Good day, ladies and gentlemen. Welcome to the Q3 2013 Generac Holdings Inc. Earnings Conference Call. My name is Mark. I'll be your operator for today. At this time, all participants are in listen only mode. Later, we will conduct a question- and- answer session. If at any time you require operator assistance, please press star followed by zero. We will be happy to assist you. As a reminder, this conference is being recorded for replay purposes. I would now like to turn the conference over to York Ragen, Chief Financial Officer. Please proceed.
Thank you. Good morning. Welcome to our Third Quarter 2013 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'll 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.
Thanks, York. Good morning, everyone. Thank you for joining us today. Our third quarter 2013 results continue to demonstrate the numerous secular growth drivers for our business, as well as the ongoing execution of our Powering Ahead strategic plan. Third quarter net sales increased 21% over the prior year to $363 million as we once again experienced double-digit organic growth led by strong shipments of commercial and industrial products, as well as home standby generators. Adjusted EBITDA and adjusted earnings per share increased 31% and 36% respectively in the quarter, with EBITDA margins increasing 210 basis points over the prior year, primarily as a result of ongoing improvements in warranty rates.
Growth in shipments of home standby generators was again strong as the market adoption for these products continues to grow as a result of a combination of factors highlighted by the overall additional awareness created from major power outages in recent years, additional distribution, and increased sales and marketing efforts. Our residential dealer base further expanded as we ended the third quarter with over 5,200 dealers. We continue to add dealers at a pace above historical rates with over 400 net dealers added thus far in 2013 and nearly 1,000 net dealer adds since the end of 2011. Further adding to the growth in home standby generators is our progress on a number of recently launched sales and marketing initiatives highlighted by our A.M.P. targeted marketing process, the PowerPlay in-home selling solution, as well as our Power You Control national advertising campaign.
We believe these factors, including a more favorable environment for residential investment, are driving a new and higher baseline level of demand for home standby generators. With penetration rates of home standby generators at only approximately 3% of single-family unattached homes in the U.S., we continue to believe there remains a substantial opportunity for Generac to further grow the market for this emerging product category. A.M.P., PowerPlay, and the national advertising campaign were fully launched in early 2013 and remain an important corporate focus as these key initiatives are targeted to further extend the awareness of home standby generators in the quarters ahead. The number of dealers using PowerPlay continued to grow during the third quarter, and we are on target to achieving an approximately 20% adoption rate by our dealer base by the end of 2013.
We remain encouraged by the rollout of PowerPlay thus far as we continue to see a notable improvement in our sales closure rates for dealers using this new and innovative sales tool. In addition, our Power You Control direct response television advertising, which launched at the end of May, is expanding awareness and generating sales leads for the product category at an attractive cost relative to other forms of direct marketing. Shipments of portable generators declined during the third quarter of 2013 due to less severe power outages relative to the third quarter of 2012, which saw significant demand from the derecho windstorm event that impacted the Midwest and Mid-Atlantic regions, and to a lesser extent, Hurricane Isaac, which impacted portions of the Gulf Coast region.
Despite the decline in portable generators during the current year quarter, year to date 2013 shipments of these products have been much stronger relative to our initial expectations entering the year. Combined with our broad relationships at retail, this has provided us with expanded placement for portable generators, and as a result, we believe we continue to experience increased market share gains in this product category compared to the prior year. Our ongoing success in portable generators has further solidified our leading position in providing a full range of backup power products for the residential market and has positioned Generac as being the household name in backup power.
Sales of commercial and industrial products increased at a strong double-digit organic growth rate during the third quarter as increased awareness of the need for backup power on the part of businesses positively impacted results. The strong momentum that we experienced during the first half of 2013 from our telecom national account customers continued during the third quarter as wireless providers in particular looked to further safeguard their networks from future outages. Additionally, we continue to see attractive revenue growth from shipments of light commercial generators used in smaller footprint retail applications as market interest in cleaner burning, more cost-effective natural gas-fueled backup generators continues to increase as a result of the exceptional value proposition of these products.
Also contributing to our strong revenue growth in C&I products during the third quarter were the acquisitions of Ottomotores, which closed in December 2012, and Tower Light, which closed in August 2013. We continue to remain active on the acquisition front by announcing earlier this month the agreement to purchase substantially all of the assets of the generator division of Baldor Electric Company, a wholly owned subsidiary of ABB Group. Baldor Generators offers a complete line of standby and prime-rated products ranging from 3 kW - 2.5 MW throughout the U.S. and Canada. The addition of these products significantly expands our industrial product offering and essentially doubles the addressable domestic market that Generac and its distribution partners can serve.
Acquiring the higher power product line from Baldor Generators accelerates our organic efforts to increase our share of the commercial and industrial power generation market, while also adding a 255,000 sq ft purpose-built facility that provides significant production and testing capacity for future growth. The integration of Baldor Generators will be a key corporate focus throughout 2014, and we're excited about the opportunity to execute on the potential revenue synergies by further strengthening the combined distribution of the companies. Additionally, although early in the process, we believe there are meaningful cost synergies to be gained given our lean product cost structure and increased manufacturing and sourcing scale as we transition the acquired products and facility into the Generac portfolio.
With regards to our EBITDA margin improvements, I want to take a few moments to comment on some very positive trends that we continue to see with declining warranty rates for our products. We spoke briefly last quarter about warranty rate improvements being a key driver favorably impacting our adjusted EBITDA margins over the prior year, and the momentum on this front continued into the third quarter. Over the last five years, our teams have delivered on numerous design and manufacturing improvements in an effort to further enhance product reliability and the ownership experience to give our customers the peace of mind that they expect when they buy a Generac generator to protect their home or business. The reduction in warranty rates in the current year is evidence that these longer-term efforts are having a positive impact on both customer satisfaction and the profitability of the company.
