Generac Holdings Inc. (GNRC) Q1 2012 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the First Quarter 2012 Generac Holdings Inc. Earnings Call. My name is Janeda, and I will be your operator for today. [Operator Instructions] As a reminder, this conference is being recorded for replay purposes. I would now like to turn the conference over to your host for today, Mr. York Ragen, CFO. Please proceed.

Good morning, everyone, and welcome to our first quarter 2012 earnings call. I'd like to thank everyone for joining us this morning. With me today is Aaron Jagdfeld, our President and Chief Executive Officer. We will begin our call today by commenting on forward-looking statements. Certain statements made during this presentation, as well as other information provided from time to time by Generac or its employees, may contain forward-looking statements and involve risks and uncertainties that could cause actual results to differ materially from those in these forward-looking statements. Please see our earnings release or our SEC filings for a list of words or expressions that identify such statements and the associated risk factors. In addition, we'll make reference to certain non-GAAP measures during today's call. Additional information regarding these measures, including reconciliation to comparable US GAAP measures, is available in our earnings release and SEC filings. I'll now turn the call over to Aaron.

Thanks, York. Good morning, everyone, and thank you for joining us today. We're pleased to report our first quarter 2012 results this morning, which we believe demonstrates our strong execution and the significant earnings power of Generac, as we recorded $294.6 million in net sales and $75.8 million of adjusted EBITDA for the quarter. Demand for our products increased to record levels following the multiple outage events that impacted the US during the second half of 2011 and was a large driver of our 138% year-over-year sales growth. Our ability to rapidly respond to this substantial increase in demand is a direct result of the efforts of our dedicated work force and our flexible operations. With the significant increase in production during the quarter, we were able to improve lead times for our products, allowing us to quickly fulfill the increased demand that occurred in the second half of 2011 and into the first quarter of 2012. With only 2.5% of US households owning a home standby generator, we believe last year's outage events have created significant awareness for this growing product category. As we've experienced in the past, we expect this increased awareness will accelerate the adoption of these products, leading to a new and higher baseline for home standby generator demand over the longer term. In addition to increased home standby sales, we also saw considerable strength in portable generator shipments as we continue to gain share in this market. Our success in portable generators after reentering this product category less than four years ago further solidifies our leading position in providing a full set of backup power solutions for the residential market. Also, while we are still in the early stages of both programs, we were encouraged by the first quarter results related to our recent residential product introductions of power washers and Honeywell licensed generators. In addition to executing on the significant increase in residential product demand, the Magnum Products acquisition also contributed to our year-over-year sales growth as end market demand for portable power equipment remained strong. With little to no overlap with Generac's products, distribution channels and end markets, the Magnum acquisition brings further diversification to our business while also providing cross selling opportunities for our sales teams. As we further integrate Magnum's operations, we are on track to achieve our cost synergy targets. We commented last quarter on our view that the Magnum acquisition will prove to be an attractive use of shareholder capital. And after two quarters under Generac's ownership, we continue to see Magnum as a complementary and strategic investment. Our significant organic revenue growth and the Magnum Products acquisition combined to drive a substantial increase in net income, earnings per share and free cash flow for the quarter. We have generated over $180 million of free cash flow over the last 12 months ended March 31, 2012. The free cash flow generation capabilities of Generac are what set us apart from many of our peers. Our attractive margins, efficient use of capital and favorable tax attributes have allowed us to significantly reduce our outstanding debt, as we have paid down approximately $166 million over the last six quarters. As a result of our strong free cash flows, we are also announcing a special cash dividend this morning of up to $10 per share. Our ability to return a significant amount of capital to shareholders is attributable to our strong conversion of EBITDA to free cash flow, which has led us to achieve our stated leverage target of 2X consolidated net debt to EBITDA. As part of this proposed special cash dividend, we plan to execute a recapitalization in which we intend to incur, subject to market and other conditions, approximately $650 million of additional debt to fund this special cash dividend. This special dividend will highlight for our shareholders the value of the cash flows from our business, and we are confident that our business model will allow us to accommodate this additional leverage. We believe the current financing markets afford us a cost effective and flexible source of capital to execute this transaction, and we believe our new capital structure will provide us with the flexibility to further invest in future organic growth initiatives as well as pursue additional bolt-on acquisitions that fit our strategy. I would now like to turn the call back over to York to discuss first quarter results in more detail. York?

