Generac Holdings Inc. (NYSE:GNRC) Q2 2023 Earnings Call Transcript

Generac Holdings Inc. (NYSE:GNRC) Q2 2023 Earnings Call Transcript August 2, 2023

Generac Holdings Inc. beats earnings expectations. Reported EPS is $2.99, expectations were $1.16.

Operator: Good day and thank you for standing by. Welcome to the Second Quarter 2023 Generac Holdings Inc. Earnings Call. At this time all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. [Operator Instructions] Please be advised that today’s conference is being recorded. I would now like to hand the conference over to your speaker today, Mike Harris, SVP, Corporate Development and Investor Relations. Please go ahead.

Mike Harris: Good morning, and welcome to our second quarter 2023 earnings call. I’d like to thank everyone for joining us this morning. With me today is Aaron Jagdfeld, President and Chief Executive Officer; and York Ragen, Chief Financial Officer. We will begin our call today by commenting on forward-looking statements. Certain statements made during this presentation as well as other information provided from time to time by Generac or its employees may contain forward-looking statements and involve risks and uncertainties that could cause actual results to differ materially from those in these forward-looking statements. Please see our earnings release or SEC filings for a list of words or expressions that identify such statements and the associated risk factors.

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

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

The current year quarter continued to be impacted by elevated levels of field inventory for home standby generators as well as a decline in clean energy product shipments year-over-year. Global C&I product sales increased approximately 24% to an all-time quarterly record with broad-based growth across nearly all regions and channels. Adjusted EBITDA margins were negatively affected by the significant unfavorable sales mix as well as reduced operating leverage driven by lower home standby shipments and continued investments for future growth. Importantly, continued favorable price cost dynamics have created a meaningful margin tailwind, providing a partial offset to the unfavorable sales mix. Second quarter home standby shipments grew at a strong sequential rate, but declined significantly on a year-over-year basis as the second quarter of 2022 included the reduction of excess backlog and we continue to meaningfully under-ship end market demand in the current quarter as we focused on further reducing field inventories of home standby generators.

Baseline power outage activity in the U.S. was well above the long-term average, but meaningfully weighted toward the final weeks of the quarter. Home consultations or sales leads were roughly flat from the prior year period and increased sequentially off an unseasonably strong first quarter. Additionally, home consultations during the second quarter was still more than 4x higher than the second quarter of 2019, further supporting our view that consumer interest in the product category has achieved a new and higher baseline level. Our residential dealer account returned to sequential growth in the quarter, ending at approximately 8,700, an increase of 500 dealers from the prior year. We continue to invest in growing the installation capacity of our channel partners, and we are making good progress towards our initiatives to increase dealer count, train non-dealer contractors, streamline the installation process and raise home standby category awareness across trade groups.

We believe these efforts are important to the longer-term growth trajectory of the product category as the mega trends that support the demand growth outlook remain firmly intact. Activations, which are a proxy for installs, improved sequentially over the first quarter, but declined from a strong comparable period in 2022 that included the benefit of a backlog of installations in certain regions during the prior year. Activations were also below our prior expectations for the quarter, primarily due to the weaker consumer spending environment for home improvement. But despite this relative softness, activations during the quarter were more than double second quarter 2019 levels. Close rates were flat sequentially and remained meaningfully higher than the comparable period of 2022, but underperformed our expectations as a result of the shift in consumer spending patterns.

The number of home standby generators in field inventory further declined in the quarter, while days of field inventory relative to historical norms also decreased sequentially. However, with close rates and activations lower than expected in the quarter, the field inventory normalization process is now expected to extend further into the second half of the year. As a result, we expect the elevated field inventory levels to further impact home standby shipments in the second half relative to our prior expectations with the return to year-over-year growth in home standby shipments now anticipated in the fourth quarter. We believe the stronger outage environment in the final weeks of the second quarter and the resulting strength in IHC support this expected return to growth later in the year.

Longer term, the mega trends that are driving awareness for backup power solutions are as compelling as ever. Homeowners and business owners are becoming increasingly sensitive to the growing frequency of power outages driven by extreme weather and grid operators are struggling to solve the growing supply demand imbalances that are a byproduct of the accelerated energy transition that is underway. Importantly, these are not short-term issues as the transition to the next-generation power grid will be an uneven process and is expected to take decades to complete. We believe our unparalleled suite of solutions is well positioned to solve many of the energy-related challenges that consumers and businesses will inevitably face. I now would like to provide some commentary on our chore products, which consists of a broad lineup of outdoor specialty power equipment used for property maintenance in large residential and light commercial applications.

These products, which are increasingly shifting towards battery-powered solutions experienced significant growth in recent years as homeowners have been spending more time to money on property maintenance since 2020. However, shipments in the second quarter declined from the prior year and were below our prior expectations as higher channel inventories in the industry, unfavorable weather trends and shifting consumer spending patterns impacted demand for chore products. This weaker than previously expected demand environment is expected to persist in the second half of the year, also contributing to our lower outlook for residential product sales. Now moving to our residential energy technology products and solutions. Second quarter sales were in line with our prior expectations and grew at a strong rate sequentially as shipments of our power cell energy storage systems improved and ecobee sales hit an all-time record for the quarter.

Ecobee drove strong sales growth over the prior year and continue to take share in the smart thermostat market by strong positioning with professional contractors and new placement with key retailers. The ecobee team is progressing towards the launch of a smart doorbell camera in the second half of this year, which will provide for increased homeowner engagement with our home energy management platform. As the central hub of our home energy ecosystem, we firmly believe that ecobee’s feature-rich devices and significant expertise and user experience will provide to be – will prove to be key differentiators for Generac’s residential energy technology efforts. Although we are making progress in our future product roadmaps and building the confidence – and rebuilding the confidence of solar installers, the broad residential solar and storage market in the U.S. is showing signs of slowing.