Our Powering Ahead strategic plan is focused on driving baseline growth. We have been successfully executing on this strategy over the past three years by remaining focused on four key growth objectives: growing the residential market, gaining commercial and industrial market share, diversifying our end markets, and finally expanding into new geographies. When you combine our Powering Ahead strategy with the long-term growth drivers for our business and the potential for further recovery in residential investment and non-residential construction, we believe Generac is well-positioned over the long term to drive future growth and shareholder value. I'd now like to turn the call back over to York to discuss third quarter results in more detail. York?
Thanks, Aaron. Net sales for the third quarter 2013 were $363.3 million, a 20.9% increase as compared to $300.6 million in the third quarter of 2012. Looking at net sales by product class, residential product sales increased to $192.7 million in the third quarter of 2013 as compared to a strong prior year net sales comparison of $191 million. During the third quarter, Generac continued to experience solid growth in shipments of home standby generators in comparison to the prior year, as well as continued growth on a sequential quarter-over-quarter basis. The continued strength in home standby shipments is due to a combination of factors, including the additional awareness created by major power outages in recent years, driving the further adoption of the category, and expanded distribution broadening the availability of the product.
Other drivers of home standby growth are increased sales and marketing initiatives to create and close leads more effectively, overall strong operational execution to satisfy the increased demand, and a more favorable environment for residential investment. The strength in home standby generators was partially offset by a decline in shipments of portable generators due to less severe power outage events in the current year quarter relative to the prior year. Recall that prior third quarter had a number of major outages during the quarter, which did not repeat. Also contributing to the revenue growth for residential products during the third quarter of 2013 was our growing presence in the market for engine-driven power washers. Looking at our commercial and industrial products, net sales increased 61.8% to $151.5 million in the third quarter of 2013 from $93.6 million in the third quarter of 2012.
The increase in C&I net sales was primarily driven by a very strong organic increase in shipments to certain national account customers, in particular, certain customers in the telecom and rental verticals. As wireless telecom providers continue to harden their networks and as certain national rental companies update their mobile power equipment fleets, we have seen robust growth during the current year quarter. As commented on in previous quarters, there can be some variability in our C&I product shipments from quarter-to-quarter, primarily due to the timing of capital spending by these national account customers. In addition to growth from our national account customers, we also saw growth coming from natural gas standby generators used in light commercial applications, as our commercial teams have been focused on penetrating this significant opportunity.
Supplementing our organic growth, the Ottomotores acquisition, which closed in December 2012, and the Tower Light acquisition, which closed in August 2013, contributed to year-over-year growth in C&I products as well. Our other product sales category improved to $19.1 million in the third quarter of 2013, an increase of 19% from prior year third quarter sales of $16 million. This growth was primarily due to increased sales of service parts as the installed base of our product continues to grow with the overall growth of the company. Gross margin for the third quarter was 38.4%, which was approximately flat as compared to 38.5% in the prior year quarter. Gross margin during the current year quarter reflects the mix impact from the addition of Ottomotores sales, along with a higher mix of organic C&I products.
This was mostly offset by the positive impact from a moderation in commodity costs and continued execution of cost reduction initiatives across the company. Operating expenses for the third quarter of 2013 declined $4.5 million or 8% as compared to the third quarter of 2012. A large contributor to this reduction was the improved overall warranty rates experienced during the current year quarter, which resulted in a $5.6 million favorable adjustment to warranty reserves, impacting margins by approximately 150 basis points. A decline in the amortization of intangibles also contributed to the reduction in operating expenses. Partially offsetting these reductions were operating expenses associated with the Ottomotores and Tower Light businesses, as well as increases in sales, engineering, and administrative infrastructure to support the strategic growth initiatives and higher baseline sales levels of the company.
Excluding non-cash intangible amortization expense, operating expenses as a percentage of net sales during the third quarter of 2013 were 12.4%, representing a 230 basis point decline as compared to 14.7% in the prior year quarter. Again, the lower warranty expense was the main driver of this 230 basis point improvement, which includes the reversal of warranty reserves combined with lower overall baseline warranty rates. Excluding the $5.6 million favorable adjustment in warranty reserves, operating expenses as a percentage of net sales for the third quarter would've been 14%. Adjusted EBITDA increased 31.2% to $100.1 million, or 27.5% of net sales, in the third quarter of 2013 as compared to $76.3 million or 25.4% of net sales in the same period last year. This increase in Adjusted EBITDA margin is predominantly related to the warranty rate improvements just discussed.
Adjusted EBITDA over the last 12 months as of September 30, 2013, was $382.1 million or 26.3% of net sales during that period. GAAP net income for the third quarter of 2013 was $47.1 million as compared to $25.5 million for the third quarter of 2012. Adjusted net income, as defined in our earnings release, increased 36.2% to $73.7 million in the current year quarter versus $54.1 million in the prior year third quarter. This increase is attributable to improved operating earnings during the quarter, resulting from a 20.9% increase in net sales and higher EBITDA margins, as well as $4.4 million in lower interest expense due to a reduction in interest rate from the May 2013 refinancing of our senior secured term loans. Offsetting these improvements was an $8.4 million increase in cash income tax expense.
Diluted net income per share on a GAAP basis was $0.67 in the third quarter of 2013 compared to $0.37 per share in the third quarter of 2012. Adjusted diluted net income per share, as reconciled in our earnings release, was $1.06 for the current year quarter compared to $0.78 per share in the prior quarter, a 35.9% year-over-year increase. With regard to cash income taxes, third quarter of 2013 includes the impact of a cash income tax expense of $9.5 million as compared to only $1.2 million in the prior quarter. As we commented during recent conference calls, our cash income taxes for 2013 are expected to increase going forward due to a combination of our NOL carry-forward becoming fully utilized during 2013 and higher overall profitability levels. Cash income taxes for 2013 were previously estimated to be approximately $15.5 million-$16.5 million.