Thanks, Aaron. As previously mentioned, net sales for the first quarter 2012 were $294.6 million, a 137.6% increase as compared to $124 million in the first quarter of 2011. On a pro forma basis when including the results of Magnum Products for the entire period, last 12 months net sales as of March 31, 2012, were $1.038 billion. Looking at net sales by product class, residential product sales increased 153.1% to $175.1 million in the first quarter of 2012 from net sales of $69.2 million in the first quarter of 2011. Generac once again experienced robust shipment levels of home standby generators as a result of the increased awareness of these products, caused by the multiple major outage events that occurred during the second half of 2011. As we have previously stated, the majority of our residential product sales relate to home standby generators. In the first quarter of 2012, we experienced significant year-over-year growth in shipments of these products through a combination of increased production rates along with continued strength in order rates in comparison to the prior year. As Aaron mentioned, as a result of our significant increase in production rates for home standby products during the first quarter, we were able to improve the lead times for these products, helping to fulfill the surge in demand, which followed the 2011 major outages. With regards to portable generators, we continued to see strength for these products during the first quarter of 2012 with strong double-digit growth versus prior year. We once again expanded our shelf space at retail with our portable generator product line, and as a result, we believe we expanded our market share and now hold a leading position for these products in the US market. Also contributing modestly to the revenue growth for residential products in the first quarter of 2012 was increased revenue from our power washer product line and our Honeywell licensed generators, which were first introduced in the first and second quarters of 2011. We continue to roll out distribution for these products, and we are encouraged by our progress to date. Looking at our commercial and industrial products, net sales increased 137% to $105 million in the first quarter of 2012 from $44.3 million in the first quarter of 2011. The increase in net sales was primarily driven by the Magnum Products acquisition, strong shipments of natural gas gen sets into the industrial dealer channel and increased shipments to industrial national account customers. In addition, net sales during the first quarter also benefited from the resolution of certain previously delayed shipments caused by a short-term shortage in the supply of certain components sourced overseas. As a reminder, there can be some variability in our C&I product shipments from quarter to quarter, primarily due to the timing of capital spending by our national account customers. With regards to Magnum, results during the first quarter of 2012 came in above our expectations as strong demand from energy and construction end markets continued. Key drivers of growth for Magnum include the replacement of aging fleets by rental equipment companies, the overall expansion of rental fleets due to an ongoing secular shift toward equipment rentals and continued market share gains with Magnum's mobile generator and mobile pump product lines. Looking forward, we expect to take advantage of future cross selling opportunities, as we have had some early successes with Generac's industrial national account customers purchasing Magnum's mobile generators, and we continue to attract a number of cross selling leads across sales teams. Our progress to date with the integration has been very favorable as we work towards our goal of achieving roughly $2 million in cost synergies. Much of the savings we are projecting will come primarily as a result of improved purchasing scale with certain components and commodities as well as from improved utilization and efficiencies in Magnum's operations. We will continue to realize these cost synergies throughout 2012 and remain on track to achieve the full realization on an annualized basis by the end of the year. Our other product sales category improved to $14.5 million in the first quarter of 2012, an increase of 38% from prior year first quarter sales of $10.5 million. As a reminder, this product category is mostly comprised of the sales of aftermarket service parts as well as loose engines to lawn and garden OEMs. The increase in the other product category primarily relates to the contribution of parts revenue from the Magnum acquisition, elevated service parts sales as a result of focused initiatives to drive increased parts sales to our distribution partners and increased parts demand that was generated by the major outage events that took place in recent quarters. Gross margin for the first quarter of 2012 was 37.7%, compared to 36.8% in the fourth quarter of 2011 and 38.1% in the prior year first quarter. The mix impact from the addition of Magnum Products sales reduced total company gross margins by almost 200 basis points during the first quarter of 2012 as compared to the first quarter period last year. Mostly offsetting this decline, gross margin during the first quarter was impacted favorably by a higher mix of home standby generators and a lower mix of portable generators. In addition, the positive impact from price increases implemented throughout 2011 and improved overhead absorption during the current year quarter was largely offset by higher commodity costs relative to the prior year. Operating expenses for the first quarter of 2012 increased by $15.5 million or 43% as compared to the first quarter of 2011. These additional expenses were driven primarily by increased variable operating expenses on a substantial increase in organic sales, operating expenses associated with Magnum, increased sales, engineering and administrative infrastructure to support the strategic growth initiatives and higher baseline sales levels of the company and increased incentive compensation expenses as a result of the company's financial performance during the quarter. Adjusted EBITDA increased to $75.8 million in the first quarter of 2012 as compared to $27.5 million in the same period last year. Pro forma for the Magnum acquisition, when including the results for Magnum for the entire period, last 12 months adjusted EBITDA as of March 31, 2012 was $245.9 million. GAAP net income for the first quarter of 2012 increased to $30.1 million compared to $4.8 million for the first quarter of 2011. It is important to note the first quarter of 2012 includes a more normalized GAAP tax rate of 38.8% as compared to a tax rate of 1.9% in the prior year first quarter. As previously discussed, prior to the fourth quarter of 2011, a full valuation allowance was recorded with regard to the company's net deferred tax assets, resulting in a nominal effective tax rate. As was first the case in the fourth quarter of 2011, a full valuation allowance is no longer required with regard to the company's net deferred tax assets, and therefore, a full income tax provision was recorded in the first quarter of 2012. We expect to have a normalized tax rate in the 38% to 40% range going forward, given there is no longer a valuation allowance to offset. More importantly, we will continue to experience significant cash tax savings from our favorable tax attributes, which include a step-up in asset basis and NOL carryforwards relating to the 2006 change in control transaction, and to a lesser extent, the recent Magnum acquisition, which are expected to generate significant cash tax savings into the future. As a result, we believe we will not be paying federal income taxes for the foreseeable future, which is the reason we are only reflecting cash taxes in our adjusted net income calculation. Adjusted net income, as defined in our earnings release, increased to $66.1 million versus $17.1 million in the prior year first quarter. The substantial improvement in adjusted net income is attributable to improved operating earnings during the quarter resulting from the 137.6% increase in revenue, including the incremental results from the Magnum acquisition. Interest expense in the first quarter of 2012 declined to $5.7 million compared to $6 million in the same period last year. The slight decline in interest expense was the result of approximately $82 million in debt prepayments over the last 12 months, mostly offset by a modest increase in the weighted average cost of capital, cost of debt. Diluted earnings per share for the first quarter was $0.44 compared to $0.07 per share in the first quarter of 2011. Adjusted diluted net income per share, as reconciled in our earnings release, was $0.96 for the current year quarter compared to $0.25 per share in the prior year quarter. Free cash flow, defined as net cash provided by operating activities less capital expenditures, was $36.4 million in the first quarter of 2012, which was up significantly from $11.1 million in the same period last year. Strong operating earnings were partially offset by increased working capital investment, driven by the replenishment of inventory levels to support higher production rates and seasonal build requirements. Inventory was purchased during the first quarter to support the significant increase in production for home standby generators. In addition, as we prepare for the upcoming summer storm season, we are replenishing finished good inventory levels that were depleted in the second half of 2011. Free cash flow over the past 12 months was $183 million, representing 93% of the adjusted net income reported during that time period. As we announced today, the company is pursuing a recapitalization to fund a special cash dividend to shareholders. Before discussing further details about the transaction, we wanted to review our current capital structure and recent trend in leverage ratios. Looking at our capital structure as of March 31, 2012, we had $573.7 million of term loan debt outstanding, net of unamortized original issued discount, and $91.7 million of consolidated cash and cash equivalents on hand, resulting in consolidated net debt of $482 million and a consolidated net debt to LTM adjusted EBITDA leverage ratio of 2X. This compares to a 3.7X net debt leverage ratio at March 31, 2011. Historically, we have demonstrated the ability to pay down debt through our strong free cash flow generation. Specifically, total debt has been reduced by $156 million during the past six quarters using cash on the balance sheet, resulting in a significantly improved leverage ratio. The company's net debt to adjusted EBITDA leverage ratio has declined from 4.1X at the end of the first quarter of 2010 to 2.0X by the end of the first quarter of 2012. I'd now like to provide some additional details regarding our announcement of a proposed special cash dividend to shareholders. We are currently pursuing a recapitalization in which we intend to incur, subject to market and other conditions, approximately $650 million of additional debt to fund in large part the special cash dividend of up to $10 per share on our outstanding common stock. As part of this transaction, we expect to enter into new debt financing in the aggregate amount of approximately $1.2 billion, which is expected to be comprised of approximately $800 million of senior secured debt and the remaining in senior unsecured financing. The proceeds from the new debt financing will be used to pay the special cash dividend and to refinance our existing credit facilities. In addition, we anticipate our current $150 million unfunded revolver will be replaced with the similar-sized asset-backed revolver. The declaration of the special cash dividend is conditioned upon obtaining new debt financing under acceptable terms. We currently expect our Board of Directors will declare and authorize payment of this special cash dividend before the end of the second quarter of 2012. Given our strong free cash flow conversion, which includes minimal cash taxes from our significant deferred tax assets, we're very comfortable in our ability to continue funding our growth initiatives while also servicing our debt. With that, I'd now like to turn the call back over to Aaron to provide some additional comments with regards to our 2012 outlook.

