Generac Holdlings Inc.

Ladies and gentlemen, thank you for standing by and welcome to the second quarter 2020 Generac Holdings Incorporated conference call. At this time, all participant lines 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 1 on your telephone keypad. Please be advised that today's conference is being recorded. If you require any further assistance, please press star 0. I would now like to hand the conference over to your speaker today, Mike Harris, Vice President of Investor Relations and Corporate Development. Thank you. Please go ahead, sir.

Good morning, and welcome to our second quarter 2020 earnings call. I'd like to thank everyone for joining us this morning. With me today is Aaron Yagfilm, President and Chief Executive Officer, and York Reagan, Chief Financial Officer. We will begin our call today by commenting on forward-looking statements. Certain statements made during this presentation are 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. Additional information regarding these measures, including reconciliation to comparable U.S. GAAP measures, is available in our earnings release and FCC filings. I will now turn the call over to Aaron.

Thanks, Mike. Good morning, everyone, and thank you for joining us today. We're excited to discuss our financial results reported earlier this morning in which sales, adjusted EBITDA, and adjusted EPS were all records for a second quarter and were led by strong growth in residential products of approximately 27%. Relative to expectations, second quarter revenue dramatically exceeded our prior forecast and adjusted EBITDA margins were much higher than previously forecasted, primarily due to the higher than expected shipments of residential products, which led to a considerable favorable mix impact on profitability. Home standby shipments came in significantly higher than our prior forecast, primarily driven by robust demand as a result of the heightened awareness of the need for backup power since the onset of the COVID-19 pandemic. We also experienced higher than expected growth for chore products, sold directly to consumers as homeowners increased outdoor project activity while spending more time at home. As expected, the ongoing pandemic around the world had an adverse impact on demand for CNI products during the second quarter, but collectively shipments were modestly better than our prior forecast. On a year-over-year basis, net sales increased approximately 1% during the second quarter of 2020 as compared to the strong prior year second quarter. Gross margin, excluding the impact of restructuring charges, expanded 330 basis points compared to prior year. An adjusted EBITDA margin was very strong at 22.5%, increasing 190 basis points over the prior year, as both exceeded our expectations primarily due to favorable mix from higher-than-expected shipments of residential products. Before discussing second quarter results in more detail, I wanted to stress that as the COVID-19 pandemic continues to grow, a high degree of uncertainty exists regarding the magnitude and timing of an economic recovery and the potential impacts on our end markets and overall business. However, what appears to be fairly clear to date is that demand for our residential products is significantly benefiting from an emerging trend that we are referring to as home as a sanctuary, where millions of people are working, learning, shopping, entertaining, and in general, spending more time at home. Primarily as a result of this trend, along with the elevated concerns about future outages, we are significantly increasing our full-year revenue and earnings outlook for 2020, including much higher expectations for the second half of the year. We'll provide further details regarding this updated guidance in the outlook portion of our prepared remarks this morning. Now, discussing our second quarter results in more detail. Shipments for home standby generators during the quarter once again increased at a very strong rate compared to the prior year, driven by the heightened awareness since the onset of COVID-19 and also benefiting from the elevated outage activity and awareness events in recent years, an above-average hurricane forecast for 2020, and a significant increase in demand in California. Several key metrics that we monitor closely for home standby demand continued to be exceptionally strong during the second quarter. Activations grew at a very substantial rate compared to the prior year, with broad-based strength across all U.S. regions and Canada. This strength was led by robust growth in the West region, driven by California, and the South Central and Southeast regions. The combination of in-home and virtual consultations rose dramatically during the second quarter, with broad-based strength across the country and outsized growth in California and Florida, and Texas in particular. More importantly, home consultations during the quarter experienced strong growth in every single state in the contiguous U.S., which we believe supports our view of the emerging home as a sanctuary trend. The power outage severity environment also continues to trend above baseline levels, with outages significantly higher during the second quarter relative to the prior year. In fact, outage severity on a trailing 12-month basis has notably exceeded the long-term baseline average in recent years. We also ended the second quarter with over 6,700 residential dealers, an increase of approximately 650 or 11% compared to the end of the prior year second quarter. This includes a significant increase in California, ramping up to over 450 dealers at the end of the quarter from approximately 200 dealers at the end of the prior year second quarter. More recently, early in the third quarter, these key demand metrics for home standby have continued to be much higher relative to prior year levels. Specifically regarding home consultations, as previously discussed during our last earnings call, we mentioned that April home consultations were up approximately double versus the prior year. And since that time, this tremendous strength has continued through July. We believe this increase can be attributed to several factors. Overall power outage severity continuing to trend above baseline levels. Second half predictions for a well above average Atlantic hurricane season. The prospects for an active wildfire season in California. and now the emerging trend of Americans viewing their homes as a sanctuary. Importantly, our dealers now have the ability to offer a homeowner a traditional in-home consultation or one that can be largely conducted remotely, which we are referring to as a virtual home consultation, or VHC. During the second quarter, we rolled out the VHC process through aggressive communication and training, and to date, our dealers are experiencing similar close