Good day, ladies and gentlemen, and welcome to the second quarter 2013 Generac Holdings Inc. earnings conference call. My name is Katina, and I'll be your coordinator for today. At this time, all participants are in a listen-only mode. We will facilitate a question-and-answer session towards the end of the presentation. To pose a question at any time, please key star one on your touch-tone telephone. If at any time during the call you require assistance, please key star followed by zero, and a coordinator will be happy to assist you. As a reminder, this conference is being recorded for replay purposes. I would now like to turn the presentation over to your host for today's call, Mr. York Ragen, Chief Financial Officer. Please proceed.
Good morning and welcome to our second 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 will make reference to certain non-GAAP measures during today's call. Additional information regarding these measures, including reconciliation to comparable U.S. GAAP measures, is available in our earnings release and SEC filings.
I'll now turn the call over to Aaron.
Thanks, York. Good morning, everyone, and thank you for joining us today. We are pleased to report our second quarter 2013 results this morning, which we believe continue to demonstrate the powerful macro growth drivers for our business, as well as the ongoing progress we are making in executing our Powering Ahead strategic plan. Our second quarter net sales increased 45% over the prior year to $347 million, with very strong double-digit organic growth, which remained broadly based across our product categories and all major regions in the United States. We are particularly impressed with the organic growth that we have experienced when considering it follows the prior year second quarter, in which net sales increased nearly 50% over the second quarter of 2011.
We converted this robust revenue growth into even higher growth rates for adjusted EBITDA and adjusted earnings per share of 65% and 64%, respectively, as we saw a 320 basis point improvement in EBITDA margins during the quarter versus prior year. Growth in shipments of home standby generators were again very strong during the quarter as the market for these products continues to develop, with more homeowners becoming aware of the importance of having a backup power system. As homeowners experience more frequent and longer duration power outages, they are increasingly seeking technology solutions which ensure their basic comfort, safety, and expected standard of living. As a result, home standby generators are becoming more mainstream given this increased need and awareness.
The accelerated adoption rate for these products has led to further expansion of our residential and light commercial distribution network, ending the second quarter with over 5,100 dealers, which is nearly 1,000 more since the end of 2011. As we support the increased awareness with expanded distribution, we believe we are driving a new and higher baseline level of demand for home standby generators. As the clear leader in the home standby generator category over the last decade, with approximately 70% market share, we believe it is incumbent upon us to continue to drive growth and increase the penetration rate of this emerging backup power solution in households across the United States. We are supplementing the main growth drivers of an extended Afterglow period and expanded distribution with some new and exciting sales and marketing initiatives to further increase the awareness of home standby generators.
These initiatives include our A.M.P. targeted marketing process, our PowerPlay in-home selling solution, and our recently launched national advertising campaign. The number of dealers using PowerPlay continued to grow during the second quarter, as we are well on our way to achieving an approximate 20% adoption rate by our dealer base by the end of the year. We are very pleased with this rollout so far, as we are still seeing a notable improvement in sales closure rates for dealers using this new and innovative sales tool. In addition, our Power You Control direct response television advertising campaign was recently launched at the end of May, and we are selectively targeting certain national networks as well as specific local regions of the country. Although still early in the campaign, we are encouraged with the response rate relative to other forms of direct marketing.
The sales leads we are generating come directly into our lead management team here at Generac, where they are qualified and directed to our dealers who are using PowerPlay, thereby leveraging our investment and increasing the likely closure rate. With penetration rates at only approximately 3% of single-family unattached houses in the U.S., we believe there remains a substantial opportunity for us to continue to grow the market for home standby generators. We also experienced a strong double-digit year-over-year increase in portable generator shipments during the second quarter of 2013 through the combination of inventory replenishment and overall expanded placement for these products at our retail customers. Shipments of portable generators during the first half of 2013 have significantly exceeded our expectations.
Unlike previous major power outages, where demand for portable generators increases rapidly and then settles back down to baseline relatively quickly, we are seeing a longer tail of demand following Superstorm Sandy. We believe this extended period of elevated demand, as well as further market share gains, have driven our outperformance of portable generator shipments so far in 2013. Our ongoing success in portable generators after re-entering this product category in 2008 has further solidified our leading position in providing a full range of backup power products for the residential market. In doing so, we have positioned the Generac brand as being the household name in backup power. Also contributing to the year-over-year sales growth in residential products in the second quarter was an increase in revenue from power washers.
We have developed a full line of washers since re-entering the market in 2011, which includes the recently introduced OneWash, the industry's only variable speed power washer. OneWash is a premium priced product addition which serves as an important complement to our existing broad product line, which has price points in the entry level to the midpoint range. This new power washer product has met our initial expectations, including positioning Generac as the leader in providing some much needed innovation to this market. With the successful rollout of a new product, as well as increased placement of our consumer and prosumer units at our retail channel partners, we believe we are making good progress in growing our market share in the power washer product category.
Demand for our commercial and industrial stationary generators continues to see very good momentum due to the increased awareness of the need for backup power on the part of businesses. In particular, we experienced strong revenue growth from our telecom national account customers during the second quarter, as wireless providers look to further safeguard their networks from future outages. The need for reliable mobile voice and data has become increasingly more important, and as a result, wireless carriers are facing both increasing competitive and regulatory pressures to harden their networks. As a market leader in the telecommunications segment, we believe providing backup power for this critical communications infrastructure represents a compelling secular growth opportunity for the company.
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. As power outages are becoming more prevalent, business owners are also becoming keenly aware of the need for backup power to protect their revenue streams and perishable inventories. Helping to increase the awareness in this optional standby market is a key corporate initiative for 2013, and recently we launched a concentrated direct marketing campaign, our largest such effort to date, targeted at certain businesses in the light commercial category, including a particular focus on gas stations and convenience stores.