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

Combined with our core competencies around sales and marketing, lead generation, distribution, customer support and global sourcing. I’d now like to provide commentary on our C&I products, which once again outperformed our expectations. Global C&I product sales grew 24% over the prior year to an all-time quarterly record as multiple mega trends continue to support demand for backup power and mobile products around the world. Domestic C&I product sales grew at a robust rate in the second quarter, highlighted by strengthened shipments to a number of key customers for beyond standby applications, industrial distributors and national rental equipment companies. Shipments of natural gas generators used in applications beyond traditional emergency standby projects continued to see tremendous growth during the second quarter.

We believe we are in the very early innings of this exciting new market opportunity as grid stability concerns and volatile energy markets are expected to further drive demand for these solutions. Leveraging our position as the leading provider of natural gas generators we are building an increasingly comprehensive solution set to enable the deployment of our products in multi-asset applications, such as pairing our smart grid ready generators with our emerging C&I storage, connectivity, advanced controls and grid services solutions. Shipments of C&I generators through our North American distributor channel grew once again at a strong rate and channel backlog also increased sequentially during the quarter. Quoting activity for C&I products remains robust, highlighting the ongoing strength in demand for backup power in this important channel that serves a wide range of end markets.

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

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

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

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

York?

York Ragen: Thanks, Aaron. Looking at second quarter 2023 results in more detail, overall, net sales decreased 23% to $1 billion during the second quarter of 2023 as compared to $1.29 billion in the prior year second quarter. The combination of contributions from recent acquisitions and the favorable impact from foreign currency and approximately 3% net favorable impact on revenue growth during the quarter. Briefly looking at consolidated net sales for the second quarter by product class, residential product sales declined 44% to $499 million as compared to $896 million in the prior year. As Aaron discussed in detail, lower shipments of home standby generators, power cell energy storage systems and shore products drove this decline in residential product sales.

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

In addition, international shipments of C&I power generation products and controls and automation solutions also contributed to this growth. Net sales for other products and services increased 37% to $117 million as compared to $86 million in the second quarter of 2022. This increase was primarily due to the acquisition of electronic environments given their additional service capabilities. We called out that this acquisition closed last year on June 30. Gross profit margin was 32.8% compared to 35.4% in the prior year second quarter due to the significant impact of unfavorable sales mix given the sharp decline in home standby mix compared to the prior year. This was partially offset by previously implemented pricing actions and lower input costs from improved commodities, logistics and plant efficiencies that are providing an important tailwind to margin trends that are expected to continue in the second half of 2023.

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

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

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

As disclosed in our earnings release, GAAP net income for the company in the quarter was $45 million, as compared to $156 million for the second quarter of 2022. The current year net income includes approximately $15 million of additional interest expense compared to the prior year due to higher borrowings and interest rates. In addition, GAAP income taxes during the current year second quarter was $16 million or an effective tax rate of 25.9% as compared to $46 million or an effective tax rate of 22.5% for the prior year. The increase in effective tax rate was primarily due to a lower benefit from equity compensation in the current year quarter. Diluted net income per share for the company on a GAAP basis was $0.70 in the second quarter of 2023 compared to $2.21 in the prior year.

Adjusted net income for the company, as defined in our earnings release, was $68 million in the current year quarter or $1.08 per share. This compares to adjusted net income of $185 million in the prior year or $2.86 per share. Cash flow from operations was $83 million as compared to $24 million in the prior year second quarter, and free cash flow, as defined in our earnings release was $54 million as compared to $6 million in the same quarter last year. The increase in free cash flow was primarily due to significantly lower working capital investment in the current year quarter as inventory levels have stabilized, partially offset by lower operating earnings, higher interest payments and higher CapEx. Total debt outstanding at the end of the quarter was $1.62 billion, resulting in a gross debt leverage ratio at the end of the second quarter of 2.8x on an as-reported basis which is expected to moderate in the second half of the year as LTM EBITDA begins to increase.

With that, I will now provide further comments on our outlook for 2023. As disclosed in our press release this morning, we are updating our outlook for the full year 2023. The softer than previously expected consumer spending environment for home improvement has impacted our outlook for residential products most notably for shipments of home standby generators. As a result of the software consumer, we are seeing lower close rates and activations relative to prior expectations which is causing higher field inventories and lower distributor sentiment compared to our previous guidance commentary. As a result of these factors, we now expect residential product sales for the full year 2023 to decline in the mid-20% range compared to the prior year, which compares to our prior expectation for a decline in the high teens range.

Partially offsetting this incremental weakness in residential products, we are raising our outlook for C&I product sales which are now expected to grow at a mid-teens rates during the year as compared to our prior guidance of a mid to high single-digit rate. Overall net sales for the full year are now expected to decline between minus 10% to minus 12% as compared to the prior year, which includes approximately 2% net favorable impact from acquisitions and foreign currency. This compares to the previous guidance range of a decline between minus 6% to minus 10%. From a quarterly pacing perspective, we now expect a slight year-over-year decline in overall net sales for the third quarter with the return to year-over-year growth in the fourth quarter.

This guidance assumes a level of power outage activity during the remainder of the year that is in line with the long-term baseline average. And consistent with our historical of course, this outlook does not assume the benefit of a major power outage event during the year. Looking at our gross margin expectations for the full year 2023, we now anticipate approximately 100 basis points of gross margin improvement over 2022 levels. We still expect sequential quarterly improvements in gross margins in the third and fourth quarters with third quarter gross margins projected to be approximately 150 to 200 basis points higher than the second quarter of 2023. The anticipated sequential improvement in gross margins in the second half is expected to be driven by improved sales mix with higher shipments of home standby generators, lower input costs and the realization of cost reduction initiatives as compared to the first half of the year.