rates and sales cycle times in relation to the in-home visits they have traditionally used. Recall that our previous guidance anticipated a decline in close rates, assuming a lower consumer spending environment during the pandemic. However, overall close rates have actually remained consistent with historical trends, which gives us confidence to raise the outlook for residential products for the full year. Also, the exceptional strength in home standby demand is occurring much earlier in the year than normal, before we even enter the heart of the hurricane and wildfire seasons, which typically doesn't occur until the latter half of the third quarter or early into the fourth quarter. Should these additional events materialize, we could see additional growth, particularly for portable generators. With demand for home standby generators at an all-time high, we are working to aggressively ramp our supply chain and production levels to satisfy the increased demand for these products, and we are targeting to be at record daily build rates by the fourth quarter. This production ramp also includes the official launch next week of the industry's largest air-cooled generator, a 24-kilowatt machine that will add to our broad product offering and increase our competitive advantage in the market. This product comes on the heels of a number of other industry-leading features and products introduced over the last several years that have continued to advance our goals of driving the availability, affordability, and awareness of the home standby generator category. Further lending support of an emerging home-as-a-sanctuary trend, we also experienced strong growth for our chore products during the quarter, which significantly exceeded our expectations. Recall that chore products consist of a wide range of specialty outdoor power equipment, including field and brush mowers, chipper shredders, log splitters, stump grinders, and pressure washers, and are used in a variety of property maintenance applications. The strength experience during the quarter was led by the sale of these products directly to consumers as homeowners increased outdoor project activity while spending more time at home. So far in the third quarter, demand for these products continues to outpace normal seasonality as homeowners spend much more time in the yards working on outdoor projects. Rounding out our discussion on residential products is an update on clean energy. The secular growth opportunity within the U.S. market for energy storage and monitoring systems remains very compelling through a combination of changing regulations, advancements in technologies, improving economics, and the increased resiliency desired from these products. Although shipments of our recently launched PowerCell energy storage systems contributed to the company's year-over-year growth in the second quarter, they declined on a sequential basis as the overall solar market was negatively impacted by a sharp drop in the pace of installations as a result of the COVID-19 pandemic. The decline in solar installations was due to permitting delays and other restrictions, including certain instances where this activity was deemed non-essential by certain state and local municipalities. The consensus expectation for the solar industry is for a V-shaped recovery for installations during the second half of the year. Based on this outlook and the visibility we have through existing orders and our sales pipeline, along with recent trends for home consultations and system activations, we're still expecting strong sequential improvement in power cell shipments during the third and fourth quarters. With the overall pullback in the solar market during the second quarter, we now believe shipments of energy storage systems for full year 2020 to be at the low end of our previous guidance range of 125 to 150 megawatt hours of product. This outlook remains significantly ahead of the expectations we discussed during our investor day last September, which reflects our success in the marketplace to date, as well as the increasing level of solar plus storage attachment rates that the industry is experiencing, in part, driven by homeowner concerns over backup power. Despite the COVID-19 pandemic, we're making good progress in building out our clean energy dealer base, ramping our technical support capabilities, and reducing our system costs. In addition, we continue to be excited about our new Sinova partnership, and we're off to a very encouraging start as we have begun engaging and providing leads to their distributors. We see the relationship as a strategic partnership and expect a solid sales ramp starting in the third quarter. We're also making important strides in growing this nascent market through targeted advertising, lead generation, and virtual in-home sales capabilities. Our new clean energy infomercial that began airing earlier this year continues to be very well received and is driving good lead volume into our recently launched lead management and selling system that we call PowerPlay CE. We have also made important progress thus far in 2020 in developing an innovative pipeline of new products that will be coming to market over the next several quarters. We believe these new products will further enhance our competitive position and differentiation in the energy storage, monitoring, and management market, and will ultimately provide what consumers really want, a whole-house storage solution with load management capabilities that can provide energy independence. While the impact of the pandemic has resulted in a brief softening of the market for energy storage for 2020, particularly in the second quarter, we believe the longer-term drivers remain firmly in place. With installations of these systems still forecasted to experience exceptional growth over the next several years, we believe we are favorably positioned to participate in that growth by leveraging our strong brand, innovative product portfolio, and lead generation capabilities. With regard to our C&I products, it's quite clear that the COVID-19 pandemic is having a significant adverse impact on the overall market for power generation and related equipment given major declines in GDP growth rates around the world. Domestic shipments of C&I products declined during the second quarter at a significant rate as compared to the prior year, but we're modestly ahead of our expectations as discussed during our last earnings call. As expected, shipments of mobile products to national rental account customers declined significantly during the quarter, primarily due to the continued impact of the pandemic and the collapse in oil prices. Recall that demand for mobile equipment was already softening at the beginning of this year, as many of our national rental customers were deferring some capital spending. The sudden