Our campaign is centered around driving awareness of the tremendous return on investment that these products have for particular businesses, as well as educating business owners on the amount of hours, on average, that utility power is lost over the course of a year in their local area. We are developing specific sales tools for both our national account sales teams and our independent dealer sales teams to use in demonstrating the payback of standby generators. Given the relatively low penetration of light commercial backup generators, we believe there is a large growth opportunity that exists by focusing on improving the adoption rate with small businesses. We attribute our success over the last several years to the development and execution of our Powering Ahead strategy. Since mid-2010, this strategic plan has served as the framework for the significant investments we have made to drive the baseline growth of Generac.
As a quick review, this strategy is organized around four key growth objectives. First, by growing the residential standby market. Secondly, by gaining commercial and industrial market share. Third, by diversifying our end markets with expanded product offerings and services. Fourth, by expanding into new geographies. We have remained intensely focused on the first objective of Powering Ahead by making significant investments to grow the residential standby generator market through our numerous initiatives targeted at increasing the awareness, availability, and affordability of these products. We have resourced this particular objective with a strong infrastructure, and the investments we have made to date have helped us capitalize on the powerful growth drivers within the residential products portion of our business. At the same time, we have also been focused on better balancing the overall products and markets that we serve through our three remaining Powering Ahead strategic objectives.
Much of this diversification has been achieved over the last couple of years through several strategic acquisitions that have given us access to new products, new markets, and new customers. Our Magnum product acquisition has allowed us to enter the mobile power equipment market that predominantly serves the construction and energy sectors through rental channels. Our Ottomotores acquisition has given us access to larger output power generation equipment serving the Latin American market. In addition, the launch of our Power Washer product line has allowed us to leverage our existing retail customer relationships, supply chain, and manufacturing capacity. We believe there is significant opportunity for growth in the global power generation and engine-powered equipment markets, and we are committed to pursuing these through organic initiatives, as well as maintaining an active M&A pipeline.
Another example of our efforts to become a more balanced company with improved global focus can be found in our announcement last week of the signing of an agreement to acquire Tower Light, a leading European developer and supplier of mobile light towers with headquarters outside Milan, Italy. With distribution in over 50 countries, Tower Light is a great strategic fit for Generac's business, providing an expanded product offering of light tower generators to support additional geographic markets from those we serve today. When combined with our Magnum Mobile products, this acquisition positions Generac as the global leader in light towers, allowing us to participate in the growing rental market outside the U.S.
With over 100 employees and approximately 37 million EUR in net sales in fiscal 2012, Tower Light's customers and end users buy their products not only on price, but they also place a high level of importance on innovation, durability, and sustainability. The product line today includes the industry's widest range of LED-based lighting towers, as well as several hybrid lighting solutions that drive dramatic improvements in fuel efficiency. Tower Light operates a flexible development and production environment, which allows them to provide customized products designed for specific applications or local market demands with relatively short lead times, leading to premium margins for the company. Although early in the process of exploring opportunities for revenue synergies, we have already identified several attractive cross-selling opportunities that we're currently evaluating.
With respect to cost synergies, we are estimating that over the next 18 months, we can drive approximately $1 million in component-related savings on an annualized run rate basis. The execution of our Powering Ahead strategy has resulted in a more balanced company with improved global focus. When combined with the powerful macro opportunities in the residential and light commercial backup power market, we believe we have the right strategy in place to drive future growth and shareholder value. I would now like to turn the call back over to York to discuss second quarter results in more detail. York?
Thanks, Aaron. Net sales for the second quarter 2013 were $346.7 million, a 45% increase as compared to $239.1 million in the second quarter of 2012. Looking at net sales by product class, residential product sales increased 59.3% to $196.6 million in the second quarter of 2013 relative to a prior year net sales comparison of $123.4 million, which saw year-over-year sales growth of 34% over the second quarter of 2011. The growth in the current year was broad-based, primarily driven by very strong double-digit increases in shipments for both home standby and portable generators.
With regards to home standby generators, the continued strength in shipments is due to a variety of factors, including the continuing demand from recent major power outages driving further adoption of the category, expanded distribution broadening the availability of the product, increased sales and marketing initiatives extending the awareness of the category, overall strong operational execution to satisfy the increased demand, and an improving environment for residential investment. Portable generator shipments during the second quarter of 2013 were up strongly in comparison to the prior year quarter. Our broad relationships at retail have provided us with an increase in portable generator shelf space over the last several years. As demand remains strong for backup power following the recent major power outages, we are also seeing increased pull-through of portable generators.
We believe our solid execution and working capital investments have allowed us to capture a leading share of the portable generator market. Also contributing to the revenue growth for residential products during the second quarter of 2013 was our growing presence in the market for engine-driven power washers. Looking at our commercial industrial products, net sales increased 32% to $133.4 million in the second quarter of 2013 from $101.1 million in the second quarter of 2012. The increase in net sales was primarily driven by the Ottomotores acquisition. We also saw strong organic revenue growth for our C&I products due to robust shipments to telecom national account customers, as well as increased sales of light commercial natural gas generators used in smaller retail applications. These increases were slightly offset by a difficult prior year comparison during the quarter for certain of our mobile products sold through national rental accounts.
Our other product sales category improved to $16.6 million in the second quarter of 2013, an increase of 13.7% from the prior year second quarter sales of $14.6 million. This growth is primarily due to increased sales of service parts as the installed base of our products continues to grow with the overall growth of the company. Gross margin as a percent of sales for the current year second quarter was 37.8%, compared to 36.6% in the prior year second quarter. This 120 basis point improvement was primarily the result of higher mix of home standby generators shipped in the current year quarter, improved pricing, and moderation in product cost due to lower commodities and the execution of cost reduction initiatives. These margin improvements were partially offset by the mix impact from the addition of Ottomotores sales.
