Generac Holdlings Inc.

Q2 2022 Earnings Conference Call

8/3/2022

spk08: The conference will begin shortly. To raise your hand during Q&A.
spk10: Good day, and thank you for standing by. Welcome to the second quarter 2022 Generac Holdings earnings call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question and answer session. To ask a question during this session, you will need to press star 1 1 on your telephone. You will then hear a tone acknowledging your request. Please be advised that today's conference is being recorded. I would now like to turn the call over to Mike Harris, Senior VP, Corporate Development and Investor Relations. Please go ahead.
spk16: Good morning. Welcome to our second quarter 2022 earnings call. I'd like to thank everyone for joining us this morning. With me today is Aaron Yagfeld, 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 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 SEC filings. I will now turn the call over to Aaron.
spk13: Thanks, Mike. Good morning, everyone, and thank you for joining us today. Our second quarter results were very strong with robust revenue growth, significant sequential margin expansion, and all-time records in net sales, adjusted EBITDA, and adjusted EPS. Shipments of home standby generators and global CNI products outperformed our previous expectations, primarily driven by continued progress on our capacity expansion and our team's ability to effectively manage the challenging supply chain environment. Gross and adjusted EBITDA margins were also ahead of our expectations in the quarter, reinforcing our prior forecast of margins bottoming in the first quarter. Gross margins benefited from favorable product mix, largely driven by home standby generators. These dynamics drove adjusted EBITDA margin outperformance and sequential margin expansion combined with impressive top-line growth resulted in an all-time quarterly record for adjusted EBITDA dollars. Positive underlying demand trends led to continued backlog strength, with C&I products and home standby backlog both providing us with considerable visibility for the quarters ahead. Year over year, overall net sales increased 40% to $1.29 billion and grew sequentially from the first quarter of 2022, which was the previous all-time record. Strong momentum in core sales, which excludes the impact of acquisitions in foreign currency, continued in the quarter with 33% growth over the prior year. Overall residential sales growth was again very robust, driven by a substantial increase in shipments of home standby generators, as well as the impact from recent acquisitions. The CNI sales increase was broad-based, led by growth across all channels domestically, all regions internationally, and the contribution from recent acquisitions. Adjusted EBITDA margins expanded sequentially from 17.3% in the first quarter to 21% due to improved price realization and the moderation of input costs. Importantly, we expect growing realization of previously announced price increases in the second half of the year, further execution on cost reduction projects, and continued easing of input cost headwinds, resulting in sequentially improving margins over the remainder of the year. Now, discussing our second quarter results in more detail, shipments of home standby generators grew at an exceptionally strong rate over the prior year. Growth also accelerated sequentially from the first quarter as we continued to expand production and power outage activity in the U.S., as measured on a rolling four-quarter basis at the end of the second quarter, remained above the long-term baseline average. In addition to elevated baseline outage activity in the U.S., severe storms left more than one million utility customers without power in Ontario and Quebec in May, which resulted in robust leading indicators of demand in Canada as well. Power grid stresses are expected to persist, with forecasts for the upcoming hurricane season pointing to another year of above average activity and multiple grid operators warning of potential outages as a result of excessive demand coinciding with supply challenges. Home consultations, or sales leads, continued to point to strong underlying demand for home standby generators, growing at a mid-teens rate despite a strong prior year comparable period driven by the Texas winter storm event in February of 2021. This demand was broad-based with four of five regions experiencing year-over-year growth in home consultations in the quarter. To frame just how much home standby baseline demand has grown over the last several years, second quarter home consultations were more than four times greater than pre-COVID levels seen in the second quarter of 2019. Importantly, strength in this leading market indicator has continued here in the month of July. In addition, activations, which are a proxy for installs, continued to grow at a solid rate in the second quarter compared to the prior year, led by the South Central and Midwest regions. as we further added to our residential dealer base as we entered the quarter with approximately 8,200 dealer partners. We continue to make excellent progress increasing our production levels for home standby generators, with daily build rates dramatically higher as compared to prior year levels, and ramping sequentially as our Trenton, South Carolina facility continues to expand capacity. As we have increased build rates, lead times have continued to improve, and we are getting product in the hands of our customers and channel partners in a more consistent and a more timely basis. As a result of this progress, close rates on our sales leads have begun to improve, supporting our belief that reducing our lead times will improve our ability to capture more of the new and higher baseline of home consultations or sales leads within our sales pipeline. Our build rates and supply chain challenges have been the main growth constraint for the home standby category over the last few years. We have now ramped production capacity to the point that our lead times for the product category have materially improved. However, the constraint has now shifted to the installation capacity of our dealer base, driven primarily by contractor labor availability, permitting and utility-related delays, and shortages in certain materials needed to complete an installation. As a result, project lead times for homeowners, as measured by the time between a signed contract and the installation date, have not come down in proportion with our production lead times. We have a number of initiatives focused on increasing installation bandwidth in the market, including aggressive campaigns to add new dealers to our network, cultivate and train non-dealer contractors on home standby installations, and decrease the overall time associated with the project. Additionally, as housing construction activity begins to slow, we believe we have a greater ability to focus installing contractors on improving the pace of home standby installations. I'd now like to discuss our increasingly diverse suite of clean energy products and solutions. With the closing and integration of the Ecobee acquisition, and given the growing commercial sales synergies and cross-functional initiatives between residential energy storage and microinverters, monitoring and management devices, and grid services solutions, we now have one of the broadest portfolios of clean energy products and solutions in the industry. Net sales from these combined clean energy products grew well over 50% on an as reported basis in the second quarter over the prior year. Macroeconomic uncertainty, input cost pressures, industry-wide supply chain and logistics challenges, and lack of clarity around regulatory policy have impacted residential clean energy markets as of late. But rising prices for traditional energy sources and a growing focus on energy independence and security have the potential to more than offset these concerns and continue to drive adoption of alternative and emerging solutions over time. Additionally, we're very encouraged by last week's announcement of the Inflation Reduction Act as a potential positive catalyst for demand, although it's still not fully through the legislative process. As we work to capture this demand, our residential clean energy installer network continues to grow as we ended the second quarter with approximately 2,800 trained and certified technicians. with approximately 1,150 registered dealers on our PowerPlay sales platform. We remain excited about the new and innovative products we're bringing to market in 2022, including the recent product launch of PowerManager and the pending launches of our PowerGenerator, which is the industry's only engine-driven battery charger, an AC coupling solution for our PowerCell storage product for use in retrofit applications, and our new PV microinverter product called the PowerMicro. As expected, we began shipping PowerMicros for beta testing in June and are now working to expand beta testing with full commercial launch expected in the fourth quarter. I'd now like to provide a quick update on Ecobee. Integration is proceeding as planned, and we continue to make good progress in developing cross-selling opportunities for Ecobee's hardware solutions through Generac's distribution partners. The Ecobee team successfully launched two new thermostats with industry-leading features during the quarter, and high temperatures and rising energy costs across North America are driving increased interest in the smart thermostat category. Early reception on these new products has been encouraging, reinforcing Ecobee's differentiated competitive position focused on intelligent, intuitive, feature-rich devices that maintain comfort while unlocking significant