate. Again every 1% is $2 billion.

Other installed home systems, central air conditioning has a 70% plus rate of penetration. I don’t know, and that’s been around since the 1940s, it’s taken that long to hit the 70%. I don’t know that home standby generators can be 70% at some point, I do know that the 12% of our U.S. households have a portable generator.

And again, portable generators have been around since the 1950s, when we started the category. The replacement cycle on portable generator is between 12 and 15 years. This category is relatively new at 12 years, the home standby generator category.

Clearly, if you are a home owner having a permanently installed fully automatic system that runs off of natural gas of propane like our home standby generators, provides a tremendous amount of additional utility and value than a portable generator that you have to pull out of your garage, you got to be home when the power is out, pull out that portable generator that you haven’t run for a few years out of your garage, pour gasoline from somewhere in your garage into that unit, fire it up and plug in extension cords to power up what you want to power up.

It works and you can make it work, and that’s how people solved power outages before the fully automatic permanent systems came to be. But as those systems age, the portable generators, we believe that when people come back into the market, they’re going to see the opportunity to step up to something like this, like this home standby category.

And so we believe that that’s something going forward that is really indicative of the type of opportunity in terms of penetration rate, where this category could go longer term.

So just shifting gears a little bit on here to the commercial and the industrial space because we’ve talked a lot about residential and we’re 70% share on the residential space, but on the commercial and industrial space, we’re only a 15% share player in the permanently installed systems. From a macro standpoint, the drivers for demand in the commercial and industrial markets, we listed two kind of major drivers up here and they probably impact more our business given the products that we’re involved with.

But on the left hand side, there is a secular shift that’s going on towards backup power generation being more focused on natural gas fueled than diesel historically, and backup power generation in industrial systems have been around for over 80 years, historically they’ve been diesel powered.

So if somebody takes a diesel truck engine, you can take it from a mine haul cart, or you can take it from a marine application, and it’s put into a generator and it runs off a diesel fuel. That is how backup powers themselves for nearly 80 years.

In the last 10 years, backup power is starting to shift more to natural gas, and obviously natural gas availability has improved dramatically here with all of the gas shale plays that are out there, and the pricing of natural gas has come down dramatically as well as the fuel source. But that’s not the primary driver of why nat gas gensets are beginning to displace diesel powered gensets in the marketplace. It’s for the simple fact that a like-for-like, a natural gas set under 200 kilowatt is less expensive than a diesel set; it wasn’t always the case. Diesel engines have been made in mass in the types of ranges that we are talking about on the 200 kilowatt set for truck applications for long time. The problem is as the emissions regulations have picked up over the last several years, the cost of that diesel engine has gone up dramatically, 2x, 3x, even 4x from Tier 4 to Tier 0.

And so the cost of the engine is the largest cost component of the generator. So as you can imagine, the cost of a diesel generator, the street price of a diesel generator has gone up dramatically in the last several years, kind of marching alongside increases in diesel engine technology and the cost of diesel engines.

It’s not that gas engines are less regulated. Frankly, they’re just as much regulated. Any gas engine in your vehicle is regulated very heavily. It’s no different off-road for products that are powered by natural gas. The major difference is the fuel source that turns out clear. Natural gas is a lot cleaner as a fuel than diesel fuel. So it needs less pre-treatment and less after-treatment in the generator itself versus a diesel system.

And so, all the after-treatment that goes into diesel engine technology is going to drive that price. That is creating an opportunity for companies like Generac that are very focused on natural gas.

Even though we’re only 15% share in the total commercial industrial market, we’re number one in terms of market share for nat gas products. It’s a niche space within power generation, but it’s a space we’ve been in for over 30 years, and we perfected the fuel systems and the technologies that go with those fuel systems to power those natural gas sets.

And it’s made us really the leader in that industry over the last 30 years. It’s only been in the last few years that the shift from diesel to nat gas has been accelerating, and so we’re benefiting from that accelerated shift. And that’s something that is a big driver of our growth, we believe, going forward in the future, at least as it relates to C&I.