Operating expenses for the second quarter of 2013 increased $4.2 million, or 8.5% as compared to the second quarter of 2012. This increase was primarily driven by operating expenses associated with the Ottomotores business, as well as increased sales, engineering, and administrative infrastructure to support the strategic growth initiatives and higher baseline sales levels of the company. Partially offsetting these increases was a $5.9 million decline in the amortization of intangibles. In addition, we are also experiencing improved warranty rates, resulting in reduced warranty reserves during the quarter. Excluding non-cash intangible amortization expense, operating expenses as a percentage of net sales during the second quarter of 2013 were 13.9%, representing a 200 basis point decline as compared to 15.9% in the prior year quarter. Favorable operating leverage on higher volumes and the improved warranty rates are the main drivers of this 200 basis point improvement.
Adjusted EBITDA increased 65% to $90.1 million, or 26% of net sales in the second quarter of 2013 as compared to $54.6 million, or 22.8% of net sales in the same period last year. Our attractive EBITDA margins improved by 320 basis points in the current year quarter, primarily as a result of the items just mentioned: improved product mix, improved price cost, warranty reserve improvements, and leveraging our SG&A infrastructure on the higher organic shipment volumes. Adjusted EBITDA over the last 12 months as of June 30th, 2013 was $358.3 million, or 25.8% of net sales during that period. GAAP net income for the second quarter of 2013 was $28.3 million, as compared to $9.3 million for the second quarter of 2012.
Adjusted net income, as defined in our earnings release, increased 67% to $66.6 million in the current year quarter versus $39.9 million in the prior year second quarter. This increase is attributable to improved operating earnings during the quarter, resulting from a 45% increase in net sales and higher margins, partially offset by higher interest expense due to higher debt levels and interest rates compared to prior year, as well as higher cash income taxes. Diluted net income per share on a GAAP basis was $0.40 in the second quarter of 2013 compared to $0.14 per share in the second quarter of 2012. Adjusted diluted net income per share, as reconciled in our earnings release, was $0.95 for the current year quarter compared to $0.58 per share in the prior quarter, a 63.8% year-over-year increase.
As previously announced, on May 31st, 2013, the company completed refinancing of its senior secured credit facilities, pursuant to which it has incurred $1.2 billion of senior secured term loans to replace its prior term loan facilities. The new term loans will mature in 2020 and will initially bear interest at LIBOR plus 2.75%, with a LIBOR floor of 0.75%. Beginning in the second quarter of 2014, the spread of LIBOR of the new term loans can be reduced to LIBOR plus 2.5% to the extent that the company's net debt levered ratio falls below 3.0x . Following the refinancing, the company used a portion of the proceeds from the new term loans to fund a special cash dividend to its stockholders of $5 per share and to pay related financing fees and expenses.
The special dividend constituted a declared amount of $342.1 million in the aggregate, of which $340.8 million was paid on June 21st, 2013. As a result of the refinancing transaction and other debt prepayments, an extinguishment of debt charge of $13.5 million was recorded in the second quarter of 2013. In summary, the current quarter debt refinancing transaction resulted in a 275 basis point reduction in interest rate as compared to the prior term loan facilities. Despite increasing our overall outstanding debt, this very attractive cost of debt allowed us to reduce our interest expense on an annualized run rate basis by approximately $7 million, resulting in an approximately $0.06 of accretion to adjusted EPS. We are very pleased we were able to return significant capital to shareholders while at the same time having the refinancing transaction being accretive to adjusted earnings.
We were able to accomplish all of this while maintaining a comfortable leverage position at 3.4x gross debt to adjusted EBITDA as of June 3rd, 2013, and also maintaining flexibility to grow the business with regards to liquidity, covenants, and access to additional capital. Interest expense in the second quarter of 2013 increased to $14.3 million, compared to $9.9 million in the same period last year. The increase was a result of higher debt levels and interest rates compared to the prior year period. Due to the reduction in interest rate from the current year refinancing transaction completed in May 2013, interest expense during the third quarter of 2013 is expected to be approximately $13 million, which includes approximately $1.5 million of deferred financing costs and original issue discount amortization.
With regards to cash income taxes, the second quarter of 2013 includes the impact of a cash income tax expense of $2.7 million as compared to only $272,000 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 being fully utilized during 2013 and higher overall profitability levels. Cash income taxes for 2013 were previously estimated to be approximately $14 million-$15 million. Based on our increasing guidance for the full year 2013, partially offset by additional tax deductions relating to our recent debt refi, cash income tax expense is now projected to be $15.5 million-$16.5 million for the year, which translates into a cash income tax rate of 6.5%-7.5%.
Importantly, our favorable tax shield through our 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, any incremental pre-tax profit over this tax shield will be taxed at the projected 36%-38% tax rate going forward. Free cash flow, defined as net cash provided by operating activities less CapEx, was $30.3 million in the second quarter of 2013 as compared to $17.8 million in the same period last year.
Strong operating earnings were partially offset by increased working capital investment, driven primarily by seasonal finished good inventory replenishment and, to a lesser extent, higher capital spending levels. Free cash flow over the past 12 months remains strong at $223.3 million. As of June 30th, 2013, we had a total of $1.21 billion of bank debt outstanding, net of unamortized original issue discount, and $126.6 million of consolidated cash and cash equivalents on hand, resulting in consolidated net debt of $1.084 billion. Our consolidated net debt to LTM adjusted EBITDA leverage ratio at the end of the second quarter was a comfortable 3.0x, compared to 3.5x ratio at June 30th, 2012. With that, I'd now like to turn the call back over 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 products, as well as the expected closing of the Tower Light acquisition early in the third quarter of 2013, we are again raising our sales guidance for full year 2013. Full year net sales are now expected to increase in the low 20% range over the prior year, which is an increase from the low to mid-teens rate previously expected. Specifically for the second half of 2013, net sales are forecasted to increase in the mid-single digit range as compared to the very strong prior year second half period. Even after excluding the pending Tower Light acquisition, net sales are still forecasted to grow in the low single digit range during the second half of 2013 over the prior year period.