Given the significant megatrends that support our long-term growth opportunities, we remain focused on driving innovation, executing our strategic initiatives, and investing for the future. As a result of these ongoing investments, we expect operating expenses as a percentage of net sales to be approximately 20% to 21% for the full year 2023. Given these gross margin and operating expense expectations, adjusted EBITDA margins before deducting for non-controlling interests are now expected to be approximately 15.5% to 16.5% for the full year 2023 compared to the previous guidance range of 17% to 18%. From a quarterly pacing perspective, we still expect adjusted EBITDA margins to improve throughout the remainder of the year, primarily driven by sequentially improving gross margins as previously discussed, and to a lesser extent, improved leverage of operating expenses on an expected higher sales volumes.

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

For the full year, we expect adjusted net income to free cash flow conversion to be strong well over 100% as working capital moderates off of peak levels. We’re also providing updated guidance details to assist with modeling adjusted earnings per share and free cash flow for the full year 2023. Importantly, to arrive at appropriate estimates for adjusted net income and adjusted earnings per share, add-back items should be reflected net of tax using the expected effective tax rate. For 2023, our GAAP effective tax rate is still expected to be approximately 25% as compared to the 19.6% full year GAAP tax rate for 2022. The year-over-year increases driven primarily by expectations for lower share-based compensation deductions, increased mix of income in higher tax jurisdictions, higher tax on foreign income in 2023 compared to 2022.

Interest expense is now expected to be approximately $92 million compared to the prior guidance of approximately $90 million, assuming no additional term loan principal prepayments during the year and current expectations for SOFR rates throughout 2023. Interest expenses is expected to moderate in the third and fourth quarters as cash flows on our interest rate swaps become more favorable and as we expect to pay down a portion of our outstanding revolver indebtedness. Our capital expenditures are still projected to be approximately 3% of our forecast and net sales for the year. Depreciation expenses now forecast to be approximately $62 million compared to the previous guidance of approximately $60 million in 2023. GAAP intangible amortization expenses now expected to be approximately $102 million during the year as compared to the previous guidance of approximately $100 million.

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

Q&A Session

Operator: [Operator Instructions] Our first question comes from the line of Tommy Moll with Stephens Inc. Your line is now open.

Tommy Moll: Good morning, and thanks for taking my questions.

Aaron Jagdfeld: Hey, Tommy.

Tommy Moll: Aaron, I wanted to start on the topic of channel inventory for the home standby product category. Last quarter, I think you were at about 1.5 times normal. Where do you sit now and am I hearing you correctly that embedded in your outlook is that that converges to the normal level by fourth quarter?

Aaron Jagdfeld: Yes, Tommy, it’s – I mean, that’s obviously the central question here and has been a topic as we’ve discussed over the last several quarters. You’re right, we said, I think somewhere in the 1.4 to 1.5 times range is where we were last time we talked in April. Today, we believe that number is closer to 1.2 to 1.3 times as we exit – as we exited the first half. And with the assumption of a softer consumer spending environment in particular around kind of residential investment, these types of projects, home improvement projects, we’re really looking at a more moderated close rate. It’s interesting because we actually are seeing a lot of inbound activity in terms of sales leads. They’re just not – the close rate on those leads is not growing at the rate that we thought it would, and that’s really the kind of the – and then it just becomes a maths [ph] problem from there.

We’re just not going to drain the inventory as quickly because we’re not going to convert those leads to activations at the rate that we thought we would here in the second half and that is – that’s going to create basically a situation where that elevated field inventory is going to persist a bit longer than we had originally thought. So through – really kind of through the year here, it’ll start to taper off and there’s definitely and I think you’ve done this with channel checks, we do our own channel checks and we know what field inventory looks like really with a high degree of accuracy region to region and dealer to dealer, wholesaler to wholesaler, retailer to retailer. And so we see regions where actually there isn’t a field inventory issue anymore.

And we see other regions where field inventories are still higher than normal. So it’s become more of a mixed bag, if you will around the field inventory story. Whereas I would say you wind the clock back two or three quarters, it was – two or three quarters ago, it was everywhere. So the field was full of inventory in all regions. So now we’re starting to see some of that normalization be achieved in certain regions and in fact go beyond that. We’ve got a couple of regions you get up into Canada, in the Quebec markets where in particular where they’ve had a number of outages and we can’t get them enough product, they don’t have the installation bandwidth. So we get back to that issue and that’s obviously another area we’ve been focused on.

So hopefully that gets the answer to your question

Operator: [Operator Instructions] And the next question comes from the line of Michael Halloran with Baird. Your line is now open.

Michael Halloran: Hey, morning everyone. So following-up a little bit on that…

York Ragen: I think we lost, Mike.

Aaron Jagdfeld: We lost Mike.

York Ragen: We lost, Mike.

Michael Halloran: [Indiscernible] The distribution channel’s growing too. Can you hear me or no?

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

Michael Halloran: Yes, no problem. There’s a lot of moving pieces here from a channel perspective and in the home standby side, we kind of take along to that inventory question, but you’ve got high inventory. You’ve taken your outlook down a little bit slower consumer conversion, but the IHCs are higher, you’re gaining distribution inventory is at least normalizing a little bit. Can you help sync from a forward commentary how you think this demand curve starts playing out? Maybe just a little behind the hood on the sellout from a channel perspective, how you think those sequentials kind of work from a sellout perspective versus what normal might look like and just kind of any context to the – what the true underlying run rate might look like if you try to normalize for these moving pieces.

