Generac Q3 2022 Earnings Call Transcript

Quartr
Provided by Quartr
November 2, 2022

There are 12 speakers on the call.

Operator

Welcome to

Speaker 1

the Generac Third Quarter 2022 Earnings Results Conference Call. At this time, all participants are in a listen only mode. After the speakers' presentation, there will be a question and answer is raised. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Mr.

Speaker 1

Mike Harris, Senior Vice President, Corporate Development and Investor Relations, please go ahead.

Speaker 2

Good morning, and welcome to our Q3 I'd like to thank everyone for joining us this morning. With me today is Aaron Jagdfeld, President and Chief Executive Officer and York Regan, 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 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.

Speaker 2

In addition, we will make reference to certain non GAAP measures during today's call. Additional information regarding these measures, including reconciliation to comparable U. S. GAAP measures, is available in our earnings release and SEC filings. I will now turn the call over to Aaron.

Speaker 3

Thanks, Mike. Good morning, everyone, and thank you for joining us today. Our Q3 was in line with the preliminary results we announced on October 19. Momentum in the commercial and industrial product category Strong, the residential product sales while still growing compared with the prior year were weaker than expected in the quarter, driven by lower shipments of home standby generators and Clean Energy Products relative to our prior expectations. Year over year, overall net sales increased 15% to $1,090,000,000 primarily driven by core sales growth of 10%, which excludes the impact of acquisitions and foreign currency.

Speaker 3

Overall, residential product sales grew 9% during the quarter, led by sales of home standby generators and the impact from recent acquisitions, partially offset by lower shipments of Power Cell Energy Storage Systems. C and I product sales increased 20% led by growth across all channels domestically, strength in the European region and the contribution from recent acquisitions. Now discussing our 3rd quarter results in more detail. Home standby generator sales grew at a mid teens rate over the prior year. Baseline power outage activity in the U.

Speaker 3

S. During the quarter remained above the long term baseline average and Hurricane Ian, which occurred in the last week of the quarter, drove total power outage activity well above the long term average. Home consultations or sales leads were lower in the quarter when compared to the prior year, which included Hurricane Ida. However, the Q3 of 2022 was tied for the 2nd highest total for any given quarter since we began tracking the metric in 2013 and we experienced a return to year over year growth in the month of October resulting from Hurricane Ian. We continue to focus on expanding our distribution network as we experienced sequential growth in our residential dealer base and ended the quarter with nearly 8,500 dealer partners, a net increase of approximately 300 dealers sequentially.

Speaker 3

Activations, which are a proxy for installs, continued to grow in the Q3 compared to the prior year. However, as we mentioned in our preliminary announcement, installation capacity for home standby generators lagged our production output. The ability of installing contractors to fully service the demand for backup power from homeowners continues to be constrained by labor availability, permitting and utility related delays and shortages in certain materials needed to complete an installation. Furthermore, growth in our dealer base was constrained in prior quarters by our extended production lead times. All of this resulted in elevated levels of field inventory and lower than expected orders from our channel partners despite the continued strength in end customer demand.

Speaker 3

Importantly, to address these activation challenges, we're working on a number of specific initiatives to increase home standby installation bandwidth, such as providing resources to help existing dealers expand their labor forces and additional installation training locally for non dealer contractors. We are working to streamline home standby projects by creating universal permitting packages and replicating past successes in simplifying approval processes from certain local utilities. Other efficiency related initiatives include dealer scheduling and quotation refinement to enhance the top of the sales funnel and optimize the allocation of sales leads within the dealer channel to favor those dealers that have capacity to install more generators. Importantly, we have also intensified efforts to further expand our overall dealer count and we expect another strong quarter of sequential growth in the 4th quarter. Our dealer count growth initiatives have recently benefited from our shorter production lead times, which have now mostly returned to normal levels as we ramped our production output of home standby generators in prior quarters.

Speaker 3

Although installation capacity constraints have resulted in lower orders from our channel partners, It is important to reiterate that underlying demand and market fundamentals of the home standby category remains strong as supported by meaningfully sequential improvements in a number of key dealer related metrics during the Q3. In home consultations grew, close rates continue to rebound And while still elevated, the time between contract signing and installation declined meaningfully as compared to the 2nd quarter. Dealer productivity, as measured by activations per day per dealer, improved to an all time high during the Q3. In addition, our dealer survey data suggests approximately half of all the field inventory is allocated to an active customer contract, highlighting the need to further increase the pace of installs to close the gap between strong end customer demand and installation capacity. While the previously mentioned sequential improvements provide evidence that our channel partners are beginning to make progress in working through their elevated backlogs and field inventory, We expect home standby order headwinds to persist through the first half of twenty twenty three as field inventory levels normalize.

Speaker 3

Even when assuming no major outage events, In the second half of twenty twenty three, we expect significant sequential sales growth from the first half of the year and only a modest decline in sales on a year over year basis as we maintain a new and higher baseline level of demand. Over the last 30 years, the home standby category has grown in a step function pattern as penetration rates have expanded rapidly for several years at a time, driven by notable major power outage events, followed by periods of flatter growth as demand normalizes. With each successive growth period comes increased awareness around home standby generators and increased distribution for these products, both which have been critical in helping the category reach new and higher levels of baseline demand. The latest growth step that the product category has was underpinned by an increase in power outage activity over the past several years with 4 of the top 10 major outage events since 2010 having occurred in just the last 2 years alone. This growth can be evidenced through a number of key market metrics in comparing the 1st 3 quarters of 2022 to the comparable period of 2019 as activations per day more than doubled, home consultations more than tripled and our dealer count increased by nearly 40% from 6,200 to 8,500.

Speaker 3

The approximate mid teens compounded annual growth rate in the category over the Several decades can be tied to the increase in power outages over that time as the nation's electrical grid has struggled to reliably supply power to homeowners and businesses. The aging and under invested grid infrastructure has become more vulnerable to the increasing severity of high impact weather related events such as hurricanes, Heat waves, derechos, ice storms and polar vortexes. Additionally, new megatrends have emerged that we believe will drive the next step of growth in the category. Grid resiliency concerns have been increasing as decarbonization trends accelerate, causing a widening gap between supply and demand, leaving many utilities and grid operators scrambling to avoid rolling blackouts over the past several years, and we believe little has been done to rectify this situation. We also believe the Home as a Sanctuary megatrend will persist as the shift to remote or hybrid work remains intact.

Speaker 3

The electrification of homes continues to grow and demographic trends are driving increased levels of aging in place. With the nationwide penetration rates still in the mid single digit range And these megatrends firmly intact, we are confident that the long term growth trajectory for the home standby category remains significant. I'd now like to discuss our residential clean energy products as shipments of Power Cell Energy Storage Systems in the 3rd quarter were negatively impacted by the significant liquidity challenges of a large customer that ceased operations and subsequently filed for bankruptcy. Additionally, during the quarter, we continued to address certain warranty related matters for the upgrade of a component within our PowerCell Energy Storage System. As part of this effort, we have engaged a number of 3rd party service companies to assist with the completion of these upgrades and these efforts are well underway.

