Generac Holdings Inc (GNRC) 2015 Q1 法說會逐字稿

Good day ladies and gentlemen and welcome to the Generac Holdings 2015 first-quarter earnings conference call.

My name is Adrian and I will be your operator today.

(Operator Instructions).

As a reminder, this call is being recorded for replay purposes.

I would now like to turn the call over to York Ragen, Chief Financial Officer.

Please proceed sir.

Thank you.

Good morning and welcome to our first-quarter earnings call.

I would like to thank everyone for joining us this morning.

With me today is Aaron Jagdfeld, our President and Chief Executive 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 our 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 US GAAP measures, is available in our earnings release and SEC filings.

I will now turn the call over to Aaron.

Thanks York.

Good morning, everyone, and thank you for joining us today.

Net sales in the first quarter of 2015 were $312 million as compared to $342 million in the prior year, primarily due to a decline in shipments of commercial and industrial products and, to a lesser extent, sales of residential products.

C&I product sales were impacted by a decline in shipments to telecom national account customers and softness in oil and gas related capital investment.

Residential products sales were impacted primarily due to a decline in power outage severity compared to the prior year, which reduced shipments of portable generators along with harsh winter weather that slowed installations of home standby generators, in particular in the key Northeast region of the US.

However, despite the adverse market conditions, shipments of home standby generators were approximately flat when compared to the prior year and product activations actually remained above prior-year levels in every other region outside the Northeast.

We believe the conditions that contributed to the softer demand environment in the first quarter were mainly temporary in nature and we are confident that the long-term growth drivers for our business remain firmly in place.

The power outage severity environment experienced during the first quarter continued to be well below normal baseline levels and was down significantly relative to the first quarter of 2014.

In fact, the outage environment in the first quarter of 2015 was the lowest we've observed in the more than five years that we've been tracking outages on a detailed basis.

Over the course of our long history in this business, we've observed that power outages activity runs in cycles.

As we have said previously, we believe that growth in the home standby category occurs in a step function manner but the penetration rate for the category accelerating during periods following major outage events and slowing again as the impact of those major outages subsides.

Each successive step that the category takes is representative of a new and higher baseline rate of demand resulting from increased awareness and expanded distribution.

We believe that the recent performance of the category clearly demonstrates that this pattern continues to play out as the penetration rate of home standby generators grew rapidly following the major outage events that occurred in the second half of 2011 and 2012 and we have been able to hold that new and higher level of demand despite a meaningfully lower power outage environment over the last two years.

For some added historical perspective, shipments of home standby generators in the first quarter of 2015 were more than double compared to the first quarter of 2011, which was essentially the prior first-quarter baseline before the multiple major outage events that occurred.

The resiliency of home standby generators in the current backdrop of such a challenging power outage environment gives us continued confidence in the future growth prospects for this product category when outage activity eventually reverts back to normal levels.

We believe holding this baseline level of demand for home standby generators during the current year first quarter is further proof that our initiatives are helping to increase the awareness of the product category, including our innovative sales and marketing techniques put in place over the past several years.

These efforts are highlighted by our four step system to identify and qualify sales leads and improve the sales closure rate for home standby generators, including our A.M.P.

targeted marketing process, our increased use of media spending, the qualification of incoming leads, and the use of our PowerPlay in-home selling solution by our dealers to close sales.

We have continuously refined and improved our sales and marketing methods over the past two years and we are seeing favorable trends on a number of metrics involving PowerPlay, including the number of dealers using this in-home selling solution, the scheduling of in-home consultations, or IHCs as we refer to them, and the number of dealers participating in training programs designed to improve sales closure rates.

We are also working on some important initiatives during 2015 to further increase sales leads and improve closure rates for home standby generators.

In addition, we continue to drive participation in our PowerPro dealer program to further align our industry-leading dealer network with the factory.

The power per designation is the most comprehensive program available to dealers who need a stringent set of requirements, ensuring that our customers receive a best-in-class sales and service experience when purchasing Generac products.

From a longer-term perspective, we continue to expect the trend of an increasing level of power outages to remain in place driven by an aging and underinvested electrical grid and the frequency of severe weather that we believe will continue well into the future.

With only approximately 3.5% of US households owning a stationary backup generator, we believe there remains substantial opportunity to grow this market over the longer-term.

Turning to the commercial and industrial portion of our business, as we expected entering 2015, a significant decline in energy prices experienced since mid-2014 is having a notable impact on demand for mobile equipment that is primarily used in upstream oil and gas applications.

Although the steep drop in energy prices has reduced equipment spending in the near term, we believe investment related to exploration and drilling activities will be impacted more negatively than spending associated with production activities, which is where our products are generally used.

In addition, more strict regulations limiting the flaring of natural gas is expected to continue to be a catalyst for increased demand for natural gas generators at these production sites.