value creation and energy conservation for homeowners and grid operators. This differentiation also drives significant market opportunity for Ecobee's energy services offering, which has been further enhanced by synergies with Generac's grid services efforts. Ecobee's installed base of more than 2 million connected homes is particularly valuable to grid operators seeking load flexibility and resilience. Consumer awareness of elevated energy market volatility is also driving potential growth for recurring services revenue as Ecobee enables consumers to take advantage of variable rate pricing structures. Additionally, we are beginning to leverage the amazing talent within the Ecobee team to help accelerate the development of our residential energy ecosystem, a key element of our connected devices strategy. Now expanding a bit more on Generac Grid Services, the team continues to drive momentum in its increasingly impressive and diverse sales pipeline, building on the recent success across software as a service, turnkey, and performance contracts, as well as experiencing an increasing mix of hardware sales, which are proving to be a competitive differentiator for our grid services business. From distributed generation and storage to load flexibility assets, our grid services suite of solutions is unmatched in the market. We announced a number of recent contract wins since our first quarter call that highlighted our expanding capabilities, including EV charging monitoring and optimization, a turnkey program for low- and moderate-income households utilizing power cell energy storage systems, and a unique solution for the German power market. Utilities and grid operators continue to warn of potentially significant disruptions to the power grid as a result of supply-demand imbalances, underscoring the need for new technologies to decentralize and digitize the power grid through the development of virtual power plants, or VPPs. As an example, this need was on full display during the recent heat wave in Texas, as a number of home standby generators enrolled in a VPP program were autonomously controlled by our Concerto software platform to take demand off the grid and help keep critical community resources online. The market opportunity for residential energy storage and microinverters, monitoring and management devices, and grid services solutions remains extremely compelling. and we believe will prove to be a key long-term future growth driver for Generac. For the full year 2022, we expect net sales of these clean energy products and solutions to approximately double from the prior year to more than $500 million in sales, with strong core and inorganic growth contributions and an even larger opportunity in the years ahead. Now let me make some comments on our CNI products, which also grew at a strong rate in the second quarter across nearly all end markets and geographies. Specifically, global CNI net sales increased 22% on an as-reported basis and 16% on a core basis as compared to the prior year. Strong growth in net sales for domestic CNI products in the second quarter was led by national rental equipment and telecom customers, as well as our North American distributor channel. We saw continued strength in demand during the quarter, which contributed to a further increase in our backlog for CNI products and supports our expectations for solid growth to continue in the category. Shipments of CNI stationary generators through our North American distributor channel also grew significantly in the second quarter, and improving close rates helped drive growth in orders and backlog in this channel. Strong momentum in quoting activity has continued as of late, highlighting the sustainability of demand trends for backup power for CNI applications. Shipments to national telecom customers increased again during the second quarter as compared to the prior year, as several of our larger telecom customers further invest in hardening their existing LTE sites and begin to build out their fifth generation or 5G networks. Telecom infrastructure upgrades remain one of the key megatrends we expect to drive growth for our business in the coming years. We also experienced substantial growth with our national and independent rental equipment customers during the quarter. These customers have been investing heavily in equipment to refresh and expand their fleets to serve increased commercial construction activity as well as other infrastructure projects, supporting a resilient demand environment for mobile products and the megatrend of the critical need for infrastructure improvements. We also continue to see material traction in orders for off-grid energy's mobile energy storage systems from our key North American rental channel partners as they work to reduce the carbon footprint of their equipment fleets. Momentum remains strong across our domestic CNI channels and is being supplemented by emerging capabilities that support the long-term growth profile of the category. Specifically, we're establishing a strong reputation in applications beyond traditional emergency standby projects, driven by our ability to deliver customized turnkey solutions to serve this market. Our unique hardware and software portfolio in this vertical is highlighted by expanding smart grid ready features that allow connection to grid services programs. Large CNI generators can provide enhanced resiliency and stability for grid operators while simultaneously providing a tangible and meaningfully improved return on investment for the asset owners, which is driving demand for these solutions across a diverse range of customers. Strong momentum also continued in our international segment, with total sales increasing 43% year over year during the second quarter, with 34% core sales growth when excluding the benefit of the deep sea and off-grid energy acquisitions and the unfavorable impact of foreign currency. The core sales growth was driven by strength across all regions, most notably in Europe and Latin America. The European region has seen strong demand across product lines as the heightened focus on energy independence and security that emerged following Russia's invasion of Ukraine has continued, but longer-term implications are uncertain as geopolitical and macroeconomic conditions in the region remain volatile. International energy security concerns are not unique to Europe, and we are evaluating additional opportunities for home standby generators across multiple regions as a result. External sales in the Latin American region continue to grow at a solid rate. while intersegment sales grew substantially as our Generac Mexico operations continued to ramp production of telecom products for the North American market. In addition to strong core growth, our recent international acquisitions, Deepsea Electronics and Off-Grid Energy, reported impressive results in the second quarter. Demand for Off-Grid Energy's mobile storage systems continues to grow across our global distribution footprint as we integrate the product offering through our commercial sales branches and channels. In addition, we have several product development projects underway within the CNI energy storage category, including an expansion of the power capacity range of the mobile product lineup, as well as potential stationary applications. Concerns around power security and energy prices in key international markets underpin the opportunity for an increasingly broad storage product portfolio for CNI applications. Deep Sea also benefited from healthy global demand for advanced generator controls during the quarter, and we remain very excited about the additional engineering capabilities DeepSea brings as we leverage the team's electronics controls expertise to advance product roadmaps across our enterprise. Our international segment has also experienced much stronger profitability despite inflationary headwinds and supply chain challenges. Second quarter adjusted EBITDA margins expanded to 14.5% from 9.7% in the prior year period due to the accretive margin profiles of the DeepSea and off-grid acquisitions, improved overhead absorption, and better operating leverage on significantly higher volumes. In closing this morning, I'm extremely proud of our team's continued ability to deliver record results and maintain our 2022 outlook despite the developing uncertain economic environment. Our strong sequential margin improvement reinforces our expectation that margins bottomed in the first quarter of 2022 and will continue to improve throughout this year. Additionally, our recent refinancing has provided further liquidity to accelerate our evolution into an energy technology solutions company. We remain focused on executing against our Powering a Smarter World enterprise strategy, and the megatrends supporting this strategy are as compelling as ever, many of which have the potential to decouple from the broader macroeconomic environment. Structural supply-demand imbalances facing the grid are not impacted by inflation, and increasingly severe and volatile weather cannot be slowed by higher interest rates. The energy ecosystems that we are building for the future will give our end customers the ability to take control of their power security, lower their energy bills, and reduce energy consumption, while also helping utilities and grid operators to balance supply and demand. With our broad portfolio of products and solutions, combined with our services, our distribution, our brand, and importantly, our expertise, Generac is uniquely positioned to lead the evolution to a more resilient, efficient, and sustainable energy future. I now want to turn the call over to York to provide further details on our second quarter 2022 results and our outlook for the year. York.