Aaron Jagdfeld: Yes, Mike. There are a lot of moving pieces, as you said, and when you think about the sell in versus sellout, again, we’re channel to channel, when we look at kind of the different metrics that we look at in every channel, we see some different things going on channel to channel. We do see our dealer channels, which are more turnkey project channels feel like they’re in and then the metrics bear this out that they’re in better shape than some of the other channels. So when we look at our wholesale channels and in particular our retail channels, retail would be is lagging for us right now. So when we look at – when we look through – at sell through at retail and we look at the – kind of the food traffic at retailers and I think you guys have those on the call here have heard some of the more recent commentary from some of the larger retailers.

I think the food traffic has slowed and we are definitely seeing that in our residential product categories that we sell through retail. With maybe the notable exception being ecobee as we called out – in our prepared remarks this morning, which is interesting. And that really is probably more owed to higher energy prices and the opportunity to use those ecobee products to reduce your energy costs. But on the – the moving pieces that are in this and kind of thinking about the pacing, if that’s more your question, Mike, what we see here is as the kind of fog clears of this field inventory issue, we think that the dealers are kind of first to recover here, followed by – likely by wholesale. And then we’ve got a little bit further to go with retailers.

The ones that are probably at the – when we talk about normalization at 1.2 to 1.3 times is across everything, right? So – and we sell kind of on an omnichannel basis, so dealers are better than that. Wholesalers are probably somewhere maybe a little worse than that and retailers are quite a bit worse than that at this stage. We do believe this will start to normalize here as we go throughout the third quarter. And as we get into the fourth quarter in particular, we should start to see that abate. The end market demand part of your question is interesting, because as we said, sales leads IHCs remain strong. In fact, they were even up sequentially from Q1 and they’ve – they’re just not converting quite at the same level. Now, what we’re not sure of at this point is if that conversion is just delayed or if that conversion is more the result primarily of the consumer just saying they’re not going to buy at all, right?

Are they just not going to buy today or they’re not going to buy at all? And so as we continue to work on that, we’ve stood up an entire group here, we call it, our nurturing team for lack of a better terminology, but these are a team of dedicated salespeople that reach back out to unclosed leads. We’ve got quite a house file that we’ve built here of unclosed leads. The number of leads we’ve generated over the last several years is tremendous. And as you can imagine, a high percentage don’t close. So the opportunity to reengage with those homeowners at the right time with perhaps the right offer is growing. And we think that that represents an area of opportunity for us and one that we’re leaning into. But that’s something that – we’re still kind of in development phase on.

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

York Ragen: Yes, I think the key is, seasonally – we do expect the home standby category to pick up in the second half of the year versus the first half, especially as inventory begins to normalize towards the – throughout the second half. I think it’s to Aaron’s point though, it’s just – maybe it’s not going to improve as much as we thought relative to three months ago, because of the software consumer that we’re seeing.

Operator: [Operator Instructions] And the next question comes from the line of Jeff Hammond of KeyBanc Capital Markets Inc. Your line is now open.

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

Aaron Jagdfeld: Yes. Sure, Jeff. That is surprise to us as well. Although, as we look at – I would say kind of maybe comparable industries, where you’ve got bigger ticket types of home improvement projects, pools, patios, furniture, things of that nature. We’re maybe not seeing, I think you’re hearing commentary, but we’re all not seeing maybe the consumer step up to the same level that we all expected. And that I think is indicative of perhaps, just the work that the federal reserve is doing here to tamp down inflation with higher rates. I think it’s starting to bite in some of these areas in particular on these bigger ticket type of purchases. So that – for the home, anything tied to residential investment. I would tell you that, we did see, to get to the point that we’ve made in the past and that you’re making here, we thought that close rates previously had come down, because of the long lead times in the product, which we believed were kind of at the root of that.

They bounced off the bottom kind of Q1 of 2022 and improved nicely sequentially up until this quarter. And this quarter, they kind of flattened out and where basically our guidance here contemplates that they don’t go up any further this year. That’s really the – that’s the change, right? We had – our previous guidance had contemplated that close rates would continue to improve, albeit not dramatically so, as we said on the last call, it’s going to take some time to return to those pre-COVID close rates. But the feedback from the channel around close rates is that homeowners are, they’re struggling to, again, with bigger ticket types of purchases and they’re just – they’re taking more time to think through that. And so we just think that that phase of the project, and again, I think the good news is we’ve got a sales lead, even if it didn’t close, we have the opportunity to re-engage with that customer and friction in the past, when we look at re-engagement, our close rates are better if we choose the right time to reengage, right, i.e., if another outage moves through a local market and our team engages with all those unclosed IHCs, those unclosed opportunities in that market, perhaps over the last 12, 24, even 36 months, we see a much higher close rate the second time around.

So it’s kind of like the friction is lower because that process of the in-home sales consultation has already been – has already taken place. And so that just leads to an easier time to get to closure at least historically. So we’re going to – and that’s really where we’re putting a lot of our efforts here in the second half of this year is into that nurturing effort that I talked about before to really work on how do we get more unclosed IHCs to closure.

Operator: [Operator Instructions] And your next question comes from the line of Mark Strouse with J.P. Morgan. Your line is now open.

Mark Strouse: Yes. Good morning. Thanks for taking our questions. Sorry to beat a dead horse here. I just want to ask on field inventory levels, again, a different way of looking at it, just how you’re thinking about what normal inventory levels are? The 1.2x to 1.3x that you’re talking about today, does your outlook kind of assume that that goes back to 1.0x? Or based on the channel checks that you mentioned earlier, is there a chance that that potentially goes even lower, at least temporarily, given kind of what you’re talking about with the macro? And then can I sneak up – sneak in a quick follow-up? Just to be clear, what I’m hearing, the margin issues are – at least the margin headwinds you’re talking about in guidance that is a mix issue. You’re not signaling any changing in pricing. Just want to make sure that that’s clear. Thank you.