Thanks, York. Primarily as a result of our increased full year outlook for residential sales, we are revising upward our guidance for full year 2012. Previously we were forecasting net sales to increase at a mid to high teens rate as compared to 2011. We now expect that total net sales will increase at the high end of this range, growing at a projected high teen's rate as compared to the prior year. Our revised guidance continues to assume no material improvement in the macroeconomic environment and no comparable major outage events during the balance of this year. Specifically, for the second quarter of 2012, total net sales on an as-reported basis are forecasted to increase between 35% and 40% in comparison to the second quarter of 2011. As we commented during our last call, lead times for home standby generators at the end of the fourth quarter of 2011 extended out as far as 8 to 10 weeks for most of our most popular models. The accelerated ramp in our production rates for home standby generators since the beginning of the year, coupled with a mild winter, which enabled the installation of these products to continue throughout the season, has helped to bring lead times at the end of the first quarter down to approximately three to four weeks. Looking forward, we expect demand for home standby generators to remain strong over the next several quarters relative to the most recent comparable periods with no major outage events. This expectation is due to the afterglow the company historically experiences after major power outages as homeowners look to protect themselves from future outages. As the initial surge in demand levels off, we believe that the awareness and additional distribution points added will create a new and higher baseline level of demand for home standby generators as we move towards the second half of 2012. Increased awareness of home standby generators, combined with the more targeted approach to finding prospective buyers for these products as well as greater distribution, are all contributing factors to the baseline growth of this product category. As a result, total company net sales for the second half of 2012 are expected to increase at a high teen's rate in comparison to the previous baseline level experienced in the second half of 2010, which again is the most recent comparable period with no major outage events. For reference, total company pro forma net sales for the second half of 2010 were $370.4 million. Consistent with our previously issued guidance, gross margins are expected to be approximately flat during 2012 compared to the prior year. The unfavorable mix impact of adding Magnum Products is expected to be offset by a higher sales mix shift toward home standby generator shipments and a lower mix of portable generators. Additionally, the realization of price increases, improved manufacturing overhead absorption, commodity cost moderation and cost reduction projects should also impact gross margins favorably throughout the balance of 2012. In line with our previous guidance, as reported consolidated operating expenses as a percentage of net sales excluding amortization of intangibles are expected to be slightly higher as compared to 2011 as we continue to invest in our infrastructure to support our strategic growth initiatives and our overall higher level of sales. As a result of this revised outlook, adjusted EBITDA for the full year 2012 is now expected to increase in the mid-teens range compared to 2011. While second quarter 2012 adjusted EBITDA is expected to increase in the mid-20% range over the comparable period prior year. In closing, we believe our first quarter results clearly provide a tangible example of the significant earnings power of Generac's business model. We have continued to grow revenues through product innovation, expanded distribution and increased awareness of home standby generators. Our powering ahead strategy, which we implemented less than two years ago, has served as a template for our investments in the company. In addition to our accomplishments over the last several quarters, we continue to make important progress on a number of our powering-ahead-related initiatives that we expect will drive our longer-term growth. These initiatives are linked to each of the four strategic objectives of growing the residential market, gaining share in the commercial and industrial market, diversification through new products and services and expanding our geographic reach. In addition to our powering ahead initiatives, we believe we are well positioned to capitalize on the powerful macro growth drivers for our business. In particular, prolonged underinvestment in the aging electrical grid in the United States is leading to more frequent and longer power disruptions for homeowners and business owners. With the broadest product offering in the industry, we believe Generac is well positioned for the longer-term opportunities that will result from the continuing increase in demand for backup power. Our leadership position in natural gas generators in particular is allowing us to capitalize on the secular trend away from diesel-fueled units and towards cleaner burning, more cost-effective natural gas fueled solutions. Add to these macro drivers a potential future recovery in residential investment and non-residential construction, and we believe our prospects for growth are very compelling. This concludes our prepared remarks this morning. Thank you again for joining us. At this time, we'd like to open the call up for questions. Operator?