spk05: Thanks, Aaron. Looking at second quarter 2022 results in more detail, net sales increased 40% to $1.29 billion during the second quarter of 2022, another all-time record, as compared to $920 million in the prior year second quarter. The combination of contributions from acquisitions and the unfavorable impact from foreign currency had an approximate had an approximate 7% impact on revenue growth during the quarter. Briefly looking at consolidated net sales for the second quarter by product class, residential product sales grew to $896 million as compared to $600 million in the prior year, representing a 49% increase despite a strong prior year comparable. Contributions from our clean energy acquisitions and the unfavorable impact of foreign currency contributed approximately 7% of revenue growth for the quarter. Home standby generator sales made up the vast majority of the residential product core sales growth, increasing by more than 50% over the prior year as we continue to expand production capacity for these products. Commercial and industrial product net sales for the second quarter of 2022 increased 22% to $309 million as compared to $254 million in the prior year quarter. Contributions from the deep sea and off-grid acquisitions and the unfavorable impact of foreign currency had a net impact of approximately 6% on net sales growth during the quarter. The strong core revenue growth was broad-based, driven by growth across all regions globally and all channels domestically. Net sales for other products and services increased 31% to $86 million as compared to $66 million in the second quarter of 2021. Contributions from acquisitions and the impact of foreign currency contributed approximately 13% of this revenue growth during the quarter. Strength in aftermarket service parts continues to be a key driver of the core sales growth in this category due to a larger and growing installed base of our products in the field, which is also leading to higher levels of extended warranty revenue. Also contributing to the increase was continued growth in our services offering in certain parts of our business. Gross profit margin was 35.4% compared to 36.9% in the prior year second quarter, as the challenging supply chain and overall inflationary environment drove higher input costs during the quarter. Specifically, the lagging impact of elevated commodity prices and other surcharges, higher inbound logistics and expediting costs, increased labor rates, and continued plant ramp-up costs all pressured margins relative to the prior year quarter. The increasing realization of multiple pricing actions previously implemented and favorable sales mix partially offset these higher input costs. We're very encouraged that gross margins expanded 360 basis points on a sequential basis as pricing benefits increased and input costs began to ease during the second quarter, reinforcing our expectation that margins have bottomed in the first quarter. Operating expenses increased 83 million, or 53%, as compared to the second quarter of 2021, This increase was primarily driven by higher recurring operating expenses from recent acquisitions and an increase in intangible amortization expense. Higher employee costs and additional variable expenses from the significant increase in sales volumes also contributed to the increase. Operating expenses excluding intangible amortization as a percentage of revenue increased approximately 75 basis points as compared to the prior year period. due to the impact of recent acquisitions that have a higher operating expense load relative to sales as those businesses scale for future growth. Adjusted EBITDA before deducting for non-controlling interest as defined in our earnings release was an all-time record $271 million or 21% of net sales in the second quarter as compared to $218 million or 23.7% of net sales in the prior year. The decline in EBITDA margin versus prior year was driven by the previously discussed decline in gross margins and higher operating expenses. But again, we're very pleased with the 370 basis point sequential improvement EBITDA margins relative to Q1 2022. I will now briefly discuss financial results for our two reporting segments. Domestic segment total sales, including intersegment sales, increased 42% to $1.13 billion in the quarter, as compared to $793 million in the prior year, with the impact of acquisitions contributing approximately 6% of the revenue growth for the quarter. Adjusted EBITDA for the segment was $242 million, representing a 21.5% margin as compared to $204 million in the prior year, or 25.7% of net sales. The lower domestic EBITDA margin in the quarter was primarily due to higher input costs and the impact of acquisitions, partially offset by the increasing realization of previously implemented pricing actions and favorable sales mix. International segment total sales, including intersegment sales, increased 43% to $203 million in the quarter, as compared to $142 million in the prior year quarter. Core sales, which excludes the impact of acquisitions and currency, increased approximately 34% compared to the prior year. Adjust EBITDA for the segment before deducting for non-controlling interest was 29.5 million, or 14.5% of net sales, as compared to 13.7 million, or 9.7% of net sales in the prior year. The significant expansion in international EBITDA margins was primarily due to strong margin contributions from the deep-sea and off-grid energy acquisitions and improved overhead absorption and operating leverage on significantly higher sales volumes. Now switching back to our financial performance for the second quarter of 2022 on a consolidated basis, as disclosed in our earnings release, GAAP net income for the company in the quarter was $156 million as compared to $127 million for the second quarter of 2021. GAAP income taxes during the current year quarter were $45.8 million, or an effective tax rate of 22.5%. as compared to $46.4 million or an effective tax rate of 26.6% for the prior year. The decrease in effective tax rate was primarily due to a discrete tax item in the prior year quarter resulting from a legislative tax rate change in a foreign jurisdiction that unfavorably revalued deferred tax liabilities by $7 million, which had an approximate 4% tax rate impact to the prior year quarter. Diluted net income per share for the company on a GAAP basis was $2.21 in the second quarter of 2022 compared to $2.01 in the prior year. Adjusted net income for the company as defined in our earnings release was $194 million in the current year quarter or $2.99 per share. This compares to adjusted net income of $153 million in the prior year or $2.39 per share. Recall from last quarter, and as disclosed in our reconciliation schedules in our earnings release, our adjusted net income and EPS for the current year no longer adjust for cash taxes due to the expiration of our significant tax yield that originated from our LBO transaction in 2006. Cash flow from operations was $24 million as compared to $123 million in the prior year second quarter, and free cash flow as defined in our earnings release was $6 million as compared to $96 million in the same quarter last year. The decline of free cash flow was primarily due to a much higher working capital investment in the current year quarter, partially offset by higher operating earnings. Inventory levels stabilized in the second quarter, so the higher working capital investment during the current year quarter was primarily driven by an increase in accounts receivable, given sequential sales growth, and a reduction in accounts payable as we optimized inventory levels and purchasing patterns. We expect free cash flow conversion to return to the historical long-term average in the second half of 2022, resulting in approximately 90% conversion of adjusted net income to free cash flow. We significantly enhanced our liquidity profile in the second quarter with the amendment of our existing credit facilities. This included establishing a new term loan facility in an aggregate principal amount of $750 million, and a new revolving credit facility in an aggregate principal amount of $1.25 billion, which was unfunded at closing. Proceeds from the $750 million new term loan were used to prepay $250 million of the existing term loan B facility and to fully pay off the existing ABL revolving credit facility, which had $285 million outstanding at closing, with the remaining funds added to the balance sheet to be used for general corporate purposes. Our new term loan A and revolving credit facility mature in June 2027. These new debt facilities will initially bear interest at SOFR plus 150 basis points through the end of 2022. And beginning on January 1st, 2023, the applicable spread will range from 125 to 175 basis points based on the company's total leverage ratio. Additionally, our existing term loan B does not mature until December 2026. We do not have any required principal payments on this facility until the maturity date, and it has a low cost of SOFR plus 175 basis points. We also maintain our interest rate swap arrangements that fix our interest rate exposure on approximately 500 million of this debt through the maturity date of December 2026. As of June 30th, 2022, we had approximately $1.72 billion of liquidity comprised of 467 million of cash on hand and $1.25 billion of availability on our revolving credit facility. Also, total debt outstanding at the end of the quarter was $1.37 billion, resulting in a gross debt leverage ratio at the end of the second quarter of only 1.5 times on an as-reported basis. Before discussing outlook, I want to highlight that we have been repurchasing our shares opportunistically thus far in the third quarter. We have exhausted the remaining $124 million of share repurchase authorization that existed as of the end of the second quarter. As a result, on July 29, 2022, the company's board of directors approved a new stock repurchase program that allows for the repurchase of up to $500 million of our common stock over a 24-month period. With that, I will now provide further comments on our outlook for 2022. As Erin previously discussed, we are maintaining our sales growth and adjustee without margin guidance for the full year 2022. We continue to expect net sales to increase between 36 to 40% as compared to the prior year on an as reported basis, which includes an approximate 4 to 7% net impact from acquisitions and foreign currency. This revenue outlook still assumes shipments of residential products increase at a mid to high 40% rate during 2022. and revenue for C&I products is still expected to grow at a high teens rate compared to the prior year. Looking at seasonality for the second half of the year, revenue is expected to increase sequentially in both the third and fourth quarters, continuing the strong double-digit year-over-year growth trends, with fourth quarter sales levels up more modestly above the third quarter. Looking at our gross margin profile, as discussed, we expect that margins have bottomed in the first quarter, We continue to expect fourth quarter gross margins to recover back to first quarter 2021 levels in the 40% range, driven by increasing price realization, continued easing of inflationary pressures through the remainder of the year, and further materialization of cost reduction benefits. This would result in gross margin percent for the full year 2022 to be approximately in line with 2021 levels, which is consistent with our previous expectations. Operating expenses as a percent of sales, excluding amortization expense, for the full year 2022 are still expected to increase approximately 100 basis points compared to full year 2021, primarily due to the impact of recent acquisitions that have a higher operating expense load relative to sales as they continue to invest for future growth. Adjusted EBITDA margins before deducting for non-controlling interest are still expected to be approximately 21.5 to 22.5 for the full year. From a seasonality perspective, adjusted EBITDA margins are projected to improve sequentially in the second half, primarily driven by improving gross margins, as previously discussed, with fourth quarter 2022 adjusted EBITDA margins approaching 26%. Several additional guidance items that we provide to assist with modeling adjusted earnings per share and free cash flow require updating for the full year 2022. Our GAAP effective tax rate is now expected to be approximately 24% for the remaining quarters of the year, resulting in a full year 2022 GAAP effective tax rate of approximately 23%. For full year 2022, we now expect interest expense to be approximately $52 to $54 million, an increase from the previous guidance of $42 to $44 million, reflecting our updated capital structure due to the refinancing of our credit facilities in June 2022. In addition, we have updated our interest rate assumptions to reflect the latest market expectations for sulfur in the second half of 2022. In addition, we have updated our interest rate assumptions to reflect the latest market expectations for sulfur in the second half of 2022. This assumes no additional changes in outstanding debt for the remainder of the year. Depreciation expense is still expected to be approximately $54 to $56 million in 2022, given our assumed CapEx guidance. Gap intangible amortization expense in 2022 is now expected to be approximately 100 to 105 million as compared to our previous guidance of the high end of the 95 to 100 million dollar range. Stock comp expense is still expected to be between 32 to 34 million for the year. Our full year weighted average diluted share count is now expected to be at the low end of the previous guidance range of approximately 65 to 65.5 million shares given our share repurchase activity in July 2022. Our capital expenditures are still projected to be approximately 2.5% to 3% of our forecasted net sales for the year. And as previously mentioned, free cash flow conversion in 2022, given our assumed CapEx guidance. Gap intangible amortization expense in 2022 is now expected to be approximately $100 to $105 million, as compared to our previous guidance of the high end of the $95 to $100 million range. Stock comp expense is still expected to be between $32 to $34 million for the year. Our full-year weighted average diluted share count is now expected to be at the low end of the previous guidance range of approximately 65 to 65.5 million shares, given our share repurchase activity in July 2022. Our capital expenditures are still projected to be approximately 2.5 to 3% of our forecasted net sales for the year. And as previously mentioned, free cash flow conversion is expected to return to historical norms of approximately 90% in the second half of the year. Finally, this 2022 outlook does not reflect potential additional acquisitions or share repurchases that could drive an incremental shareholder value. This concludes our prepared remarks. At this time, we'd like to open up the call for questions.