Speaker 3

As a result of these items, we recorded a $55,000,000 charge into the quarter, comprised of an $18,000,000 bad debt reserve and a $37,000,000 warranty charge. The challenges we experienced in our clean energy business in the Q3 were very disappointing, but we believe that the solar plus energy storage market continues to represent important strategic opportunity for Generac longer term. However, this quarter's results have demonstrated the need for us to further expand our distribution by focusing our efforts on partnering with high quality, reputable sales and installation companies for these products. Importantly, we are committed to In addition, we continue to broaden our product offering and bring new innovations to this market as we announced an update to the PowerCell Energy Storage System during the quarter that enables AC coupled battery storage as well as AC generator integration. Work also continues on our PB microinverter product called the Power Micro As our beta testing began late in the Q2 and will continue through the balance of this year, we anticipate a phased commercial rollout beginning in the first half of twenty twenty three and a full commercial launch targeted for the second half of the year.

Speaker 3

I'd now like to provide a quick update on our ecobee acquisition, which we completed last December. During the initial period of our ownership, we have been focused on developing cross selling opportunities for ecobee's hardware solutions through Generac's distribution partners and have seen positive indications of demand for smart thermostats alongside other clean energy products. Synergies between ecobee and Generac's grid services teams continues to be validated and we are identifying higher potential value creation for ecobee's devices in demand response programs amid ongoing concerns around grid stability and rising energy prices. We've also begun leveraging the talented ecobee team to help accelerate our connected devices strategy, which is core to the development of our residential energy ecosystem that will ultimately be accessed and controlled by a single pane of glass user interface. I also want to provide some additional color on the efforts of our grid services team as they continue to execute on a growing and diversified sales pipeline.

Speaker 3

We have further expanded our efforts to extract synergies across our commercial teams as they work to offer an increasing mix of Generac hardware alongside our Concerto Grid Services software platform. Our comprehensive suite of solutions aimed at distributed energy resource management related programs is unmatched and is proving We announced a number of program wins since our Q2 call, including software as a service contracts with Dominion Energy and UK based Pearlstone Energy, as well as a performance contract with Arizona Public Service, which demonstrates Generac's unique ability to deliver end to end solutions in grid services programs. The long term market opportunities for residential energy storage, microinverters, monitoring and management devices and grid services solutions remains highly attractive and core to our strategic vision. However, the loss of a major customer during the quarter along with the specific warranty related issue has impacted near term demand and our outlook for the full year 2022. We now expect the combination of clean energy technology products and services to deliver sales between 300 $330,000,000 for the full year 2022 as compared to our previous guidance of approximately 500,000,000 Our continued investment in the people and processes involved in the development of these products remains a key focal area for the company as we work to further broaden our product offering, while also improving the quality and performance of the technologies we've acquired and developed over the last 3 years.

Speaker 3

With that in mind, we're building a talented and focused clean energy Beginning with the addition of Norm Taff in August as our new President of this organization, along with the new Chief Technology Officer, Senior Vice President of Finance and a Senior Vice President of Policy. Norm and his team bring decades of industry leadership experience as well as robust technical expertise that will help drive Generac's Integrated Clean Energy Technology Solutions forward. Additionally, the policy backdrop for this market has never been more favorable with the Inflation Reduction Act providing the necessary visibility for long term value creating investments. We will continue to build out our energy technology leadership team and our suite of products and solutions as we expect to play an important role in the transition to a cleaner, more sustainable and more reliable electric grid. As a result of these investments and the strong outlook for this market, We expect Clean Energy Technology sales to return to strong growth for the full year 2023 with sequentially improving results throughout the year.

Speaker 3

Our C and I products continue to perform exceptionally well in the quarter as global C and I net sales increased 20% on an as reported basis and 23% on a core sales basis, which excludes the impact from acquisitions and foreign currency as compared to the prior year. C and I products in the Q3 was led by strength across national rental equipment, telecom and industrial distributor customers. We experienced continued strength in demand during the quarter as backlog for our C and I products remained at record levels and expanded further in the month of October, giving Excellent visibility that solid growth will continue in the category well into 2023. Shipments of C and I stationary generators through our North American distributor Channel grew significantly again in the 3rd quarter and order trends indicate this momentum will continue in the quarters ahead as backlog in the channel increased on a sequential basis. Quoting activity and close rates remain elevated compared to prior year levels, highlighting our market share gains as well as the durability of demand trends for backup power for C and I applications.

Speaker 3

Shipments to National Telecom customers also increased again during the Q3 as compared to the prior year as several of our larger national customers continue to invest in hardening their existing sites and the build out of their 5th generation or 5 gs networks. These networks are increasingly considered as part of the nation's critical infrastructure and require backup power for resiliency. Upgrades to telecom infrastructure remain one of the key megatrends that we expect to drive growth for our business in the coming years as global tower and network hub counts continue to expand. We also experienced another quarter of substantial growth with our national and independent rental equipment customers as they continue to invest in equipment to refresh and expand their fleets. We anticipate the demand environment for mobile products will remain robust in the quarters ahead as the megatrend around the critical need for infrastructure improvements continues to play out.

Speaker 3

Strong customer interest for our natural gas generators used in applications beyond traditional emergency standby projects also continued in the quarter, with sales of these products growing at an exceptional rate. We believe we are in the very early innings of growth for this exciting new market opportunity as grid stability concerns and volatile energy markets are expected to further drive demand for these innovative solutions. We also took a significant step forward in our C and I generator connectivity efforts shortly after quarter end with the acquisition of Blue Pillar, an industrial Internet of Things platform developer that enables distributed energy generation monitoring and control. Blue Pillar's connectivity solutions can make Previously stranded C and I backup generators available for use in grid services programs by connection to the Concerto platform and will provide a foundation for our longer term vision of creating a single user interface for a suite of connected C and I assets. Our International segment continued to experience very strong momentum as total sales increased 14% year over year during the Q3, with 22% core total sales growth when excluding the benefit of acquisitions and the unfavorable impact of foreign currency.

Speaker 3

Core total sales growth was driven by strength across all regions, most notably in Europe and Latin America, with inter segment sales also growing substantially in the quarter as our Generac Mexico facility further ramped production of telecom products for the North American market. The European region has seen remarkably strong demand across Concerns over power security amid the conflict in Ukraine have continued to rise, and we are providing backup generators to the region through our European sales branches. Longer term demand trends are less certain, however, as geopolitical and macroeconomic conditions in the region remain volatile, but end market awareness of the need for resiliency has increased across the continent in recent quarters. The subsequent effect of the war on Europe's Energy Complex has highlighted the dependence on continuous power sources for homes and businesses around the globe. Looking into 2023 for our global C and I products, Given the strong demand fundamentals and existing backlog, our preliminary view anticipates continued strong year over year growth throughout the entire year.