Thank you. [Operator Instructions] Your first question comes from the line of Zack Larkin with Stephens.

This is Chris Godby in for Zack Larken at Stephens. So first of all, the $370.4 million number, that was for the second half of 2010 pro forma including Magnum, correct?

Correct.

Okay. Great. And then looking ahead for the remaining three quarters of this year, how should we maybe think about seasonality this year? Will you expect it to follow typical patterns that you've seen in the past?

I think that’s, Chris, how we're viewing it. In years without a storm – or, excuse me, in years after a year of storms like we had last year, we typically see seasonality take a little bit different track with the first half of the year being more robust than the second half. And that of course is assuming that there are no major comparable events in the second half of this year.

I think our guidance for second quarter, talking about second quarter being up 35% to 40% compared to second quarter of 2011, that's sort of gives you some guide as to how that's playing out. And then I think the second half statements in terms of that new and higher baseline compared to similar periods without outages, again, that’s – again, those forecasts are assuming no major outages for the balance of 2012. Our guidance would indicate how that would play out.

Okay. Great. That makes a lot of sense. And then can you talk a little bit more about how the mild winter affected you in the quarter? It seems like maybe we had a little bit of a pull forward affect in terms of installations. Can you maybe talk about that a little bit more?

I think there's probably two ways to look at the mild winter. Certainly from an installation standpoint, our distribution was able to get out in areas of the country like the Northeast and the Midwest, where typically in January or February, it would be awfully difficult to install these products. So we traditionally see installs slow down at that time of the year. But with the winter playing out the way that it did, distribution was able to continue to install, and therefore, we believe, worked down their own backlog internally, if you want to think of it that way. If they had orders that they had taken and they were waiting to install product. At the same time, we had ramped up our production very aggressively, and so the combination of us ramping up our production very aggressively in Q1 and the combination of the installers and distribution being able to continue to put those products into the field, we were able to work down the lead times very quickly. Again from that 8- to 10-week range at the end of the year to something in the 3 to 4-week range. That’s the one side of the answer, Chris. The other side of it is, obviously, with a mild winter, although we were able to increase our portable generator sales at a good clip year-over-year in terms of first quarter numbers, a lot of that was due to some pickup in shelf space that we had and some pipeline fill coming off of the strong second half of last year. But right now, inventories are at a pretty good level, I would say, going into the season. Normally at this point, retailers may be looking at restocking more aggressively out of the season because if normal winter weather plays out, they generally have regions of the country where they're depleted in inventory as a result of winter weather. But that of course didn't happen this year.