spk10: Great. And as a reminder, to ask a question, you'll need to press star 11 on your telephone. Please stand by while we compile the Q&A roster. And our first question comes from Michael Halloran of Baird.
spk15: So there's a lot of great content in there. Could you just help me triangulate with something? You're talking about backlogs that are starting to be filled, you know, lead times coming down. At the same time, really good IHC consultations and you feel pretty good about the underlying demand environment. So could you maybe give some context to what that backlog bleed has looked like or what the inventory lead times look like and maybe put that in context for then the visibility that you have, how far out that tracks relative to a typical timeline?
spk13: Yeah, Mike, this is Aaron. Yeah, the lead times have come down now, on average, we're talking home standby category here, you know, eight to 10 weeks, which, you know, again, is, I think, directly the result of our actions in increasing production and was always part of the plan as we've talked. What we're really encouraged by and what continues to pace ahead of kind of expectations here is the, you know, front end kind of lead generation, the end market I think there are a couple of catalysts there that we can point to that I think are probably at work. The first would be the summer season here has come with it a number of high-profile kind of warnings, if you will, from utilities and grid operators about the potential for outages on shortfalls in supply, just raw supply not being enough to meet demand. catalyst that's new this year. A second one, obviously, we got a very aggressive forecast again here for hurricane season. You know, it's been quiet so far, but, you know, the season forecast was well above average. And then the third thing I would point to as a catalyst for why we think the end market is still, you know, very active in the category is really around this outage that happened in Canada. You know, we don't talk about Canada as much as we probably should. It's a You know, we have over 500 dealers up there. You know, it's actually, you know, it's a great market because from a demographic standpoint, it fits quite well with the buyers of the category. But they suffered a pretty high-profile outage of a million utility customers in Ontario and Quebec about a month and a half ago it was. And that really has, you know, it jumps off the page when you look at it in our statistics when we track by region. We actually tracked some, you know, just a lot of data really down to the zip code level in areas. But it's interesting to see how much of an impact that had for us in that part of the world. So I would point to those things, you know, again, and market demand very strong, but we continue to ramp production to, you know, bring the lead times on the category down.
spk15: The backlog part of that question then, Aaron, where's the backlog rough and tough and then maybe some thoughts on how far that visibility stretches out for you at this point?
spk13: Yeah, you know, we've always said home standby visibility, you know, usually it's not very good, right? Because we typically don't have a backlog. We've been in a backlog situation now for close to two years as we've been working to ramp production and tackle these supply chain challenges, which we've been doing. You know, that backlog is still significant. And in fact, you know, we As we have said previously, we still expect to have a backlog by the time we exit this year. So even though we've got our ramp ongoing in production output, we're still not going to catch that by the end of the year. We'll continue to bring the lead times down, but the backlog is still significant for home standby.
spk15: Thanks, Dan. Appreciate it.
spk13: Thanks.
spk10: And your next question is from Julian DeMullion Smith, Bank of America. Julian, your line is open.
spk04: Oh, sorry, guys. I wasn't sure. Excellent. Thank you. Appreciate the time, guys. Good morning. So, let me just come back to the gross margin question. Obviously, you guys reaffirming here the outlook and troughing off 1Q. Can you comment a little bit about some of the input cost reductions flowing through How much latitude should that provide you as you look forward going into your longer-term outlook, 23, 24, et cetera? How much is that going to cascade? And also, can you speak a little bit more about repricing the backlog, the success, and perhaps pricing trajectory, giving some of the moderation and the cost input there?
spk05: Yeah, Julie, this is York. So we posted 35.4% gross margins in the second quarter. Very pleased with the sequential improvement off of Q1. And we are starting to see pricing read through. You mentioned repricing the backlog. We did announce a price increase in April that repriced the backlog as of June 1. We still have some additional pricing that launched late last year that will will flow through backlog into Q3. But as our prepared comments said, you know, if we posted 35.4% gross margins in Q2, expect them to get closer to 40% by the end of the year. As we ramp that, what is that 4% to 5% increase, about half of that sequential increase will be about, half of that will be pricing, price realization continuing to come through. The other half being moderation of input costs. When you look at commodities starting to roll over, we'll see the lagging impact of that. There's always a lag in our realization. As commodities move, there's always a lag. We'll start seeing some of that here in the latter part of the year. We're seeing inbound freight costs come down. Some of our expediting costs are coming down. Just getting our plants absorption improved. We do have a number of just cost out projects we're working on our bill of material of our product of our products that will materialize in the second half so all that supports and gets us comfortable with that progression of of of sequential margin improvement uh to the point where when we exit 2022 here uh we'll feel you know very comfortable with our margin profiles again back to where they were early part of 2021 before all this inflationary pressures happened
spk04: Got it. Yeah. It sounds like maybe there's even more latitude there as you continue to compound with some of these benefits. But maybe if I can pivot quickly, I know you said high teens for CNI. Just with respect to that business, and obviously there's a litany of reasons why you should continue to see some of that input. How is that trajectory going today? And how much is that helping some of the backlog commentary here to just continue to keep that at a robust level? I know that obviously the backlog here is normalizing for some of the factors from last year, but Can you comment a little bit on CNI here and how that could complement the backlog?