The other side of that macro picture for us is again another secular trend shift from the shift from buying equipment to renting equipment. So this graphic here on the right hand side was actually I lifted this from the United Rentals deck they put together when they purchased RSC, Rental Service Corp.

Their thesis, their investment thesis in that purchase was that contractors, road contractors, commercial contractors and others, were shifting from instead of buying the equipment outright and owning it with some kind of a lien to a bank or a note to a bank on it, they would rather rent that equipment. And the reason that, that shift is occurring in the marketplace is really driven by the depth of the last recession and the pullback.

Contractors found themselves without any business but they still own this equipment, and they also own the note to the bank on the equipment. And so banks were reprocessing a lot of secondary equipment and putting out in the secondary market a lot of the types of equipment that Magnum sells like mobile generators, light towers, but even beyond that, bulldozers, I mean big, big construction equipment.

So there has been a shift that contractors come to the realization that they would rather rent that equipment, maybe pay a little bit of a premium to rent it. But if the market dries up, they can turn the rental in, they can go back to United Rentals or they can go back to RSC or Hertz and say, I’m done renting that, the rental period is ended.

They have no obligation beyond the rental period. So they can better match their expenses with the revenues. And so that is the real shift that’s happening and that’s been beneficial for our Magnum business, again the business we bought last October. So those two macro themes are very prevalent in our C&I business.

I think if there is one slide in this deck that you take something away from today about Generac it’s this distribution slide. This is not only a differentiating factor for Generac versus some of our competitors, but it also represents what I believe to be a very significant barrier to entry for others who are looking at our 70% share on the residential market in particular and saying, I want to be in that market as well. If 1% equals to $2 billion, then maybe we should be in that market as well, meaning somebody else.

And so, what’s significant about this is our distribution philosophy, as it relates to residential products, differs very dramatically from the distribution philosophy employed to lot of other industries. It’s a very open philosophy in distribution. We’ll sell online to people like Amazon.com, we’ll sell to wholesalers and industrial supply companies like Grainger. We’ll sell our products to electrical wholesalers like Rexel or Graybar. We’ll sell direct to 4,400 electrical contractors, we’ll sell into retailers like Lowe’s and Home Depot and others, you can find those products there.

Basically, wherever you shop, however you buy product, if you want to buy a turnkey solution from a dealer, if you feel comfortable buying something from Home Depot and taking it home on a Saturday and more of a DIY project or if you want to buy it online, if you’re comfortable putting down your credit card for $3000 online. How you shop is how we want you to find the product. Who are we as a manufacturer to limit you and your choice in buying the product? We feel very strongly about this in terms of this open philosophy.

We also feel that it’s a very important part when you have a category of product that’s still relatively new and is severely under-penetrated as home standby generators that the ability to find that product in more outlets is really key to us driving awareness for those products.

So that is a big part of the philosophy as well is not only the fact that we believe in free markets and allowing you to have choice on where you buy products, but it’s also allowing us to drive awareness by having more, call it more points of light out there to distribute the product. That’s a big part of the strategy and that’s what’s represented on the left hand side, there is all the different ways that we go to market. All of the dots on this map or the pushpins here represent the 4,400 dealer locations that we have around the U.S. We have amassed those dealer locations over the last 10 years.

We add between 300 and 400 new dealers every year on that basis. And again, it’s taken us a good solid 10, 11 years to get to the 4,400 that we have today. We spend a tremendous amount of money every year on boarding those new dealers and training them, technical training and sales training.

These are electrical contractors. They are not natural born sale people. They are great people. They are great hardworking people, but they don’t sell products for living, okay, they wire homes and they work on projects. They bid a project. They come in. They pull wires through the basement. They do the project. They get paid. They leave. They don’t try and sell you anything over there. So they don’t have natural sales skills.

What we’re trying to do is turn that 4,400 dealer base into a sales force for these products. We have to teach them how to sell. Simple things, it’s a kitchen table sales pitch. They are coming into your home and they are trying to convince you and your family on why you want this product. That takes a certain amount of sales skill, certain amount of salesmanship. How to overcome objections, whether it’d be price or location of the product or the amount of time it takes to have it installed, whatever the objections are, those are, it sounds very 101 kind of sales 101, but that’s when we start out with electrical contractors, it’s sales 101.