Speaker 3

In closing this morning, we were disappointed that our Q3 results were below our prior expectations, but we believe we have action plans in place to address the underlying challenges in the business. New Clean Energy Technology leadership has brought an increased emphasis on quality and innovation, and we remain confident in the long term growth opportunity for this strategic area of our business. Important initiatives to help ease home standby installation bottlenecks are well underway. And as the home standby market normalizes, We are confident that the new and higher baseline of end demand for the product category will become clear. Hurricane Ian is the latest example of increasingly severe and more volatile weather patterns, And we believe the Power Grids growing supply and demand imbalance is far from resolved as we add intermittent renewable generation sources while simultaneously pursuing the electrification of our homes, our businesses and our transportation.

Speaker 3

The secular growth themes and megatrends supporting the We will continue to invest in innovative products and solutions to lead the evolution to the next generation grid. I now want to turn the call over to York to provide further details on our Q3 2022 results, our outlook for the year and our preliminary views on 2023.

Operator

George? Thanks, Aaron. Looking at Q3 2022 results in more detail, net sales increased 15% to $1,090,000,000 during the Q3 of 2022 as compared to $943,000,000 in the prior year Q3. The combination of contributions from acquisitions and the unfavorable impact from foreign currency had an approximate 5% net impact on revenue growth during the quarter. Briefly looking at consolidated net sales for the Q3 by product class.

Operator

Residential product sales grew to $664,000,000 as compared to $609,000,000 in the prior year, representing a 9% increase over a strong prior year comparable. Contributions from the ecobee acquisition and the slight unfavorable impact of foreign currency contributed approximately 5% of revenue growth for the quarter. Home standby generator sales made up the majority of the residential product core sales growth increasing at a solid mid teens rate over the prior year. This was partially offset by weakness in shipments of Power Cell Energy Storage Systems. Commercial and industrial product sales for the Q3 of 2022 increased 20% to $311,000,000 as compared to $258,000,000 in the prior year quarter.

Operator

Contributions from acquisitions and the unfavorable impact of foreign currency provided a net headwind of more than 2% to net sales growth during the quarter. The strong core net sales growth was broad based across most regions internationally and across all channels domestically with particular strength in national rental equipment, telecom, industrial distributor and energy management channels. Net sales for the other products and services category increased 49 percent to $113,000,000 as compared to $76,000,000 in the Q3 of 2021. Core sales growth for the category was 17% due to strength in aftermarket service parts and extended warranty revenue recognition, along with strong growth in our services offerings in certain parts of our business, both domestically and internationally. Gross profit margin was 33.2% compared to 35.6% in the prior year Q3 as we continue to experience modest price cost headwinds during the quarter from a margin percent standpoint.

Operator

In addition, recent acquisitions and a less favorable sales mix, primarily driven by a lower proportion of home standby product sales also negatively impacted margins in the current year quarter. Operating expenses increased $111,000,000 or 68% as compared to the Q3 of 2021. This increase includes $55,300,000 of pre tax charges comprised of $17,900,000 of bad debt expense related to a clean energy product customer that has filed for bankruptcy and a $37,300,000 charge for clean energy product warranty related matters. The remaining increase was primarily driven by higher recurring operating expense from recent acquisitions and an increase in intangible amortization expense. To a lesser extent, higher employee costs and higher marketing spend also contributed to the increase.

Operator

Adjusted EBITDA before deducting for non controlling interest as defined in our earnings release was 184,000,000 or 16.9% of net sales in the 3rd quarter as compared to $209,000,000 or 22.2 percent of net sales in the prior year. I will now briefly discuss financial results for our 2 reporting segments. Domestic segment total sales, including intersegment sales, increased 18% to $947,000,000 in the quarter as compared to $802,000,000 in the prior year with the impact of acquisitions contributing approximately 8 percent of the revenue growth for the quarter. Adjusted EBITDA for the segment was $160,000,000 representing a 16.9% margin as compared to $188,000,000 in the prior year or 23.4 percent of net sales. The lower domestic EBITDA margin in Quarter was primarily due to continued price cost headwinds.

Operator

In addition, continued operating expense investments for future growth And the impact of acquisitions had an unfavorable effect on margins during the quarter as operating expenses as a percentage of sales came in higher than expected on the lower shipment volumes relative to expectations. International segment total sales, including intersegment sales, increased 14% to $183,000,000 in the quarter as compared to $160,000,000 in the prior year quarter. Core total sales, which excludes the impact of acquisitions and currency, increased approximately 22% compared to the prior year. Adjusted EBITDA for the segment before deducting for non controlling interest was $24,000,000 or 13.2 percent of net sales as compared to $21,500,000 or 13.4 percent of net sales in the prior year. This margin performance was impacted by a higher mix lower margin intersegment sales, which was mostly offset by favorable operating leverage on significantly higher volumes.

Operator

Now switching back to our financial performance for the Q3 of 2022 on a consolidated basis. As disclosed in our earnings release, GAAP net income for the company in the quarter was $58,000,000 as compared to $132,000,000 for the Q3 of 2021. The current year net income includes the pretax charges totaling $55,300,000 related to the clean energy bad debt and warranty related matters. GAAP income taxes during the quarter GAAP income taxes during the current year Q3 was 11,600,000 or an effective tax rate of 16.1% as compared to $32,600,000 or an effective tax rate of 19.7% for the prior year. The reduction was due to multiple discrete tax items that drove the tax rate down versus prior year on a net basis.

Operator

Diluted net income per share for the company on a GAAP basis was $0.83 in the Q3 of 2022 compared to $1.93 in the prior year. Adjusted net income for the company as defined in our earnings release was $112,000,000 in the current year quarter or $1.75 per share. This compares to adjusted net income of $151,000,000 in the prior year or $2.35 per share. Cash flow from operations was negative $56,000,000 compared to positive $74,000,000 in the prior year Q3. And free cash flow as defined in our earnings release was negative $73,000,000 as compared to positive $42,000,000 in the same quarter last year.

Operator

The decline in free cash flow versus the prior year was primarily due to lower operating earnings, Increased tax payments and higher working capital levels in the current year quarter, partially offset by lower capital expenditures. As of September 30, 2022, we have approximately $1,480,000,000 of liquidity comprised of approximately $230,000,000 of cash on hand and $1,250,000,000 of availability on our revolving credit facility. Also, Total debt outstanding at the end of the quarter was $1,360,000,000 resulting in a gross debt leverage ratio at the end of the 3rd quarter of 1.6 times on an as reported basis. Additionally, during the Q3, we repurchased 536,600 shares of our common stock for $123,900,000 which exhausted our previously existing stock repurchase program. In July 2022, Our Board of Directors approved a new stock repurchase program that allows for the repurchase of up to $500,000,000 of our common stock over a 24 month period.

Operator

With that, I will now provide further comments on our updated outlook. As previously disclosed 2 weeks ago within our pre release, We updated our net sales growth and adjusted EBITDA margin guidance for the full year 2022. In line with the pre release, We still expect net sales in 2022 to increase between 22% to 24% as compared to the prior year on an as reported basis, which includes an approximate 5% to 7% net impact from acquisitions and foreign currency. This revenue outlook assumes sales of residential and C and I products both increase at a similar rate in the low to mid-twenty percent range during 2022 over the prior year. Also in line with our pre release, adjusted EBITDA margins before deducting for non controlling interest are still expected to be approximately 18% to 19%.