decline in economic activity and corresponding drop in fleet utilization in March forced them to further and dramatically reduce equipment purchases, which has carried over into the second quarter. Shipments to national telecom customers also declined at a considerable rate on a year-over-year basis as compared to a strong prior year comparison, as these customers initially deprioritized capital spending, certain capital spending, in response to the current environment. Additionally, with the formal approval of the merger of T-Mobile and Sprint on April 1st, capital spending for these companies is expected to be lower in the short term as they combine and rationalize their network assets. Recall that demand trends with telecom national customers can vary from quarter to quarter based on the timing of capital deployment and and project planning cycles. Lastly, shipments of CNI stationary generators through our North American distributor channel were also lower in the quarter, as this channel began to experience the impacts from a decline in project quoting as non-residential construction activity continues to slow. However, the significant decline in quotations for new projects experienced in March and April during the onset of the pandemic has recovered somewhat in recent months, which has improved the overall outlook for this channel for the remainder of the year. Additionally, our CNI product outlook now includes the recent acquisition of Energy Systems, our industrial distributor located in Northern California. This acquisition enhances our ability to serve what we view as one of the largest power generation markets in the U.S. for both CNI and residential products. We want to welcome the approximately 50-person team of Energy Systems into the Generac family and look forward to expanding our presence in the rapidly growing California market. As expected, the ongoing global pandemic had a significant impact on demand outside the U.S. and Canada during the second quarter. As COVID-19 moved from China in January to Europe in February and then on to Latin America, the first quarter demand environment was challenging and worsened considerably during the latter part of that period and into the second quarter. As GDP growth rates were sharply reduced around the world, revenues for our international segment in the second quarter declined approximately 25% on a core basis compared to the prior year. These declines were broad-based in almost every market that we serve and magnified the slower economic growth and geopolitical headwinds that were already being experienced in recent quarters. Despite this weakness, overall international revenue during the second quarter moderately exceeded our expectations, and our current full-year outlook is also slightly more favorable for this business as certain regions such as Europe are trending better than previously feared. Recall that last quarter we discussed the execution of between $25 to $30 million of cost-reduction initiatives that we were targeting across the business to address an expected slowdown in demand from the impact of the coronavirus pandemic. Given the magnitude of the downturn in demand for C&I products, where shipments declined 33% over the prior year, we initiated a number of meaningful restructuring actions for this part of our business during the second quarter to better align our cost structure with current global customer demand trends. Accordingly, as reported in our earnings release earlier this morning, the second quarter includes $11.5 million of pre-tax charges related to business optimization, non-cash asset write-downs, and other restructuring costs, with the vast majority related to CNI products. The specific restructuring efforts were mostly within our mobile and international operations, and include work furloughs and headcount reductions, as well as a recording of a number of non-cash asset write-downs. We believe these actions are necessary to address the longer-term negative impacts from the pandemic, and we estimate the cost reductions will yield approximately $10 to $12 million of annualized cost savings once fully implemented by the end of the year. With the strength in our residential business, the original cost reduction actions are more muted, as the $25 to $30 million of initial savings are partially offset by incremental incentive compensation and headcount investments, given our increased outlook. Although near-term market conditions are challenging for these businesses, we remain optimistic on the long-term opportunity for mobile products, which aligns with an expected fleet replacement cycle nearer term, and the compelling megatrend of much-needed infrastructure investments around the world. In addition, the secular growth opportunities remain intact for our international businesses, including the increasing penetration of home standby and natural gas generators for commercial and industrial applications, alongside the market share opportunities in supplying critical support equipment for wireless telecom sites and entering the emerging space for energy storage for both residential and CNI applications. In closing, we remain very excited about our future growth prospects, which are driven by several megatrends and powerful macro secular drivers. And we will continue to aggressively invest in the strategic initiatives that align with Generac's powering our future strategy. Demand for the company's residential generators continues to benefit from the trend of increasing power outages as a result of more severe weather, driven in part by global warming. And as we have discussed this morning, recent demand for these products are now clearly benefiting from the new and emerging home as a sanctuary trend. with millions more working, learning, shopping, entertaining, and spending much more time at home. In addition, we're confident that once we get through this pandemic, future growth prospects for our CNI products remain compelling, driven by the increasing penetration of natural gas generators in a wide variety of applications, the major investment cycle needed for legacy infrastructure, and wireless telecommunications shifting to 5G architecture. We are also extremely excited about the long-term growth opportunity for our clean energy products, including the potential to leverage and combine our new capabilities in energy storage, monitoring, and management with our core competencies and strategies with natural gas generators. We believe this will better enable us to enter new and adjacent markets that align with the evolving megatrend around the disruption of the traditional electrical utility model, including decentralization of the grid and a migration towards distributed energy resources. I'd now like to turn the call over to York to provide further details on our second quarter results. York?