Generac Q2 2023 Earnings Report

Generac EPS Results

• Actual EPS: $1.08
• Consensus EPS: $1.16
• Beat/Miss: Missed by -$0.08
• One Year Ago EPS: $2.99

Generac Revenue Results

• Actual Revenue: $1,000.00 million
• Expected Revenue: $979.51 million
• Beat/Miss: Beat by +$20.49 million
• YoY Revenue Growth: -22.50%

Generac Announcement Details

• Quarter: Q2 2023
• Date: 8/2/2023
• Time: Before Market Opens
• Conference Call Date: Wednesday, August 2, 2023
• Conference Call Time: 10:00AM ET

Generac (NYSE:GNRC) is an energy technology company that designs and manufactures power generation and energy management products. Its portfolio includes residential standby generators, portable generators, commercial and industrial generator systems, and related transfer switches, controls and monitoring technologies.

The company also offers clean energy and electrification solutions, including battery energy storage systems, solar-related products, electric vehicle chargers and load-management technologies. Generac provides installation, maintenance, monitoring and other support services through its distribution and dealer networks.

Founded in 1959 by Robert Kern, Generac is headquartered in Waukesha, Wisconsin. The company serves residential, commercial, industrial and other customers in the United States and international markets, primarily through independent dealers, distributors, retailers and direct sales channels. Aaron Jagdfeld has served as Generac’s president and chief executive officer since 2008.

Generac Q2 2023 Earnings Call Transcript

Key Takeaways

• Q2 net sales declined 23% year-over-year to $1.0 billion, led by a 44% drop in residential product sales amid softer consumer spending.
• Global C&I product sales grew 24% year-over-year to an all-time quarterly record, driving an upward revision of full-year C&I growth to the mid-teens.
• Elevated field inventory and lower-than-expected home standby close rates have extended the residential inventory normalization into H2, pressuring shipments.
• Full-year guidance cut to a 10–12% overall sales decline and 15.5–16.5% adjusted EBITDA margin, down from prior mid-single-digit sales decline and 17–18% EBITDA outlook.
• Ecobee smart thermostat sales hit an all-time quarterly high, and a smart doorbell camera launch is scheduled for H2 to bolster the home energy management platform.

Presentation

[Operator]

Good day, and thank you for standing by. Welcome to The Second Quarter 2023 Generac Holdings Inc. Earnings Call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question-and-answer session. To ask a question during the session, you will need to press star one, one on your telephone. You will then hear an automated message advising your hand is raised. To withdraw your question, please press star one, one again. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Mike Harris, SVP, Corporate Development and Investor Relations. Please go ahead.

[Mike Harris, SVP of Corporate Development and Investor Relations at Generac Power Systems]

Good morning, and welcome to our second quarter 2023 earnings call. I'd like to thank everyone for joining us this morning. With me today is Aaron Jagdfeld, President and Chief Executive Officer, and York A. Ragen, Chief Financial 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 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.

[Mike Harris, SVP of Corporate Development and Investor Relations at Generac Power Systems]

Additional information regarding these measures, including reconciliation to comparable U.S. GAAP measures, is available in our earnings release and SEC filings. I will now turn the call over to Aaron.

[Aaron Jagdfeld, President and CEO at Generac Power Systems]

Thanks, Mike. Good morning, everyone, thank you for joining us today. Our second quarter net sales were in line with our prior expectations as stronger than expected C&I product shipments offset residential products, which were lower than expected as a result of a softer consumer spending environment that impacted shipments of Home Standby generators and Chore products. This had an unfavorable mix effect on gross margins, resulting in slightly lower Adjusted EBITDA margins than previously expected. Year-over-year, overall net sales decreased 23% to $1 billion, quarter sales declined 26% during the quarter. Residential product sales decreased 44% as compared to a strong prior year quarter that benefited from significant excess backlog reduction for Home Standby generators.

[Aaron Jagdfeld, President and CEO at Generac Power Systems]

The current year quarter continued to be impacted by elevated levels of field inventory for Home Standby generators, as well as a decline in clean energy product shipments year-over-year. Global C&I product sales increased approximately 24% to an all-time quarterly record, with broad-based growth across nearly all regions and channels. Adjusted EBITDA margins were negatively affected by the significant unfavorable sales mix, as well as reduced operating leverage, driven by lower Home Standby shipments and continued investments for future growth. Importantly, continued favorable price cost dynamics have created a meaningful margin tailwind, providing a partial offset to the unfavorable sales mix.

[Aaron Jagdfeld, President and CEO at Generac Power Systems]

Second quarter Home Standby shipments grew at a strong sequential rate, but declined significantly on a year-over-year basis as the second quarter of 2022 included the reduction of excess backlog, and we continued to meaningfully undership end market demand in the current quarter as we focused on further reducing field inventories of Home Standby generators. Baseline power outage activity in the U.S. was well above the long-term average, but meaningfully weighted toward the final weeks of the quarter. Home Consultations or sales leads were roughly flat from the prior year period and increased sequentially off an unseasonably strong first quarter. Additionally, Home Consultations during the second quarter were still more than 4x higher than the second quarter of 2019. Further supporting our view that consumer interest in the product category has achieved a new and higher baseline level.

[Aaron Jagdfeld, President and CEO at Generac Power Systems]

Our residential dealer count returned to sequential growth in the quarter, ending at approximately 8,700, an increase of 500 dealers from the prior year. We continue to invest in growing the installation capacity of our channel partners, and we are making good progress towards our initiatives to increase dealer count, train non-dealer contractors, streamline the installation process, and raise Home Standby category awareness across trade groups. We believe these efforts are important to the longer-term growth trajectory of the product category as the megatrends that support the demand growth outlook remain firmly intact. Activations, which are a proxy for installs, improved sequentially over the first quarter, but declined from a strong comparable period in 2022, that included the benefit of a backlog of installations in certain regions during the prior year.

[Aaron Jagdfeld, President and CEO at Generac Power Systems]

Activations were also below our prior expectations for the quarter, primarily due to the weaker consumer spending environment for home improvement. But despite this relative softness, activations during the quarter were more than double second quarter 2019 levels. Close rates were flat sequentially and remained meaningfully higher than the comparable period of 2022, but underperformed our expectations as a result of the shifting consumer spending patterns. The number of Home Standby generators and field inventory further declined in the quarter, while days of field inventory relative to historical norms also decreased sequentially. However, with close rates and activations lower than expected in the quarter, the field inventory normalization process is now expected to extend further into the second half of the year.

[Aaron Jagdfeld, President and CEO at Generac Power Systems]

As a result, we expect the elevated field inventory levels to further impact Home Standby shipments in the second half relative to our prior expectations, with a return to year-over-year growth in Home Standby shipments now anticipated in the fourth quarter. We believe the stronger outage environment in the final weeks of the second quarter and the resulting strength in IHC support this expected return to growth later in the year. Longer term, the mega trends that are driving awareness for backup power solutions are as compelling as ever. Homeowners and business owners are becoming increasingly sensitive to the growing frequency of power outages driven by extreme weather, and grid operators are struggling to solve the growing supply-demand imbalances that are a byproduct of the accelerated energy transition that is underway.

[Aaron Jagdfeld, President and CEO at Generac Power Systems]

Importantly, these are not short-term issues, as the transition to the next generation power grid will be an uneven process and is expected to take decades to complete. We believe our unparalleled suite of solutions is well positioned to solve many of the energy-related challenges that consumers and businesses will inevitably face. I'd now like to provide some commentary on our Chore products, which consist of a broad lineup of outdoor specialty power equipment used for property maintenance in large residential and light commercial applications. These products, which are increasingly shifting towards battery-powered solutions, experienced significant growth in recent years as homeowners have been spending more time and money on property maintenance since 2020.

[Aaron Jagdfeld, President and CEO at Generac Power Systems]

However, shipments in the second quarter declined from the prior year and were below our prior expectations, as higher channel inventories in the industry, unfavorable weather trends, and shifting consumer spending patterns impacted demand for Chore products. This weaker than previously expected demand environment is expected to persist in the second half of the year, also contributing to our lower outlook for residential product sales. Moving to our residential energy technology products and solutions. Second quarter sales were in line with our prior expectations and grew at a strong rate sequentially, as shipments of our PWRcell energy storage systems improved and ecobee sales hit an all-time record for a quarter. ecobee drove strong sales growth over the prior year and continued to take share in the smart thermostat market by strong positioning with professional contractors and new placement with key retailers.

[Aaron Jagdfeld, President and CEO at Generac Power Systems]

The ecobee team is progressing towards the launch of a smart doorbell camera in the second half of this year, which will which will provide for increased homeowner engagement with our home energy management platform. As the central hub of our home energy ecosystem, we firmly believe that ecobee's feature-rich devices and significant expertise in user experience will prove to be key differentiators for Generac's residential energy technology efforts. Although we are making progress in our future product roadmaps and building the and rebuilding the confidence of solar installers, the broad residential solar and storage market in the U.S. is showing signs of slowing.