Based on our increase in guidance for full year 2013, cash income tax expense is now projected to be $23 million-$24 million for the year, which translates into an anticipated full year 2013 cash income tax rate of 8.5%-9.5%. However, you should remember our favorable tax shield through annual intangible asset amortization in our tax return remains intact through 2021, resulting in approximately $49 million of cash tax savings per year for the next nine years. As a result, our cash income tax rate is expected to be significantly lower than our current projected 36%-38% GAAP income tax rate for the foreseeable future.
As we drive higher profitability over time, cash income taxes can be estimated by applying the projected 36%-38% tax rate on pre-tax profits going forward, then deducting the approximately $49 million of annual cash tax savings each year through 2021. Free cash flow, defined as net cash provided by operating activities less capital expenditures, was $76.7 million in the third quarter of 2013 as compared to $61.6 million in the same period last year. The increase in free cash flow was primarily the result of strong operating earnings and lower capital spending levels compared to the prior year quarter, partially offset by a modest overall increase in working capital investment as we were able to monetize seasonal inventory levels during the prior year quarter. Free cash flow over the past 12 months was $238.4 million.
As of September 30th, 2013, we had a total of $1.21 billion of outstanding debt, net of unamortized original issue discount, and $116.5 million of consolidated cash and cash equivalents on hand, resulting in a consolidated net debt of $1.09 billion. Our consolidated net debt to LTM adjusted EBITDA leverage ratio at the end of the third quarter was 2.9 x compared to 3.1 x ratio at September 30th, 2012. Given our strong free cash flow profile, we are confident in our ability to continue to invest in the future growth of the business, both organically and through M&A, while also reducing leverage levels over time. With that, I'd now like to turn the call back to Aaron to provide additional comments on our outlook for the remainder of 2013.
Thanks, York. As a result of the continued strong demand for our home standby generators, as well as a modest impact from the expected closing of the Baldor Generators acquisition during the fourth quarter of 2013, we are once again raising our sales guidance. Full year net sales are now expected to increase in the low to mid 20% range over the prior year, which is an increase from the low 20% range previously expected. This guidance continues to assume no major power outage events for the remainder of the year. As we have discussed, demand for home standby generators continues to benefit from additional awareness and adoption created from the major power outage events in recent years, our expanded distribution, the execution of our current sales and marketing initiatives, and the more favorable environment for residential investment.
This has driven adoption rates for home standby generators even further than previously expected. As a result, total residential product sales are now expected to increase at a mid to high teens rate for the full year 2013 over the prior year, which compares to the high single-digit growth rate previously expected. As discussed, our guidance for the remainder of the year does not include any assumptions for major power outage events. The prior year fourth quarter included Superstorm Sandy. As a result of this strong prior year comparison, we expect the fourth quarter of 2013 here. We expect shipments of home standby generators will increase during the fourth quarter over the prior year, which we believe further demonstrates the continued adoption of this emerging product category.
Net sales for commercial and industrial products are expected to be in line with the previous guidance of increasing in the low 40% range. Summarizing our sales growth assumptions for full year 2013, total company organic year-over-year growth is now expected to be between 14%-16%, which represents an increase from our previous guidance of between 11%-13%. Acquisitions are expected to contribute between 8%-9% growth for a total expected year-over-year net sales increase in the low to mid 20% range. Consolidated gross margins for 2013 are now expected to increase by approximately 50 basis points as compared to the prior year, which represents an improvement from the previous expectation of approximately flat. The expected improvement in gross margin is due to a more favorable mix of residential home standby products.
As a result of this increased outlook, we expect full year gross margins of approximately 38%, representing a nearly 100 basis point improvement relative to two years ago, while continuing to diversify and globalize our business during this time. Operating expenses as a percentage of net sales, excluding amortization of intangibles, are now expected to decline by approximately 75-100 basis points as compared to 2012, which is an improvement from the previous expectation of approximately flat. This updated outlook is driven primarily by the previously discussed improvement in our warranty rates and, to a lesser extent, increased operating leverage on higher sales volumes versus previous expectation. As a result of the higher sales outlook and improved margin guidance, we now expect adjusted EBITDA for full year 2013 to increase in the low 30% range, which is an increase from the low 20% range previously expected.
In closing this morning, we believe that continued underinvestment in the electrical grid, an aging population, an increased reliance on uninterrupted power and data, and more severe and unpredictable weather will drive strong demand for our residential, commercial, and industrial backup generators well into the future. In particular, given the relatively low penetration for both home and light commercial standby generators, we believe there is a substantial opportunity for long-term growth as the leader in these emerging product categories. In addition, we remain very positive about the significant opportunity to provide backup power for critical communications infrastructure, the overall ongoing secular shifts in the market toward natural gas generators, and the rental of mobile power equipment.
These growth drivers are also supplemented by a consensus expectation of an improving macroeconomic environment heading into 2014, with certain indicators such as single-family housing starts, new single-family home sales, and non-residential construction all expected to demonstrate some level of improvement. Additionally, we have been focused on better balancing the overall products that we offer and geographies that we serve. Much of this diversification has been achieved over the past couple of years through our strategic acquisitions of Magnum Products, Ottomotores, Tower Light, and the pending closing of Baldor Generators. These acquisitions are an integral part of our Powering Ahead strategic plan and have allowed us to accelerate the diversification and international expansion of our business. This concludes our prepared remarks. At this time, we'd like to open up the call for questions. Operator?
Ladies and gentlemen, if you have a question, please press star followed by one on your phone. If your question has been answered or you would like to withdraw your question, please press star followed by two. Questions will be taken in the order received. Your first question comes from the line of Charlie Brady from BMO Capital Markets. Please proceed.
Good morning, guys. How are you?
Hey, Charlie. How are you?