The waste gas now required to be captured or consumed can essentially serve as a free fuel source, leading to a very attractive ROI and payback period for these generators.

With the low level of energy prices seen during the past several months, E&P companies are under intense pressure to reduce their operating costs and we are seeing signs in the marketplace that this is leading to additional awareness and resulting substitution of natural gas generators in lieu of diesel generators within oil and gas applications.

As a leader in natural gas generators, we believe we are in a strong position to capitalize on this opportunity.

However, we continue to take a more conservative approach to our outlook for this end market for the remainder of 2015 as we gain further clarity on the impact of lower energy prices on the demand for capital equipment.

We commented during our prior call in February that we expect the telecom capital spending environment to remain subdued throughout 2015, particularly during the first half of the year.

Capital spending patterns of telecom national account customers are generally somewhat cyclical and as we have commented many times in previous calls, it can be difficult to predict the timing of spending which can vary from quarter to quarter and year to year.

However, we believe the long-term secular penetration opportunity for backup generators at cell towers remains firmly in place due to the need for wireless providers to protect their revenue streams as well as the increasing competitive and regulatory pressures they face to harden their networks.

At only 30% to 35% penetration of generators on cell tower sites, we believe there is a significant runway to continue to penetrate this sector as the leader in this end market.

Our Ottomotores (technical difficulty) Latin American market through operations in Mexico and Brazil experienced solid growth in shipments during the first quarter of 2015, which follows a similar level of year-over-year growth experienced during the fourth quarter of last year.

Although we believe the general economic environment in Latin America has stabilized in recent quarters, the improved performance at Ottomotores is more attributable to the tangible progress we have made with our integration efforts and other actions we have taken over the past year.

This includes the change in leadership made during the second half of 2014, the recent realignment of our Latin American commercial sales team, operational improvements, and the realization of several cross-selling revenue synergies.

Despite projections for modest overall economic growth in the Latin American region in 2015, we believe Ottomotores will continue to benefit from an increase in larger project bid activity driven by improving infrastructure spending as well as continued execution on strategic initiatives.

The Ottomotores acquisition remains an essential platform for our international expansion efforts by providing a local manufacturing presence and access to the important Latin American market for power generation and other engine powered equipment.

Lastly, we have commented over the past several quarters on the progress we made during 2014 in building out and expanding our capabilities for large industrial generators.

This includes the consolidation of our manufacturing footprint for larger output products into the Baldor acquired facility in Oshkosh, Wisconsin, and our focus on increasing our distribution partners' product knowledge and sales bandwidth to better enable them to sell these larger generators and systems.

We also have a number of new initiatives that are underway in 2015 focused on the continued optimization of our industrial dealer network as well as various projects to improve our specification and closure rates that we believe will provide greater opportunities for growth in this market.

Additionally, our 2015 outlook for C&I products includes the expectation of an improving and more favorable nonresidential construction environment that should provide more sales opportunities for our distribution partners to increase their interaction with the engineering firms and electrical contractors responsible for specifying and selecting our products.

I would now like to turn the call back over to York to discuss the first-quarter results in more detail.

York?

Thanks Aaron.

Net sales for the first quarter of 2015 were $311.8 million as compared to $342 million in the first quarter of 2014.

Looking at net sales by product class, residential product sales during the first quarter of 2015 were $156.8 million as compared to $164 million in the prior-year quarter.

The decrease was primarily driven by a decline in portable generator sales as a result of a power outage severity environment that remained well below normalized and prior-year levels.

Shipments of home standby generators were approximately flat versus prior year despite the low outage environment and harsh winter conditions in certain key parts of the United States.

Partially offsetting the overall decline in residential products was a modest contribution from the Pramac acquisition.

Looking at our commercial and industrial products, net sales were $133.8 million in the first quarter of 2015 as compared to $157.4 million in the prior-year first quarter.

The decline over the prior year was primarily the result of an ongoing weakness in capital spending by certain of our telecom national account customers.

In the prior-year first quarter, shipments to these telecom customers were significant as they invested heavily in hardening their wireless networks with backup power.

Starting in the second half of 2014, we experienced a sharp decline in demand from certain key customers as they deferred capital spending on these projects.

And this has continued into the first quarter of 2015.

To a lesser extent, we also saw reduced sales of mobile equipment going into oil and gas markets given the rapid decline in energy prices.

Partially offsetting the weakness in telecom and oil and gas end markets were contributions from the MAC acquisition as well as growth in Latin America shipments, which increased at a solid rate over the prior year.

Net sales for the other products category were $21.2 million in the first quarter of 2015 as compared to $20.7 million in the prior year.

This modest increase was primarily driven by the addition of aftermarket parts sales from recent acquisitions.