Operator

This EBITDA margin expectation reflects a modest sequential improvement in gross margins in the 4th quarter compared to the 3rd quarter levels, with higher operating expenses as a percentage of sales partially offsetting the sequential gross margin improvement. Now I'd like to provide some further comments regarding our initial framework for net sales growth in 20 23. Summarizing Aaron's earlier remarks, our preliminary view for 2023 Anticipates that the first half of the year will experience year over year weakness on a consolidated basis. We expect to return to solid growth in the second Half of the year, resulting in overall net sales to only decline modestly for the full year 2023 as compared to 2022. Again, as Aaron previously discussed, home standby generator sales growth is expected to face significant headwinds in the first half of twenty twenty three, But as field inventories normalize, we anticipate strong sequential sales growth and a much more modest decline in sales growth over the prior year in the second half of twenty twenty three.

Operator

Clean Energy Technology is expected to experience robust sales growth for the full year As we continue to expand our presence, build out our distribution and launch new products into this market, resulting in sequentially improving results during 2023. Our preliminary view for 2023 C and I product sales growth anticipates continued strong growth throughout the year. This preliminary guidance assumes no this preliminary guidance assumes power outage activity that is in line with the long term baseline average and does not assume a prolonged recessionary environment that meaningfully impacts consumer spending during 2023. Additionally, this is a preliminary early look into our 2023 forecast and we will provide a more detailed update when we report 4th quarter results in mid February of next year. Shifting back to 2022, We will now provide additional guidance details to assist with modeling adjusted earnings per share and free cash flow for the full year 2022.

Operator

Our GAAP effective tax rate is now expected to be approximately 24.5% for the Q4 of the year, resulting in a full year 2022 GAAP effective tax rate of approximately 21.5%. For full year 2022, we now expect interest expense to be approximately $53,000,000 to $55,000,000 an increase from the previous guidance of $52,000,000 to $54,000,000 reflecting higher than previously expected benchmark interest rates. This assumes no additional changes in outstanding debt for the remainder of the year. Depreciation expense is still expected to be approximately $54,000,000 to $56,000,000 in 2022. GAAP $32,000,000 $34,000,000 for the year.

Operator

Our full year weighted average diluted share count is now expected to be Approximately 64,500,000 shares compared to the previous guidance of 65,000,000 to 65,500,000 shares. Our capital expenditures are now projected to be approximately 2% to 2.5% of our forecasted net sales for the year compared to prior guidance of approximately 2.5 Free cash flow conversion is expected to be closer to 100% of adjusted net income in the 4th quarter as the investment in working capital begins to level off. Finally, this updated 2022 outlook does not reflect potential additional acquisitions or share repurchases that could drive incremental shareholder value. This concludes our prepared remarks. At this time, we'd like to open up the call for questions.

Speaker 1

And our first question comes from Michael Halloran with Baird. Your line is now open.

Speaker 4

Hey, good morning guys. So just kind of want to talk through what happened between Q2 to today is the first question. Obviously, in the Q2, you talked about installation challenges potentially being a headwind, but I think the magnitude caught a lot of people by surprise and how Quickly that changed. And so could you maybe talk about the dynamic like that got you misaligned with what was happening in the channel, is the first question?

Speaker 3

Yes. Mike, this is Aaron. Yes, it's a great question and one that obviously not only Caught us by surprise, but even our channel partners, I think we hit kind of our peak output levels With home standby, we've been working very hard over the last couple of years to we've quadrupled the output and we really we hit our stride As we predicted, we would kind of as we exited the Q2 and began the Q3. And so we are producing at a really high rate. And we thought that was Really important because we wanted to bring our lead times down because we knew that that was having a negative impact on close rates, was having a negative impact on our ability to sign new channel partners.

Speaker 3

So we really were working hard to do that. And so we kind of opened the floodgates on shipping to get all that product out in the market. And what we started to see at the end of the second quarter and we mentioned it as you said on the call was that our installation our activation rate, which is Our proxy for installations, it was up year over year, but it wasn't increasing at the same rate commensurate with Our output increase. And so we could see field inventory building. And we had been talking to our channel partners for Several quarters about this coming and we were trying to get them prepared for that helping them hire people.

Speaker 3

We had a number of programs actually in place to get ahead of this. But in the end, it just we have 8,500 channel partners, dealers and then obviously a lot of Non dealer contractors who install these products and it's a ton of one off conversations and we just weren't able Change that inflection point on the installation rate to the degree we thought we could. So the flaw in the model, the simple answer is the flaw in the model here was that We modeled unconstrained installation bandwidth and that actually was not how it played out. We've never had that happen before by the way. I've seen probably 6 of these cycles in the past and successively as we kind of hit our peak rate with new output levels, We had never seen the installation bandwidth be a barrier.

Speaker 3

So that was the problem And it unfortunately stacked up really quick when you're shipping at those rates and only installing at kind of marginally higher rates. So So the field inventory started to stack up and they physically started to run out of room, run out of credit. And so what we saw is we saw cancellations and deferrals on orders from those home standby dealers and other channel partners during the quarter and that accelerated through the quarter here in Q3. So And it became very clear very quickly and again that's why we did the pre release because as soon as we put all this together and we could see what happened a couple of weeks ago, it's like okay this It's information we want to get to folks so they understand it. And we've redoubled our efforts, tripled our efforts on what we can do to increase Installation bandwidth.

Speaker 3

So anyway, that's kind of answering your first question. That's the issue in a nutshell, if you will, for home standby.

Speaker 4

So that's super helpful. And related, if

Speaker 5

I think about the time it's going

Speaker 4

to take to sync the channel up, I guess I'm having a hard time syncing up the idea that the underlying pieces are still pretty healthy And we gave a lot of good metrics in the prepared remarks and in the press release around what's happening on the consultation side, the closures, etcetera. With how long it's going to take to right size the inventory. And maybe it's just a bandwidth conversation with where the installers are at, But I'd love to have a sense for how I can kind of take that timeframe and sync it with what you're calling still pretty healthy underlying demand.

Speaker 3

Yes. I think probably the best way to maybe get your head around that is we believe that currently today field inventory levels are about double where they should be. And so that's the bad news, right? That's the additional output that we put into the market ahead of the installation Capacity increasing to the right levels. We do we are modeling that installation capacity is going to increase next year.

Speaker 3

The challenge of course is that just seasonally we're coming into as we turn the page here and get into Q1 and Q2, We normally run into a seasonally low period of installations because parts of the country like the Midwest and the Northeast where installations are much harder to do because of the cold weather, because of winter. So unfortunately, even though We're targeting that installations are going to improve year over year. We have this seasonal challenge we've got to deal with. It's just Nature, we can't really that's a hard one to fix. And so it won't increase Necessarily as quickly as we needed to in the first half.

Speaker 3

Now the good news is when we pull our dealers, half of that field inventory that's out there today is spoken Meaning it's got a customer contract against it, a customer's got a deposit on it. And again, it's indicative of the installation challenge because We're now back to what we said in the prepared remarks is mostly normal lead times. We still have backlog. We have a couple of models. We're still out there, some liquid cooled product, things So that's supportive of where we're going here in Q4.