[Aaron Jagdfeld, President and CEO at Generac Power Systems]

As a result, we now expect our suite of residential energy technology products and solutions to deliver gross sales at the low end of our previous range, between $300 million-$350 million for the full year 2023, as weaker solar and storage industry demand dynamics are expected to persist throughout the balance of the year. To better compete in these large and growing market opportunities, we are continuing to invest heavily in the world-class talent and R&D infrastructure that is required to achieve next-level quality while developing and commercializing innovative solutions. We believe our competitive advantages will be built around the combination of these ongoing investments, differentiated monitoring and management capabilities, and a unique and seamless user experience, combined with our core competencies around sales and marketing, lead generation, distribution, customer support, and global sourcing.

[Aaron Jagdfeld, President and CEO at Generac Power Systems]

I'd now like to provide commentary on our C&I products, which once again outperformed our expectations. Global C&I product sales grew 24% over the prior year to an all-time quarterly record, as multiple megatrends continued to support demand for backup power and mobile products around the world. Domestic C&I product sales grew at a robust rate in the second quarter, highlighted by strength in shipments to a number of key customers for beyond standby applications, industrial distributors, and national rental equipment companies. Shipments of natural gas generators used in applications beyond traditional emergency standby projects continued to see tremendous growth during the second quarter. We believe we are in the very early innings of this exciting new market opportunity, as grid stability concerns and volatile energy markets are expected to further drive demand for these solutions.

[Aaron Jagdfeld, President and CEO at Generac Power Systems]

Leveraging our position as the leading provider of natural gas generators, we are building an increasingly comprehensive solution set to enable the deployment of our products in multi-asset applications, such as pairing our Smart Grid Ready generators with our emerging C&I storage, connectivity, advanced controls, and grid services solutions. Shipments of C&I generators through our North American distributor channel grew once again at a strong rate, and channel backlog also increased sequentially during the quarter. Quoting activity for C&I products remains robust, highlighting the ongoing strength and demand for backup power in this important channel that serves a wide range of end markets. In addition, we experienced another quarter of robust growth against a strong prior year comparison with our national and independent rental equipment customers as they continued to refresh and expand their fleets.

[Aaron Jagdfeld, President and CEO at Generac Power Systems]

While order patterns from rental companies have moderated after several quarters of exceptional performance, this end market has substantial runway for growth, supported by the critical need for future infrastructure-related investments. As the leading provider of backup power to the North American telecom market, sales to national telecom customers increased slightly during the second quarter as compared to a strong prior year comparison. Although we continue to expect shipments and order trends for these products to be uneven during the second half of the year, we believe investment in telecom infrastructure remains a secular trend as global tower and network hub counts further expand and the increasingly critical nature of wireless communications requires backup power for resiliency.

[Aaron Jagdfeld, President and CEO at Generac Power Systems]

Positive momentum also continued during the second quarter for our international segment, as total sales increased 10% year-over-year, with the combined impact of acquisitions and favorable foreign currency effects contributing approximately 4% to sales growth. Core total sales growth was driven by strength in nearly all regions, as well as global sales of our controls and automation solutions from our Deep Sea and Motortech acquisitions. While energy security concerns in Europe have moderated from peak levels seen in prior quarters, we continue to see positive momentum in important long-term international growth markets, including India, the Middle East, and Australia. As the global energy transition accelerates, demand for electricity around the world grows, and the threat of increasingly severe and volatile weather persists, we believe that the demand we are seeing in these markets supports our view that the need for power resilience is a global issue.

[Aaron Jagdfeld, President and CEO at Generac Power Systems]

Accordingly, we are continuing to invest and build out our international product and distribution capabilities to serve these large and diverse growth opportunities. As disclosed in our press release this morning, we are raising our full-year sales growth guidance for global C&I products to mid-teens range from prior expectations for a mid to high single-digit increase. In addition to the strong second quarter performance, the increased guidance is being primarily driven by continued strong backlog and operational execution for our domestic C&I products. In closing this morning, our C&I product category has continued to perform extremely well as our global teams have driven strong execution. A softer than previously expected consumer environment impacted second quarter results and is the main driver in the reduction in our second half outlook for residential products.

[Aaron Jagdfeld, President and CEO at Generac Power Systems]

We view the headwinds in our residential product categories as temporary, and we remain confident in the robust longer-term outlook for our broad portfolio of backup power products and energy technology solutions. This confidence, combined with our history of strong cash flow generation and healthy financial profile, allows us to maintain a long-term focus on executing our Powering a Smarter World enterprise strategy. We will continue to make the necessary investments to capitalize on the mega trends that drive the future growth opportunities inherent in this strategy. We look forward to providing a more detailed update on our longer-term strategic vision at our upcoming Investor Day in late September. I'll now turn the call over to York to provide further details on second quarter results, as well as the outlook for 2023. York?

[York Ragen, CFO at Generac Power Systems]

Thanks, Aaron. Looking at second quarter 2023 results in more detail, overall net sales decreased 23% to $1 billion during the second quarter of 2023, as compared to $1.29 billion in the prior year's second quarter. The combination of contributions from recent acquisitions and the favorable impact from foreign currency, had an approximate 3% net favorable impact on revenue growth during the quarter. Briefly looking at consolidated net sales for the second quarter by product class, residential product sales declined 44% to $499 million, as compared to $896 million in the prior year. As Aaron discussed in detail, lower shipments of Home Standby generators, PWRcell energy storage systems, and Chore products drove this decline in residential product sales.

[York Ragen, CFO at Generac Power Systems]

In particular, for Home Standby, the year-over-year declines were due to a tough prior comparison, where we were working down excess backlog, combined with the current year that is impacted by field inventory destocking. Commercial and industrial product sales for the second quarter of 2023 increased 24% to $384 million, as compared to $309 million in the prior year quarter. Contributions from recent acquisitions and the favorable impact of foreign currency contributed approximately 2% revenue growth in the quarter. This very strong core sales growth was driven by broad-based growth across nearly all regions and channels, highlighted by an increase in domestic shipments to direct customers for beyond standby applications, industrial distributors, and the national rental equipment channel. In addition, international shipments of C&I power generation products and controls and automation solutions also contributed to this growth.

[York Ragen, CFO at Generac Power Systems]

Net sales for other products and services increased 37% to $117 million, as compared to $86 million in the second quarter of 2022. This increase is primarily due to the acquisition of Electronic Environments, given their additional service capabilities. The call that this acquisition closed last year on June 30th. Gross profit margin was 32.8%, compared to 35.4% in the prior year's second quarter, due to the significant impact of unfavorable sales mix, given the sharp decline in Home Standby mix compared to the prior year. This was partially offset by previously implemented pricing actions and lower input costs from improved commodities, logistics, and plant efficiencies that are providing an important tailwind to margin trends that are expected to continue in the second half of 2023.

[York Ragen, CFO at Generac Power Systems]

Operating expenses increased $2 million, or 1%, as compared to the second quarter of 2022. This increase was primarily driven by increased employee costs to drive and support future growth, higher marketing and promotion spend, and the impact of recurring operating expenses from recent acquisitions. This was mostly offset by lower variable operating expenses on the lower sales volumes. Adjusted EBITDA, before deducting for non-controlling interests, as defined in our earnings release, was $137 million, or 13.6% of net sales in the second quarter, as compared to $271 million, or 21% of net sales in the prior year. This lower EBITDA percent was primarily driven by the higher operating expenses as a percent of sales, given the lower sales volumes compared to the prior year, and to a lesser extent, the lower gross margins.

[York Ragen, CFO at Generac Power Systems]

I will now briefly discuss financial results for our two reporting segments. Domestic segment total sales, including inter-segment sales, decreased 28% to $815 million in the quarter, as compared to $1.13 billion in the prior year, with the impact of acquisitions contributing approximately 3% revenue growth for the quarter. Adjusted EBITDA for the segment was $103 million, representing 12.7% of total sales, as compared to $242 million in the prior year, or 21.5% of total sales. The lower domestic EBITDA margin in the quarter was primarily driven by the significant impact of unfavorable sales mix and reduced operating leverage on the lower shipments. The impact of acquisitions and continued investments in future growth also negatively affected margins during the quarter.

[York Ragen, CFO at Generac Power Systems]

These margin headwinds were partially offset by favorable price and cost benefits. International segment total sales, including inter-segment sales, increased 10% to $224 million in the quarter, as compared to $203 million in the prior year quarter. Core sales, which excludes the impact of acquisitions and currency, increased approximately 6% compared to the prior year. Adjusted EBITDA for the segment, before deducting for non-controlling interest, was $33 million or 14.9% of net sales, as compared to $30 million or 14.5% of net sales in the prior year. This stronger margin performance was primarily driven by favorable price and cost benefits. Now, switching back to our financial performance for the second quarter of 2023 on a consolidated basis.