Importantly, the second half of 2012 had two major power outage events with the Mid-Atlantic region's derecho early in Q3 and Superstorm Sandy in the fourth quarter. Our revised top-line guidance for 2013 continues to assume no major power outage events for the remainder of this year. Our guidance also continues to assume no material changes in the current macroeconomic environment. We expect the demand for home standby generators will continue to benefit from increasing awareness and adoption as a result of the major power outage events that have occurred in recent years, along with our expanded distribution, which is resulting in the formation of a new and higher baseline level of sales for these products.
We also believe the ongoing improvement in the environment for residential investment and execution on our sales and marketing initiatives will further drive home standby penetration rates. Total residential product sales are now expected to increase in the high single-digit range in full year 2013 over the prior year, which compares to the low single-digit growth previously expected. Our guidance for the remainder of the year does not include any assumptions for major outage events, and prior year second half included multiple major outage events. As previously guided, we continue to expect a year-over-year decline in shipments of portable generators in the second half of this year. We believe we are gaining share in the market for these products through additional retail placement.
Net sales for commercial and industrial products are now expected to increase in the low 40% range over the prior year, which is an increase from the low 30% range previously expected. This increase in guidance is primarily due to an improved organic outlook for C&I shipments, along with the expected closing of the Tower Light acquisition early in the third quarter of 2013. Excluding the Ottomotores and Tower Light acquisitions, organic revenue growth within the C&I product category is now expected to increase at a mid to high teens rate over the prior year, which compares to the high single-digit organic growth rate previously expected. The increased organic growth rate for C&I products is being mostly driven by increased spending from our telecommunications national account customers as they continue to make investments to improve the reliability of their wireless networks.
Our outlook for C&I products continues to assume a modestly improved non-residential construction market in 2013 over the prior year. Summarizing our sales growth assumptions for full year 2013, total company organic year-over-year growth is now expected to be between 11% and 13%, which represents an increase from our previous guidance of between 5%- 7%. The acquisitions of Ottomotores and Tower Light are expected to contribute between 9% and 10% growth for a total expected year-over-year net sales increase in the low 20% range. Consolidated gross margins for 2013 are still expected to be flat as compared to the prior year. This guidance implies that gross margins in the second half of the year will moderate as the benefit of product cost reductions is more than offset by an expected higher mix of C&I shipments.
As a result of maintaining this outlook, we continue to expect full year gross margins of approximately 37% for the third year in a row while we continue to diversify and globalize our business. Operating expenses as a percentage of net sales, excluding amortization of intangibles, are now expected to be flat for full year 2013 as compared to 2012 at approximately 14.5%, which is an improvement from the previous expectation of slightly up compared to the prior year. This improved outlook is largely due to an improvement in our warranty rates, resulting from our intense focus on improving overall product quality over the last several years. As a result of the higher sales outlook and improved operating expense guidance, we now expect adjusted EBITDA for the full year 2013 to increase in the low 20% range, which is an increase from the low teens percentage range previously expected.
We continue to expect cash flow conversion to remain strong during the year and to be consistent with the cumulative average during the past four years of free cash flow representing between 90%-95% of our adjusted net income. In closing this morning, we believe our second quarter results further demonstrate the progress we are making in executing our Powering Ahead strategic plan. We delivered very strong organic revenue growth once again this quarter, which was broadly based across our major product categories and all significant regions in the U.S. The investments we have been making are driving performance that is exceeding our expectations. With continued momentum entering the second half, we have raised our outlook accordingly.
We believe the powerful macro drivers for our business, which include the under-investment in the electrical grid, an aging population, and an increasing reliance on uninterrupted power and data, will continue to drive further awareness of the need for backup power. Given the relatively low penetration for both home and light commercial standby generators, we believe there is substantial growth opportunity as the leader in this emerging product category. This concludes our prepared remarks, and at this time, we'd like to open up the call for questions. Operator?
Thank you. Ladies and gentlemen, if you wish to ask a question, please press star one on your touchtone telephone. If your question has been answered or you wish to withdraw your question, please press star two. Please press star one to begin. Your first question comes from the line of Christopher Glynn representing Oppenheimer. Please proceed.
If we could elaborate on the closure rate improvements seen from PowerPlay and what you're measuring against, I think previously, you talked about the early adopters maybe having higher closure rates to begin with.
Hey, Chris. That's a great question and something we're watching very closely as we roll this out. We really like what we're seeing in closure rates. I think it's still too early. It was probably too early in the first quarter that we had it out that I commented on it, we're pretty excited about looking at it. We're digging deeper into that to understand those. Again, we're targeting about 20% of our dealers to be on PowerPlay. I think that's 20% of the dealer count. I will say that these are the better dealers. They represent over half the sales that run through our dealer channels, which represents the majority of sales in the residential standby category.
We think that as we increase the adoption rate, what we're seeing in closure rates today, I think in another couple of quarters or so, we're going to be comfortable to maybe talk more deeply about those improvements. I'll tell you, just my experience having been around this and having watched closure rates for a while, we really like the uptick that we're seeing. We think that the system is having an impact. We definitely know that it's having an impact. We are dialing it in. We've released a couple of different versions of it since the initial version. I think we're on version 3 or 3.5 At this point. We're expanding its functionality. We're expanding the training on it to make sure that it's something that people understand how to fully use.