Speaker 3

But what ends up happening is that we have It's mostly normal lead times for us to our channel partner, but if you are a homeowner and you call and you try and get a product, you still are being quoted longer lead times Because of these constraints, whether they be people constraints or permitting constraints or component constraints, gas meter upgrades, There are localized issues all over the country where some of our channel partners are bumping up against Just delays. And so they're working through that. And as those ease, that will help. But we think that it's likely going to take the first half of next year To get through this and that's going to put pressure on the incoming order rate for home standby through the first half of next year. And so that's really the challenge.

Speaker 3

We think that again, in our prepared remarks, we said by the second half of the year, we're back to growing again in the category and really only down modestly for the year in total for the category. So anyway, so that's I think when you put it all together, we feel pretty good about Longer term that the end markets supportive.

Speaker 4

That makes sense. So basically what you're saying is relatively normal sequentials On the home standby category for the next few quarters from couple of quarters from the run rate you're talking about in the back half of this year Before there's a potential inflection as things start catching up and normalizing a little bit.

Operator

Return to

Speaker 6

normal seasonality.

Speaker 3

Right. Return to normal seasonality, return to growth in the second half. And then again, I just the first half is going to be down considerably, second half will grow, still down kind of moderately for the category, Only modestly for the company overall. That's kind of our overall guide for next year, but just to clarify that.

Speaker 4

Thanks a lot. Thanks. Thanks for that. Appreciate it.

Speaker 3

Yes. Thanks, Mike.

Speaker 1

Thank you. And our next question comes from Jeff Hammond with KeyBanc Capital. Your line is now open.

Speaker 7

Hey, good morning guys. Good morning, Jeff. Hey, Jeff. Hey, Just on kind of the as you're thinking about the guide, I just want to kind of understand how you're thinking about like comping the backlog Drawdown that you're seeing this year and then what that would imply for kind of underlying demand for the category?

Speaker 3

Yes. I mean, again, that's a big part of the headwind for the first half in Exetera is the comp because we're obviously, we were Bringing that backlog down heavily in the 1st 2 quarters of this year. And so we'll be comping against that without having the benefit of that backlog As we get into next year, so that's a big benefit.

Operator

Yes. And then Aaron's point about the home standby category being Moderately in the second half. That's because you are trying to comp like some of that backlog headwind that we're bringing down here in the back half?

Speaker 3

No, moderately in total, up Returning to growth in the second half, but yes, for 2023.

Speaker 6

Yes, for the standby. Okay.

Speaker 3

For standby, if we're talking just standby,

Operator

Yes, we're just talking standby. But that we've got the headwind on the backlog that's driving

Speaker 3

That's what's driving that exactly.

Speaker 7

And then just what are you guys doing with your production levels as you get this reset? And just how should we think about Destock of your own invent it looks like your own inventories are a bit elevated as well.

Speaker 3

Yes, they are and you saw that read through just the working capital increase in the 3rd quarter. Driving free cash flow negative For the quarter, we see that coming back around in Q4. So we basically slowed the factories down, Still have some material coming at us, but that's starting to slow as well. We should basically get into a better position in Q4 and then Really working hard through the first half of next year to bring down those inventory levels, both raw materials and finished goods As it relates to the home standby category in particular, it's actually kind of a dichotomy because in our industrial business, We're constrained still in certain components and our inventory levels are low and we're struggling to kind of feed our factories with materials there on our industrial side. And we would be able to, in fact, go even higher Faster with our industrial business if we could get more engines and breakers and other things that are in shorter supply.

Speaker 3

But on the home standby side, We're definitely seeing a lot of material hitting our distribution centers as we slow production down.

Speaker 1

Thank you. And our next question comes from Brian Drab with William Blair. Your line is now open. Hi, thanks for taking the questions.

Operator

Hey, Brian.

Speaker 1

Maybe shifting to clean energy for a minute. So I think that the energy storage business in 2021 was around $220,000,000 to $225,000,000 It looks like the guidance that you're giving us now for $300,000,000 to $330,000,000 implies that that's something like 30% or so this year. Is that about right?

Speaker 3

And what are the overall

Speaker 1

numbers growing yet? And Can you clarify

Speaker 3

that? Yes. The market is still growing, although there's some mixed comments out there about the market growth. But, yes, the loss of that major customer of ours In the second half of the year here, they really ceased operations in July. So we've got to do the hard work that Honestly, we should have been doing all along of continuing to expand our channel to more channel partners.

Speaker 3

And but that hurts us Definitely in the year, Brian. So yes, unfortunately, that's going to be down this year. Looking for that to return to growth next year, but As we kind of fill in with new customers and we kind of reset, so 2022 is going to end up being a Set year for us here on energy storage, which is disappointing, but I think and a rather painful learning lesson for us on just Some of the trials and tribulations of that market, some of the customers and the dealer partners there, having to pick your partners carefully, Again, a lot of learning cycles we're going through there.

Speaker 1

Okay. Thanks. And then For my second question, can you just clarify exactly what you're saying about 2023 one more time in terms of I think that you said total company In the prepared remarks, it's all about total company and that you'd be down modestly for the full year, up sequentially first half to second half. But I'm just wondering, is home standby expected to be up year over year in the second half?

Operator

Yes, this is York. So yes, so total company, To clarify, we said weakness in the first half total company mainly driven By the home standby discussion we just had, a little bit maybe a little bit of clean energy as we build growth there. But second half, I think important to note total company returned to solid growth for total company in the second half. You put that all together then for full year, that would only be a modest decline for full year 2023. That's total company.

Operator

So then home standby specifically, again weakness first half, So growth from first half, second half and then a much more modest decline in sales growth over the prior year in the second half of the year. So maybe down a little bit, but it's much more modest decline relative to the first half For home standby.

Speaker 1

Thank you. Our next question comes from Mark Strouse with JPMorgan. Please proceed with your question.

Speaker 8

Yes. Good morning. Thanks for taking our questions.

Operator

Hey, Mark.

Speaker 3

York, curious if you can

Speaker 8

just talk about margins Through the first half of next year, just kind of the lower factory absorption with HSB, the lower mix So HSB and then kind of offsetting that, somewhat easing of some of the supply chain issues that you've had, How we should think about margins going forward?

Operator

Yes. No, I think Aaron mentioned a return to seasonality For the home standby business, meaning Q1 is usually the lowest point in the curve. Once you catch backlog, then you return to normal seasonality. Q1 The lowest point. So, you would expect just from a mix standpoint, that sequentially from Q4 2022 to Q1.

Operator

2023, that gross margin should decline because mainly because of that mix element. But, I mean, recall, we were facing some pretty heavy inflationary pressures in Q1 of 2022. So I would expect just from a price cost standpoint, we're going to see some nice price cost benefit there. But yes, we're still putting our models together on how that's going to look, but I would expect just sequentially that given The mix changes going in the first half of next year, you'd see maybe a slight decline in gross margins relative to the run rate.