[York Ragen, CFO at Generac Power Systems]

As disclosed in our earnings release, GAAP net income for the company in the quarter was $45 million, as compared to $156 million for the second quarter of 2022. The current year net income includes approximately $15 million of additional interest expense compared to the prior year due to higher borrowings and interest rates. In addition, GAAP income taxes during the current year's second quarter were $16 million, or an effective tax rate of 25.9%, as compared to $46 million, or an effective tax rate of 22.5% for the prior year. The increase in effective tax rates was primarily due to a lower benefit from equity compensation in the current year quarter.

[York Ragen, CFO at Generac Power Systems]

Diluted net income per share for the company on a GAAP basis was $0.70 in the second quarter of 2023, compared to $2.21 in the prior year. Adjusted net income for the company, as defined in our earnings release, was $68 million in the current year quarter, or $1.08 per share. This compares to adjusted net income of $185 million in the prior year, or $2.86 per share. Cash flow from operations was $83 million, as compared to $24 million in the prior year's second quarter, and free cash flow, as defined in our earnings release, was $54 million, as compared to $6 million in the same quarter last year.

[York Ragen, CFO at Generac Power Systems]

The increase in free cash flow was primarily due to significantly lower working capital investment in the current year quarter, as inventory levels have stabilized, partially offset by lower operating earnings, higher interest payments, and higher CapEx. Total debt outstanding at the end of the quarter was $1.62 billion, resulting in a gross debt leverage ratio at the end of the second quarter of 2.8x on an as-reported basis, which is expected to moderate in the second half of the year as LTM EBITDA begins to increase. With that, I will now provide further comments on our outlook for 2023. As disclosed in our press release this morning, we are updating our outlook for the full year 2023.

[York Ragen, CFO at Generac Power Systems]

The softer-than-previously expected consumer spending environment for home improvement has impacted our outlook for residential products, most notably for shipments of home standby generators. As a result of the softer consumer, we are seeing lower close rates and activations relative to prior expectations, which is causing higher field inventories and lower distributor sentiment compared to our previous guidance commentary. As a result of these factors, we now expect residential product sales for the full year 2023 to decline in the mid-20% range compared to the prior year, which compares to our prior expectation for a decline in the high teens range. Partially offsetting this incremental weakness in residential products, we are raising our outlook for C&I product sales, which are now expected to grow at a mid-teens rates during the year as compared to our prior guidance of a mid to high single-digit rate.

[York Ragen, CFO at Generac Power Systems]

Overall net sales for the full year are now expected to decline between -10% to -12% as compared to the prior year, which includes approximately 2% net favorable impact from acquisitions in foreign currency. This compares to the previous guidance range of a decline between -6% to -10%. From a quarterly pacing perspective, we now expect a slight year-over-year decline in overall net sales for the third quarter, with a return to year-over-year growth in the fourth quarter. This guidance assumes a level of power outage activity during the remainder of the year that is in line with the long-term baseline average. Consistent with our historical approach, this outlook does not assume the benefit of a major power outage event during the year.

[York Ragen, CFO at Generac Power Systems]

Looking at our gross margin expectations for the full year 2023, we now anticipate approximately 100 basis points of gross margin improvement over 2022 levels. We still expect sequential quarterly improvements in gross margins in the third and fourth quarters, with third quarter gross margins projected to be approximately 150-200 basis points higher than the second quarter of 2023. The anticipated sequential improvement in gross margins in the second half is expected to be driven by improved sales mix with higher shipments of Home Standby generators, lower input costs, and the realization of cost reduction initiatives as compared to the first half of the year. Given the significant megatrends that support our long-term growth opportunities, we remain focused on driving innovation, executing our strategic initiatives, and investing for the future.

[York Ragen, CFO at Generac Power Systems]

As a result of these ongoing investments, we expect operating expenses as a percentage of net sales to be approximately 20%-21% for the full year 2023. Given these gross margin and operating expense expectations, Adjusted EBITDA margins before deducting for non-controlling interests, are now expected to be approximately 15.5%-16.5% for the full year 2023, compared to the previous guidance range of 17%-18%. From a quarterly pacing perspective, we still expect Adjusted EBITDA margins to improve throughout the remainder of the year, primarily driven by sequentially improving gross margins as previously discussed, and to a lesser extent, improved leverage of operating expenses on an expected higher sales volumes.

[York Ragen, CFO at Generac Power Systems]

Accordingly, we now expect third quarter Adjusted EBITDA margins to be approximately 300-350 basis points higher than the second quarter of 2023, and exit EBITDA margins for the fourth quarter of 2023 are expected to be in the low 20% range. Additionally, as Aaron discussed, we continue to make significant operating expense investments in our residential energy technology products and solutions to capitalize on the significant opportunities presented by the rapidly growing solar storage and energy management markets. As a result, we currently expect these investments to unfavorably impact our EBITDA margins by approximately 400 basis points for the full year 2023.

[York Ragen, CFO at Generac Power Systems]

We continue to expect operating and free cash flow generation to follow historical seasonality of being disproportionately weighted towards the second half of the year in 2023. For the full year, we expect adjusted net income to free cash flow conversion to be strong at well over 100% as working capital moderates off of peak levels. We are also providing updated guidance details to assist with modeling adjusted earnings per share and free cash flow for the full year 2023. Importantly, to arrive at appropriate estimates for adjusted net income and adjusted earnings per share, add-back items should be reflected net of tax using the expected effective tax rate. For 2023, our GAAP effective tax rate is still expected to be approximately 25% as compared to the 19.6% full year GAAP tax rate for 2022.

[York Ragen, CFO at Generac Power Systems]

The year-over-year increase is driven primarily by expectations for lower share-based compensation deductions, an increased mix of income in higher tax jurisdictions, higher tax on foreign income in 2023 compared to 2022. Interest expense is now expected to be approximately $92 million, compared to the prior guidance of approximately $90 million, assuming no additional term loan principal prepayments during the year and current expectations for SOFR rates throughout 2023. Interest expenses is expected to moderate in the third and fourth quarters as cash flows on our interest rate swaps become more favorable and as we expect to pay down a portion of our outstanding revolver indebtedness. Our capital expenditures are still projected to be approximately 3% of our forecast in net sales for the year.

[York Ragen, CFO at Generac Power Systems]

Depreciation expense is now forecast to be approximately $62 million, compared to the previous guidance of approximately $60 million in 2023. GAAP intangible amortization expense is now expected to be approximately $102 million during the year, as compared to the previous guidance of approximately $100 million. Stock compensation expense is still expected to be between $40 million-$43 million for the year, and our full-year weighted average diluted share count is still expected to approach 63 million shares, as compared to 64.7 million shares in 2022, which reflects the share repurchases that were completed in 2022. Finally, this 2023 outlook does not reflect potential additional acquisitions or share repurchases that could drive incremental shareholder value. As a reminder, we have $278 million of authorization remaining on our current share repurchase program. This concludes our prepared remarks.At this time, we'd like to open up the call for questions.

[Operator]

As a reminder, to ask a question, please press star one one on your telephone and wait for your name to be announced. To withdraw your question, please press star one one again. Thank you. Please stand by while we compile the Q&A roster. Our first question comes from the line of Tommy Moll with Stephens Inc.. Your line is now open.

[Tommy Moll, Equity Research Analyst at Stephens]

Morning, and thanks for taking my questions.

[Aaron Jagdfeld, President and CEO at Generac Power Systems]

Hey, Tommy.

[Tommy Moll, Equity Research Analyst at Stephens]

Aaron, I wanted to start on the topic of channel inventory for the Home Standby product category. Last quarter, I think you were at about 1.5x normal. Where do you sit now? Am I hearing you correctly, that embedded in your outlook is that, that converges to the normal level by fourth quarter?

[Aaron Jagdfeld, President and CEO at Generac Power Systems]

Yeah, Tommy, it's, I mean, that's obviously the central question here and has been a topic as we've discussed over the last several quarters. You're right. We said I think somewhere in the 1.4x to 1.5x range is where we were last time we talked in April. Today, we believe that number is closer to 1.2x to 1.3x as we exited the first half. You know, with the, the assumption of a softer consumer spending environment, in particular around, you know, kind of residential investment, these types of projects, home improvement projects, we're really looking at a more moderated close rate. You know, it's interesting because we actually are seeing a lot of inbound activity, in terms of sales leads.

[Aaron Jagdfeld, President and CEO at Generac Power Systems]

They're just not the close rate on those leads is not growing at the rate that we thought it would. That's really the kind of the. Then it just becomes a math problem from there. We're just not going to drain the inventory as quickly because we're not going to convert those leads to activations at the rate that we thought we would here in the second half. That is, that's going to create basically a situation where that elevated field inventory is going to persist a bit longer than we had originally thought. Through, you know, really kind of through the year here, it'll start to taper off. You know, there's definitely, and I think you've done this with channel checks.