Aaron Jagdfeld: Yes. Mark, thanks for the question. So I’ll take the first part which is the field, again, just kind of expanding on the field inventory, we said 1.2x to 1.3x. Our assumption is that 1.0x is “normal”. I think the key question there is, is 1.0x the right number, right? And what is 1.0x based on? And so what it is, is we went back I think it was around 2019 levels for pre-COVID, if you will levels of field inventory just to kind of pick our point of normal, right? And that’s a debatable point. Could the channel decide that their normal is lower? Potentially. Recall though that in our world, the field inventory, there’s very – there’s not a ton of field inventory at the dealer level, especially when you get in the smaller dealers.

They just don’t have the financial capacity or even the physical space to put product in. So in their world, maybe normal is zero. And that would be contemplated, of course, in the 1.0x. It’s going to be the other channel players the retailers, the wholesalers that are generally more stocking channels. And then our larger dealers that regionally will also stock product just to keep a constant flow to their teams in particular their install teams just to keep product moving. And so, if we do this on a days adjusted basis, though just to be clear, because there is seasonality to this. So as we think about this, the second half of the year is seasonally our stronger period for home standby generators. So we would see velocity typically pick up in the second half of the year.

A year, when you look at it on a day’s basis, that field inventory calculation will adjust accordingly. And then in the first half of the year, in particular first quarter, which typically is our seasonally low period, that’s when you’d see kind of that days of field inventory adjust to reflect lower installation pace. But the key question is not lost on us in terms of what’s normal. Is there a risk there around the fact that maybe channel partners decide that normal is something less? Potentially. I don’t think it would be long-lived. It’d be probably short-lived if that’s the case. But we’re trying to be I think balanced in how we’re viewing this. And we think that that kind of 1.0x is a good reflection point of – is reflective of a good point in the curve in terms of what’s normal.

And then on margin, York?

York Ragen: Yes, on the margin side, yes, in terms of the EBITDA percent guidance down. On the gross margin side, it’s all mixed. So there’s no pricing reduction assumptions in our guide, so it’s all mixed. And then when you get to OpEx, there’s a little bit of operating de-leverage on the lower sales. So that’s a smaller piece of the puzzle, but there’s no reduction in price in our guidance.

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

Jerry Revich: Yes. Hi. Good morning, everyone. I’m wondering if you could just – so margins are going to be at about 16% this year. Your targets for 2024 were in the mid-20s, and obviously a lot has changed since. But I’m wondering, is there an opportunity for margin expansion off of current levels? How would you bridge what’s reasonable to expect compared to that 24% to 25% margin target you laid out at the Analyst Day. York, I think you alluded to it in terms of 400 basis point of drag from the solar investments. But can you expand on that and what you folks view as a reasonable margin expectation in the medium-term?

York Ragen: Yes, yes, a couple things. I know I did mention in my prepared comments that Q4 – exit rate Q4 EBITDA margins are expected to be in that, that low 20% range. So we expect, obviously, things to pick up from here, especially as home standby shipments normalize. I guess, if you think about that previous Investor Day target for 2024, I know that our Energy Technology business things are just taking a little bit longer than maybe we originally laid out back in 2021 – September of 2021 for that business. This is more of a reset year for our Clean Energy business, and it’ll grow from here. So I think we’re going to level set what those, I guess, revised expectations are going to look like on September 27 when we have our Investor Day next month – September 27 next month. And I think we’ll be able to give clear updated targets for the long-term at that point. But I guess those are some data points that you can use for now.

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

Kashy Harrison: Good morning and thank you for taking the questions. So just a few quick ones here. Can you just give us a sense of the revenue gap between sales into the channel and sales out of the channel? Are you underselling this year by $100 million, $200 million, $300 million? And then on the C&I side of the business just how do you think about the repeatability into 2024? Just giving some of these cross currents surrounding construction from the infrastructure bill maybe improved the ABI, maybe ladder ends of 5G. Just how do you think about the repeatability of C&I? Thank you.

Aaron Jagdfeld: Yes. Thanks, Kashy. So, yes, we haven’t disclosed the kind of gap between sell in and sell out. So but it – we are significantly under shipping the market here – market demand here in the first half as we work through that field inventory. And that really is the pull down and guidance here on the residential side as a result of that.

York Ragen: And we can see field inventory coming down in all of our data, so we know we’re under shipping the market.

Aaron Jagdfeld: We know we’re under shipping the market pretty dramatically at this point. So – and that’s why we think that we’re going to continue to grow here sequentially through the year because that field inventory drag will reduce as we get to the back half of the year. So again, haven’t put a fine number on it just kind of from a disclosure standpoint, but we definitely see that. And then on C&I, I think the question, it was a little broken up for us, sorry about that. But I think the question was just kind of about the sustainability of C&I and what we’re seeing there. I think as we said kind of in our remarks, obviously, we’re starting to come up against tougher comps, right? We’ve been – the C&I business has been very strong for a long time.

It was another great quarter for our C&I business. Some of our national account customers, in particular, on the rental side, we’re starting to see some moderation of those order patterns here. But what we’ve heard from the – largely from our large rental customers is that utilization rates and equipment are still doing quite well. They’re holding in there. That said, I think proactively a couple of those larger customers have cut their CapEx guidance for the year. We’re pretty well locked and loaded for this year in terms of orders just in terms of our backlog. So we’re not expecting much to change there. The question will be 2024. Is that – does that roll over? Or does it – is there a significant change to that. We don’t have great visibility into that yet and wouldn’t be in a position to provide that guidance.