Speaker 8

Okay, thanks. And then just to clarify on the Clean Power business, is most of the in the revenue outlook driven by needing to backfill for the customer that has gone bankrupt or is there A broader issue with the actual product itself that there's some actual reconfiguring of the solution?

Speaker 3

Yes, the majority of it, Mark, is related to the loss of the customer. That was a really important customer for us. And Yes. The diversification of our customer base is going to be the primary focus here going forward. And obviously, we've got to restore trust too, right, in the market to some degree.

Speaker 3

There's probably a spillover effect there to a bit. But I will say this, in and like I said, we've got a lot to learn in this market. This is a painful learning lesson, but in speaking with a lot of the kind of national companies that are well established, the national solar sales and installation companies, Almost every OEM has had challenges over the course of the solar kind of Market's existence and storage being the new component here. So again, not I'm not trying to indicate that people should expect that, but it's a pretty new market. I mean penetration rates are very low on these products.

Speaker 3

The environment Being rooftop mounted, electronics is a severe environment. The warranty periods are very long, 25 year warranty periods for the rooftop mounted components, 10 years on the batteries. So You've got a pretty there's a pretty high bar there quality wise, and a lot of companies have unfortunately We struggle with that. Now I think we feel like we well, a couple of things. 1, we're very committed to this.

Speaker 3

We think it's the future. We think I think it represents some great opportunities for Generac in terms of what can fit with our brand, our distribution and our expertise in some of these areas. So we're committed to it. We've got a great balance sheet to be able to finance this. The investment needed obviously is going to be greater than we had originally thought.

Speaker 3

You can't just take startup technology and try to scale it. That's clear based on our experiences here. So we're going to have to do a lot more work around that. We're going to have to put More talent in the teams. We've started to do that.

Speaker 3

We've mentioned that in some of our prepared remarks this morning, and we're going to continue to do that. We think that this is again, it's an important part of the future. We're committed to it and we are going to be a major player in it longer term. We're going to take Our lumps here and the humility that comes with that, but in the end, I believe that we will have a lot of great success in this longer term.

Speaker 1

Thank you. And our next question comes from Joseph Osha with Guggenheim Partners, your line is now open.

Speaker 9

Thanks. Good morning. Hi. I wanted to spend a bit more time in the clean energy business. We've talked a lot about storage, which is great.

Speaker 9

Ecobee is a good sized business. So I'm wondering as you look into the next year, obviously, You don't want to get too detailed, but maybe if you could give us a little bit of a sense as to the roughly what the break Down of that business might look like. And on a related note, now that you've got this safety couple products, we talked about this before, Given some of the challenges that you've talked about with some of the other stuff, could we see you perhaps pivot more To selling that AC Coupled product alongside other people's inverters. So those are my two questions.

Speaker 3

Yes, Joe, great questions. Just let me touch on the ecobee piece first and then I'll get to the AC Coupled solution. So, ecobee is It's a great company, really well run. They've really struggled this year with component availability in the first half of the year. So, they've under delivered a bit to our expectations and their own expectations just around that.

Speaker 3

But things have really picked up here. As they exited the Q3, they're looking at 4th quarter being their highest quarter ever as a company and looking at big things. I think a lot of that you can probably tie back to Higher energy prices, right? Homeowners, I think, are looking for solutions to mitigate those higher energy prices. And a smart thermostat is kind of A really cost effective way to go after that.

Speaker 3

The paybacks are really strong and you buy one of these products, and inside of a year, you can pay that back. And that's even not even assuming the opportunity to connect that thermostat to a grid services type of program like a demand response program, which can enhance the payback even more. So really excited about that business. I think when we announced it, it was something like $125,000,000 It's grown nicely this year And we'll continue to grow. And we're not going to break down the pieces because we don't want to get into doing that every quarter here going forward.

Speaker 3

So But it's a great business, well run and a lot of upside there. And I think one of the bigger opportunities within that is just the team that they have, the expertise they have, It's going to be central to this single pane of glass initiative that we see as sitting at the heart of The smart home energy system that we've talked about, connecting, whether it be generators or PV microinverters or Storage devices or smart thermostats or water heater disconnect switches, load management, ultimately EV charging, things like that. We think all of that is

Speaker 9

to be coherent and that I did just hear you say $125,000,000 for this year, right?

Speaker 3

No, that was what we've said when we announced the deal back in December. That was their run rate.

Speaker 9

Okay. All

Speaker 2

right. They've

Operator

grown nicely.

Speaker 5

Yes, they've grown nicely since then.

Speaker 3

And then on the AC coupled The AC coupling, Joel, that is definitely a focal area and one of the things that we've been pushing to get into the market. The microinverter or excuse me, the PV, the power cell with a firmware update can accept Power from 3rd party inverters now. So we feel really good about that And that's going to be a focus area for our commercial teams as we go forward. So looking forward to that, Getting some traction in the marketplace and we think that we'll see success with that.

Speaker 4

Thank you.

Speaker 3

Thanks. You bet.

Speaker 1

Thank you. Our next question comes from Jerry Revich with Goldman Sachs. Your line is now open.

Speaker 10

Yes. Hi, good morning, everyone.

Speaker 9

Aaron, I'm

Speaker 10

wondering if you could talk about the production rate for the Standby business in the Q4, normal seasonality. I think installs tend to be up low double digits. Can you just comment on, are we now at a normalized run rate where that business Can be up sequentially in near term based on the visibility you have as of today?

Speaker 3

Well, production rates won't be because we're bringing those down because of the field inventory issue and we've got plenty of inventory as well. So that if the question is around Production rates, we won't be up in the Q4, will be lower. So we expect that and that's built into our guide today. But again, installation capacity that normally seasonally does peak in the Q4. And we continue to see again, we added 300 Dealers in the quarter alone, which is helpful for that.

Speaker 3

We're pacing well again to add more dealers here in the 4th quarter And we need to be hitting our peak rates for installation by the end of the year, but that's all contemplated in the guidance. I don't know if I'm answering your question Jerry or not, but

Speaker 10

Yes. So and earlier you mentioned production would be down as normal In the Q1 as well and so I'm just trying to understand right after every major outage event there is a new and Higher baseline, but that baseline is obviously down from the peak. And I'm just wondering, are we going to be running at that Based on the order rates that you see today without making any assumptions on installation capacity as we Head into call it $400,000,000 standby revenue quarter in the Q1, does that match the incoming Order rate or is there a risk of an additional step

Speaker 3

down? No, no, no, no. So what we've said is that the order rate is We're going to have headwinds there as they work their field inventory down. So they've got, again, field inventory, which is about double where we should be at this time of year And normal in terms of days of field inventory is about double, but about half of that So really the problem, right, the doubling is already sold. So they just have to get it installed.

Speaker 3

So because of that, The order rate is going to be artificially depressed until we get through that. So, I guess

Operator

the hurricane will just increase the backlog of our dealers Basically, that'll be helpful.

Speaker 3

Yes, exactly, right, exactly. And could accelerate some of the drawdown of fuel inventory in the Florida regions, in particular, where Ian impacted, but no, we think that the order rates that we're seeing today that we'll continue to see through the end of this year and the first half of next year are artificially low As we right size that field inventory.