We're now using it in conjunction with this new infomercial program that I talked about, this new campaign, the direct response television campaign that we launched called Power You Control. That's something that we're seeing some really interesting things in terms of the impact of both of those things in concert together. I don't want to quote a specific closure rate, I can tell you that they're materially higher than they were previous.
Okay, thanks for that. On Tower Light, wondering if you could comment on margins relative to Generac core and the revenue geographic split and current growth.
Yeah. Chris, this is York. I think with regards to margins, Aaron made some comments about their approach to the market and how they approach different geographies around the world. As Aaron mentioned, they have distribution that serves over 50 countries around the globe, and they have products that serve the specific needs for each of those markets. Therefore, with that approach, they're able to go to the market with premium margins. I want to compare it to, say, how do they compare to Magnum's margins, which what we commented in the past is more typical mobile equipment here in North America sold through the national rental accounts. They're better margins than Magnum, probably in the high teens range, that's pre-synergies. As we talked about, there's some synergies we've identified. We want to try to get those approaching 20% there.
One of the reasons why we like this business was the margins that they're generating.
Okay, just maybe the split of Europe and ex-Europe and if it's overall growing right now.
You're talking about Tower Light, Chris?
Yes, please.
Yeah. Tower Light is growing. It's grown from, we disclosed that it was EUR 37 million in sales at the end of 2012. We can say that it's grown through the first half of this year. It's on plan, definitely growing nicely. Their distribution, about two-thirds of the sales are in Europe and about one-third outside. Mainly the outside sales are going to the Middle East and Africa, a couple other parts of the world. They have distribution a little bit in Latin America. They have distribution in 50 countries, which is another kind of really nice thing that we like about this business is with their customer base and with the breadth of their distribution, we think there's some pretty neat things we can do with that in terms of adding additional products.
If you think about Magnum's product lines, a little bit fuller product lines there in terms of just outside of light towers that serve the rental market, there are some other products that we think could possibly go into Tower Light as well and into those existing customers. We're pretty excited about that.
Great. Thank you.
You bet.
Your next question comes from the line of John Quealy representing Canaccord Genuity. Please proceed.
Good morning, guys. Nice quarter, and looks good to get back to positive retained earnings for you guys. A couple questions. First, on the standby business, can you talk about relative growth rates? I think you talked about for the whole business across the country growth, but can you kind of segment that for us in terms of Northeast, Southeast, Southwest, West? How's the growth trends looking for you folks at this point of the year?
Yeah, obviously, we don't disclose growth rates by region. What we can say is, as you would expect, the growth rates in the Northeast, Mid-Atlantic, and Southeast regions of the U.S. are beyond what they are in other parts of the country. That being said, we continue to see, John, even the Midwest, we haven't had any major events here in the Midwest to speak of, yet, just the frequency of events that we do get, they're more localized in nature. They impact power for, we're not talking about weeks on end. You're maybe talking about a day or two or maybe more. Some of our best penetrated states remain here in the Midwest, which Illinois, Michigan, even parts of Pennsylvania. In terms of Western Pennsylvania, there's some great regions of the country here that for us anyway, represent good business and good growth rates.
Lower growth rates, as you would expect out West, where you don't get the severity of weather, where the grid is newer, most of it's underground. Still growth. I think that's the-
Oh, yeah.
It's up nicely. We look at that, we say, "Okay, what's driving that?" Again, it gets back to this under-penetration story across the board that as we've continued to drive awareness for the category, drive distribution points, more points of light, we think it's having that kind of an impact with our initiatives and with the things that are driving awareness.
Okay, great. Then on the portable side, it sounds like you guys have been positively surprised on the strength there. Obviously, whether it's tough compares, year-on-year decline in shipments in the back half of the year. Is that channel fill ahead of an expected somewhat storm season for the channel, Aaron, or what do you think going on in the portable side for the back half?
Yeah, there's definitely some inventory replenishment. There's no question in the front half that took place. The second half, which you're still seeing, there's a good everyday business on portable generators for the same reason that I mentioned with power outages that happen every day around the U.S. There's still a quarter million people or more without power every day in this country. The typical solution for most people is to run out and get a portable generator. With our expanded shelf position, our retail partners, this has been a category that frankly has exceeded my expectations when we made the decision to get back into it several years ago. It was more of a complementary product for us.
For us, it's become a way to strengthen our relationship with our retail partners, a way to really create a brand in Generac that speaks to backup power for the residential and consumer markets. I would say a lot of that's come on the backs of our success in portable generators. A lot of it was inventory replenishment here in the first half of the year. The second half, I think the replenishment's pretty well done this cycle now, what you're going to see is normal sell-through ahead of normal weather patterns. There's seasonality in the category that happens typically late in the second quarter and throughout the third quarter with your active weather patterns around the U.S., just summer storm season.
Yeah. Then last two questions quickly. In terms of the national account business, was that surprising? What are your qualitative expectations for national accounts in the back half of the year?
Yeah. We've been watching national accounts with a lot of interest. It's a big piece of our business. We love that business because we think we do it very well. We think we have a good program set up with our national account sales team. A lot of it's coming, as we said, from the telecommunications vertical. We are seeing some traction in other verticals as well. Financial services industry, we've got a couple of national account customers there that are new to us. It's primarily the telecom space, and as in our prepared remarks, as we said, that it's not only the competitive pressures in terms of uptime with the networks, but also the regulatory pressures, the drumbeat there around, are cell towers going to be regulated relative to needing backup power?
We're watching that with great interest, obviously, in terms of the impact it could have for us. Our national account customers are by and large proactive on that already. It's just going to push them to do it faster. They're already out there. We serve all the major telecom companies. We're the primary supplier to all of them. It's kind of a specialized space. Those products are a little bit nichey. They are somewhat customized for each of the different networks and the network providers. We like the future of that, as we kind of indicated in our implied guidance here in the back half. A lot of that's going to be driven by national account business. Some of the other national account stuff on the rental space is also starting to come alive.