[Aaron Jagdfeld, President and CEO at Generac Power Systems]

We do our own channel checks, and we, and we know what field inventory looks like really with a high degree of accuracy, region to region and dealer-to-dealer, wholesaler-to-wholesaler, retailer-to-retailer. We see regions where actually there isn't a field inventory issue anymore, and we see other regions where field inventories are still higher than normal. It's become more of a, a mixed bag, if you will, around the field inventory story. Whereas I would say you wind the clock back two or three quarters, it was two or three quarters ago, it was everywhere. You know, the field was full of inventory in all regions. Now we're starting to see some of that normalization be achieved in certain regions, and in fact, go beyond that. We've got a couple of regions.

[Aaron Jagdfeld, President and CEO at Generac Power Systems]

You get up into Canada, in the Quebec markets, where, in particular, where they've had a number of outages and, you know, we can't get them enough product. They don't have the installation bandwidth. We get back to that issue, and that's obviously another area we've been focused on. Hopefully that, hopefully that, gets, gets to answer your question.

[Operator]

One moment for your next question. The next question comes from the line of Michael Halloran with Baird. Your line is now open.

[Michael Halloran, Senior Research Analyst and Associate Director of Research at Baird]

Hey, morning, everyone. You know, following up a little bit on that...

[Aaron Jagdfeld, President and CEO at Generac Power Systems]

Uh-oh. I think we lost him.We lost Mike.

[York Ragen, CFO at Generac Power Systems]

We've lost Mike?

[Michael Halloran, Senior Research Analyst and Associate Director of Research at Baird]

... the de-stock comps. You know, the distribution channel is growing, too. Can you hear me or no?

[Aaron Jagdfeld, President and CEO at Generac Power Systems]

Mike, we, we lost you there for a second. Can you repeat your question?

[Michael Halloran, Senior Research Analyst and Associate Director of Research at Baird]

Yeah, no problem. There's a, there's a lot of moving pieces here, from a, from a channel perspective, and, you know, in, in the Home Standby side and kind of tagging along to that inventory question. You've got high inventory, you, you're taking your outlook down a little bit, slower consumer conversion. The IHCs are higher, you're gaining distribution, inventory is at least normalizing a little bit. Can, can you help think from a forward commentary, how you think this demand curve starts playing out?

[Michael Halloran, Senior Research Analyst and Associate Director of Research at Baird]

Maybe, maybe just a little behind the hood on the sell out from a channel perspective, how you think those sequentials kind of work from a sellout perspective versus what normal might look like, and just kind of any context to what the true underlying run rate might look like if you try to normalize for these moving pieces?

[Aaron Jagdfeld, President and CEO at Generac Power Systems]

Yeah, Mike, there, there are a lot of moving pieces, as you said. When you think about, you know, the sell-in versus sell-out, you know, again, we're channel-to-channel, when we look at kind of the, you know, the different metrics that we look at in every channel, we see some different things going on channel to channel. We do see our dealer channels, which are more turnkey project channels, feel like they're in, and, and the metrics bear this out, that they're in better shape than some of the other channels. When we look at our wholesale channels, and in particular, our retail channels, retail would be, is, is lagging for us right now.

[Aaron Jagdfeld, President and CEO at Generac Power Systems]

When we look at, when we look through, at sell-through at retail, and we look at the, you know, kind of the foot traffic at retailers, and, you know, I think you guys, those on the call here have heard some of the more recent commentary from some of the larger retailers. You know, I think the foot traffic is, has slowed, and we are definitely seeing that in our residential product categories that we sell through retail. With maybe the notable exception being ecobee, as we called out, in our prepared remarks this morning, which is interesting. That really is probably more owed to, higher, you know, higher energy prices and the opportunity to use those ecobee products, to reduce, your energy costs.

[Aaron Jagdfeld, President and CEO at Generac Power Systems]

On the, you know, the, the, the moving pieces that are in this and kind of thinking about the pacing, if that's more your question, Mike, you know, what we see here is as the kind of fog clears of this field inventory issue, we think that the dealers are kind of first to recover here, followed by, likely by wholesale. You know, we've got a little bit further to go with retailers. They're the ones that are probably at the... When we talk about normalization at 1.2x to 1.3x, it's across everything, right? We sell kind of on an omni-channel basis, so dealers are better than that. Wholesalers are probably somewhere, you know, maybe a little worse than that, and retailers are quite a bit worse than that at this stage.

[Aaron Jagdfeld, President and CEO at Generac Power Systems]

We do believe this will start to normalize here as we go throughout the third quarter, as we get into the fourth quarter, in particular, we should start to see, we should start to see that abate. The end market demand, part of your question is interesting because, as we said, sales leads, IHCs, remain strong. In fact, they were even up sequentially from Q1. They've, you know, they're just not converting quite at the same level. Now, what we're not sure of at this point is if that conversion is just delayed or if that conversion is more the result, primarily of the consumer just saying they're not going to buy at all, right? Are they just not going to buy today, or they're not going to buy at all?

[Aaron Jagdfeld, President and CEO at Generac Power Systems]

As we continue to work on that, we've stood up an entire group here. We call it our nurturing team, for lack of a better, for lack of a better terminology. These are a team of dedicated salespeople that reach back out to unclosed leads. We've got quite a house file that we've built here of unclosed leads. You know, the number of leads we've generated over the last several years is tremendous. As you can imagine, a high percentage don't close. The opportunity to reengage with those homeowners at the right time, with perhaps the right offer, is growing. We think that that represents an area of opportunity for us and one that we're leaning into.

[Aaron Jagdfeld, President and CEO at Generac Power Systems]

But that's something that, you know, we're, we're still kind of in development phase on. I would tell you it's not, we haven't perfected it yet, but we're, we're doing a ton of work around that to see how we can continue to stimulate demand, in particular around those customers that have already gone through the in-home consultation process. I don't know if I'm getting to the heart of your question or not, but we, you know, we see end market demand as strong, at least at this point, awareness is strong. We need to see conversion improve to help us accelerate the, you know, clearing of the field inventory levels. We are making good progress there. It's just not as quickly as we had hoped.

[York Ragen, CFO at Generac Power Systems]

Yeah, I think the key is, you know, seasonally, we do expect the Home Standby category to pick up in the second half of the year versus the first half, especially as inventory, you know, begins to normalize, towards the end of the, throughout the second half. I think it's to Aaron's point, though, it's just maybe it's not going to improve as much as we thought relative to three months ago, because of the softer consumer that we're seeing.

[Operator]

One moment for your next question. The next question comes from the line of Jeff Hammond with KeyBanc Capital Markets Inc. Your line is now open.

[Jeffrey Hammond, Managing Director and Equity Research Analyst at KeyBanc Capital Markets]

Hey, guys. just, just back on this, this close rate dynamic, I'm just wondering if you're getting feedback from your dealer network on, you know, kind of why the close rates are, are lower. Is it, is it, you know, financing costs or, or the higher costs? Because I know you had been contemplating lead time, you know, or, or close rates getting better as lead times shorten. you know, that seems to be the big surprise and, and just looking for more, more feedback color.

[Aaron Jagdfeld, President and CEO at Generac Power Systems]

Yeah, sure, Jeff. That, that is, you know, a surprise to us as well. Although, you know, as we look at, I, I would say kind of maybe comparable industries where you've got bigger ticket types of home improvement projects, pools, patios, furniture, things of that nature, we're maybe not seeing, you know, I, I think you're, you're hearing commentary, but we're all not seeing maybe the consumer step up to the same level that we all expected. And that, I think, is indicative of perhaps, you know, just the, the, the, the work that the Federal Reserve is doing here, to, to tamp down, inflation with, with higher rates. I think it's starting to bite in some of these areas, in particular on these bigger ticket type of purchases. That.

[York Ragen, CFO at Generac Power Systems]

For the home.

[Aaron Jagdfeld, President and CEO at Generac Power Systems]

For the home, you know, anything tied to residential investment. You know, I would tell you that, that, you know, we did see, to get to, to the point that we've made in the past and that you're making here, we thought that close rates previously had come down because of the long lead times in the product, which we believed were, were, you know, kind of at the root of that. They bounced off the bottom, kind of Q1 of 2022, and improved nicely, sequentially, up until this quarter. This quarter, they kind of flattened out, and we're basically, our guidance here contemplates that they don't go up any further this year. That's really that's the change, right? We, we had our, our previous guidance had contemplated that close rates would continue to improve, albeit not dramatically so.

[Aaron Jagdfeld, President and CEO at Generac Power Systems]

As we said on the last call, it's gonna take some time to return to those pre-COVID close rates. The, the feedback from the channel, around close rates is that homeowners are, you know, they're struggling to, you know, to, to, again, with bigger ticket types of purchases, and they're taking more time to, to think through that. We just think that, that, that, that phase of the project... Again, I think the good news is we've got a, we've got a sales lead. Even if it didn't close, we have the opportunity to reengage with that customer. Friction in the, in the past, when we look at reengagement, our close rates are better if we choose the right time to reengage, right?