Okay. Great. And then one final question for you. Can you maybe discuss the competitive environment you're seeing right now? In particular, can you maybe give us an update on what you believe your market share in your end markets currently?

Sure. As we stated on the residential standby side, we believe our market share remains in the 70-percentile range. It's a market that there's not a lot of tracking information out there, so those are management estimates, of course, but pieced together, we think, to the best of our ability. On the portable generator side, as we've stated in our prepared remarks today, we do believe over the last several quarters we've reestablished ourselves as the number one market share player in the US market for portable generators. We believe the market share, depending on what report you look at, is anywhere between 20% and 25% in terms of share. And you can look at it. It's a little bit different from units to dollars, but it's roughly in the same range, in that 20 to 25-percentile range. On the C&I side of our business, if we just look at total C&I kind of ex-Magnum here for a second, we believe that in the stationary products market, our market share is somewhere in that 12% to 15% range. And then Magnum holds a leading share position in North America in light towers. Again, we've publically stated that that’s somewhere in the 30%-plus range, and they're an up-and-coming player in the mobile generator and mobile pump space.

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

Good morning. I'm wondering, gentlemen, if you can give us an update on your product development plan on the industrial and natural gas generator product line? Any size range or extensions that you're considering. And also I'm wondering if you could give us some more context on the rising interest level your citing in natural gas over diesel generators for these applications? Perhaps quantify that with order rates and inquiries so far this year.

That's a good question, Jerry. Natural gas, obviously, has come to the forefront here most recently. We've been very focused on that niche end of the market for the last 20 years. So I guess we're finally in vogue when it comes to nat gas. We've developed a lot of technologies and a lot of capabilities around natural gas, not only on the residential side, clearly, where we dominate that space. But also in the light commercial and the industrial space, where we've continued to see, as you mentioned, as we mentioned in our prepared remarks this morning, kind of a long-term secular shift that is starting to accelerate somewhat here towards natural gas. A lot of that shift is occurring as a result of diesel products becoming frankly higher priced. Diesel engines have become much more complex due to the regulatory environment over the last seven to eight years. And it's not that natural gas gen sets or any less clean or less complex, it's just, frankly, the fuel source that it starts out is cleaner than diesel is. And as it's cleaner, it needs less pretreatment and less after treatment in terms of what we need to do with the emissions of the equipment. So what we're seeing in our own product line, in terms of product development, we've got the largest natural gas product line in the industry. We continue to add positions to that both on the topside of that product line in terms of going larger into C&I, as well as down in the light commercial space, where we've made a number of changes to our product relative to the engines that power those products around certain engine ranges where we are now the manufacturer of certain of those engines. So that's changed for us here recently in the last couple of years. And we believe gives us an improved position as it relates to supply and also cost position in many of those products. I think as far as trends, what we've seeing here, again, we've been seeing a long-term shift. But that is beginning to accelerate and, as we've said, the long-term growth rates for gas sets we believe is spark ignited, as it's referred to in our industry, we believe are going to continue to grow at a rate that outstrips that of diesel. Natural gas, you don't have the storage issues that you have with diesel. You've got first piece costs that, in a certain range of products, you get underneath kind of under 200 kilowatt and smaller products that you'd use in light commercial applications like small footprint retail stores, restaurants, C stores, bank branches, health clinics, things of that nature. The first piece cost advantage over natural gas over diesel is sometimes as much as 25% or 30% of the cost of the machine. So that clearly, from a return on investment standpoint for a business, makes a natural gas powered generator a pretty attractive investment.

And, Aaron, on the second part of the question, can you just quantify the year-to-date quarter growth for nat gas powered industrial gen sets versus diesel for your business?

We haven't traditionally broken that out, Jerry, but that's something that, again, we point to the longer-term trend are greater for gas then they are for diesel. That would apply in the short-term as well. You're seeing that in our results, exactly.

And, York, what were your Magnum construction equipment sales in the quarter? And what does your sales guidance imply for the Magnum business for the year?

I guess what I could say is about, if you look at our growth for the total company, 137.6%, about maybe a quarter of that was related to Magnum. So you could get some idea in terms of organic versus Magnum growth. And we're not necessarily breaking out specifically our outlook between Magnum and Generac, but I think from a C&I standpoint, I think we said last quarter that both Generac and Magnum C&I product sales would grow at a similar pace in 2012 from an outlook standpoint.