The CapEx spending by the larger national rental accounts, which is mainly what we serve through our Magnum business, we're starting to see that pick up as well. Yeah, we continue to be bullish on national accounts, barring any unforeseen pullback on a macro basis in the economy.
Great. Thanks very much, guys.
Thanks, John.
Your next question comes from the line of Charles Brady, representing BMO Capital Markets. Please proceed.
Hi. Good morning, guys. This is Andrew Dunham for Charles Brady.
Hey, Andrew.
Hi, Andrew.
I was just wondering, with respect to rental companies, are you guys seeing them not just replacing what they have, but also kind of expanding their fleets in terms of light towers and generators?
That's a great question, Andrew. The light tower category in particular is one of those categories that's expanding. When you talk about the shift to more nighttime construction, that's kind of new market, if you will. There's always been some amount of night construction, but road construction at night is becoming much more prevalent around the U.S. as construction companies, municipalities, state governments, they try to avoid congestion issues that come from shutting down roadways during the day. The other sector there that has obviously come on strong is the oil and gas sector, the energy sector. That has remained relatively soft in the first half of this year, the energy sector. Road construction has remained pretty bullish. I think there's an expansion of some fleets. Certainly, there's a replenishment cycle there.
These are products that go about four years in terms of their average life, four-five years. That replacement cycle's been pretty heavy in 2011 and all the way into the first half of 2012. What we've seen now is those companies becoming more aggressive at spending CapEx dollars here again, as we indicated, the back half of 2013. On the mobile generator side, just to kind of round out the discussion, we're taking share there. Magnum only has been in that market for about six or seven years, it just takes time to build those relationships, to prove themselves with the quality of the product. We continue to deepen our penetration of those products, Magnum-branded products, at their rental customers that are currently buying light towers, and that's been a success story for us.
Okay, great. That was helpful. I was just wondering if you could quantify the gross margin impact that Ottomotores had in the quarter.
Yeah, this is York. It's probably, if you're talking margins went up 120 basis points, that there was an offset to that with Ottomotores, maybe a percentage to a percentage and a half.
Okay. Last question, just is that $13 million and the $1.5 million of deferred financing, the run rate we should use going forward?
Yeah. That was a Q3 2013 first full quarter with the new credit facility, yeah.
We would remind you, though, there's a function within that credit facility that if we get to a net debt leverage of 3x or less, we'll step down a quarter point.
250, correct.
LIBOR + 250. Still remain the 75 basis point floor.
Through second quarter of 2014, if our net leverage is below 3.0x , we'll step down to that 2.5x .
That could
It will reduce a quarter percent.
Yeah, that could bring that run rate down obviously slightly.
All right, great. Thanks, guys.
Thanks, Andrew.
Your next question comes from the line of Jeffrey Hammond, representing KeyBanc Capital. Please proceed.
Hey, good morning, guys.
Hey, Jeff.
I don't know if I missed this, did you give an organic growth rate for the quarter in commercial? Can you give us the Ottomotores contribution?
We didn't specifically give it, if we grew 32% for C&I all in, we still had about 11% organic. Still very healthy organic growth on the C&I side for the quarter.
You guys clearly have been talking about a robust demand period, share gains, and I'm just wondering within all this, what you're seeing from a competitive landscape. Are people investing more, adding capacity, introducing new products at the rate you guys are, or is it pretty quiet?
No, Jeff, I think the main competitors for us, if we just talk home standby for a second, the main competitors in that space have remained relatively unchanged for the last several years, and they've always been aggressive. I think they compete with us in terms of trying to expand the market. In terms of their level of investment, I think one of the things that benefits Generac is this is our focus, our primary focus, whereas the primary focus of most of our competitors is something else first. I think in terms of management resource, in terms of financial resource, in terms of focus, I think that benefits us in terms of why we've been able to maintain our share, and grow the market all in the same breath here with all the initiatives and things that we're working on.
The competitive set, they're well aware of the opportunity here. It's just a question of focus and a question of resources and time allocation, I think, by those other companies.
Just longer term question about capital allocation. Clearly, equity is less involved. You've had a couple of years of these special dividends. How should we think, the same or differently about capital deployment in the out years as you continue to generate strong cash flows?
I think we've been pretty consistent in our message on how we're going to allocate capital and the deployment of capital going forward. The first thing, we want to put as much capital towards growth as we can in terms of growing the business organically. We've said that we want to pay down debt. I think a more comfortable range for us in terms of a leverage ratio would be somewhere in that 2x- 3x on a net debt basis. We think that there's some room to continue to pay down debt. Both on M&A, which we've been doing right along here would be the next priority for us, and you see that evidenced with another acquisition here that we just announced with Tower Light, which we really like in terms of broadening the company out, both in product and in global scale.
After that, we get through that progression. Jeff, I think we'd evaluate what does make sense. Is it time to initiate a regular dividend for the company, for the shareholders? Would it be another special dividend, a share buyback? There's a range of options there. I think the thing that we want to leave our shareholders with the knowledge of is it that we're going to deploy capital in the way that's going to get them the best return and get us the best return. We have a lot of opportunities out there for us to grow this company organically and through M&A. I think we're going to be very judicious, and we always have been. It's kind of in our DNA. We're very judicious about how we spend capital here.
Great. Thanks, guys.
Thanks, Jeff.
Yeah.
Your next question comes from the line of Ross Gilardi, representing Bank of America Merrill Lynch. Please proceed.
Yeah, thanks, guys. Good morning.
Hey, Ross.