[Aaron Jagdfeld, President and CEO at Generac Power Systems]

I.e., if another outage moves through a local market and our team engages with all those, unclosed IHCs, those unclosed opportunities in that market, perhaps over the last 12, 24, or even 36 months, we see a much higher close rate the second time around. It's kind of like the friction is lower because that process of the in-home sales consultation has already taken place. That, that just leads to an easier time to get to closure, at least historically. That's really where we're putting a lot of our efforts here in the second half of this year, is into that nurturing effort that I, that I talked about before, to, to really work on how do we get more unclosed IHCs to, to closure.

[Operator]

One moment for your next question. Your next question comes from the line of Mark Strouse with JPMorgan. Your line is now open.

[Mark Strouse, Executive Director at JPMorgan]

Yes, good morning. Thanks for taking our questions. Sorry to beat a dead horse here. I just want to ask on field inventory levels again, a different way of looking at it, just how you're thinking about what normal inventory levels are. You know, the 1.2x to 1.3x that you're talking about today, does your outlook kind of assume that that goes back to 1.0x? Or, you know, based on the channel checks that you mentioned earlier, is there a chance that that potentially goes even lower, at least temporarily, given kind of what you're talking about with the macro? Then can I sneak in a quick follow-up?

[Mark Strouse, Executive Director at JPMorgan]

Just, just to be clear, what I'm hearing, the margin issues are, at least the margin headwinds you're talking about in guidance, that is a mix issue. You're not signaling any changing in pricing. Just wanna make sure that that's clear. Thank you.

[Aaron Jagdfeld, President and CEO at Generac Power Systems]

Yeah, Mark, thanks for the question. I'll take the, the first part. Again, just kind of expanding on the field inventory. You know, we said 1.2 to 1.3. Our assumption is that it, you know, 1.0 is quote, unquote, "normal." I think the key question there is, is 1.0 the right number, right? What is 1.0 based on? What it is, is we went back, I think it was around the 2019 levels for, pre-COVID, if you will, levels of field inventory, just to kind of pick our point of normal, right? That's a debatable point. You know, could the channel decide that their normal is lower? Potentially.

[Aaron Jagdfeld, President and CEO at Generac Power Systems]

Recall, though, that, you know, in our world, the, the field inventory, you know, there's not a ton of field inventory at the dealer level, especially when you get into smaller dealers. They just don't have the financial capacity or even the physical space to put product in. In their world, you know, maybe, maybe normal is 0. That would be contemplated, of course, in the, in the 1.0. It's gonna be the other channel players, you know, the retailers, the wholesalers that are generally more stocking channels, and then our larger dealers, that, you know, regionally will also stock product just to keep, you know, a constant flow to their teams, in particular, their install teams, just to keep product moving.

[Aaron Jagdfeld, President and CEO at Generac Power Systems]

You know, we do this on a days-adjusted basis, though, just to be clear, because there is seasonality to this. As we think about this, the second half of the year is seasonally our stronger period for Home Standby generators. We would see velocity typically pick up in the second half of the year. Ergo, you know, when you look at it on a days-basis, you know, that field inventory calculation, you know, will adjust accordingly. Then in the first half of the year, in particular, first quarter, which typically is our seasonally low period, that's when you'd see kind of that days of field inventory, adjust to reflect lower installation pace. The key question is not lost on us in terms of what's normal.

[Aaron Jagdfeld, President and CEO at Generac Power Systems]

Is there a risk there around the fact that maybe channel partners decide that normal is something less? Potentially, I don't think it'd be long-lived. It'd be probably short-lived, if that's the case. You know, we're trying to be, I think, balanced in how we're viewing this, and we think that that kind of 1.0x is a good reflection point of, is reflective of a good point in the curve in terms of what's normal. On margin-

[York Ragen, CFO at Generac Power Systems]

Yeah, on the margin side, yeah, in terms of the EBITDA percent guidance down. On the gross margin side, it's all mixed. Yeah, there's no pricing reduction assumptions in our guide, so it's all mixed. Then when you get to OpEx, there's a little bit of operating deleverage on the lower sales, so that's, that's a smaller piece of the puzzle, but there's no, there's no reduction in price in our guidance.

[Operator]

One moment for your next question. The next question comes from the line of Jerry Revich with Goldman Sachs. Your line is now open.

[Jerry Revich, Senior Investment Leader and Head of U.S. Machinery, Infrastructure, and Sustainable Tech Franchise at Goldman Sachs]

Yes, hi, good morning, everyone.

[Aaron Jagdfeld, President and CEO at Generac Power Systems]

Hey, Jerry.

[Jerry Revich, Senior Investment Leader and Head of U.S. Machinery, Infrastructure, and Sustainable Tech Franchise at Goldman Sachs]

I want to hear just. Hi. You know, margins are going to be at about 16% this year. You know, your targets for 2024 were in the mid-20s, and, you know, obviously, a lot has changed since. I'm wondering, is there an opportunity for margin expansion off of current levels? You know, how would you bridge what's reasonable to expect compared to that 24%-25% margin target you, you laid out at the Investor Day? York, I think you alluded to it in terms of 400 basis point of drag from the solar investments, but can you expand on that and what you folks view as a reasonable margin expectation in the medium term?

[York Ragen, CFO at Generac Power Systems]

Yeah, yeah, a couple of things. I know I did mention in my prepared comments that Q4 exit rate, Q4 EBITDA margins are expected to be in that, that low 20% range. We expect, obviously, things to pick up from here, especially as Home Standby shipments normalize. I guess, if you think about that previous Investor Day target for 2024, I know that our energy technology business, things are just taking a little bit longer than maybe we originally laid out back in 2021, September of 2021 for that business. This is more of a reset year for our clean energy business, and, and it'll grow from here.

[York Ragen, CFO at Generac Power Systems]

I think we're going to level set, you know, what those, I guess, revised expectations are going to look like on September 27 when we have our Investor Day next month, September 27, next month. I think we'll be able to give, you know, clear, updated targets for the long term at that point. I guess those are, those are some data points that you can use for now.

[Operator]

One moment for your next question. Our next question comes from the line of Kashy Harrison with Piper Sandler. Your line is now open.

[Kashy Harrison, Senior Research Analyst at Piper Sandler]

Good morning, and thank you for taking the questions.

[Aaron Jagdfeld, President and CEO at Generac Power Systems]

Hey, Kashy.

[Kashy Harrison, Senior Research Analyst at Piper Sandler]

Hey, just, just a few quick ones here. 2023, can you, can you just give us a, a sense of the revenue gap between sales into the channel and sales out of the channel? Are you underselling this year by $100 million, $200 million, $300 million? On, on the C&I side of the business, just how do you think about the repeatability into 2024? Just giving some of these crosscurrents surrounding, you know, construction from the infrastructure bill, maybe improved, ADI, maybe latter ends of five three. Just, just how do you think about the repeatability of C&I? Thank you.

[Aaron Jagdfeld, President and CEO at Generac Power Systems]

Yeah. Thanks, Kashy. Yeah, we haven't disclosed the kind of gap between sell-in and sell-out. But we are significantly undershipping the market here, market demand here in the first half as we work through that field inventory, and that really is the, the pull-down in guidance here on the residential side as a result of that.

[York Ragen, CFO at Generac Power Systems]

We can see field, we can see field inventory coming down in all of our data.

[Aaron Jagdfeld, President and CEO at Generac Power Systems]

Very clear.

[York Ragen, CFO at Generac Power Systems]

We know, we know we're undershipping the market.

[Aaron Jagdfeld, President and CEO at Generac Power Systems]

We know we're undershipping the market, you know, pretty, pretty dramatically at this point. You know, that's why we think that, you know, we're going to continue to grow here sequentially through the year, because that field inventory drag will reduce as we get to the back half of the year. Again, haven't put a haven't put a fine number on it, just kind of from a disclosure standpoint, but we, we definitely see that. On C&I, I think the question, it was a little broken up for us. Sorry about that. I think the question was just kind of about the sustainability of C&I and, and what we're seeing there. I think was, you know, as we said, kind of in our remarks, obviously, we're starting to come up against tougher comps, right?

[Aaron Jagdfeld, President and CEO at Generac Power Systems]

We've been the C&I business has been very strong for a long time. It was another great quarter for our C&I business. Some of our national account customers, in particular on the rental side, you know, we're starting to see some moderation in those order patterns here. What we've heard from the, you know, largely from our, our large rental customers, is that utilization rates and equipment are still doing quite well. They're holding in there. That said, I think, you know, proactively, a couple of those larger customers have cut their CapEx guidance for the year. You know, we're pretty well locked and loaded for this year in terms of orders, just in terms of our backlog, so we're not expecting much to change there.

[Aaron Jagdfeld, President and CEO at Generac Power Systems]

The question will be 2024, and, you know, is that-- does that roll over, or does it, you know, does, is there a significant change to that? We don't have great visibility into that yet and wouldn't be in a position to provide that guidance. On the telecom side, as we talked in the last call, and as we mentioned in our prepared remarks this morning, our large national telecom customers, you know, that demand tends to be, we referred to it sometimes in the past as lumpy. I think we used the term uneven this morning.