On the telecom side, as we talked in the last call, and we mentioned in our prepared remarks this morning, our large national telecom customers, that demand tends to be – we’ve referred to it sometimes in the past is lumpy. I think we used the term on even this morning. But from quarter-to-quarter, it can accelerate and decelerate quite quickly, which would seem surprising, but I think because they – the way they manage projects and certain things can come and go in terms of their CapEx spending capabilities, it can be turned on very quickly and turned off very quickly. And so we’ve seen some of that kind of manifest itself here and was expected in the second half of the year. So nothing unexpected there, but I think the long-term setup when we talk to all the telecom customers is we’re in kind of a multiyear up cycle for telecom spending.

We think just near term kind of unevenness in the way that CapEx is going to be deployed. But they have a lot of hardening to do with their networks here yet over the next several years. So we think that’s a run that’s going to be – it’s going to continue. And then I would tell you that within our core C&I products domestically and globally, in particular, where our products are now being deployed for what we refer to as beyond standby applications. So a generator could be used to be called upon at times of stress for the grid, right? So you’ve got very high temperature extremes or low temperature extremes or other points in the curve where the grid is under duress, the generator can be called into action by perhaps a local utility or grid operator and can – that power then can be flowed into the grid for support.

And that is – those products are becoming much more popular. In fact, we’ve had a really good run there. We think we’re in the early innings of the use of these products. And really, what it is, is it allows customers who would otherwise be looking at a generator strictly from a – when you look at it from an economic standpoint, it’s about risk mitigation, either loss of revenue, loss of inventory, loss of process, something like that. You have to weigh that against the initial capital cost of the equipment and the ongoing maintenance of the equipment over its life. You can now essentially buy down that first piece cost, which has always been a barrier to ownership for the category by allowing for that product to be used in these beyond standby applications, and thereby monetizing that asset in a way that didn’t exist previously.

So we think that as the grid continues to transition, that these assets that we’re formerly stranded basically, right? They were not connected to the grid necessarily only connected to – for emergency backup purposes for a property that they can be monetized in a way they couldn’t before. And that’s I think, an exciting opportunity for us, and we’re seeing more of that manifest itself here in the C&I markets.

Operator: And your next question comes from the line of George Gianarikas with Canaccord Genuity. Your line is now open.

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

Aaron Jagdfeld: Yes. Thanks for the question, George. Actually, we do have – when we talk about price, you probably need to talk about net price, but the promotion dollars end up down in kind of operating expense in some cases. So – it’s not really just from an accounting – a technical accounting standpoint, it’s not always price. But we are using more promotion than we used maybe a year ago, certainly more than two years or three years ago.

York Ragen: And that’s included in our guidance.

Aaron Jagdfeld: And that is included in the guidance. So I think to maybe put a finer point on it, those teams that we’ve unleashed here on our unclosed IHC file continue to work on different types of promotional activities. We’re doing a lot of testing around what works, what doesn’t work. We’ve run some national promos. We ran one earlier this year, and we’ll have one on our schedule here at some point later this year. So that’s – those things are certainly included in the guidance. There’s a question, of course, do we need to do more? I think at this point, we believe we’ve got the right level in there to support the close rates that we’ve built into the most recent guidance. At some level, you just – you can’t promote perhaps to your way to a consumer that if the consumer is going to be stubborn and it’s going to be painful for them to spend because they’re concerned about, obviously, a lot of things around inflation around their employment status.

I mean there’s so many things that go into that. that make up why and when a consumer feels confident to do that. Certainly, power outages and historically for us, softer consumer environments, we generally have been able to break away from when you get outages. And so that still exists here as an opportunity. Our guidance contemplates kind of a normal outage environment. And we have been experiencing kind of above normal outage activity here through – at least through the – late in the second quarter, we saw that tick up and actually July in and of itself has been somewhat active as well. So continue to watch that and see what impact that will have on close rates. But we do have a level of promotion in our guidance around trying to improve close rates for the balance of the year.

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

Donovan Schafer: Hey guys. Thanks for taking the questions. So I want to talk about chore and portables. So chore usually doesn’t get much attention, but this quarter, you guys actually called it out in a high level. Well, of course, some pack up, of course, that was the main driver. But do you think these smaller pieces can unfold in ways that kind of nudge things. I remember, I think, with the polar vortex in Texas. At the time, I think a lot of folks thought that’s great news, but you won’t be in that quarter, because you were supply constrained. You considering that manufacturing HSV, but you did end up beating and it came down to the portables, because you had that ready and so these can add up in ways that matter.

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

But with Mean Green Mowers and the other clean energy chore products you have in this California lot going into effect, is that something where you see jumping to a 10%, 20% growth or a 2x, 3x over a number of years? Kind of a broader magnitude there. And then same thing on portables because you’ve launched a portable battery product a larger portable generator and a dual fuel generator, which those are all significant feature additions in those product categories. So anything on kind of the next year or so growth rate you would expect around those approximately?

Aaron Jagdfeld: Yes. Yes. Thanks, Donovan. So obviously, the regulatory environment continues to change, an outright ban on small engines in California, you’re spot on with that. California is pushing ahead with that. I think that like all kind of regulatory actions, sometimes there are unintended consequences of that, whether they be – maybe advanced purchases, maybe pull in of demand around that. We’re not seeing anything today for people who are loading up on, kind of internal combustion engine driven chore or generator products. Just to be clear, by the way, it’s – it would only impact this – the portable generators and chore products, home standby is not a part of that ban at this point. So just to be clear and you’re right, it’s a smaller part of our business.

I mean, we did call out chore this time because frankly, they had a terrible second quarter and terrible first half. Very much in line with the residential portions of many of the other public companies that serve that market. I will say, it’s part of our strategy there that the strategy behind the Mean Green acquisition is those are electrified zero turn radius commercial mowing piece of equipment. And we have seen a dramatic rise in interest around those products but they’re expensive. And so conversion is more difficult. Now, the IRA that Inflation Reduction Act has provided for some subsidy for those products. And we have – we expect that will be clarified through treasury year over the back half of this year which will certainly help.