Morning, Charlie.
I just want to touch on the warranty reserve reversal. That was a one-off type of thing in this quarter, right? I understand the warranty rates are going down, but as far as the sharp reversal and the rate, the 6.7% rate, that's kind of a one-off for Q3, right? The rate kind of on a percentage basis back up.
Yes. This is York. The $5.6 million that we referred to in the prepared remarks was really, I guess, what you say as sort of the one-off, maybe non-run ratable reversal of the warranty reserve. That's where I think we tried to recalibrate on a normalized basis backing that out. About a 1.5% impact to margin.
Okay. Going forward, your overall, I mean, there is some positive impact on a go-forward long-term rate because your rates have come down on a long-term run rate, correct?
Yeah, I think you can see that because margin operating expense improved, what, 230 basis points, and that impact of that reserve reversal is about 150 basis points. That delta is reflective of the improved rate going forward.
Okay. On the portables, can you quantify how much portables were down in the quarter? When you talk about the market share gains, can you put any kind of granularity or quantify what kind of gains you're getting on the market share in portables?
Yeah. Charlie, we don't break out portables in home standby. From a market share gain perspective. We continue to see our share. I think we spoke publicly last year and on quarterly calls previously. We felt our share was somewhere in that low 20% to approaching mid 20% range, and we feel like we're probably gaining. Obviously, the growth in that share has slowed as we kind of approach maybe more of a steady state here of kind of that mid to upper 20% range of share. We have picked up, we believe, a few more points here on the quarter, just year-over-year.
Okay. Then on the C&I don't know if you mentioned it, what's the core growth rate on C&I ex-acquisitions?
Yeah. As I said, very strong organic growth on C&I. It was probably in that high 30% range. We saw strong growth there, highlighted by what I talked about from those national account customers, seeing significant capital spending from those national account customers.
Just following on the telecom side of that, can you quantify how much of that C&I growth came out of the telecom market?
No, again, we don't break out the different verticals just from a competitive standpoint, but it's obviously an important part of our C&I business and was a driver, as we mentioned.
Big driver, yeah.
We saw it ramping up kind of.
Majority of the growth?
Sorry, Charlie?
Is it a majority of the C&I growth in the quarter from telecom?
No, we saw growth. As we mentioned in our prepared remarks, even in the light commercial products continue to do very well. The natural gas products for small footprint retail, those are really not telecom-oriented. Broadly, we saw also with our Magnum business the large national rental accounts were also pretty good purchasers of equipment in the quarter. That's something that, those things were all drivers, basically.
Okay, great. Thanks.
Thanks, Charlie.
Your next question comes from the line of Ross Gilardi from Bank of America. Please proceed.
Yeah, thanks, guys. Good morning.
Morning, Ross.
I just have a few questions. First of all, is there any way to look at your standby sales on more of like a same-store basis? What I'm getting at is your sales growth really due to expanded distribution, or are your existing dealers also seeing year-on-year growth?
Yeah. We look at all of those figures, we haven't reported them publicly, we have seen growth in what I think you would traditionally refer to as a same-store sales type number. We are seeing that increase there as well as just raw points of, as we said, net dealer adds in general as well. It's really both.
Okay. On the portable side, what's your sense on inventory in the channel now, given that it's been a light hurricane season? If that continues, I realize we've got a few weeks left, would you expect that you've got a couple of quarters of de-stocking to go through in portables, or does it feel like the inventories are actually pretty balanced in the chain?
No, inventories are definitely heavier. They're seasonally appropriate ahead of events, as you indicated, it's been a pretty quiet season thus far. Inventory in the channel for portable generators is at elevated levels. I wouldn't say they're beyond seasonally appropriate, should it remain quiet for the balance of the season here, we'll go through the normal de-stocking effort. A couple of quarters is an appropriate way to think about that. That's the way we think about it when we plan for it. We plan not only what we've got in our inventories here, but also in the channel. We look at it in totality, we decide, we make a call on what we think the season's going to look like, and we plan accordingly. If you don't get a season, you just have to burn that off.
Again, per my comments about increased shelf space and market share, we've got the placement to be able to do that, it doesn't concern us. We'll monetize the inventory, we'll adjust our purchases and manufacturing accordingly, if the season remains quiet.
Thanks, Aaron. I'll just ask, you referred to the newer and higher baseline a couple of times in your last few quarters. Is that meant at all to be an initial comment on 2014? Anything you can say at this point about your level of confidence in growth for the next several quarters as we head into perhaps your toughest comps on the back of Sandy?
I mean, the new and higher baseline comment is one we've actually used over the years because I think as we've said, when you have a category, and I'm referring to home standby generators now, when you have a category of product like that's really in its infancy, it's an emerging category, is another word we've referred to it as. It takes a while to spool that up in terms of penetration rates. You can look back at other installed home products as proxies over the years, whether you're talking about home security or whether you're talking about central air conditioning. It takes, frankly, a long period of time to ramp up penetration rates.
In our world, what you'll see from time to time is these accelerated points of adoption along the curve, that is really the result of large scale, kind of large awareness events or outage events, things like Sandy or an Irene, which can accelerate the adoption rate, so make it go faster for a period of time. Then you kind of fall into a new, as we refer to it, a new and higher baseline level of demand. You kind of hold onto that demand or a good part of that demand. The reasons for that, as we've talked in the past. It's that distribution that we're expanding, right? Now you've got distribution points in markets that Tier 2, 4 hadn't had distribution, you've got increased awareness in general. The category is still very much word of mouth.
It's still very much in a viral marketing phase. As one person gets one of these products, and there are maybe five or six or 10 neighbors around them that see that product, and the next time there's an outage in their local neighborhood, their house is the only one that's lit up. It takes on kind of a viral type of approach in terms of the next homeowner that buys. That's really what is at the heart of our direct marketing strategies with our A.M.P., assimilation of our A.M.P. data and some of the other sales and marketing initiatives we've been working on. That's really my comments on the new and higher baseline.