[Aaron Jagdfeld, President and CEO at Generac Power Systems]

From quarter-to-quarter, you know, it can accelerate and decelerate quite quickly, which is, would seem surprising, you know, I think because they, you know, the way they manage projects and, and certain things can come and go in terms of, you know, their CapEx spending capabilities, it can be turned on very quickly and turned off very quickly. We've seen some of that kind of manifest itself here and was expected in the second half of the year, so nothing unexpected there. You know, I think the long-term setup when we talk to all the telecom customers, is, you know, we're in kind of a multiyear upcycle for telecom spending. We think just near term, kind of unevenness in the way that CapEx is going to be deployed.

[Aaron Jagdfeld, President and CEO at Generac Power Systems]

They have a lot of hardening to, to do with their networks here yet, over the next several years. We think that's a, that's a run that's, that's gonna be, that's gonna continue. Then, you know, I would tell you that within our, our core C&I products, domestically and globally, you know, in particular, where our products are now being deployed for what we refer to as beyond standby applications. A generator, you know, could be used to be called upon at times of, of stress for the grid, right? You've got, you know, very, you know, high temperature extremes or low temperature extremes, or other points in the curve where the grid is under duress.

[Aaron Jagdfeld, President and CEO at Generac Power Systems]

The generator can be called into action by, you know, perhaps a local utility or grid operator, and that power then can be flowed into the grid for support. That is, those products are becoming much more popular. In fact, we've had a really good run there, and we think we're in the early innings of the use of these products. Really what it is, is it allows customers who would otherwise be looking at a generator strictly from a, you know, when you look at it from an economic standpoint, it's about risk mitigation, either loss of revenue, loss of inventory, loss of process, something like that. You have to weigh that against the, you know, the initial capital cost of the equipment and the ongoing maintenance of the equipment over its life.

[Aaron Jagdfeld, President and CEO at Generac Power Systems]

You can now essentially buy down that first piece cost, which has always been a barrier to ownership for the category, by allowing for that product to be used in these beyond standby applications, and thereby monetizing that asset in a way that, that didn't exist previously. We think that as the grid continues to transition, that these assets that were formerly stranded, basically, right, they were not connected to the grid necessarily, only connected to, you know, for emergency backup purposes for a property, that they can be, they can be monetized in a way they couldn't before. That's, I think, an exciting opportunity for us, and we're seeing more of that manifest itself here, in the C&I markets.

[Operator]

One moment for your next question. Your next question comes from the line of George Gianarikas with Canaccord Genuity. Your line is now open.

[George Gianarikas, Managing Director and Senior Analyst at Canaccord Genuity Group]

Hi, good morning, thanks for taking my question. I think I heard, as part of your strategy to close or increase close rates, you did not contemplate price reductions across the residential portfolio. My question is, why not? Why isn't that an option that's on the table to help improve close rates, particularly in an environment where your input costs are going down? Thank you.

[Aaron Jagdfeld, President and CEO at Generac Power Systems]

Yeah, thank, thanks for the question, George. Actually, you know, we do have when we talk about price, we probably need to talk about net price, but the promotion dollars end up down in kind of operating expense in some cases. It's not really, you know, just from an accounting, a technical accounting standpoint, it's not always price. We are, you know, we are using more promotion than we used maybe a year ago, certainly more than two or three years ago.

[York Ragen, CFO at Generac Power Systems]

That's included in our guidance.

[Aaron Jagdfeld, President and CEO at Generac Power Systems]

That is included in the guidance. You know, I think to, to maybe put a finer point on it, those teams that we've, we've unleashed here on our unclosed IHC file, you know, continue to work on different types of promotional activities. We're doing a lot of testing around what works, what doesn't work. We've run some national promos. We ran one earlier this year, you know, and, and we'll have one on our schedule here, you know, at some point later this year. That's, you know, those things are, you know, certainly included in the guidance. There's a question, of course, do we need to do more?

[Aaron Jagdfeld, President and CEO at Generac Power Systems]

You know, I think at this point, we, we believe we've got the right level in there to support the close rates that we've built into the, the most recent guidance. At some level, you know, you, you just, you can't, you can't promote, perhaps, to your way to a consumer that if, if the consumer is gonna be stubborn and, and it's gonna be painful for them to spend because they're concerned about, you know, obviously, you know, a lot of things around inflation, around, you know, their, the, their employment status. I mean, there's so many things that go into that, that, that make up why, you know, why and when a consumer feels confident to do that.

[Aaron Jagdfeld, President and CEO at Generac Power Systems]

Certainly, power outages, and historically for us, softer consumer environments, we generally have been able to break away from when you get outages. So that still exists here as an opportunity. Our guidance contemplates kind of a, a normal outage environment. You know, we have been experiencing kind of above normal outage activity here through, at least through the late in the second quarter, we saw that kick up and actually July in and of itself has been somewhat active as well. Continue to watch that and see what impact that will have on close rates, but we do have a level of promotion in our guidance, around trying to improve close rates for the balance of the year.

[Operator]

Your next question comes from the line of Donovan Schafer with Northland Capital Markets. Your line is now open.

[Donovan Schafer, Managing Director and Senior Research Analyst at Northland Capital Markets]

Hey, guys, thanks for taking the questions.

[Aaron Jagdfeld, President and CEO at Generac Power Systems]

Hey, Donovan.

[Donovan Schafer, Managing Director and Senior Research Analyst at Northland Capital Markets]

Hey, I want to talk about Chore and portables. You know, Chore usually doesn't get much attention, but, you know, this quarter, you guys actually called it out and highlighted... Of course, some backup, you know, of course, HSB, that was the main driver. I do think, you know, these smaller pieces can unfold in ways that kind of nudge things. I remember, I think, with the polar vortex in Texas. At the time, you know, I think a lot of folks thought, that's great news, but you won't be in that quarter because you were, you know, supply constrained. Maybe you're constrained on manufacturing HSB, but you did end up beating, and it came down to the portables because, because you had that ready and all that. These can add up in ways that matter.

[Donovan Schafer, Managing Director and Senior Research Analyst at Northland Capital Markets]

Talking about chore products, you know, California, the California ban on small-sized gasoline engines, you know, under 25 horsepower, that goes into effect at the end of this year. I think old, you know, mowers and everything get grandfathered in. It's not like if you, you know, own a gasoline lawnmower, you got to ditch it come, you know, January 1st. Any new purchases, I believe, need to be electric. I'm curious, you know, if, you know, because it's a smaller piece of the, the revenue mix, you know, something like this has to almost like double or something to really become meaningful. You know, with portables, when the polar vortex hit Texas, it's kind of like what happened is you had this just massive surge in portables, getting shipped to that state.

[Donovan Schafer, Managing Director and Senior Research Analyst at Northland Capital Markets]

In, in the case of something like this, I don't think, you know, come January 1st, you're going to suddenly get like a sudden doubling in Chore products. But with Mean Green Mowers and the other, you know, clean energy Chore products you have in this California law going into effect, you know, is that something where you see jumping to, you know, a 10%, 20% growth or a 2x, 3x over a number of years, kind of a broader magnitude there? Same thing on portables, because, you know, you've launched a portable battery product, you know, a larger portable generator and a, and a dual fuel generator, which those are all, you know, significant feature additions in those product categories.

[Donovan Schafer, Managing Director and Senior Research Analyst at Northland Capital Markets]

Anything on kind of, you know, the next, you know, year or so growth rate you would expect around those, approximately?

[Aaron Jagdfeld, President and CEO at Generac Power Systems]

Yes. Yes, thanks, Donovan. You know, obviously, the regulatory environment continues to change. You know, an outright ban on small engines in California, you know, you're spot on with that. You know, California is pushing ahead with that. You know, I, I think that like all kind of regulatory action, sometimes there are unintended consequences of that, whether they be, you know, maybe advanced purchases, maybe pull-in of demand around that. We're not seeing anything today for people who are loading up on, you know, kind of internal combustion engine-driven Chore products or generator products. Just to be clear, by the way, it would only impact the, you know, the portable generators and Chore products. Home Standby is not a part of that, that ban at this point. Just to be clear.

[Aaron Jagdfeld, President and CEO at Generac Power Systems]

You're right, it's a smaller part of our business. I mean, we did call out Chore this time because, frankly, they had a terrible second quarter and terrible first half, very much in line with the residential portions of many of the other public companies that serve that market. I will say, you know, it's, it's part of our strategy there, that the strategy behind the Mean Green acquisition is those are electrified, zero-turn radius, commercial mowing piece of equipment. We have seen a dramatic rise in interest around those products, but they're expensive, and so conversion is more difficult.

[Aaron Jagdfeld, President and CEO at Generac Power Systems]

The IRA, that Inflation Reduction Act, has provided for some subsidy for those products, and we expect that that will be clarified through treasury here over the back half of this year, which will certainly help. We are the leader in that commercial segment when it comes to electrified commercial mowers, and that is going to be an exciting part of the business to watch. We're electrifying the rest of our chore products platform using the technology that we acquired with Mean Green. Again, part of what you know, the brush cutting platforms and things that are so important to us there in chore products are being electrified as well.