And, York, I guess since them we've seen some much more positive CapEx announcements out of your rental customers, so I'm wondering if you've revised your guidance to reflect that.

I don't think specifically. Jerry, we talk to those guys quite a bit, and so our forecast, our numbers earlier in the year certainly contemplated that the rental companies were going to be fairly aggressive in CapEx. Obviously with the United Rentals purchase of RSC, that's given us pause here to kind of reevaluate -- RSC was not a strong customer of Magnum, so there may be some additional upside opportunity for us there. We're sorting through that and trying to understand just kind of how the procurement landscape is going to fall out once the consolidation and integration is completed in that acquisition.

Your next question comes from the line of Christopher Glynn with Oppenheimer.

I had a question on C&I sort of underlying trends and run rates since it seems like the guide has some deceleration. At least approaching an elegist [ph] to residential. So I was just wondering how much you think backlog resolution contributed in the quarter. And also, what do you think the awareness impact was on the C&I segment? We haven't really talked about that.

Let me touch that first, Chris. The awareness in the C&I, there's a much longer tail on that. Homeowners tend to react quicker than businesses do. For businesses, the purchase of a generator tends to be a little bit more involved, a little more thought out, and there are obviously budgetary cycles and things that you have to work through with businesses that you don't necessarily have as top of [ph] constraints with homeowners on. If a homeowner wants a generator for their home after an outage, they're going to go out and figure out how to get one. Businesses are -- it's a little bit longer tail to that. So as the afterglow for businesses, our history and our perspective on that is that, that will tend to trail a little bit longer than will the homeowner piece. The homeowner piece is going to be a little bit more immediate, and the C&I side will experience some of that, in the Northeast in particular here, probably over the back half of this year into 2013. And maybe even a little bit longer. What it really does is it highlights for certain of our national account customers where they have weaknesses in their operations in certain regions of the country. So some of our telecommunications customers in particular, they've focused on building out their networks in the northeast because there are obviously large population concentrations there. And so where they saw power outage interruptions from the events last year, they may decide to elevate their CapEx spending more geared towards projects in those regions around backup power. I don't think -- we're probably not really reflecting too much of that yet because again it’s a slower -- it's a little bit slower tail. I would also remind you that when you look back at the second quarter of last year for C&I, as we've said here, our results can be a bit lumpy as it relates to C&I because of our national account customers' purchasing habits. So we saw last year in CapEx spending for those national account customers in the second quarter was a little bit of a -- there was some projects that rolled out that we don't necessarily think will repeat this year. So that might be part of the deceleration you're seeing relative to the residential results that we're talking about. As far as the impact of the resolution of the first part of your question, the impact of the resolution of the backlog issue related to the component supply chain, we had a Japanese supplier that had issues after the tsunami last year. Really about maybe $5 million to $6 million of the C&I sales in Q1 would be related to the resolution of that issue.

Okay. And then on the production levels you hit in the quarter, pretty impressive. Did you have to engage in any contract manufacturing or anything like that?

On the home standby generators side we did not. We have a very flexible operation here. We pride ourselves on that. And every once in a while, when you get events like this, you get to test out just how flexible you are. I was incredibly impressed with our operations team, and in particular our supply chain team. And we have a very deep supply chain group here in terms of competencies in what we do. And the ability to -- and it's not just us going out and hiring people to ramp up our operations here in Wisconsin. It really is -- that same effort has to get repeated throughout supply chain. And some of that supply chain obviously extends overseas as well as domestically here. And it's a lot of coordinated effort, and it really outstripped our expectations, to be frank. That coupled with the ability of distribution to continue installing products throughout the first quarter we think had a pretty material impact on the results. And you see that in the lead times really compressing down probably further than we were expecting them to compress. And really, due to just our outstanding execution as it relates to Q1 production ramp.

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

Just on the special dividend, can you just talk about the rationale for the magnitude and just how you're thinking about leverage profile going forward? And then, if you can give us any kind of sense of what you're thinking in terms of financing cost?