We are the leader in that commercial segment when it comes to electrified commercial mowers. And that is going to be an exciting part of the business to watch. And we’re electrifying the rest of our chore products platform using the technology that we acquired with Mean Green as again, part of what we’re the brush cutting platforms and things that are so important to us there in chore products are being electrified as well. So we think we’ll be prepared as these bans take place. The one in California, certainly as you said, end of this year and we’ll have to see how it plays out. California also has on top of the federal subsidies, some state level subsidies for the purchase of those types of products to incentivize the switch from internal combustion engine driven products to electrified products.

So we’ll continue to watch that portable generators different type of category, right? And this is where I think the unintended consequences of regulation, which if you have a multi-day outage, you’re just – you can’t buy a battery to get you through that, sorry, to California regulators. They’re not thinking that through. They should have left open products that are used for emergency use. And in their infinite wisdom, they probably will create waivers when they run into problems like they’ve done in the past for other areas of the market. They have these strict regulations and then they waive them when there are emergencies. And I wouldn’t be surprised to see the same happen here. There’s – generating power is different than storing power.

That’s all there is to it. That said, we do have storage products, portable storage products that we’re introducing in the marketplace that are good for temporary short duration outages – outage protection but they also are expensive relative to the cost of internal combustion engine driven generators, which again, for emergency use, like those products are used primarily those that is the most cost effective way to serve the market. And unfortunately, those types of regulations only hurt the part of the market that it has less flexibility with their pocketbook and their checkbook around buying a product during an emergency. So that’s unfortunate and hopefully regulators will use their heads and clear heads of prevail there if emergencies do present as we believe will be the case long term here, as the grid in particular in California goes through a transition.

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

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

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

So the ability to consolidate purchases on engine platforms, some of the alternator platforms, and obviously the ability to use our Deep Sea controls across our global platforms and get the gain the benefit of scale there as well. That said, that market internationally, as I said, is primarily C&I, and it’s primarily diesel. So diesel powered generators are still at least outside the U.S. and Canada, the primary kind of legacy solution for emergency backup. And those products, in fact, I would say like in the U.S., natural gas backup power represents for C&I anyway, about 40% of the market here with about 60% diesel. Outside the U.S. and Canada, it’s more like 98% diesel, 2% gas. So the opportunity that exists is to introduce gas products, of which we’re the leader globally in, introduce those gas products into new regions and into the hands of new customers that we believe could benefit from connecting those products to natural gas pipelines as opposed to reliant on diesel refueling.

There are benefits there far beyond just the continuity of fuel supply but also the emissions profile of those products and gas is tends to be cleaner than that of diesel, and so you see some real benefits there. You see customers who are now focused more on that. Regionally, we’ve really focused here, I would say in the last few years on India in particular, through an acquisition of a company called Captiva. Pramac acquired Captiva several years ago, and we continued to invest heavily in that market, and we’re seeing very nice growth albeit off of a small base, but very nice growth there. That’s an area that we’re going to continue to focus on. I think we mentioned Australia, another great opportunity for us. The Middle East has been a great market in terms of growth.

On the home standby side, if you look at residential sales, we actually have an interesting level of HSB that we’re shipping into all parts of the world, which is really interesting. You see this in our activation data; we can see exactly where products are being installed and it’s just overshadowed by two things: one, by the size of the HSP business here in North America; but two, the growth rates of C&I internationally have just kind of been so good. You just, we haven’t talked a lot about the kind of growing HSB base that’s underneath all of that; but it is growing. We’ve introduced – we just introduced a product and HSB product in India, and that is getting some nice traction already. We’re continuing to introduce those products.

Again, we’ve now got products that are compliant with very strict gas codes in Australia. And so we’re really kind of – when we say we’re the only kind of company that serves Australia, that’s true because the gas codes are very strict there. None of our competitors are able to meet the strict code requirements in Australia, and we see that as a wide open market and opportunities for good growth. And then the Latin American markets, which represent a, we believe a really good opportunity for us getting good penetration in places like Argentina, even places like Brazil, where we’re seeing the product really get – start to get the awareness levels start to increase. That’s really what we have to focus on. We’re kind of back to the early days of HSB back in North America, if you wind the clock back.

So we got a lot of work to do, but we are seeing pockets of that. I don’t think it will be anything that will kind of contribute meaningfully to our international segment results here in the near-term. But longer term, we believe the gas product, gas C&I products and HSB products, we see higher growth rates for those products than we do for the traditional C&I products.

Operator: [Operator Instructions] And your next question comes from the line of Stephen Gengaro with Stifel. Your line is now open.

Stephen Gengaro: Thanks and good morning everybody.

Aaron Jagdfeld: Good morning.

Stephen Gengaro: Thanks for taking the question. So just one for me, the – when we look at the inventory, the HSB inventories that that everybody’s been talking about. Is there any detail you can give us on sort of location of inventory relative to recent power outages?

Aaron Jagdfeld: Yes. I mean we haven’t – we haven’t talked about field inventories at that level of granularity. But I think I may have mentioned in my response to a previous question that we are seeing evidence where there are regions, certainly pockets locally where field inventories are at normal levels or frankly, are quite a bit below what we might say would be normal because of elevated activity. So Canada has been a really interesting market here as of late with a lot of outage activity. And we see field inventories in Canada quite low versus other areas of the country. We see some other areas of the country particularly like the Midwest, is another area. Michigan is just a state that continues to get pummeled by both summer weather and winter weather.