spk13: Yeah, Julian, this is Aaron. The CNI business is, you know, we don't spend enough time talking about that business. It's a really great, solid business that has been growing quite nicely and is really the benefactor of, you know, many of these megatrends we've been talking about. CNI products, in particular, in a couple of areas, and I'll point them out, telecoms, You know, that telecom market, for us, we are a significant share player in that telecom market. We supply all the major tier one carriers here in the U.S. and many of the secondary and tertiary players as well. We have a diverse offering of product. We engineer and design specific solutions for specific network applications. So, you know, a lot of these gen sets, you would think they're standard products. And they are, but they're specific to a particular customer's network. So we'll customize around the needs of each network, which are different. So that's one trend. And obviously, as the telecom companies are spending a lot of CapEx to harden their networks and build out the fifth generation networks, we're benefiting from that trend. And we think that that will continue for the next several years at the very least. The other one is that, you know, in the rental space, the rental channel partners that we have, they're all refleeting. So they kind of went through a process after, you know, through the COVID cycle down where, you know, they reduced their purchases, obviously, with the uncertainty on what might happen. And then as the economy began to really, you know, come to life as a result of a lot of the stimulus spending, they found themselves with fleets that were aged or undersized for the market requirements. So we're, you know, a leader in, you know, when it comes to power generation, temporary lighting, temporary dewatering, heating, those types of applications. We've got a great product assortment that we sell to, again, all the major rental accounts. And that has been a, you know, that's proven to be a really, you know, a really great business. And then, you know, just one other point I'll make, you know, the international side of CNI, most of our international business is CNI. We do have a nice growing residential business in there. We don't talk a lot about that, but we're seeing home standby activations around the globe, which is, I think, you know, an indication of some of the power security issues that exist, not only here in the US, but certainly everywhere. But internationally, that business has done just incredibly well. And they've been doing well for several quarters now. And, you know, that's on the back of, you know, some of the energy security issues in Europe, But just, again, power security in general, whether you're talking about the conflict, the Russian-Ukraine conflict, or whether you're talking about challenges in other parts of the world, we need power. We need a continuous source of power, and backup generation is going to be in demand for a long time. So that CNI business is great. Book-to-bill was positive in the quarter, and backlog grew again.
spk10: And your next question is from Philip Shin of Roth Capital Partners.
spk14: Hey, guys. Thanks for taking my questions. Hey, so some of our checks suggest that lead flow has dropped, certainly in some regions. I think some regions have healthy lead flow, but others are a little bit down. Some of the lead flow might be down 25%, 40% from maybe four or five months ago. Can you talk about how that might serve as a leading indicator at all? I know you were talking about healthy IHCs, but, you know, lead flow at some level is, you know, precedes that. And then if you can touch on lead flow for the solar business as well, you know, to what extent are, you know, when you started the solar business or when you're early into it, generating lead flow is a key point of differentiation. Where does that stand with your ability to create value for your dealers and so forth? Thanks.
spk13: Yeah, thanks, Bill. I'll unpack that here. A lot of it around or all of it around leads. Let's talk a little bit about home standby leads. Four out of five regions, they were up quarter over quarter and up big in some regions. The only region we saw a pullback was in the south central region, and that's Texas. Texas is the, you know, you take that February 2021 winter event out of there. And that's where, you know, if you are doing channel checks, you may find in Texas, I mean, they were so high a year ago. In fact, I would just point out that when we look at all of our states, just, you know, individual states, Texas was still the top state on a, you know, just an absolute basis for us in the quarter. So even though, you know, the South Central region was off as a region and Texas off big within that region, actually on an absolute basis, the number of leads we generated in Texas was the highest of any of the 50 states. So, you know, I would think that, you know, if you're doing channel checks, that's the only region, at least based on our data. I think, as we said before, we're really pleased to see, you know, kind of the lead activity because it's just, it's such a great barometer of the market activity that is to come. We've proven this out. We've been tracking, you know, sales leads for almost 10 years now and it's a pretty solid, reliable predictor of volumes in the future. So it's a great leading indicator. Specifically to the clean energy business with leads, yes, as you indicated, that is and has been a differentiator for us vis-a-vis others in the marketplace, and it's really been helpful for us to help court new channel partners and new dealers. You know, giving those leads to customers in a market like the solar market as a, for instance, you know, that historically has had very high customer acquisition costs, you know, I think is, you know, I think, again, it's an area that we excel at based on, you know, our experiences with it, and our channel partners are coming to find the real value in that. That said, I think there's even more that we can do there, you know, as we dial in kind of how we go to market with our messaging, you know, and that's everything from the type of media that we buy to to, you know, to the regions and particular markets that we target. But we've enjoyed some pretty good success out of that early on here in terms of, you know, in terms of the clean energy business.
spk14: Great. Thanks, Aaron. As it relates to backlog, you know, we've talked about it a bit already, but some of our conversations with dealers suggest, you know, the 22 and 24 kilowatt are basically caught up. You know, basically it's like a one to two week lead time. And so you can kind of get it when you need it. seems like the long lead time generators are the liquid-cooled ones. And so I was wondering if that's true. And then also in your backlog, to what degree have you received cancellations in your backlog? Because some of the people we've talked to, they're full in terms of inventory, and they just don't need as much given the So just wondering if you're seeing any of that. Thanks.
spk13: Yeah, on the backlog, on the lead time question, I'll hit that here first. The category, it's about eight to ten weeks, and that's air-cooled and liquid-cooled products. That's obviously average for the weighting of each of those products within there. We have certain SKUs where we're obviously performing better than that average and certain SKUs where we're longer. It depends on sometimes component supply challenges. You know, we have, as an example, we're launching the 26-kilowatt product here this month. And so, you know, that's been sitting in backlog. So those lead times look particularly long. And we have some other products within the air-cooled family where, you know, either we have component shortages or other constraints that have manifested. And on the liquid-cooled side, you know, that demand has been incredibly robust with liquid-cooled. And, you know, our ability to increase production output there has has been a bit hampered by uh supply chain so working to to bring all of those lead times down and again we've been speaking and when we talk about lead times we've been talking about the averages and that's you know the average number of weeks of orders in in backlog and i think that's that's an important distinction because you know when you talk to dealers you know you're going to find different dealers are in different places right some dealers They can't get enough product. They'll take more product if we can get it to them. They either have the space or the financial capacity to do that. You have other dealers, maybe don't. In particular, as you get into smaller dealerships, they don't typically have a warehouse, so they run out of space more quickly. They don't typically have the financial capacity. A lot of times they're paying with a credit card even in some cases. And in the prepared remarks, I spoke to the fact that installation bandwidth, in particular when you look at the smaller end of the dealer spectrum, they're struggling to find labor. They're struggling with some components that they need, things like propane tanks and other things. They're struggling with permitting delays or getting a utility to come out to pull a meter or upgrade a meter. Those things are all starting to manifest themselves as we've kind of brought our output levels up to a significantly higher level year over year. Now you're starting to see the constraints kind of move, you know, kind of downstream, if you will. And, you know, that's exactly what we're working with the channel partners to alleviate that, you know, whether it's talking to individual AHJs about permitting issues or delays there, or, you know, it's looking to, we've even stood up, we've got HR efforts here to help hire contractors for our dealers or non-contractor labor for our dealers. depending on what their needs are. So we're recruiting for our dealers. And, of course, we're bringing new dealers in all the time. We added another 100 dealers here this past quarter. We're now at 8,200, and we need more. That's something that we're working hard on. As far as cancellations, of course, we have our policy around orders has always been a pretty – I'll call it a liberal policy that way. So the ability to cancel or defer an order is – you'll see that in those smaller dealers that are coming up against some of those constraints, as you point out. You know, I would say on balance, it's not a material number, you know, when you look at the total. But, you know, we work through that, and it's kind of dealer by dealer. It's really a, you know, it's a kind of hand-to-hand combat down in the trenches in terms of, you know, working with the dealers on, you know, and again, this is where other programs, you know, are really, really helpful with, you know, our Wells Fargo program, you know, is a great program for dealers to stock products. And so we encourage dealers, if they're not already signed up on that platform, to get on that platform. That's a great way for them to be ready for the season. The last thing we want dealers to do is to not be ready for the season. And so that's the messaging that's going out in the field.