I just had a few questions. Your residential growth rate actually accelerated in the second quarter versus the first quarter on a year-on-year basis. Was that a comp issue? Was the comp just easier, or is underlying demand actually accelerating as we get further from Sandy? Can you talk at all about what kind of demand you're seeing for standby kind of in the here and now in July? Any color you can provide as sort of as the quarter progressed in terms of growth rates.
Ross, I think your observation there is absolutely correct. I think there's a couple things underlying that. Certainly, the Q2 comp last year was a little bit easier than Q1. There was quite a bit of backlog demand we were fulfilling in the first quarter of 2012 that made that quarter a little bit more difficult comp, and that relaxed, obviously, as we got to Q2 of 2012. I look at the new initiatives that we've got that we've just rolled out here at the end of the year, the end of 2012, and in the first quarter with PowerPlay, with our A.M.P. direct targeted marketing. We've got our national ad campaign now in market. That started in late May, around the Memorial Day holiday.
I think all of those things, everything that we see on our dashboards as we look at the company and the KPIs we watch, are telling us that closure rates are improving, lead generation is up significantly, web hits are up significantly. Interest level in the category, home standby, that is, in particular, which is the majority of that residential bucket, is up significantly. We also had our power washers. That, again, this is our second full year in washers, there's a little bit there in Q2 over the prior year Q2. There's some pickup there, which is good, and we launched our OneWash product. We're gaining share in there. We're still a small player, no question about it, but it continues to be a part of that overall growth for residential.
The here and now, we don't like to make comments about the current quarter. I think, as we've said that we really have been impressed with the tail on this home standby business from Sandy. We think that the echo effect of Sandy happening in the same region as Irene the year before has had a more substantial impact on the length of that tail. Whereas we've said in the past that we would expect to normally see an elevated period of demand for about six to maybe 12 months after an event. I think we're going to see all of the 12 months, maybe longer, with this event. It'll remain to be seen what happens as the season shapes up this year, but at least right now, we really like the trajectory of that business.
That's great, guys. As you're seeing faster penetration of faster growth in portables, what kind of opportunities do you see longer term for many of those consumers to upgrade to a standby product? Are you seeing increasing incidents of that?
Yeah, that's the beauty of it. We look at our own data. When we look at home standby sales data, and we look at the registration data underlying that and underpinning that, about half of the people who have a home standby or buy a home standby generator either own or owned a portable. So if we can give people a good experience, kind of as a starter product, if you will, for backup power with a Generac-branded portable generator, the upgrade path to a Generac-branded home standby, we believe, is something that is an opportunity for us.
The ability to market directly to those people, now that we have that data, it becomes a ready-made kind of upgrade path marketing project for us and something that we're playing with right now in terms of how we can do that after people who have owned a portable generator a couple of years and maybe used it a few times. They understand that it's not a fully automatic solution. You do have to refuel it, oftentimes at inconvenient points in the middle of the evening. You have to have extension cords. The lack of automation on it means you've got to be home when the power is out. You've got to be in an area where the power outages aren't so widespread that you can't even get fuel. The downsides to using a portable generator are, it works.
It works in a pinch, it's a great product, but the increased utility and value you get by spending a little more money on a home standby is a great upgrade path. It's something we see as a great marketing opportunity for us, as we have done very well in portable generators. Over the next few years, we think there could be a good conversion rate opportunity there.
You talked about inventory replenishment in the first half by the mass merchants, what do the mass merchants do in preparation for hurricane season? Do they build a lot more safety stock this year? If there isn't a major outage event this summer, are you concerned at all that you're vulnerable to a big de-stocking event later in the second half?
It's a good question, Ross. Two parts of the question. The first part, I think that it's natural for retailers, as they did last year after Irene, to probably go heavier the season after a major event. They did that after Irene. They stocked up fairly heavy for Sandy. Because they did, I think they benefited from that. I think the stocking levels remain elevated off of Sandy, maybe even have gone up a little bit more. When we look at our in-channel inventory where our partners have talked about their inventory levels and where they want to be for the season, it is somewhat higher than the prior year. Are we concerned about not getting a storm? I think we put that into our guidance. Our guidance doesn't assume a major outage.
It assumes there is no outage, as such, it would assume de-stocking would occur in the back half of the year as a result. We built that into our guidance. The way we kind of size ourselves around that and plan around that is pretty simple. We say, "Okay, what's our everyday shelf space in portable generators?" We kind of look at that and we say, "Okay, if we didn't get an event, how long does it take us to burn that inventory off?" We calibrate our own inventory levels, as well as looking at those in the field and in-channel, we have a decision matrix there. We make some decisions about what could happen if we don't get a storm. I think you're seeing that reflected in the second half guidance as it relates to what we've issued this morning here.
I got you. Thanks. That's helpful. Your dealer network is clearly growing very rapidly, and you're citing that as a source of strength in the standby category. Is dealer inventory an increasingly important issue to follow? Talking obviously more about local electricians. Do you have dealers that are building speculative inventories of standby product in front of the hurricane season?
It's a good question, and actually one that we have remarkable visibility to now, given our activation data and things that we've talked about on calls previously. There's no question that when you look into certain regions of the country, the Northeast, the Mid-Atlantic, we're seeing some dealers that are carrying inventory. The thing we're noticing, though, is the demand has remained so strong that really every time they get an inventory position, the demand kind of eats that up. It's sold already. When you're a small dealer, what we've said traditionally and what we continue to see, there are some outlier dealers. Some of the larger dealers, I think, do take stocking positions, and it's clear based on the data we see that that's the case.