It grows and kind of holds until you get the next catalyst. There's some seasonality certainly in that as well, you'll see from quarter to quarter. That's really what the comment's about.
Okay. Thanks, Aaron. I'll get back in line.
Great.
Your next question comes from the line of Brian Drab. Please proceed.
Good morning. Congratulations on another great quarter.
Thanks, Brian.
First question, there's a lot of comments in the prepared remarks around warranty and some questions here in the Q&A. I just want to make sure that I'm understanding something correctly. How do you calculate the warranty rate, and could the recent jump in sales that you've seen over the last three, four quarters have an impact on that, just by virtue of boosting the denominator in that calculation and having a bunch of new equipment in the field?
Yeah, I think. We look at warranty rate claims history, and then we bounce that claims history against when we sold those units originally. You go back in time to when you sold the units, not to that quarter's sales, per se, and that current quarter sales. The warranty rate is indicative of when you sold the unit, back in whatever the sale to fail period is. I think we're calibrating, and there isn't an issue what you're referring to where you're just increasing your sales in that particular quarter that would cause a sort of an artificial lower warranty rate.
No, it's really the result of a meaningful decline in that experience rate.
The claims.
Yeah, the claims experience rate, as York is indicating. The application of that, there's two pieces to it, right? There's the application of that lower claims rate that lower experience rate against future sales as you accrue warranty dollars in the future. There's a release of the reserves, which is really the adjustment that we talked about here.
Non-run ratable piece.
Non-run ratable piece that we talked about. There's really two pieces to the move in warranty, but
Yeah, sure. I understand that there are the two pieces. I was just trying to make sure that I understood whether the second piece that got you the going from 150 basis points to 230 was more a function of quality, or I guess it sounds like it's exclusively really a function of quality improvements rather than math.
Yep, correct.
Okay. Thanks. Can you give us a sense at all for when you think Baldor will close, beginning of the quarter, end of the quarter? I guess we're already end of the quarter, but closer to the very end of the year or not?
Yeah, we've got some things to work through yet towards closing, so we're kind of in between sign and close here on just documents and things that need to get buttoned up. We hope within the next 30 days that we're closed on that deal.
Okay, great. Just one last question. Some hurricane activity in Mexico recently. Have you seen any impact on the Ottomotores business as a result of that?
Ottomotores is much more of a commercial and industrial focused business. Longer term, you can see impact from outage events on commercial and industrial, but they don't have portable generators that they manufacture or sell in that business at this point. We are expanding our own distribution of portables and home standbys into Mexico through Ottomotores. It's part of the synergies that we like about that business that gives us a platform. Obviously those products are sold mainly through retail, and we have to build those relationships. You wouldn't expect any major near term impact from that. Maybe longer term impact, though, in the C&I business at Ottomotores.
Right. Okay. Thank you very much.
Thanks, Brian.
Your next question comes from Mike Halloran from Robert Baird. Please proceed.
Good morning, guys.
Hey, Mike.
Hey, Mike.
First, I just want to get a sense for the puts and takes on the margin line as we head into the fourth quarter here. Obviously, very strong revenue guidance. The EBITDA guidance relative to the revenue guidance seemed to imply some pressure on that margin line going from Q3 to Q4. I'm sure there's a lot of very understandable reasons, but I just want to make sure I understand some of the puts and takes that would imply some lower margins, relative to where we stand in the third quarter, besides obviously the warranty expense item that we've already kind of talked about.
I think, the warranty non-run ratable piece, you got to factor that out.
Yep.
I think really it's a function of once you do all the math on our guidance, you'd see a bit of a mix shift there between C&I and resi. I think that mix shift would have an impact. I think that's the biggest piece of it, Mike, to be fair.
That makes sense. You're basically implying there the seasonal uptick that you tend to get in the fourth quarter on that piece of the business relative to some of the pressure points.
Yep.
Okay. That makes sense.
Yep, that's part of that
Yep. On the Baldor business, maybe just talk a little bit strategically about that. The confidence you have going up a little bit more aggressively against some of the larger players on the industrial business, the positioning that Baldor currently has in the market. I know it's not a large slice of the market today, but confidence in the technology and its ability to go against those guys. Start there, please.
Yeah. Mike, this is Aaron. Strategically, Baldor, we had made a strategic decision internally, as part of Powering Ahead and as part of our efforts to, in particular in Powering Ahead, to increase our share of the C&I market. That's really the strategic objective we're after here. We were going to do that organically. As we looked at the cost of that and the time it takes to do that organically, when this asset became available, we saw an opportunity to accelerate that. Again, they have a purpose-built facility. It's actually here in Wisconsin, which fits our footprint very well. The underpinning of why we even want to get into the higher power ranges and get up against some of the bigger guys in the market, for us to have full mind share with distribution in the commercial and industrial market.
We've got 42 dealers in the U.S., to get full mind share from these dealers, they're generator dealers, they sell all power ranges because they're generator guys. They don't just sell up to 600 kW or approach the over 600 kW market in the way we do with our modular solution, which fits certain applications, not all. We saw that, really the only path for us, if we're going to be serious about C&I going forward, is that we have to be a full line provider. We have to have 100% of their mind share, because we couldn't let them buy those higher power range products from guys like Baldor or others.
Because Baldor has a full line as well, it's kind of what we refer to as the camel's nose under the tent, in terms of you can't allow another OEM into your distribution to sell part of a product line. It really takes away from your ability to get that dealer focused on everything that you want them focused on 100% and invest in a Generac business as opposed to Generac and others. That was really the genesis of the strategic thinking behind it. Then again, the timing was just accelerated here with the Baldor asset becoming available.