spk10: And our next question is from Jeff Hammond of KeyBank Capital Markets.
spk01: Morning, Jeff. Oh, morning, guys. Sorry, I didn't hear what you said there. Can you hear me? Yep. Okay, if we could just get into battery storage, you know, I think you said there's some, you know, noise and, you know, I know there's a lot of supply chain issues. So just talk about what's going on in that business and what kind of your growth expectation or updated growth expectation is on that.
spk13: Yeah, that's great. Thanks, Jeff. Appreciate it. Yeah, on storage particularly, yeah, supply chain challenges have been numerous. In fact, I would say we hit our most challenging quarter with that here in Q2. And it was not really about cell supply. It was actually challenges in all the electronics components that go into this gear from microprocessors to FETs to everything that we used. in the inverter, in the storage cabinet, and the storage devices themselves. That was challenging in the quarter. We're hoping here for the second half to be better in supply of those components. Demand has remained strong. Again, when you look at IHCs, again, sales leads, we're seeing good strength in lead volume in clean energy. And obviously, you know, there's been a lot of noise around the regulatory environment. You know, are we going to have Build Back Better? Are we not? Now you've got the, you know, the Inflation Reduction Act, you know, which still has hurdles to clear legislatively. But, you know, that could be, you know, obviously a catalyst for additional demand, as we said in our prepared remarks. You know, our position in storage, we still feel very good about our position there. But, you know, the supply chain has been a burden here in Q2. And so, you know, more to come on that. You know, we've got, you know, I think a nice forecast here for the balance of the year, our guidance. You know, I think when you think about just, you know, we've talked about this in the past. We've gone away from, like, trying to talk about discrete numbers of megawatts and everything else. I mean, that business is so much more diverse for us in terms of clean energy and all the things that kind of work together there from the energy monitoring and management to the grid services elements to, you know, we've got our power generators, we've got, you know, our power managers, our load management controls. There's just a lot of stuff there. So we didn't feel it was appropriate to just talk about a single metric. So, you know, what we've said here and what our prepared remarks said is that we're anticipating that entire kind of complex of products and services that we refer to as clean energy, smart thermostats, everything that go into that now to be in excess of $500 billion for the full year, which is, you know, basically double what it was last year. So feeling really good about that business and where it's going in the future.
spk01: Okay, great. And then, you know, a lot of my companies have kind of built a lot of working capital into the first half and, you know, with all the supply chain and demand, et cetera. And just, I don't know if you updated, you know, the free cash flow guide and how you think, you know, working capital is, you know, how big of a source it can be in the back half.
spk05: Thanks. Jeff, this is York. We did say that looking at basically our performance to date where we're coming into the second half from a working capital standpoint, we like that we saw inventories stabilize in the second quarter. With that, we should get back to a more normalized free cash flow conversion in the entirety of the second half of the year. Recall normal cash flow conversion for this business is around 90%. So it'll probably be more weighted towards into Q4. But when you look at the second half in totality, free cash flow conversion should improve and return back to normal free cash flow levels for this business.
spk10: And your next question is from Brian Dreb of William Blair.
spk02: Hey, good morning. Thanks for taking the time. Hey, good morning. Hi, Brian. On home standby, build rates you mentioned are up significantly year over year, obviously. Can you quantify how much we're up year over year for second quarter build rates? And where is your capacity now relative to what you feel you need in that business?
spk05: Well, we did mention shipments were up over 50% for home standby, which is indicative of our build rates for this category.
spk13: That's a good proxy for that.
spk05: Yeah. No, I think our theoretical capacity, as we get Trenton up and running, and particularly another set of machine tooling here in the second quarter, that should Basically, that gets us to what our projected capacity increases were expected to be. That actually even gives us room here from where we're at today to even surge. Should we get a major event? We're good from a capacity standpoint in terms of our expectations now.
spk02: Okay, and is there anything you can tell us about capacity expansion plans for the medium term? Is there another phase to capacity expansion coming over the next couple of years? Do you feel like you're going to need that?
spk13: Well, there could be. Brian, we took the action last year of getting additional machine tooling on order, even though we don't even have an address to deliver it to at this point. We'll kind of watch how the season plays out here. And if we do get the aggressive hurricane forecast that's been projected, none of that's in our guidance, obviously. So if that comes to fruition, we probably would need to find a home for that tooling. Now, it could be an expansion of our Trenton facility, which is expandable. We've talked about that. It could be another Greenfield site. But it's a little bit of a wait-and-see approach here to the market. But at some point, our belief in the category continuing to grow is you know, there will be capacity ads that are needed, uh, you know, at some point in the future.
spk02: Okay. And then just, uh, lastly, you mentioned, I mean, there's a lot of discussion around IHCs, obviously. Um, did, did you say specifically whether IHCs were up sequentially from first quarter to second quarter?
spk13: Uh, I don't, I don't have that in front of me, but, uh, we did not, they were up. Yeah. Yeah. Mike's pointing up. So yeah, they were up sequentially. Um, They've been, they've been on a tear here, here in Q2 specifically to the catalyst that I mentioned. But, you know, it's been, we've been surprised by the robustness of the end market demand to be very, to be very frank. I mean, it's, it's something that has, I think it speaks to how the category continues to, you know, continues to move into more of a mainstream, you know, as more of a mainstream appliance, if you will, for homeowners.
spk07: in fact they were up very nicely sequentially yeah sequentially yeah very nice and our next question is from mark strauss of jp morgan uh good morning uh thank you very much for taking our questions um might be splitting hairs here a little bit but i wanted to come back to the the installation constraints with you mentioned dealer labor and permitting and other components is it a function of the those conditions deteriorating since your last call? Or is it more so they're just not keeping up with your increased manufacturing output?
spk13: No, they are increasing. We said that activations increased actually year over year. So we are seeing installs increase. They're just not increasing at the same pace. So it's not a deterioration. It's more of a, you know, it's the pace is not increasing at the same rate proportionate to our output.
spk07: Okay. Okay. That helps. And then just curious within the home standby business for new construction, new homes, just curious what you're hearing from your partners within that channel.
spk13: Well, new home construction is slowing, but, you know, again, our IHCs are up. So we've always been, you know, only marginally exposed to new construction that's, you know, I think it was something 10% to 15% of our total volume goes into that. So it's not a huge thing. It never really has been. In fact, we've always said that could be a nice opportunity area if we could get it to grow. And it has grown from kind of that 10% range to more like 15% now. But it's still kind of relative. I think it's mainly a retrofit category, kind of always has been. There's just a lot of housing stock out there in a lot of areas of the country that you know, are struggling with power quality. So we don't really see, and we're not hearing anything directly from channel partners about that. The only thing we do hear from them is that, you know, more home builders want to offer the product as a feature, as a potential, you know, not necessarily a standard feature, but certainly as a feature to the people who are looking to build a home.
spk10: And our next question is from Jerry Revitz of Goldman Sachs.
spk00: Hey, Jerry. Yes, hi. Good morning, everyone. Hi. Aaron, I'm wondering if you could just put a finer point around the order trends and standby. It sounds like, based on your backlog comments, that net orders were about $200 million in the quarter compared to $500 million last quarter. Can you just comment on that? Because I know you look at it on a forward production basis when you quote lead times. And, you know, just put that into context for us because, obviously, sharp pickup in in-home consultations. year over year, so would just love to get your thoughts on that disconnect, if those numbers are right. Thanks.
spk05: Jerry, this is York. We haven't necessarily talked orders historically. We are running up against tough comps on the order standpoint, just given the Texas outage last year, so comparing that, and as well as some of the insult bandwidth comments that Aaron talked about, but I mean, you really have to look at the IHCs to really understand what's going on with the, you know, the end market demand and, you know, having those up nicely year over year here in the quarter and up, what we said, what, four times from pre-pandemic levels. So the underlying demand for the category is still very, very strong. But comparing that order rate is versus priority is probably not the right metric.