As dealers become bigger and we have more of them, certainly field inventory becomes bigger every year as the category grows. Most dealers, by and large, Ross, what we see, these are small contractors. They don't have a lot of additional working capital, and frankly, they don't have a lot of space to store a 4 or 500-pound item, waiting, betting on the come. What they do is oftentimes, they will not buy from us until they've sold to a consumer. They go and they do an in-home consultation for a consumer or a homeowner. Then, if the homeowner chooses to accept their proposal, there's a permitting process. These are products that building permits have to be issued for. Electrical inspections have to be conducted. There's some initial work upfront.
They generally will not order the product from us until they have that permit in hand, because for them, there's no reason to be out of pocket that working capital until they absolutely know they need to be.
Your next question comes from the line of Stanley Elliott representing Stifel. Please proceed.
Good morning, guys. Thanks. You can take the mic. Question. As we're thinking about the power washer product, I know it's relatively new, but is it outlandish to think that you guys couldn't get a 10% market share or something of that magnitude now that we're two years out?
Stanley, I think that's a very reasonable goal for us. We're pushing people internally harder than that. I'll tell you, we're calibrating that we want to be the number 1 provider in this space. I think it's an area where we have expertise based on our history. We have expertise in terms of the manufacturing, in terms of the engineering. We have fantastic sourcing capabilities. These are engine-powered washers. We're not in the electric washer space, which represents, frankly, about half the market. That's not a part of the market that we're going to address with a product line today. On the gas washer side, it is something that I think when you talk about share there, I think it's very reasonable to say that 10% is something that's achievable for us.
As far as the discussions with the national accounts and I guess the line reviews have been ongoing. You had a big win last year. Are you seeing any other sorts of big wins this coming season or for next year, I guess, rather?
Yeah. We're still in the season right now in terms of line reviews. We're getting some indications back. There's some puts and takes there on what we have heard so far. I think we remain optimistic that we're going to have more wins than we will have losses, obviously, as we roll out the product line. It's a tough market. It's a competitive market. You've got to bring innovation to these accounts every year in and year out. You've got to be sharp on your costs. You've got to be sharp on your execution in terms of being able to meet their timelines, their rapid development cycles. Those are things that we're developing competencies at the company here. We've got elements of those competencies. We have more to develop.
More to come as the season kind of bears out here and we get more information in the months ahead.
Great. Lastly, has there been any sort of improvement on the regulatory environment? I know the FCC, there were some hearings, I guess, earlier this year. Is there any update to the status of that?
Yeah. From all indications that we kind of see things from the outside looking in a little bit. We've got some ears to the ground, obviously, pretty aggressively out in Washington, D.C., where this is taking place. Everything we see is that with the change in the chairperson of the FCC, that has, I think, put everything a little bit on the back burner as priorities are potentially reordered going forward. It remains to be seen whether this will continue to be a priority as it looked early on for the FCC. I don't think there's anybody that can dispute that there are more critical communications, mobile voice and data communications that are going over wireless. That is the future. The new LTE networks that are being rolled out very aggressively here by the carriers, as well as the older networks that are vulnerable to power outages.
We believe that most of our customers have been very proactive in that regard in addressing the areas of the country where they certainly have power quality issues that are more prevalent. A more widespread regulatory approach to this could obviously accelerate that for us, our business on our C&I side dramatically, as we're one of the largest providers. Everything we've heard right now is it's kind of everything's in a little bit of a holding pattern till the FCC kind of figures out with the new chairperson what the priorities are going to be going forward.
That's great. Well, thank you very much for your time and best of luck, guys. Great quarter.
Great. Thanks, Stanley.
Your next question comes from the line of Tim Mulrooney representing William Blair. Please proceed.
Morning, guys.
Hey, Tim.
Hey, Tim.
I got a couple just real quick ones. First of all, going back to the geographic question, you got All Power, Ottomotores, and now Tower Light. After the close of Tower Light, what percentage of your sales will be outside of the U.S., and what would be an ideal target as you look out over the next several years?
Yeah, I think we're saying about 10%-15% of our sales will be outside the U.S. and Canada going forward. If you pro forma Tower Light into the operations there. Obviously, with the expectation for growth beyond that, and whether that growth is organically through the acquisitions we've made, through the introduction of new products and new customers, and being part of a more larger entity like a Generac, the benefit that we can give these entities like Ottomotores, Tower Light in particular, the benefit of scale, which we think is potentially significant when you look at some things like Tower Light in particular. As I said before, the ability to offer additional products to Tower Light's customers that they don't have today. They're very focused on a singular product line in light towers.
Going forward, right now, about 10%-15%, and we would expect to grow that even further. What's a comfortable position out there? I don't think we've quoted anything specific, but we like the opportunities that are ahead of us. It's a huge market worldwide for power generation, for mobile equipment in particular. We think there's a lot of potential opportunity ahead of us.
Okay, thank you. Lastly, in your outlook statement, you discussed an improved outlook in C&I shipments. Is that driven at all by an improved outlook for commercial construction markets, or is it more your infrastructure and telecom?
I think it's more the infrastructure and telecom piece, Tim. There is a piece. We've said we expect a little bit of improvement in the non-res construction indices here going forward, frankly, all indications are that still remains fairly soft, off of obviously a very low base over the last several years. The rental companies as well was part of our C&I growth, so the national accounts there, as they build out their fleets, replenish fleets, and add new products in like mobile generators. Like I said, we're getting some better traction there with our mobile generator line in those accounts. That's also a part of that C&I uptick that we're expecting in the second half.
Great. Thanks, guys.
Thanks, Tim.
Ladies and gentlemen, this does conclude the time we have for questions and answers. I would now like to turn the call back over to Aaron for any closing remarks.
Thank you. We really appreciate everybody's attention this morning for our second quarter call. We look forward to our third quarter call, which should be sometime in the late October timeframe. Thanks again for your time this morning.
Ladies and gentlemen, thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Good day.