We do a lot of sales training and we do a tremendous amount of technical training. They are very comfortable on the electrical side of the machine. They are not as comfortable on the engine side of the machine. They are not mechanically inclined as it relates to repairing an engine. So there is a lot of technical training that we have to put into that channel, that dealer base, in order to get them to be proficient in repairing the products when needed.

So that is a, that investment and distribution, I think, represents, as I said before, one of the largest barriers to entry we have out there as a company, because somebody else, if they wanted to get into this market and they wanted to be good at it, they have to replicate that, because the last thing you want is, if you have this product, you spent $3,000, $4,000, $5,000 in this product and it doesn’t work for whatever reason, either because you haven’t maintained it or there is a problem with the machine, you need a dealer close by to come and repair it quickly, that’s why you own it.

During an outage, if it doesn’t work, it becomes a big paperweight, a big lawn ornament in your yard, okay. And that is not only an irritating thing to you, but frankly, it takes away from detracting the value proposition for the product. So the ability to have a large network of dealers that we can deploy quickly, right, to repair that product is incredibly important in this industry. And so that’s something that somebody is going to have to really work on if they want to replicate that.

On the right hand side of this graphic is the way we go to market with our commercial and industrial sets, and that looks a lot more traditional. Traditional two-step industrial distribution model, we have 50 industrial distributors around the U.S. who are interfacing with local contractors, local specifying engineering firms. The industrial products that we manufacture are highly specialized. They’re made-to-order type products and they take a fair amount of engineering work. And we work with engineers in the field to specify the solution set that’s necessary for each individual project. And so we go to market there through much, many fewer points of light.

Now just strategically speaking, a couple of things here on strategy, and then we can shift into Q&A. The strategy of Generac is quite simple. The first is to grow our residential market, how do we get that next 1% of penetration, okay. We believe there are three key drivers. It’s driving awareness, its driving availability, and its driving affordability. If we can focus on those three things, we can get that next 1% of penetration, which again represents a huge amount of market opportunity. That is a core component of the strategy.

Another core component of the strategy is the upper right hand corner, which is to gain industrial share. We want to take that 15% share position we have and we want to move it up. We think through improvements in distribution and through extensions in our product offering and continuing to focus on natural gas, we believe that we’re going to build our share position in C&I.

The bottom two pieces of the strategy, diversification of our end markets, we are a generator manufacturer, kind of at our core, which is great. Weather does impact, Andrew mentioned that at the beginning here that weather certainly impact some of our business, in terms of increasing demand for certain products, particularly, when it gets to portable generators and probably more so on our residential standby sets. Those are going to be more sensitive to major outage events.

The diversification of our business into other product lines and other markets should help stabilize the revenue so that we don’t have the kind of ups and downs that are difficult to run a company that have 2,200 employees, waiting for Mother Nature to deliver. We can’t do that. That’s not a responsible way to run a company, both for our employees or for our investors.

So, diversification, you can look at the Magnum purchase last October has really a key component of executing on that part of our strategy. We’ve got into light towers, we’ve got into mobile generators, we’ve got into mobile pumps. These are products that are not dependent on major outage events occurring, okay. They gave us access to new end markets, like oil and gas, like road construction, like commercial construction that we weren’t serving before. So entrée the new markets with new products is part of that diversification play.

And last but not least, my opening comment before that 99% of our revenues are in the U.S and Canada. It’s been a huge opportunity worldwide to take our products, which are very extendable outside of North America and take them to the rest of the world. We just haven’t focused on it, because we’ve had to tag you by the tail in terms of what’s going on here in North America with our residential business.

So because of that, we focused our energies into growing that business. And it’s not that executing on any one piece of the strategy will de-emphasize what we want to do in terms of growing the residential market, but we do think our opportunities if we resource appropriately to grow the company further when it comes to new geographies.