spk00: Okay. And, you know, what we've seen is higher baseline post-major outages. You know, we've seen generally a 30% peak to trough decline as, you know, the second adopters, if you will, wind up installing gensets a year after the peak installation rate. Can you just talk about, based on your IHCs, how you feel like that might play out This year, I know we touched on it on the last quarter's call, but I'm wondering if you could expand on that, given we've got one more quarter of information across the board here.
spk13: Yeah, Jerry, this is Aaron. You know, again, I think when you think of the category, I don't know that the historical context is the right place to look. I mean, the category has changed dramatically over the last several years. And, you know, I think all of the major kind of trends that underlie the demand in the category and the strength that we're seeing, in particular in IHCs, you know, we believe are going to remain intact here for the foreseeable future. So I think that, frankly, I just think that, you know, the world's changed, so to speak, you know, whether it's work from home or whether it's so that our home is a sanctuary trend or whether it's, you know, the power quality trends that continue to, you know, be front and center for homeowners. You know, I mean, you have homeowners who they're buying the category today or at least shopping the category today because they're worried about a potential outage. The category used to be all about outages happening and it's still, you know, largely that's an important demand catalyst, but you know, all the rhetoric and dialogue around utility companies struggling with raw supply, you know, as we work to electrify everything, as we're decarbonizing the grid, all of this, you know, kind of rapid shift in how we produce energy and consume energy is, is exposing the, you know, just massive vulnerabilities in supply and demand balancing. And that is something that is, you know, obviously a catalyst for not just home standby generators, but also CNI products, our clean energy products, our grid services products. You know, those are all directly, you know, in line to benefit from just the sheer chaos that the grid has become You know, it's a patchwork quilt to begin with, but now it's a quilt with a lot of holes in it. And you're talking about massive concerns by people about just keeping their lights on, keeping their family safe, their home, their property safe, their business, their livelihood safe, all of these things operating. So I think it's just, you know, I don't know that you can compare it to kind of what has happened historically in any of those categories.
spk10: And your next question is from William Griffin of UBS.
spk06: Great. Appreciate you squeezing me in here. Just a simple one here, but wondering if you could talk about some of the puts and takes on the sequential margin improvement in the domestic segment and specifically to what extent any product discounting initiatives may have been an offset to that.
spk05: No. Pricing realization is is actually going up. There's, if anything, very limited promotion going on. I mean, there's always some just general undercurrent of some minor promotions.
spk13: We have planned promotions that are up there.
spk05: I mean, normally, when we're not in a backlog situation, there's an ordinary course of promotions. But even when you're in backlog, you have some minor promotions going on. Sequentially, there's nothing going on there. In fact, we obviously raised price, repriced the backlog, you know, June 1st. And I think partly maybe where you're going with that is did that price increase stick in the marketplace? And it did.
spk06: Got it. And... Just curious if you could quantify what the 8 to 10 weeks of backlog translates to in terms of value. I didn't hear you mention that on the call.
spk13: Yeah, we don't disclose that. That's why you didn't hear it.
spk10: And your next question is from Maheep Benloy of Credit Suisse.
spk05: Good morning.
spk10: Morning. Maheep, your line is open. Maheep, your line is open.
spk16: So, Christy, I think we can probably go to the next question.
spk10: And that question is from Kashi Harrison of Piper Sammler.
spk03: Good morning, and thanks for taking my questions. Aaron, I just wanted to revisit lead times just one more time. You mentioned that now you're in the high singles versus 20 weeks last update. I know you had mentioned last time that because capacity is increasing, the relative dollar per week of lead times is different from what it was last time. So I was wondering if you could just give us maybe a sense of how to think about that. rate of change, you know, dollar per week this time versus last time, even if it's just like, you know, a general percentage number. And then maybe part and parcel with that, maybe just some thoughts around the length of time before these bottlenecks between the dealers and installs begin to clear along with the risks if the bottlenecks persist.
spk13: Yeah, those are great questions. You know, I think it's also a good point that the, and we've said this in the past, that as we increase our production rates, that the backlog, as we stated, in weeks of orders, that grows as the output grows per week. And we want to catch it. And we want to catch it. We think that, as we said in our prepared remarks, one thing we are seeing is we're seeing improved close rates off of IHCs because we are bringing down lead time. So that's part of our overall strategy here is if you're a customer and you're shopping the category, and even if you're here eight to ten weeks on a product, you know, you might be, you might kind of sit on the sidelines and see what happens, right? And even worse, kind of getting into the second part of your question is, you know, if a channel partner or a dealer is quoting something longer because they, you know, their bandwidth to install has got them kind of at a fixed rate that's, you know, that keeps the lead time longer. So that gap, as we pointed out, kind of grew in the second quarter because of the increase in our production output and they increased activations or installs, but not to the same level. So, you know, we're working with them to bring that inside. You know, we're going to need more dealers. We're going to need more installing contractors. We have a lot of initiatives around trying to make installations easier and less time-consuming. Today, an installation, a typical installation, still takes two individuals about an eight-hour, you know, eight hours apiece, so about 16 hours of labor in the installation. So if we could get that down, that obviously frees up some additional bandwidth. So that's where our focus has been. And again, it's dealer by dealer. So it's not widespread, but we are seeing dealers struggle with that. In particular, dealers that are in markets where either housing has been really hot in certain markets, that's where they're really struggling with labor for construction labor, contractor labor. So again, part of our prepared remarks is as the housing market cools, we actually think that'll help us refocus installing contractors' attention towards the category, and we'll hopefully improve lead times to the end market.
spk03: And just a quick follow-up there. So the high singles, would that be 50% more than last time on a per-week basis, 75% double? Just any rough sense of how to think about it on a relative basis would be great.
spk13: No, I mean, again, we'd have to do the math. I don't have a ratio like that put together. But, you know, I think lead times we quoted last time were in the 20-week range. They're roughly half of that now, 8 to 10. But, again, that 8 to 10 represents a greater amount. So, you know, in terms of our production output, so it's not half of what it was before. So to your point, I think that's the point you're trying to get to. I just don't have the math in front of me on that.
spk10: And your next question is from Praneeth Satish of Wells Fargo.
spk08: Thanks. I'm just trying to understand here with the constraints on the installer side. I mean, if there was some kind of major weather event in the second half of this year, would you be in a position to benefit from that, or would that be basically kind of adding to the 23 sales at this point?
spk13: Yeah, as we've said before, you know, Today, the plan is we're going to probably exit the year with some backlog remaining. Because of that, there's not a lot of room for upside for the storm. There hasn't been all year for HSB. We've got some room on portable generators. We're in a good inventory position there, ready to serve the market if there is an active storm season. But on HSBs, and this is, again, why we're working with the channel to increase their install capacity because we've got to get that to a higher level longer term. We have seen opportunities for that to expand, but the backdrop right now, what we're hearing from these contractors that are struggling is primarily labor, some components, and then some permitting and utility-related delays. So we're attacking all of those things. We've got a broad slate of initiatives to get after those things. and have been here for the balance of this year. Because we could see this coming. We needed to see the installation rate pick up. And while it has increased, it just hasn't increased enough at this point.
spk05: And you'd have to ramp your supply chain up further as well. That's a good point. Which in this challenging environment could limit that, but definitely would help out in 2023. That's a good point.
spk08: Got it. And then just switching gears, can you give us an update on the grid services business? How many deals did you win in Q2? And are you seeing an acceleration in that side of the business with utility rates going up and utilities kind of looking for any way to lower their costs?