And this is – the interesting thing is, I think there’s a misconception somehow that our best home standby markets are in Gulf Coast states or areas where you’re more prone to hurricanes. And that, of course those kinds of demand drivers, of course are important for the category, but actually where we see greatest kind of penetration rates and growth rates are in those states that have kind of two seasons of weather, both winter and summer have other kind of factors that play into an elevated level of outages, and Michigan is just one of those areas. I’d say it has a lot of outages caused by different extremities of weather, but also the grid is mainly above ground in Michigan. It’s older. It was built around the automotive industry, so it was built out over 100 years ago.

It’s underinvested in, in a more significant way than in other areas because it’s much more fragmented. There are many more independent grid operators in the state of Michigan than you would imagine. And so the grid doesn’t kind of heal itself well when you do run it outages and there’s a lot of trees in Michigan. So trees are part of the equation with outages. So we put all of that together and some of the states that we see the best growth and the best penetration are in states like Michigan, states like Maine. We see Ohio, Pennsylvania, those types of areas are actually very strong in the context of our growth rate. So again, as you would expect, where we’re seeing stronger rates of growth those are the areas that are getting to normalization of field inventory quicker.

And that’s – again, without providing more detail, that’s how I would give you some context around the question.

Operator: [Operator Instructions] And the next question comes from the line of Blake Keating with William Blair. Your line is now open.

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

Aaron Jagdfeld: Yes. Thanks Blake. We have seen the demographic over time as the category has grown. The category used to skew much older when you kind of wind the clock back. And over time, as it’s broadened out, we have seen the average age of buyers come down, but it still indexes to an older demographic people who have – and home ownership tends to skew that direction as well. And yes, they may, in fact, be somewhat more resilient if you will, to changes in the economy, but I think nonetheless they also – inflation does impact people that are on a fixed income, perhaps even more. Like you can make an argument that perhaps a portion of that segment is maybe a little more vulnerable to certainly trends in inflation. We haven’t seen – yes I wouldn’t say like from this point last year to this year, we haven’t seen any major shift in the demographic underpinning kind of the buyers of the category at this point.

We’ll continue to watch that as the – as time goes on here, certainly this year and into the future. But I think right now, what we’re just – what we’re seeing is that more broadly, the consumer spending environment around home improvement is softening, right? And I think that we’re getting a little bit caught up in that. And that’s what I think is impacting. Again, close rates aren’t dropping. I think that’s an important point here. They’re just not growing back to the levels that we saw pre-pandemic. We do think they’ll get back there eventually, but they’ve kind of flattened out here. So I think the challenge is that we thought they would continue to grow, and that’s the – perhaps the new piece of information this morning.

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

Keith Housum: Good morning guys. I know we’re running long so us keeps the one question here. Just in terms of the Clean Energy solution set in the redesign of the product portfolio going into 2024. If you guys just provide an update on if you guys are up to date on that or on track? And then some of the challenges that, that segment is facing right now in terms of cropping demand.

Aaron Jagdfeld: Yes. Thanks. It was – that category of product for us, well documented. We entered that market, had some struggles. We had a lot of growth. We had a lot of success early on, hit kind of our challenges with the loss of a major customer last Q3 and then some of the product quality challenges with the SnapRS device is really the product that we talked about here. We are going through our – we’re on a next-generation road map for our battery solutions. – our storage solutions. I’m very excited about that product. We’re going to talk more about that in our upcoming Investor Day. We’re going to talk about some of those products. We won’t be able to get too granular there because we don’t want to tip our hat maybe to some of our competitors in the market, but we have some really exciting things.

We’ve been – as we said on the call kind of in the prepared remarks, we’re investing very heavily to 400 basis point drag on EBITDA margin right now, which is challenging, of course, especially as the residential business is going through a cycle here that becomes even more challenging to stomach. But we’re very excited about the future of those products. The market, in general, as you’re indicating, and as we’ve seen from other participants in the market is a tougher market right now than it has been. Again, higher interest rates being probably at the root cause of that and then maybe more recently, the NEM 3.0 decision in California specifically, those two things are weighing on kind of solar and storage, solar plus storage demand here and are reflected kind of in our updated guidance this morning, we have been targeting a $300 million to $350 million range for those – that portfolio of products for the year.

We now are thinking we’re going to come in on the low end of that range. Primarily because of the softening dynamics, demand dynamics that are going on that we’re seeing in the industry. But we still are very optimistic long term, and that’s why we’re spending heavily against this opportunity. We think that we know that it’s going to take a different level of investment to become proficient and excellent in these products. We now know that after going through our experience. And we are dedicated to doing that. And we’re going to see those results. You should see some of those products, as we’ll talk in September, really going to start hitting in 2024, and we’re pretty excited about the future there without getting too specific.

Operator: And your next question comes from the line of Vikram Bagri from Citigroup. Your line is now open.

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

York Ragen: This is York. Yes. No, the promotions that we’re talking about, again, we run promotion in the ordinary course when we’re not in backlog and just again to drive awareness of the category and help get homeowners over the tipping point to make – to go ahead and make the purchase of a home standby generator. So I wouldn’t say it’s – I would say it’s a modest impact to margins overall. Again, these are our highest margin products. So you sort of – as you sell more of these products, you mix you get a significant mix benefit, which sort of overshadow whatever promotion we may be offering. So I think that’s the key there. And what promotion we do have layered into the guidance is not a significant part of the story or a significant impact to our margins.

I think when you think about the cadence of EBITDA margins over – from first half to second half, I think just mixing – getting a higher level of home standby shipments out the door, that will have a significant impact. The additional operating leverage on our fixed SG&A will have a big impact. And then we’re just going to continue to realize improved input costs as we sort of work through our inventory levels, and we’ll start seeing the realization of lower commodities and logistics costs and so – that’s really what’s going to drive the sequential improvement in EBITDA margins for first half, second half. And promotions will only have a slight drag relative to that performance.

Operator: And we have no further questions at this time. I will now turn the call back over to Mike Harris.

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

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