Yes. Absolutely. I'll take the first part of the question, and I'll let York take the financing cost question. But obviously, it's all tied together. The magnitude of the special dividend, Jeff, we analyzed a number of different scenarios and looked at really what is -- I'll step back a second. We've said from a prioritization of the uses of our cash, in the past we've said we wanted to focus on prioritizing cash towards paying down debt. And we had a [inaudible] leverage target out there to be in that kind of 2X -- really we said 2X to 3X range on a consolidated net debt basis to EBITDA. And frankly, we hit that. We achieved it very quickly here in the last couple of years, and we got to that point this past quarter and it just made sense to reevaluate our uses of cash. In terms of the magnitude of the dividend, we thought that -- one of the things that we thought we needed to do was find a better way to highlight the free cash flow of this business for our shareholders and really bring that discussion to the forefront. We have some really unique attributes in this business. And they extend from obviously our -- the margin profile of the products that we sell to the capital efficiency or the efficiency with which we deploy capital of the company. And probably even more important is the tax attributes that we've got, that were generated back in the transaction back in 2006. I think that in order to really evidence the impact and the power of the free cash flows of this business, we felt that some amount of special dividend would help us do that. The right amount, you can pick a range. But we settled on $10 because we felt that, that, from a leverage profile standpoint -- and it's 5X leverage, but I think when you look at 5X, I think you have to put that in -- I think you have to put that in perspective as it relates to analyzing that against a peer group of industrial technology companies. I don’t think it's fair to say that 5X leverage for Generac is necessarily translated into the same leverage ratio for other similar businesses because of the tax attribute. I would say that's probably the primary thing that I don't think exists in other companies. So I think when you look at that and our ability to convert our EBITDA to free cash flow -- 93% here in the last 12 months. I think it's -- that strong free cash flow conversion is, again, you put all that together and we've very comfortable with that 5X leverage, and we're going to work that back down again. And we think -- our forecasts here are we're going to continue to prioritize towards paying down debt. We also wanted to leave ourselves in the new capital structure the flexibility to do a lot of the aggressive things that we're doing right now. We're growing very aggressively organically and from bolt-on M&A as well with deals like Magnum. We wanted to continue to be able to do those things going forward. I guess, York, if you want to tackle the…

Yes, I think from a cost of debt standpoint, I think today's financing environment is very attractive, and that's another -- in terms of you asked about the rationale for this transaction. That sort of plays into the rationale as well. And from a cost of debt standpoint, we believe we could get this transaction done for approximately 7% overall cost of debt, which again is an attractive rate in this environment.

Okay. Great. So essentially, you go back to 5X and then you focus on deleveraging again, or assess it in the future.

Right. I think the way we're thinking about it is, we're just resetting our priorities. We sort of achieved our priorities, and now we're resetting them, if you will.

Okay. Great. And then can you give us the Magnum revenue contribution in the quarter?

Yes. That was, I think I had referred that to our -- of the 137.6% growth year-over-year, about 25% of that came from Magnum. 25% of the 137.6%.

Okay. That's overall.

Overall total company, as reported.

Okay. Great. So if we look at 2Q, because I'm just trying to understand maybe what was pulled forward, you don't have a particularly tough comp until 3Q, 4Q. And if we back out Magnum coming in, it seems like the core growth is, what, 10% to 15% into 2Q? That seems pretty modest for, given the trends you've kind of been seeing.

I think Aaron alluded to exceeding our expectations in terms of the production levels and bringing lead times that we referred to. Aaron also talked about some of this -- how some of our sales from our industrial national account customers can vary from quarter to quarter. So on the C&I side you've got that coming in the second quarter…

Yes, there's a little bit tougher comp coming in the second quarter because of that last year, that some of those projects are -- they're probably not going to repeat to the same level that they did last year.

Still I think resi growth is still showing strong year-over-year in the second quarter.

I do think if you think about it, Jeff, in terms of quarters, Q1, again, as we said, we really were able to ramp up production very quickly and bring our lead times down, probably beyond our expectations initially in Q1, just given the flow through of the product at the end market through distribution and then also our ability to ramp up and execute.

Okay. Do you have a sense of how much the weather and kind of restock pulled forward in the residential business similar to the quantification you called out on the commercial side?

As it relates to home standby generators, not much. I mean, there's not much of a restocking effort because there's not much stocking that goes on in that category. There is some, but it's not dramatic. I would say that again our comments on portable generators before would probably be -- there's obviously a piece of what happened in Q1 that went to restocking. We also had some new customers that we added in the first quarter for portables that rolled out. So there's a piece of that, that is offsetting probably what would be more of an underlying weakness related to not having had much in the way of outage events in Q1 that would impact our portable demand.

Okay. But on home standby, you got some help from mild weather and installations.

And installations.

How would you characterize lead time -- I mean, is there still catch-up on home standby? Or have you caught that up because of the milder weather?

Our lead times are pulling in a little bit further now. We're back down to our normal lead times of inside of two weeks. So we were three to four weeks at the end of the quarter. So there's a little bit more pull in here that's occurred as we've kind of caught it really back to our kind of stated lead times of inside of two weeks.

Your next question comes from the line of Tim Mulrooney with William Blair.

I'm calling in for Brian Drab. We just -- most of our questions have been answered, but one thing I was looking at is the gross margin. And I know that you guided to flat gross margin in 2012. But as you work to improve the operations at Magnum, do you think that you can kind of get back to the levels that you saw in 2009 and 2010? Or is this more the structural gross margin that we should be looking at going forward?

I think just -- I think we talked about how Magnum, when you layer Magnum on top of Generac, initially in the outset, it was around 250 basis point impact, and as we execute on the $2 million of cost synergies, that should compress that a bit. But I wouldn't expect to make up that entire amount. So I think maybe to answer your question, that would be -- where we're at today would be more indicative of ongoing. More of a mitral [ph] and mix standpoint.