spk13: Yeah, that has been a really active space for us. I'm really pleased with the sales pipeline that's building there. The challenge, of course, in that business, and as we've said before, is just the time it takes to get these programs through not only the utilities themselves in terms of developing the programs, but also then the regulators for approval. So we have a couple of really nice wins that we will, you'll see some announcements here in the weeks ahead on that are, I think, really are a good example, both of the wins that you'll see are really good examples of the power of the hardware plus software approach that we've taken here. And I think that, as I mentioned in the prepared remarks, we're definitely beginning to see that there's a differentiator for us as a company because we bring so much more to these potential programs by offering solutions that span everything from a smart thermostat program to a generator program to a battery program to a CNI generator program. I mean, there's you know, big chunks of load that come from CNI generators. And we can bring all of that hardware to bear alongside this, you know, really advanced software platform called Concerto that our team has developed. It's just a really interesting space going forward. And, you know, to the point about utilities, we have seen a change in their attitudes over the last several months, several quarters, really, in terms of the sense of urgency in which they're asking questions and engaging with us. We were down in Distributech, which is kind of the utility market's trade show, if you will, down in Dallas a while ago, a couple months ago. And I was struck by just the quality of the conversations, the quantity of the conversations we had with utilities and grid operators. And they just feel like their back is against the wall. They can't solve their problems with traditional means, right? Like a traditional mean being, If demand is going up because of more EV adoption in a particular market, a grid operator utility would simply have outlined a plan to add a gas peaker plant to cover those points in the curve where they need additional supply. And so that's something that they can't do anymore. Their regulators are saying, look, we're not going to allow you to add another thermal asset to your fleet for supply. And so they're finding themselves in the uncomfortable situation of having to – it's kind of like a dual mandate. They have to decarbonize their grids because of that mandate, but the other mandate is they have to continue to provide resiliency. And so they're really struggling with ways to do that, so they have to have new tools in the toolkit. And they see these virtual power plants and these distributed energy resources like generators and batteries and load management and thermostats as ways to – as really valuable ways to help them build out you know, the additional supply or the reduction in demand that they need to provide the resiliency that they're charged with providing.
spk10: And your next question is from Donovan Schaefer of Northland Capital Markets.
spk09: Hi, guys. This is Donovan Schaefer. How's it going? Good. Thanks for taking my question. So, You know, it seems like there has been so much changing, you know, all over the world in the last few months. So I'm just wondering if we can step back and talk about some of this in terms of what it means for the megatrends you guys like to talk about. So, you know, first, there's grid instability. But I do, you know, it does seem on some level that in the United States, you know, there are at least some bona fide grid investments, you know, with the infrastructure bill that was passed last year, plans to make it easier to permit transmission lines. It does seem like there's a bit of traction there. So, you know, on that front, I'm wondering if there are any risks or if there is any chance we could get, you know, kind of a reduced trend in outages, you know, not near term, but maybe say three to five years out. You know, I know MISO is I think just recently approved like 18 high-voltage transmission lines to handle 53 gigawatts of capacity or something. And then I also want to talk, you know, in the Russian situation, you know, that does make the diesel to natural gas megatrend, certainly in Europe, you know, to some people look like a bad idea. I know you also sell diesel generators, so maybe you can kind of be agnostic there, but historically... the megatrend you've talked about has been the shift to natural gas. And then kind of on the flip side, you know, you've got growth in the LNG market. Maybe that allows more HSB and natural gas generation elsewhere. Increasing energy security concerns generally. I mean, nations like Japan, Taiwan, you know, the Philippines really struggle with electricity generation, you know, limited resources having to import everything. They probably don't feel great about China right now. So those could be, you know, positive drivers. So just, I'm curious, kind of, again, stepping back and looking at mega trends from these kind of big movements globally, we've been saying, you know, what, which ones are you watching? Which one do you think could really, which things do you think could really be, you know, material over a couple of years? Um, yeah, any clarification on that would be very helpful.
spk13: Yeah, Donovan, from a megatrend standpoint, the grid's a mess, and there's nothing in the next three to five years. I mean, you can talk to any utility company, any utility executive, and while they'll get some transmission lines approved and a couple of other things going in the right direction, maybe that'll light a fire under regulators. But there's so much deferred. If you didn't have the electrify everything trend, if you just took that away for a second, And you dealt with the more severe climate experiences that we're having and just the decarbonization of the grid in general and that kind of generating fleet, those sources being, they're moving to a more intermittent nature. And because the technologies have not kept up, like battery technology is just not there yet commercially to be a viable storage technique. And that's really what we need. We need storage. If we're going to move to 100% of our power being generated from renewable sources, you've got to have the ability to store that power at times when those renewables are not able to perform. This is a massive challenge that grid operators and utility executives are trying to solve for. There's no silver bullet there. There's no easy way to do it. There's no technologies that have presented that allow for that in a commercial way in a cost-effective way certainly and there's nothing in the next three to five years and they would tell you that even if they had an approved plan all the resources necessary to execute that approved plan it would be decades just to execute against it the build out of the transmission lines the upgrade of all the equipment that needs to happen to modernize the grid it's there's there's trillions and trillions of dollars behind in deferred spending and And just the raw effort to do that is decades in the making. So we don't see anything on that front. On your question on natural gas versus diesel, I mean, almost 100% of our business CNI-wise outside of the U.S. is diesel. There's a little bit of natural gas, as we've said, and we think that that's a trend longer term that'll improve. Where the diesel and natural gas trends have been much more prevalent is here in the U.S. and where we have a lot of gas available, and that's not an issue anymore. And, you know, I do think even in Europe, you know, they need gas. So whether it comes from Russia or whether it gets imported from other areas, they're not going to move away from pipelines. You know, they've got the infrastructure. They're going to get gas. They're not going to change how they heat. They're not going to change how they use gas for processing. They need gas. So they'll get it from somewhere else. It's probably going to be imported, LNG coming into the countries that need it. And natural gas is re-designated in Europe as a clean fuel, which is great. So I think longer term, we feel really confident in those trends. Maybe shorter term, there'll be some noise around that. But again, that business today is mostly diesel. So it's really not a today impact. And then you're right. You've got other countries where there's opportunities for us. You mentioned a couple of countries in Asia. that have their islands, right? So they import, whether it's Japan or whether it's Taiwan, those are all areas where they import. And we do see LNG becoming an important fuel. And this is where I think the United States is in a really good spot here to be able to provide a path for countries that need that important fuel source, whether it's based on power generation, or process, or for energy security, that's going to be something that I think is going to be a – that's a trend that's going to continue long into the future. Natural gas is a fantastic energy resource. It's going to be part of our baseload power structure here as a global populace for a long time to come.
spk10: And our final question is from Mahit Menloy of Credit Suisse.
spk12: Oh, hey. Let's try this again. I hope you guys can hear me.
spk08: Yep. Hey, Mahit.
spk12: Oh, hey. Thanks. Towards the end, just two quick ones. One, just on the backlog, it said more than a billion dollars in the last quarter. Is it somewhere in line with that range or different and had a separate follow-up?
spk13: Yeah, again, we've talked about eight to ten weeks of orders in the backlog and the It's sizable. It's a big backlog, and we expect to still have backlog as we exit the year. That's in spite of the increased production rate. It's a sizable number. We want to get that down because that's how we think that serving the market with shorter lead times is really important to winning in the market, in particular on those sales leads that we've talked about. That's a really... important focus for us, Maheep. And we're going to continue to lean into that. And again, working on that installation bandwidth as well. But that eight to 10 weeks is really how we would speak to the backlog.
spk10: And I would now like to turn the call back over to Mike Harris for any closing remarks.
spk16: We want to thank everyone for joining us this morning. We look forward to discussing our third quarter 2022 earnings results with you in early November. Thank you again and goodbye.
spk10: And this concludes today's conference call. Thank you for participating. You may now disconnect. Begin shortly. To raise your hand during Q&A, you can dial star 1 1.
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