Yeah. If I remember correctly from my days when I covered Baldor, pretty quality assets. Maybe just compare and contrast maybe what they're bringing to the table. Obviously, you already referenced the fact that they're not a modular solution the way you guys are. From a pure quality of product standpoint, how do you guys look at it and compare it with what you have and maybe a peer group as well?
Yeah. Again, we did a lot of diligence on this on the front end, Baldor has a pretty good name in the marketplace, in our marketplace, relative to the product quality. They do manufacture not only standby rated machines, prime duty machines as well. That's usually where you're going to see a prime duty machine typically would be outside the U.S. Now most of their volume's in the U.S. and Canada. Where you see prime duty equipment inside the U.S. and Canada is going to be in oil field services, it's going to be in the energy production sectors, where those pieces of equipment are running either 24/7 or close to it, where utility power is not available. You have to have a quality machine to do that.
The engineering effort, the design, the manufacturing that they put into that product to make it that robust extends through also into their standby product. What we feel we're getting here is a high-quality product line, that we think we can do some things with, both from a revenue synergy, as I indicated, with combining the distribution in our prepared remarks. On the cost side, we continue to position ourselves as a more significant purchaser from a sourcing standpoint of not only diesel engines, but other components that you would find typical in a generator. We also have the ability, we think, to extend some of the things that we do vertically, from a vertical integration standpoint, into these products to help lean out the product cost structure for the Baldor product line.
Again, to play on the back of manufacturing and sourcing scale. We think there's some good cost synergy opportunities there once we close. It's still pretty early, as we indicated in the comments, but when we get there, hopefully next quarter we'll give people a better steer on what we're thinking about for synergies for that business.
Great stuff. Apppreciate the time.
All right.
Thanks, Mike.
Thanks, Mike.
The next question in queue is from Jerry Revich from Goldman Sachs. Please proceed, sir.
Good morning.
Morning, Jerry.
Morning, Jerry.
Aaron, can you talk about your broader portfolio at this point? A lot of additions, pieces coming together. What are the next areas that you're focused on? Just give us a broad sense. Are you still looking to add additional pieces to the C&I portfolio, or does this pretty much get you what you need in the U.S.? What other regions look interesting to you?
It's a great question, Jerry. From a pure U.S. and Canada, domestic market, if you will, standpoint, as it relates to the one strategic objective that we have, which is to increase our C&I market share, I think, the Baldor acquisition certainly puts us on a pathway there. There could be other ancillary type of products that refer more to the generator space that might be interesting, but frankly, I think we're closing in on kind of being where we want to be there from that strategic objective. From a diversification strategic objective, and then also expanding geographies, which are two other legs of the stool, there are plenty of other assets and other companies for us to continue to consider. Our M&A pipeline is still very full. We think that there are opportunities to kind of continue to build that out.
Other products that could fit into the distribution that we've built here, either through the Magnum distribution in the rental markets or through our own distribution here on the C&I side. Then certainly internationally, there are whole regions of the world where we're really not attacking yet aggressively. Southeast Asia. We've got a toehold in Europe now with Tower Light, but that's a mobile construction equipment play. We really haven't solved for stationary power generation yet. There are a ton of opportunities. The Western Hemisphere, we're getting better with Ottomotores. We've got Brazil. We've just reconstituted the Ottomotores Brazil entity. Tower Light had a Brazil entity. We combined those entities and created a Generac Brazil entity, which is a new entity down there. It's got a facility, and it's got staff. Then we've got, obviously, our facilities in Mexico through Ottomotores.
I look out, and I see a lot of opportunity yet in our pipeline. We're being pretty aggressive on that. Obviously, with our free cash flow characteristics, we think that continuing to put the cash flow to work in this manner to accelerate our Powering Ahead plan is a good use of cash.
Aaron, can you give us an update on the margin performance on the acquired Tower Light on Ottomotores business? I know Tower Light, you haven't had that long, perhaps you can give us an update on how that's doing so far. What have you seen out of the margin profile in Ottomotores versus the prior owner?
Yeah. Ottomotores, I'll focus on that first. We haven't broken out Tower Light, as we said, I think publicly, it's a very good margin business, Tower Light. Much better than what you would see traditionally here in the U.S. in a mobile equipment company. In Ottomotores, as we said before, that was a business we bought that had been under-invested in. The product cost structure was not as lean as we would've liked to have seen it. We've done some rationalization of the manufacturing footprint there already. We're moving in the right direction, I think, to lean that out. We're bullish on where the synergies could go with that business. I think we publicly stated $2 million in cost synergies for Ottomotores. We feel like we're definitely on track with that.
What we learned, even with Magnum, as an example, that was an acquisition we did two years ago, is that when you get into the second and then ultimately the third year, that's where you start to, I think, really sharpen your pencil, when it comes to other potential synergies. We think that'll be the case as well with Ottomotores as we go forward and lean out that cost structure and really start to use our newfound scale here in purchasing and in manufacturing to the benefit of that business from a margin standpoint.
Aaron, lastly, you mentioned earlier in your comments, there's going to be some seasonality in your residential business over the next couple of quarters. It's been a while since we've had a typical seasonal year from a storm standpoint. Can you just flesh that out for us? You mentioned, I think, standby should be flat in Q4 versus Q3. What's a typical seasonal pattern as you see it into the early part of next year?
Actually, we mentioned in our remarks that standby's going to be actually up in the fourth quarter, so we're actually expecting that to be up. We do expect, again, just from a seasonal standpoint, if it remains a quiet season here for the balance, the fourth quarter from a portable generator standpoint, we would see further declines in the run rates on portable generators in the fourth quarter. Then we're formulating and working through our guidance in 2014 right now. Pursuant to all my comments, both prepared and here in Q&A, we've got a tremendous amount of initiatives that we've been focused on to drive the company forward. If you look at the residential, it's that new and higher baseline. We talk about all the things from A.M.P. to PowerPlay to our infomercial, the Power You Control infomercial that launched here in May.