Operator

And remember, we have some backlog in the Q4 here that we're satisfying as well.

Speaker 3

Exactly. That's a good point.

Speaker 1

Thank you. And our next question comes from Maheep Mandloi with Credit Suisse. Your line is now open.

Speaker 5

Hey, thanks for taking the questions. I know you gave enough guidance on gross margin For the C and I for the HSE projects in Q4 and the first half. But maybe if you could just opine on OpEx In Q4 in the first half, given all the data points you're seeing on channel inventory and in house consultations, Should we expect any changes over there? And I just had a follow-up on Ashinko. Thanks.

Operator

Yes. This is York. OpEx, I think I alluded to it. OpEx may tweak up a little bit here In the Q4, as a percentage of sales relative to Q3, there's actually just some seasonality on Spend in Q4, some accrual reversals in Q3 that won't repeat. So just a modest increase in OpEx sequentially, Both dollars and as a percentage of sales, we're modeling in our guidance.

Speaker 5

And any Guidance and how should we think about it in 2023?

Operator

No, I mean, we're still we're just we gave the framework for the top line. We're still working on the framework For gross margins and OpEx, I think we're going to hold off on discussions on the margin side For next year until next quarter.

Speaker 1

Thank you. Our next question comes from Kashy Harrison with Piper Sandler. Your line is now open.

Speaker 5

Good morning and thank you for taking the questions. So just the first one for me. So the C and I other segments both quite strong. Can you maybe just dig into some detail on the strength in both of those Segments in Q3 and then maybe speak to the specific indicators you're seeing right now that give you the confidence of A continuation of strong growth entering calendar 'twenty three so early. And I have a follow-up.

Speaker 3

Yes, Kashy, really the C and I business has been ripping along here for a number of quarters and Really hitting its stride. We're taking share in the market. We're seeing in our industrial distribution channel, everything was up So our telecom vertical that is a really important vertical for the company was up. This our mobile business was up as The national rental accounts continue to re fleet and top off their fleets. Our business internationally, which is mostly C and I, was also up very nicely.

Speaker 3

Again, just a lot of the same opportunities there. Probably one area that I would call out that Was this kind of we refer to it as beyond standby applications. So mainly natural gas generators, large C and I natural gas generators that Would otherwise have normally been sold into emergency backup type of applications are being sold into applications where they're Still used as emergency backup power, but they can also be called upon to support the grid during times of significant stress, so heat waves, Outages, things like that. So think microgrids or kind of energy as a service types of programs, demand Programs where the generator can be switched on remotely by a grid operator or utility, Oftentimes connected through our grid services software platform Concerto, and we're seeing that market It was up really large in the quarter for us. Now it's still pretty small in totality, but it's growing very quickly.

Speaker 3

And The quality conversations we're having with people on projects, potential projects in the future, the pipeline here for that business Looks really good, so much so that we're oriented around adding capacity in our C and I factories to accommodate that growth. And so additional test capacity, additional manufacturing capacity, additional sheet metal fabrication capacity, we're making investments there so that we can be ready for that business as it grows because we think it's a fundamental part of the megatrend that we've identified Kind of the grid instability issues that are coming from the rapid decarbonization of utility scale sources And on the demand side, the electrification of everything, inclusive of transportation, this supply demand imbalance, Many utilities and grid operators have really struggled here and had to scramble over the summer in particular. Now they were able to avoid any major outages, Which is pretty remarkable, but in the end, the reserve margins, that's really kind of what it gets down to is the reserve margins is the excess Capacity or sources that they have over demand and those reserve margins have gotten compressed Dramatically in certain markets, out west, even here in the Midwest, where the reserve margins are down to Kind of critical levels where if you get a spike in demand or you get some kind of interruption in supply, a major plant goes offline or there's some other disruption can cause significant challenges.

Speaker 3

And this is really at the heart of what happened in February of last year in Texas. The cold snap that happened there was Exacerbated the supply demand challenges that were underlying what was going on in the ERCOT region or the ERCOT market. And so the opportunity to use generators, fossil fuel generators, but natural gas generators, which burn much Cleaner obviously than diesel generators, has really come into focus as a potential opportunity to use these assets for the purposes of grid support. So that was kind of what happened in C and I in a nutshell. As you mentioned, the other category was also up nicely.

Speaker 3

That encompasses some of our monitoring businesses, encompasses some other Areas of the business that have been growing very nicely as well. So between those two segments or not segments, but product product classifications, Those we saw really nice growth in the Q3.

Speaker 5

And just the indicators you're seeing that give you the confidence '23 so early on?

Speaker 3

Yes. So the C and I business is a backlog business. I mean that always has been a backlog business. So we look at that, you've got lead times on products there that in some cases go out 26, 36 weeks depending on the size of the product. It's custom built, and it always has been this way.

Speaker 3

This is not the new Colonel, and the story over the last two years is the fact that home standby, which has never been a backlog business, became a backlog business. But the C and I business has always been backlog, Provides great visibility for us. So we feel very good about that. You're also seeing kind of some of the public statements and like if you look at the national rental account customers that we sell to, They're indicating that they believe their CapEx budgets and CapEx spends are going to continue to grow into 2023 As again some of these megatrends around the infrastructure, investments that need to be made around the country, we have the investment The Infrastructure Act that did get passed earlier this year, there's a lot of spending that's going to come through for that, for roads and bridges and airports and ports and All those types of massive infrastructure areas, our rental customers are going to serve that. The telecom business Continues to our telecom customers continue to tell us that they're midstream in the build out of their not only hardening their existing networks, but the build out of their Generation of 5 gs Networks.

Speaker 3

So that feels really good. And then again, the quality of the pipeline, as I said, around some of these newer things Like the Beyond standby opportunities, the microgrid opportunities in C and I, we think that there's Those have a lot of legs yet going into 2023.

Operator

Yes. The fact that book to bill remains strong is promising for next year.

Speaker 1

Thank you. And our next question comes from Puneet Satish With Wells Fargo, your line is now open.

Speaker 8

Thanks. Good morning. I guess if we could just focus only on the second half 23 for a second. You mentioned that HSB could be down, but I would have thought by then that the field inventory and The installation issues would have been resolved or normalized. So I'm just wondering what's kind of driving that view for HSB in the second half of twenty twenty three given that demand is so strong.

Speaker 8

And is there a scenario where it could

Operator

be up? Yes. No, I think, we alluded to it before that. I mean, there is some backlog that we're Satisfying here in the second half of twenty twenty two that won't repeat. So there's a little bit of a, I guess, year over year headwind when you're looking at 'twenty three Versus 2022, so The

Speaker 3

guide also doesn't contemplate any major outages.

Operator

Yes, that would be upside. So if you're looking for upside, where could we grow?

Speaker 3

We did have some outages this year.

Operator

Yes, things happen. Mother Nature happens, so that would definitely be a scenario where things could grow. But That's an inherent the backlog situation here resolving that backlog here in the second half of twenty twenty two is an inherent headwind for second half of twenty twenty three. But I think sequentially as we get through these field inventory Challenges here in the first half, you definitely would see growth sequentially from first half to second half, At least in terms of how we're seeing it in our framework here for 2023.