[Aaron Jagdfeld, President and CEO at Generac Power Systems]

We think we'll be prepared as these bans take place, the one in California, certainly, as you said, end of this year. You know, and we'll have to see how it plays out. California also has, on top of the federal subsidies, some, some state-level subsidies for the purchase of those types of products, to incentivize, you know, the switch from internal combustion engine-driven products to, to electrified products. We'll continue to watch that. Portable generators, different type of category, right? Like, and this is where I think the unintended consequences of regulation, which if you have a, a multi-day outage, you're just, you can't buy a battery to get you through that. Sorry, you know, to California regulators for not thinking that through. They should have left open, you know, products that are used for emergency use....

[Aaron Jagdfeld, President and CEO at Generac Power Systems]

You know, in their infinite wisdom, they probably will create, you know, waivers when they run into problems, like they've done in the past for other areas of the market. They have these strict regulations, and then they waive them when there are emergencies, and I, I wouldn't be surprised to see the same happen here. You know, generating power is different than storing power. That's all there is to it. That said, we do have storage products, portable storage products that we're introducing in the marketplace, that are good for temporary, short duration outages, outage protection. But they also are expensive relative to the cost of internal combustion engine-driven generators, which, you know, again, for emergency use, like those products are used primarily, those that, that is the most cost-effective way to serve the market.

[Aaron Jagdfeld, President and CEO at Generac Power Systems]

Unfortunately, those types of regulations only hurt the part of the market that, you know, has less flexibility with their, with their, pocketbook and their checkbook around buying a product during an emergency. That's unfortunate, and hopefully, regulators will use their heads, and clear heads of prevail there if emergencies do present, as we believe will be the case long term here, as the grid, in particular in California, goes through a transition.

[Operator]

One moment for your next question. Your next question comes from the line of Praneeth Satish with Wells Fargo. Your line is now open.

[Praneeth Satish, Analyst at Wells Fargo]

Thanks. Good morning. Maybe I just wanted to get an update on the on the international market, and I guess, where, where do you stand on, on rollouts into, into countries like India? I guess, what, what are the competitive dynamics look like overseas, and are you introducing a new HSB or new pro- C&I product offerings for these regions? I guess, finally, when, when do you think we could see maybe an acceleration of of revenue contributions in the International segment?

[Aaron Jagdfeld, President and CEO at Generac Power Systems]

Yeah, thanks for the question. Internationally today, it's mainly a C&I market for us. Internationally, we've done very well. Our Pramac subsidiary, very well-respected brand, very well-run company, covers, you know, our geographies really outside the U.S. and Canada for us. You know, they, I mean, they've been on a tear. They continue to gain market share. The EBITDA margin profile of that company has improved dramatically over the course of our ownership here, which I think spans now something on the order of eight years, eight to nine years, something like that. We continue to make really good progress there, and we're actually getting quite a good benefit out of our global scale with C&I products here, even domestically.

[Aaron Jagdfeld, President and CEO at Generac Power Systems]

You know, the ability to, you know, consolidate purchases on engine platforms, some of the alternator platforms, and obviously be able to, you know, the ability to use our Deep Sea controls across our global platforms and get the gain the benefit of scale there as well. That said, you know, that market internationally, as I said, is primarily C&I, and it's primarily diesel. You know, diesel-powered generators are still, at least outside the U.S. and Canada, the primary kind of legacy solution for emergency backup. You know, those products, and in fact, I would say, like in the U.S., natural gas backup power represents, for C&I anyway, about 40% of the market here, with about 60% diesel. Outside the U.S. and Canada, it's more like 98% diesel, 2% gas.

[Aaron Jagdfeld, President and CEO at Generac Power Systems]

The opportunity that exists is to introduce gas products, of which we're the leader globally in, introduce those gas products into new regions and into the hands of new customers that we believe could benefit from connecting those products to natural gas pipelines as opposed to reliant on, on diesel refueling. There are benefits there far beyond just the, you know, the continuity of fuel supply, but also the emissions profile of those products on gas tends to be cleaner than that of diesel. You see some, some real benefits there, and you see customers who are now focused more on that. Regionally, we've really focused here, I would say in the last few years, on India in particular, through an acquisition of a company called Captiva.

[Aaron Jagdfeld, President and CEO at Generac Power Systems]

Pramac acquired Captiva several years ago, and we've continued to invest heavily in that market, and we're seeing very nice growth. You know, albeit off of a small base, but very nice growth there. You know, that's a, that's an area that we're gonna continue to focus on. I think we mentioned Australia, another great opportunity for us. The Middle East has been a great market in terms of growth. On the Home Standby side, if you look at residential sales, we actually have an interesting level of HSB that we're shipping into all parts of the world, which is really interesting. We see this in our activation data. We can see exactly where products are being installed. And it's just overshadowed by two things. One, by the size of the HSB business here in, in North America.

[Aaron Jagdfeld, President and CEO at Generac Power Systems]

Two, the, you know, the growth rates of C&I internationally have just kind of, you know, been, been so good, you just, we haven't talked a lot about the kind of growing HSB base that's underneath all of that. It is growing. We've introduced, we just introduced a product, an HSB product in India, and that is getting some nice traction already. We're, you know, continuing to introduce those products. Again, we've, we've now got products that are compliant with very strict gas codes in Australia. We're, we're really kind of, when we say we're, we're the only, you know, kind of company that serves Australia, that's true, because the gas codes are very strict there.

[Aaron Jagdfeld, President and CEO at Generac Power Systems]

None, none of our competitors are able to meet the, the strict code requirements in Australia, and we see that as a, as a wide-open market and, and, and opportunities for good growth. Then the Latin American markets, which represent, you know, a, we believe a, a really good opportunity for us, getting good penetration in places like Argentina. You know, even places like Brazil, where we're seeing, the product... you know, really get to, start to get the awareness levels start to increase. That's really what we have to focus on. We're kind of back to the early days of HSB back in North America, if you wind the clock back. We got a lot of work to do, but we are seeing pockets of that.

[Aaron Jagdfeld, President and CEO at Generac Power Systems]

I don't think it'll be anything that'll, you know, kind of contribute meaningfully to, you know, our International segment results here in the, in the near term. Longer term, we, we believe that gas products, gas C&I products, and HSB products, we, we see higher growth rates for those products than we do for the traditional C&I products.

[Operator]

One moment for your next question. Your next question comes from the line of Stephen Gengaro with Stifel. Your line is now open.

[Stephen Gengaro, Managing Director at Stifel]

Thanks, and good morning, everybody. Thanks for taking the question.

[Aaron Jagdfeld, President and CEO at Generac Power Systems]

Good morning.

[Stephen Gengaro, Managing Director at Stifel]

Just one for me. When we look at the inventory, the HSB inventories everybody's been talking about, is there any detail you can give us on sort of location of inventory relative to recent power outages?

[Aaron Jagdfeld, President and CEO at Generac Power Systems]

Yeah, I mean, we haven't, we haven't talked about field inventories at a, at, at that level of granularity. I think I, I, I may have mentioned in, in my response to a previous question that we are seeing evidence where there are regions, certainly pockets locally, where field inventories are at normal levels, or, or frankly, are, are, are quite a bit below what we might say would be normal because of elevated activity. Canada has been a, you know, a, a really interesting market here as of late with a lot of outage activity, and we see field inventories in Canada quite low versus other areas of, of the country. We see, you know, we see some other areas of the country, particularly like the Midwest, is another area.

[Aaron Jagdfeld, President and CEO at Generac Power Systems]

You know, Michigan is just a state that continues to get pummeled by, you know, both summer weather and winter weather. This is, you know... I think the interesting thing is, I think there, there's this misconception somehow that our best Home Standby markets are in Gulf Coast states or, you know, areas where, you know, you're, you're more prone to hurricanes. That, of course, you know, that, those kinds of demand drivers, of course, are important for the category, but actually, where we see greatest kind of penetration rates and growth rates are in those states that have, you know, kind of two seasons of weather. Both winter and summer have, you know, other kind of factors that play into, you know, an elevated level of outages, and Michigan is just one of those areas.

[Aaron Jagdfeld, President and CEO at Generac Power Systems]

Let's say it has, you know, a lot of outages caused by different, you know, extremities of weather. Also, you know, the grid is, is mainly above ground in Michigan. It's older. It was built around the automotive industry, so it was built out over 100 years ago. It's underinvested in, in a more significant way than in other areas because it's much more fragmented. There are many more independent grid operators in the state of Michigan than you would imagine. So the grid doesn't, doesn't kind of heal itself well when you do run into outages. There's a lot of trees in Michigan, so trees are part of the equation with, you know, with outages. You put all of that together, and some of the states that we see the best growth and the best penetration are in states like Michigan, states like Maine.

[York Ragen, CFO at Generac Power Systems]

Ohio.