Those things are all having an impact, we believe, on that baseline and on extending the awareness here of standby generators. When we get around to the fourth quarter results, that's when we'll give a much tighter read on guidance. Certainly seasonality, if we get a quiet period, I think the one thing we would say, if we get a quiet season here, seasonality from a quarterly basis of 2014 would probably look a lot like what it has in the past without storms. Last year was different because you're coming right off of a storm. 2011 was different because you were coming off of Irene. I don't think you'd expect the same type of seasonality with respect to the quarterly numbers as it relates to residential if we have a continued quiet period here this season.
Okay. Thank you very much.
You bet.
Your next question comes from the line of John Quealy from Canaccord. Please proceed.
Hey, good morning, guys. Congratulations.
Thanks, John.
Thanks, John.
The first question, on the dealer adds. If you go back trailing four quarters, you've publicly stated you're adding about 100 net per quarter since Q1, and I think the Q4 2012 to Q1 2013 jump was about 200 dealers. Can you comment on the gross adds there or how you're feeling with churn? What I mean about churn is, are the dealers more profitable than they were, or can you just comment a little bit more on the dealer metrics? Thanks.
What we've said with respect to dealer adds, we've always reported those numbers on a net basis. I would tell you this, John, we haven't seen anything out of the ordinary with churn that would create an issue for us there that we foresee at this point. That's pretty consistent. What I would say is, as we said in our comments, We've had 1,000 net dealer adds since the end of 2011. When you look at that is a material increase in our base off of our 5,200 a day. Ostensibly, we were in the low 4,000s at that point and at the end of 2011. We do track on a same-store sale basis, as I said previously, we're seeing improvements in top-line run rate.
From an economic standpoint, the broader the base of product that gets out in the marketplace, we're at 3% penetration today and headed higher. There's a lot of product out there from a service standpoint, service opportunity standpoint, both on an annual service basis, but we're also connecting customers who purchase their products through other non-dealer channels. We're connecting those to our dealers because our dealers are best equipped from a training standpoint, a technical ability standpoint, to repair, service, and maintain product. If somebody goes and buys a product from a big box retailer or online or any of the many other channels where they're available, that's great. We give great accessibility to the product, but at the end of the day, it is a mechanical product and does need to be serviced. That's really the economics for the dealer.
Improving profitability, I think, is going to be a direct result of the increase in base of product that's out there and available to be serviced.
In terms of margin per standby unit, anecdotally, sounds like Mobile Link has had a pretty decent uptake, and I could imagine that's decent margin as an add-on product to the core stationary. Can you comment a little bit about how you're feeling with applications like Mobile Link? What you think the uptake, how it's tracking to your expectations?
Yeah, Mobile Link is exceeding our expectations here in the first year of the launch. We just launched that product earlier in 2013 here. That is a great way for people to interact with the product. Text messages, emails, it can go online. We've got some other development around that product. That type of remote monitoring is really the class of product that we're talking about there. It's a revenue model that we haven't had here. We're dealing directly with end consumers. We're selling the service, if you will. In a lot of cases, the service in the first year is given away free as a way to entice people to get kind of soak into the product here and get used to using it. We think there's been a nice take rate so far on it. We like the product.
We're looking to expand it in other places and do some other things with it going forward. We see there's an opportunity to build not only better customer interaction with the product, but also a revenue model there that is a much more recurring revenue stream than we've had in anything we do here other than maybe service parts. It's very much in its infancy, and as it matures, I'm excited about where that could go.
Perfect. Lastly, real quick, York, I'm sorry if I missed this, I could imagine copper is in your favor. Can you talk about forward purchasing or hedging that you're doing there? Thanks, guys.
Yeah, we've got some, I guess, what we'd call more opportunist. We don't have a formal hedging program. We have some opportunistic hedges out there. They're more short-term in nature and more modest in nature. I guess I wouldn't say that we're locked in on copper at today's levels.
Operator, do we have anybody else left in queue?
Your next question comes from the line of Jeffrey Hammond. Please proceed.
Hi. Good morning, guys.
Hi, Jeff.
Hey, maybe to ask You mentioned home standby being up into the fourth quarter, and I think you've talked in the past about a 12-month afterglow on the longer end. Can you just talk about, is the resiliency there a function of A.M.P. PowerPlay and the new dealers, or maybe just talk about what you're seeing in terms of momentum on web hits and registrations and leads?
Yeah. Jeff, I think I'm probably not going to give you anything new here other than what's in my prepared remarks, just the fact that when you combine all those things, right? Those are all new programs, the things you just mentioned, and there's a third one, which is the infomercial as well. You take A.M.P., you take PowerPlay, you take the infomercial. Both A.M.P. and PowerPlay were in testing phase late last year, fully rolled out here at the beginning of the year, and then the Power You Control infomercial or direct response TV campaign was rolled in May. When you put all of that together, I think it's having everything, the evidence that we show.
Obviously, we're looking at closure rates at the dealer level and the impact of those tools that we're giving people and those marketing initiatives, we're definitely seeing better closure rates as a result, we believe, of those items. That's why we're going to continue to focus on those going forward here through the balance of 2013 and actually into 2014 as well. I think it's not out of the question to see us do some things not only to the aggressive level we're already doing them, but maybe even further with some of those things. The point here, what we're trying to make is that obviously you're going to get events like Sandy, you're going to get events like Irene from time and again. That's the way it works. That's going to accelerate the adoption rate for the category at points in the curve.
As we build out this base and as it becomes a more mainstream category of product, we think we've got a great opportunity here to take and extend the awareness from those types of events, then do some meaningful structural things like what we're doing in the sales and marketing side to keep that running forward on a positive basis. Obviously, we said in our prepared remarks about Q4, you referenced that as well. Again, I would call out probably a reversion to a more normal seasonality pattern with these types of products once you get into next year, if the season remains quiet. Very bullish on the new baseline that we're building at this point.