Okay. That's helpful. And then just one last thing. I noticed that your G&A was down quite a bit on a sequential basis. Is that because the fourth quarter had a few one-time things going on? Or is this first quarter G&A kind of representative of what we should expect for the rest of the year?

Well sequentially, I guess it's off a little bit. But I think there's incentive [ph] comp in there as well as we've been adding infrastructure to support our growth initiatives. So I think those are a large part of the drivers. As well as the variable costs and whatnot. And Magnum rolling in, in the fourth quarter had a piece of it too.

[Operator Instructions] Your next question is a follow-up from the line of Jerry Revich with Goldman Sachs.

Just a couple of follow-ups. I'm wondering if you could say more about the power washer contribution in the quarter and what type of sales run rate do you expect for that business as we exit the year?

Yes. That business, Jerry, as you know, this would be our first kind of season, right? We kind of launched those products last year. We introduced them in roughly the end of the first quarter, beginning of the second quarter last year and began to shop them around to customers, and we did have some customers take those products. It was a pretty modest contribution here in Q1 still. But we like the trajectory of that business, but remember, there is some seasonality there. It's primarily -- it really is kind of a Q1, Q2 game in terms of power washers. There could be some more -- a little bit maybe around certain events like Labor Day and as you get into the holidays. But primarily, it's a spring season type of product. You can think of it more of a lawn and garden type of pattern for seasonality-wise. We're very pleased with our placement there so far. The products have been incredibly well received by the end market. A lot of retailers, a lot of big retailers, already had their season set this year and set without us. And so where we've been -- we've been kind of nibbling on the edges. We have gotten some placement in certain parts of the country with certain of those large retailers. But we're still kind of working through kind of one-off promos to test the products and see how they perform with some of those retailers. And we're in the middle of line reviews right now for next year. And we're pretty excited about the prospects for that business going forward. It's a tough market. It's a competitive market, but we think we've got some innovation there that we're bringing to that market that we believe, for the longer-term, we think we're going to be a player there.

And so based on the line reviews that are complete so far, what's your ready market position that’s in hand heading into next year? And what's the range of upside if the reviews go as you plan and hit your targets?

I haven't sat and scribbled out a range of reviews. We're not going to give guidance for 2013 on the call. But I do think that it's -- we're kind of in the single-digit market share right now. Very low single-digits. And we're growing. There are a couple of manufacturers out there that dominate the space, and we have our work cut out for us to be a worthy competitor there. So they're not going to roll over and just give us the market. We do think we're going to have to prove our worth for the end consumer in terms of bringing innovation and feature sets to the marketplace that consumers feel are worth paying for and worth putting the Generac brand in their garage. So that's something that, as we work through the year, I think we'll be able to provide a little bit more clarity into that. But right now, there really aren't many of the line reviews that are complete, so I think it'd be pretty premature for us to comment on that.

Okay. And for the residential standby business, can you give us an update on the distribution. You've had a number of training programs over the past couple of quarters in the Northeast. I'm wondering if you could give us a distribution count update? And also, have you been able to make progress on the Honeywell branded generators, or has it been too tough because of the focus on their core business during the install season here?

Yes. Absolutely. So the first part of the question, Jerry, the residential distribution we've done – obviously, when you get events like we had out east, the other thing that happens in addition to the demand increase for the product is also we get quite a few interested parties in being dealers for the company. And so we have expanded our distribution very nicely in the first quarter of this year. Probably from an inflection point beyond what we would normally go [ph] in terms of a trend, beyond what we would normally see this time of year. So right now our distribution is approaching 4,500 dealers at the end of the quarter. And so that's up from -- we were at over 4,200 at the end of the year, so we've added -- and that's on a net basis, that add. So that has been a nice area for us, and we believe there's going to be – again, part of our comments about this new and higher baseline that gets developed is around adding points of life to points of distribution for the product category because it's so underpenetrated. And so we think that that's a key component of that, and so we're really excited about that. A lot of the training programs that we've done, we've had to really accelerate even further because we've added distribution so quickly. So we've been scrambling, and again, to add the infrastructure here at the company to support more dealers through more dealer development effort, through more training. We've got some really cool programs for our dealers that we rolled out here recently at the beginning of the year at our dealer forums, and we're really excited about where that's going to take our dealer base going forward in terms of making them more successful at selling the product and really identifying where opportunities are for sales. On the Honeywell side, that program also we mentioned in our prepared remarks, but that program's done quite well for us. We found that the HVAC space, which is what we're really targeting with that Honeywell brand is an area that's ripe for opportunity relative to the number, the sheer number of dealers and distributors in that space that could use a product category in addition to their heating and cooling products. So it's been very popularly received, obviously in parts of the country like the Northeast that have experienced outages where demand is higher. We are seeing a nice uplift with those products.

And at this time we have no further questions. I would now like to turn the call back over to Aaron Jagdfeld for any closing remarks.

Again, we appreciate everybody's time this morning. And we look forward to speaking to you on our second quarter call. Thank you very much.

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