[Aaron Jagdfeld, President and CEO at Generac Power Systems]

Ohio, Pennsylvania. Those type, those types of areas are actually very strong in the context of our growth rates. Again, as you would expect, where we're seeing stronger rates of growth, those are the areas that are getting to normalization of field inventory quicker. That's, you know, again, without providing more detail, that's how I would give you some context around the question.

[Operator]

One moment for your next question. The next question comes from the line of Blake Keating with William Blair. Your line is now open.

[Blake Keating, Equity Research Associate at William Blair]

Hi, good morning. This is Blake on for Brian. Just quickly, I wanted to ask about, you know, you've previously mentioned that your largest piece of customers in Home Standby are generally older and, and less, less affected by the macro environment. I'm just looking to get some additional color there. You know, are they actually impacted, impacted by the macro environment? Just trying to understand what's causing the, the slowdown, in the consumer, the consumer outlook for Home Standby.

[Aaron Jagdfeld, President and CEO at Generac Power Systems]

Yeah, thanks, Blake. You know, we, we have seen the demographic over time as the category's grown. You know, the category used to skew much older when you kind of wind the clock back. You know, over time, as it's broadened out, we have seen the average age of buyers come down, but it is still, you know, it still indexes, you know, to an older demographic. You know, people who have and homeownership tends to, to skew that direction as well. Yes, they, they may, in fact, be somewhat more resilient, if you will, to changes in the economy. I think nonetheless, they also, you know, inflation does impact people that are on a fixed income, perhaps even more. Right?

[Aaron Jagdfeld, President and CEO at Generac Power Systems]

You can make an argument that, that perhaps a portion of that segment is maybe a little more vulnerable to certainly trends in inflation. We haven't seen. You know, I wouldn't say like from this point last year to this year, we haven't seen any major shifts in the demographic, underpinning kind of the buyers of the category at this point. We'll continue to watch that, as, you know, as time goes on here, certainly this year and, and into the future. Yeah, I think right now, what we're, what we're seeing is that, more broadly, the consumer spending environment around home improvement is, is softening, right? And I think that we're getting a little bit caught up in that, and that's what I think is impacting. Again, close rates aren't dropping.

[Aaron Jagdfeld, President and CEO at Generac Power Systems]

I think that's, that's an important point here. They're just not growing back to the levels that we saw pre-pandemic. We, we do think they'll get back there eventually, but they've kind of flattened out here. I think that the challenge is that we thought they would continue to grow, and that's perhaps the new piece of information this morning.

[Operator]

One moment for your next question. Your next question comes from the line of Keith Housum with Northcoast Research. Your line is now open.

[Keith Housum, Managing Director and Research Analyst at Northcoast Research Partners]

Good morning, guys. I, I know we're running long, so I'll keep it to one question here. Just in terms of the clean energy solution set and the redesign of the product portfolio going into 2024, if you guys could just provide an update on if you guys are up to date on that or on track, and then, you know, some of the challenges that that segment's facing right now in terms of in dropping demand?

[Aaron Jagdfeld, President and CEO at Generac Power Systems]

Yeah, thanks, Keith. It was, you know, that category of product for us, well documented. You know, we, we, we entered that market, had some struggles. We had a lot of growth. We had a lot of success early on. Hit kind of our challenges with the loss of a major customer last Q3, and then some of the product quality challenges with the SnapRS device is really the product that we talked about here. You know, we are going through our. We're on a next generation roadmap for our battery solutions, our storage solutions. I'm very excited about that product. We're gonna talk more about that in our upcoming Investor Day. We're gonna talk about some of those products.

[Aaron Jagdfeld, President and CEO at Generac Power Systems]

We won't be able to get too granular there because we don't wanna tip our hat maybe to some of our, our, our competitors in the market. We have some really exciting things. We've been as we said on the call, kind of in the prepared remarks, we're investing very heavily. It's a 400, you know, basis point drag on EBITDA margin right now, which is challenging. Of course, when especially as the, the residential business is going through its cycle here, that becomes even more challenging to stomach. We're very excited about the future of those products. The market in general, as, as you're indicating, and as we've seen from other participants in the market, is, is, is a tougher market right now than it has been.

[Aaron Jagdfeld, President and CEO at Generac Power Systems]

Again, higher, higher interest rates being probably at the root cause of that, and then maybe more recently, the NEM 3.0 decision in California, specifically. Those two things are weighing on kind of solar and storage, solar plus storage demand here, and, and are reflected kind of in our updated guidance this morning. You know, we have been targeting a $300 million-$350 million range for those, that, that portfolio of products for, for the year. We, we now are thinking we're gonna come in on the low end of that range, primarily because of the, the softening, dynamics, demand dynamics that are going on, that we're seeing in the industry. We still are very optimistic long term, and that's why we're spending, heavily, against this, this opportunity.

[Aaron Jagdfeld, President and CEO at Generac Power Systems]

We think that, we know that, it's gonna take a, a different level of investment to become proficient and excellent in these products. We, we now know that after going through our experience, and we are dedicated to doing that. And we're, you know, we're gonna see those results. You should see some of those products, as we'll talk in September, really gonna start hitting in, in 2024. And we're, we're pretty excited about the future there, without getting too specific.

[Operator]

Your next question comes from the line of Vikram Bagri with Citigroup. Your line is now open.

[Vikram Bagri, Alternative and Renewable Energy Analyst at Citigroup]

Good morning, everyone. When talking about-

[Aaron Jagdfeld, President and CEO at Generac Power Systems]

Morning

[Vikram Bagri, Alternative and Renewable Energy Analyst at Citigroup]

... margin improvement, you talked about, better product mix, cost cuts, and lower input costs, and the absence of promotions to clear the inventory was not a driver. It seems like you, you, you plan on continuing promotions, given persistently high inventories and your target of improving the conversions. Can you, one, sort of give us directionally, what the impact of these promotions was on gross margins and operating margins, dollar terms or percentage terms? Then, two, how long or what sort of the magnitude of promotions do you plan on running, to, to achieve both those targets, improving the conversion rates and reducing the inventories?

[York Ragen, CFO at Generac Power Systems]

No, this is York. Yeah, no, the promotions that we're talking about, again, we, we run promotions in the ordinary course when we're not in backlog, and just again, to drive awareness of the category and help, help, you know, get homeowners over the, over the tipping point to go ahead and make the purchase of a Home Standby generator. I, I wouldn't say it's. I would say it's a modest impact to margins overall. Again, these are our highest margin products, so you sort of, as you sell more of these products, you mix, you get a significant mixed benefit, which sort of overshadows whatever promotion we may be offering. I think that's, that's the key there.

[York Ragen, CFO at Generac Power Systems]

What promotion we do have layered into the guidance is, is, is not a significant part of the story or a significant impact to our margins. I think when you think about the cadence of EBITDA margins over from first half to second half, I think, you know, just mixing, getting a higher level of Home Standby shipments out the door, that will have a significant impact. The additional operating leverage on our fixed SG&A will have a, a big impact. Then we're just gonna continue to realize improved input costs as we sort of work through our inventory levels, and, and we'll, we'll start seeing the realization of lower commodities and logistics costs and, and what not.

[York Ragen, CFO at Generac Power Systems]

That's, that's really what's gonna drive the, the sequential improvement in EBITDA margins from first half, second half, and, and promotions will only have a slight drag, you know, relative to that performance.

[Operator]

We have no further questions at this time. I will now turn the call back over to Mike Harris.

[Mike Harris, SVP of Corporate Development and Investor Relations at Generac Power Systems]

We want to thank everyone for joining us this morning. We look forward to discussing our third quarter 2023 earnings results with you in early November, as well as providing an update on our longer-term strategic vision at our upcoming Investor Day on September 27th. Thank you again, and goodbye.

[Operator]

This concludes today's conference call. Thank you for your participation. You may now disconnect.

Participants

Executives

• Aaron Jagdfeld, President and CEO
• Mike Harris, SVP of Corporate Development and Investor Relations
• York Ragen, CFO

Analysts

• Blake Keating, Equity Research Associate at William Blair
• Donovan Schafer, Managing Director and Senior Research Analyst at Northland Capital Markets
• George Gianarikas, Managing Director and Senior Analyst at Canaccord Genuity Group
• Jeffrey Hammond, Managing Director and Equity Research Analyst at KeyBanc Capital Markets
• Jerry Revich, Senior Investment Leader and Head of U.S. Machinery, Infrastructure, and Sustainable Tech Franchise at Goldman Sachs
• Kashy Harrison, Senior Research Analyst at Piper Sandler
• Keith Housum, Managing Director and Research Analyst at Northcoast Research Partners
• Mark Strouse, Executive Director at JPMorgan
• Michael Halloran, Senior Research Analyst and Associate Director of Research at Baird
• Praneeth Satish, Analyst at Wells Fargo
• Stephen Gengaro, Managing Director at Stifel
• Tommy Moll, Equity Research Analyst at Stephens
• Vikram Bagri, Alternative and Renewable Energy Analyst at Citigroup