What's the new bogey as you kind of surpass this 20% dealer on PowerPlay? What's kind of the new bogey to think about in terms of adoption rates there?
That's a great question. I haven't given it a tremendous amount of thought. We're in the middle of our planning stage right now. We're having some dialogue back and forth with our team here to make sure we're all aligned on what we do think that is. I think it's a meaningful step up. I think part of it is you have to look at the 20% that have adopted, they don't represent just 20% of the sales. Those are generally the dealers who are more heavily involved in the category, from a mind share standpoint, from a staffing standpoint, resource standpoint. That 20% of dealers that have adopted, that's on a dealer count basis, that represents more than 20% of the dollars. Obviously, there's a point of diminishing returns. You push this out and push it out, but you're getting connected to smaller and smaller dealers.
That's one side of the coin. The other side of the argument that we make or that I like to make here is that, you don't know where the next great dealer's going to come from. You sign up a dealer, he gets involved in the category for the first time. If you give that dealer the right tools to be successful, and they're entrepreneurial enough to promote the category and promote the business, and they do the things that we ask them to do, they could have great success with that. You can't just say because they're a small dealer today, we shouldn't push it. They could be a big dealer tomorrow as a result of pushing it.
I don't want to quote a number at this point, I would think we're going to be pushing hard to get a number and we'll quote you something on that when we get to next year.
Okay. Just a couple of housekeeping items on the acquisitions. Can you quantify what the acquired revenue was in the quarter?
We talked about organic growth for C&I in that high 30% range. If we grew 62% for C&I, the delta there would be acquisitions, Jeff.
Okay. You had two months of Tower Light?
We had really one, if you think about it.
Yeah, really one. Unfortunately, Italy kind of shuts down.
In August
August. You buy a company, and it closes.
Okay. That's probably why it seems like a lower number.
You got to think about that in terms of the run rate. Correct.
Is there any way to kind of give us a rough size, trailing 12 months sales on Baldor, and kind of any profitability metrics in terms of where they stand relative to your other businesses?
Yeah, we haven't disclosed revenues for some pretty competitive reasons there. I think, obviously, as we've said, the current business is not optimized. When you look at the profitability of that business today, I think we really believe that there's an opportunity to take our scale, to take our manufacturing capabilities, to really go after leaning out that product cost structure and doing some things there. There's also some great revenue synergies that this is a product line that our dealers don't have access to directly from Generac. They do from others, but not all of our dealers are in this market because we don't offer it. We'll have some nice synergies with that. There's some great connection of synergies between the Magnum business and the Baldor business relative to the rental markets and the oil and gas markets.
We're really excited about that we think that there's an opportunity there to do something that is pretty cool. The other thing I would mention, this is a carve-out of a much bigger business, right? We're buying assets, so it's a little hard to really kind of look at the true profitability. You can do as much as you can do in diligence to try and figure out what it would run rate to. At the end of the day, until you really get it in-house and we assimilate it into our portfolio, both on a facility basis and the way we do manufacturing, as well as from a product basis and the way we design products, I think we'll probably have a better glimpse of it once we get this thing closed and get into the next quarter, Jeff.
We may be able to make some more comments on it then.
Okay. Thanks, guys.
Thank you.
Your next question comes from Christopher Glynn from Oppenheimer. Please proceed, sir.
Morning, Chris.
I don't know what happened. I don't know if he disconnected.
Okay.
If he wants to press star one again. He is in the call? He's back in. Hold on one moment.
All right.
Okay. Christopher Glynn.
Yep. Can you hear me?
Yeah. Hey, Chris.
Chris.
Hi. Good morning. Not sure what happened there. We've been talking about the new higher resi baseline, and for my question, I don't think there's any possibility of an empirical answer. I wonder if you had any gut thoughts on how much of what we're seeing right now is the new baseline versus some element of extended afterglow.
Obviously, what gets really hard to parse apart on this, and we've talked about this on other calls, is if you go back, we had not only Sandy, but you had Irene, you had the snowstorm in October, Snowtober, I think, as it was referred to. You've had other numerous outages out on the East Coast, smaller to larger. They all build on each other. To try and parse apart baseline versus what's coming off of which outage, I mean, what do you point to? It's just really, we've tried to do that scientifically. We've tried to do it from a gut perspective and both ways. What we continue to focus on, Chris, is expanding distribution and focusing on the programs and the tools that we're putting in the hands of those dealers that we're putting out on the street to sell our products.
Some of the more, I would say, national level and regional level marketing campaigns that we've been ramping up here to get the product category in front of more people and explain it to more people. That.
Create our own awareness.
To create our own awareness, if you will, to create our own storm, if you will. That's really what we're focused on here going forward, because it's a really bad strategy to sit around and watch the Weather Channel. I mean, that's not a strategy for a business.
It's not. Okay. If we look at the mix and the margin impact in the fourth quarter, understandable. Would that be probably a good proxy to start thinking about 2014 as things have kind of calming down a little on the residential side?
Yeah, Chris, this is York. We're pulling those numbers together now. We haven't commented on 2014 margins at this point. We haven't given any guidance on 2014. We're still pulling that together ourselves. It'd be premature to comment on 2014 margins.
Fair enough. Thanks.
All right.
There is no further questions in queue. I would now like to turn the call over to Aaron Jagdfeld for closing remarks.
All right. Thank you. We want to thank everyone this morning for joining us, and we look forward to discussing our fourth quarter and full year 2013 earnings results, which will be out sometime in February of next year. With that, we thank you.
Thank you very much. This concludes today's conference. Thank you for your patience, your participation. You may now disconnect. Have a great day.