Just briefly here financially as we talked, about $1.1 billion in revenues overall in the LTM period to Q2. Our adjusted EBITDA in that same LTM period now is just short of $260 million. The key graphic here at the lower left hand corner is the free cash flow, the unlevered free cash flow through Q2 on an LTM basis is almost $212 million. It’s a huge, I mean, and there are three reasons why. One is, we have great margins in this business, okay. You can see the line graph in the upper right hand, upper left hand side, 36.4% gross margin, okay, great margins in this business, our EBITDA margins are in the low 20%, 20% to 25% depending on the year. So we generated tremendous amount of cash flow through our EBITDA, frankly through our profitability.

The second thing is the low CapEx business. There is just not a lot of CapEx we set this year publicly CapEx between $15 million and $17 million. So it’s a very low CapEx, less than 2% of sales. And the third piece is we have a fantastic tax attribute in this company. When the company was sold by the founder in 2006, there was a leverage by our transaction sold to private equity and it created a massive tax shield, effectively through a piece of the tax curve, we were able to step up the basis of the assets, amortize that over a 15 year period, and that effectively creates a $49 million cash tax shield every year.

So the first $49 million of our cash tax goes to the shield, goes against the shield. So effectively, our cash taxes every year are nominal, less than $1 million just in local taxes and other things that we pay for local governments. And so the free cash flow power of this company is really the summation of those three things. And really I think it’s a testament to the type of business we built in over a 50 year period, but really in the last 10 years.

We’ve got some relative comp sets here to kind of illustrate best-in-class in terms of our five year sales CAGR, in terms of our free cash flow yield in particular, which you would expect with the kind of free cash flow generation this company has. Our EBITDA margins on an LTM period in some respectable company there in terms of the top 10 peer group and then our EV-to-EBITDA multiple, when you adjust for the valuation of that tax shield, puts us at about a 9.2 handle on an LTM period.

The business outlook for 2012, we’ve reiterated this, you can look at the transcripts. But effectively, we’ve raised guidance off of our Q2 earnings, and so we’ve now said that we see net sales increasing in the low 20% range for the year versus strong 2011. Adjusted EBITDA, we said high-teens range versus 2011. We said interest expense for the current year will be between $49 million and $50 million. In the following year, it’ll go up slightly.

We did do a special dividend here that we paid out in the June timeframe and we did lever up a little bit. We’re at about 3.5 times right now, net debt-to-EBITDA, and that, those debt service costs should rise between $60 million and $65 million next year. We are going to continue to convert our EBITDA to cash flow at a very aggressive rate. You can see that from 2009 to 2011, we converted 93% of our EBITDA to free cash flow, which is just an unbelievable amount.

Financial policy, people have asked us, what you’re going to use all that cash for. It’s very simple. It’s the same policy we had in place before the special dividend, but effectively we’re going to use it to pay down debt. We de-levered this company dramatically, when the company was down as an LVO, it was about seven times back in 2006, net debt-to-EBITDA.

We brought that down to, when we did the IPO at the time that was February 2010, we were about 4.5 times. And prior to the special dividend after Q1, we’re about 2.3 times. So we looked at, our leverage ratio at that point so that we could handle, this company can certainly handle more leverage given the free cash flow profile of the company, and so we – that’s when we decided to use special dividend.

But going forward, we’re going to continue to focus on debt pay down again, we’re going to continue to invest in the business both organically if we find bolt-on acquisitions that make sense, we’re investing that as well. And also at some point, we may decide to return capital to shareholder again, once we’ve kind of gone through those priorities in terms of the order there that I’ve just listed out.

I listed the investment highlights for you. So, I think at this point if there a few questions, we’ve got some time left to take questions.

Question-and-Answer Session

Andrew Obin – Bank of America Merrill Lynch

I’ll ask the first question. Can you comment on the impact of power outages in the Mid-Atlantic in July and your orders through the third quarter? And how do you think recent high hurricane activity in the south impacts your backlog for the rest of the year?

Aaron P. Jagdfeld

Sure. So it’s a good question. Obviously, we give guidance, as we still give annual guidance. We started the year, we gave guidance. We always give guidance without major events because what that should mean is only upside for investors. If we execute on our strategy and we meet our guidance and frankly outages are going to happen, outages happens everyday, and there’s 250,000 people in the U.S. everyday without power.