Speaker 8

Got it. That's helpful. And then just switching gears on PowerCell. You mentioned that a certain component Needed to be upgraded and so you're enlisting kind of 3rd party installers for repairs. Can you elaborate on what that component is?

Speaker 8

And then has that component been fixed In new batteries that are being produced? Yes.

Speaker 3

We have an upgrade path on that component. It's a rooftop mounted Shut off device and that device is the previous generation of that device Has a higher failure rate than what we like to see. So, we're proactively replacing those devices for customers, so they don't see an interruption of the production of their systems. So, but everything is we've got a path forward and have had a path forward here for some time. We just have to get the upgrades complete.

Speaker 3

And so to speed that up, we brought in a bunch of 3rd party service companies that are going to help us do that. We were relying on some of our channel partners, but The loss of that largest channel partner became obvious that we needed to enlist the help of others and that's why the 3rd party folks are going to be in there. And that upgrade, The total effort there is what's reflected in that additional warranty reserve charge that we took here in the quarter.

Speaker 1

Thank you. Our next question comes from Donovan Shafer from Northland Capital Markets. Your line is now open.

Speaker 6

Hey guys. Thanks for taking the questions.

Speaker 3

Hi, guys.

Speaker 6

Hi, can you hear me?

Speaker 3

Yes.

Speaker 6

Okay, okay. Great. So on the home standby side, I was just curious, is there any kind of a pattern And the lower orders from the channel partners in terms of, is it more concentrated on the side of Big box retailers like Home Depot and Lowe's or maybe regional installers or even potentially kind of the longer tail Smaller installers, I think the smaller installers tend to be limited, maybe more on warehouse space and access or willingness to use credit. So I'm just curious if it kind of is disproportionately in any one of those areas? And then I have a follow-up.

Speaker 3

Not dramatically so, Donovan. I mean, it's pretty much fits the historical in terms of just the channel, The mix, if you will, the channel mix within home standby hasn't changed dramatically. I mean, we do have Some of the stocking channels, right, like if you look at a retailer or you look at a wholesaler for us, Those are traditionally stocking channels where a non dealer contractor comes in or a homeowner comes in and buys one of the products out of stock. Whereas our dealers, it's they generally only buy from us when they have a contract signed by a homeowner because they and that's nothing's changed with that. That's kind of the way the business has paced.

Speaker 3

I think to answer your question, there's nothing dramatically different about the mix channel to channel going on there.

Speaker 6

Okay. And then as a my next my follow-up question is just focusing on what's going on in Europe, Yes, because you guys in commercial and industrial, you really are kind of a global business and you've got a lot in Europe and India, Other parts of Southeast Asia, there's kind of just so much. But when I look at what's going on in Europe, it feels like there are a lot of puts and takes that could be Kind of both tailwinds and headwinds because you've got the energy crisis and all the fears and stability around there, but then simultaneously you're So, going to have people saying, this is why we shouldn't be using natural gas. And so, there might be resistance against natural gas infrastructure And installing more generator sets to rely on that, maybe even if there's any diesel that might be seen as much more of like Short term thing and so they don't want to invest the CapEx for a longer term backup. So it just seems like there's a lot of potential And the sort of differences of Eastern Europe versus Western Europe.

Speaker 6

So could you just go into a little bit more detail on like what exactly you're seeing Specifically in Europe and how that's kind of unfolding for your businesses?

Speaker 3

Yes. That's a good question. I mean, Europe Has and has always been a mostly diesel C and I generator market. So that's just the level set. We have seen Growth in natural gas gensets in not only the European market, but also India, here recently Coming off a base of almost nothing.

Speaker 3

There's nothing there. So, and I think on the margins maybe Yes, on the edges, I should say, not to confuse with gross margins or anything. On the edges of the discussion, yes, there are some pipeline, You know, if people want to limit gas connections, natural gas isn't going away. That is about the most foolish thing for people to think Is the right answer for anything here. Natural gas is needed for heating, for cooking.

Speaker 3

It's plentifully available. It burns cleanly. We would do well as a society to continue to focus on further improvements in cleaning up The emissions that come from natural gas, whether it be the extraction emissions or it's the consumption emissions, but Because I think it's a fuel that can really help us shift as a populous here, as a global populous further away from More carbon intense forms of energy generation like coal and other fuels. So again, it's not it might be on the edges you're going to see some natural gas limitation just like we are seeing here in the In places like California, Berkeley, other places like that where they've taken it on taken the They've taken it on themselves to close off new natural gas connections. Reality of it is you can get a propane tank anyway.

Speaker 3

So I mean it's kind of a fruitless Effort, the generators run off of propane as well. So you don't actually need pipeline. It's helpful, but you don't need pipeline gas. So, Again, I think there's our view is there's going to be plenty of growth in the C and I generator world, even the home standby generator world outside of North America And natural gas gens are going to be part of that natural gas and propane gens.

Speaker 1

Thank you. And our final question comes from Saree Boroditsky with Jefferies. Your line is now open.

Speaker 11

Thanks for fitting me in. So just going back to the home standby commentary, you talked about only a modest decline in the second half of the year. Could you just help frame how you're thinking about the magnitude of the decline in the first half of the year?

Operator

No, we didn't necessarily frame that out. I think what we're looking at is More, when you look at the total company, returning to solid growth in the second half, Resulting in only a modest decline for the total company for the full year. I saw you can sort of get the magnitude of What that means for the first half on a total basis, you know that based on our comments that C and I is going to continue to be strong in the first half, so you'll see growth there. We'll be sequentially improving our clean energy business throughout the year in 2023. And so that basically leaves you sort of gives you some framework for How to put all the pieces together.

Speaker 11

Okay. And then it seems like sales grew faster at home standby than anticipated when you kind of gave out that Could you provide us with an estimate on where that puts you from a penetration rate at the end of this year? And then any thoughts on where we could go from there?

Speaker 3

Well, pen rate this year around 6% is where we anticipate ending. So it doesn't it didn't change that dramatically. And we're going to have to update our guidance in the long range guidance. Again, I would point out, we did say At our Investor Day, the growth was not going to happen in a straight line. I know we have people who haven't been around the company That long and are learning kind of how the cycles work here, but we have in particular with home standby, we have the dramatic increased cycles where you have these step functions up, Then growth kind of levels off comes off of the peak actually comes down off of a peak into and normalizes to a baseline level, a new baseline level that's materially higher than the And then you kind of as you increase awareness and distribution, then you're ready for the next step up in growth.

Speaker 3

So it's more of a step function grower. We'll have to review the long term targets. We're not prepared to update them this morning, but We are going to have we'll have another Investor Day next year for sure, if not before then in terms of updating the long range guidance.

Speaker 1

Thank you. I would now like to turn the conference back over to Mike Harris for any closing remarks.

Speaker 2

We want to thank everyone for joining us this morning. We look forward to discussing our Q4 and we will be discussing with you in mid February. Thank you again and goodbye.

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Earnings Conference Call
Generac Q3 2022
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