Thunderstorm is rolling through the Boston area this morning. We’ve got thunderstorms back home in Milwaukee. 250,000 people in this country are without power everyday. That’s what drives the category. What drives awareness and increase of the adoption rate at certain points in the curve are major events, right, widespread power outages where millions of people are impacted.

This event that, Andrew you’re referring to at the end of June, is derecho event, it’s straight line windstorm that went all the way from Indiana stretching through to the Mid-Atlantic region, left 3.5 million people without power. Certainly, it’s an area of the country where they’ve experienced some power quality issues on the Eastern seaboard in the past.

The more events that you have and the more times that you’re without power at home, the more you start to get, frankly, you get upset about it. You don’t know who to be upset at, you want to be upset at the utility company, you want to be upset at Mother Nature, but effectively, you start to realize that the problem is not going away. The grid continues to age, they’re under-investing in the grid dramatically, you’re on your own, so people turn to our type of product for relief to that situation. And so, we’ll see increased adoption rates for home standby generators in the next two to four quarters as a result of that derecho event.

Now the event, the hurricane that just came through Isaac, down in New Orleans, lesser event, only about 1 million people, I know it’s not lesser from a flooding standpoint for the people who are impacted by the storm, but from a power outage standpoint, quite a bit smaller event. Louisiana has been impacted from time again only going back to hurricane Katrina and Wilma and some other storms have impacted that region of the country. They’re frankly they’re used to power quality issues as it relates to weather. So we have a very good distribution base down in that part of the country.

So we would expect there to be a nominal lift coming out of a region like that. And again, those are the types of events, those kind of major outage events that were not in our original guidance. So, again, outages are good for our business. We have not given specific guidance for Q3 and Q4 other than to say that we’ve raised our guidance for the entire year. We did raise that guidance after that derecho event. So that was in our math when we did that, but obviously that was before the last event that happened with Hurricane Isaac. Other questions? Get to lunch.

Andrew Obin – Bank of America Merrill Lynch

Well, I’ll ask a question…

Aaron P. Jagdfeld

Go ahead.

Andrew Obin – Bank of America Merrill Lynch

On the industrial side.

Aaron P. Jagdfeld

Yeah.

Andrew Obin – Bank of America Merrill Lynch

One of the concerns that we’re seeing in the industrial space is sort of order activity, total order activities coming to a slowdown, I think we’re going to the election. What are you seeing in your business and do you think we’re going to see a pickup after the election?

Aaron P. Jagdfeld

Yeah, some of the comments in our public comments around the C&I business have been exactly that is that we believe that there is a law that’s taking place here ahead of the election. This is the same malice we get into, that businesses get into ahead of every four years here in terms of the uncertainty that comes from what the next administration may want to focus on after the election.

Our order rates, we’ve seen as we said on the C&I side, we have seen some tampering of the enthusiasm around investment, in particular in the oil and gas space. I think it’s been, there has been somewhat of a pullback there. So some of the products that we ship into those markets related to the Magnum business, we’ve seen some pullback. But offsetting that, the shift to natural gas, right, the sets that are still being sold out there, there are more sets being sold that are natural gas than diesel, which is favoring us. So, we’re actually offsetting some of that with the shift towards natural gas.

And so, and as you’ve gotten some of these major outage events as well when you go back to, you guys go back to Hurricane Irene last fall out here in Milwaukee, and you go back to the early snowstorm that struck this part of the country, you’ve actually got quite a few businesses that when they got in their planning cycle for 2012, they decided that they needed to add a generator and they’re starting to get into that type of a phase right now where they’re putting those products on. So I think that’s offsetting for us.

Often times, we see this business somewhat decoupled from the general economic environment and that’s something that we’ve said before and something we believe happens when you get the economic cycles, we’re not as intrude with those cycles maybe as other businesses, other traditional equipment businesses would be.

Andrew Obin – Bank of America Merrill Lynch

I don’t want to stand between anybody and their lunch so…

Aaron P. Jagdfeld

I don’t either, so we will see those light and then we’ll turn you guys over to lunch hour. Thanks a lot. I appreciate it.

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