Gross margin for the first quarter was 32.9% compared to 34.9% in the prior-year first quarter.

Temporary increases in certain product overhead related costs along with recent acquisitions were partially offset by a more favorable mix of residential products in the quarter.

As mentioned in our previous earnings call, we continue to experience incremental costs associated with the West Coast port congestion, unfavorable absorption of manufacturing overhead related costs due to lower volumes, and mark-to-market adjustments on copper forward contracts.

Once again, we expect most of these costs to be temporary in nature and to moderate beginning in the second quarter of 2015 and into the second half of 2015.

Operating expenses for the first quarter of 2015 increased $3.5 million, or 6.4%, as compared to the first quarter of 2014.

An increase in marketing and advertising expenses and the addition of recurring operating expenses associated with recent acquisitions were the primary drivers for this increase.

Overall continued improvements in warranty rates helped to partially offset these OpEx increases.

Adjusted EBITDA was $57.1 million, or 18.3% of net sales, in the first quarter of 2015 as compared to $77.5 million, or 22.7% of net sales, in the same period last year.

This decline in adjusted EBITDA margins compared to prior year was attributable to the 200 basis point decline in gross margins combined with the 250 basis point increase in operating expenses as a percentage of net sales as a result of the factors just discussed.

Adjusted EBITDA over the last 12 months was $316.9 million.

GAAP net income for the first quarter of 2015 was $19.7 million as compared to $34.7 million for the first quarter of 2014.

GAAP income taxes during the first quarter were $11 million, or a 35.9% effective tax rate, as compared to $19.5 million, or a 36% rate, for the prior year.

Adjusted net income as defined in our earnings release was $34.1 million in the current-year quarter versus $50.7 million in the prior year.

This decline over the prior year is the result of the overall decline in operating earnings, as previously discussed, partially offset by $4.8 million in lower cash income taxes.

Diluted net income per share on a GAAP basis was $0.28 in the first quarter of 2013 compared to $0.50 per share in the first quarter of 2014.

Adjusted diluted net income per share as reconciled in our earnings release was $0.49 for the current-year quarter compared to $0.72 per share in the prior year.

With regards to cash income taxes, the first quarter of 2014 includes the impact of a cash income tax expense of $5.1 million as compared to $9.9 million in the prior-year quarter.

This year-over-year decline in cash income taxes for the quarter was primarily the result of lower pretax earnings along with a reduction in the expected cash income tax rate relative to the prior year.

Relative to our previous guidance, our cash income tax rate for full-year 2015 is now expected to be approximately 17% versus the previous expectation of approximately 18% primarily due to the reduced full-year outlook that we are reporting this morning.

As a reminder, our favorable tax shield through annual intangible amortization in our tax return results in our expected cash income tax rate being significantly lower than our currently projected GAAP income tax rate of 36% for 2015.

As we drive profitability over time, cash income taxes can be estimated by applying a projected longer-term GAAP income tax rate of approximately 36% on pretax profits going forward and then deducting the approximately $49 million of annual cash tax savings from the tax shield each year through 2021.

Free cash flow, defined as net cash provided by operating activities less capital expenditures, was $18.7 million in the first quarter of 2015 as compared to $31.4 million in the same period last year.

The year-over-year decline was primarily the result of a decline in operating earnings during the current-year quarter partially offset by a reduction in working capital use of cash as compared to the prior year.

Free cash flow over the last 12 months was $205.6 million.

As we mentioned in our earnings release this morning, we made a prepayment of debt during the first quarter totaling $50 million.

This voluntary payment allowed us to maintain our credit agreement leverage ratio below our target of 3 times and it can be applied against any future excess cash flow payment that are required pursuant to our term loan credit facility.

This $50 million debt prepayment resulted in the recording of a $1.4 million loss on extinguishment of debt, which is included within the other income expense section on income statement.

Updating our interest expense guidance as a result of this debt prepayment, we now expect total interest expense to be in the range of $45 million to $46 million, which includes $38 million to $39 million of cash outflow for debt service costs plus approximately $7 million of deferred financing costs and original issue discount amortization for our credit facility.

This interest expense guidance assumes no additional debt prepayments during 2015, our existing interest rate swap contracts remain in place, and that LIBOR rates do not increase beyond our current LIBOR floor of 75 basis points.

As of March 31, 2015, we had a total of $1.04 billion of outstanding debt net of unamortized original issue discount and $150.1 million of consolidated cash and cash equivalents on hand, resulting in consolidated net debt of $887.1 million.

Our consolidated net debt to LTM adjusted EBITDA leverage ratio at the end of the first quarter of 2015 was 2.8 times.

Additionally, at the end of the first quarter of 2015, there was approximately $150 million available on our ABL revolving credit facility.

With that, I would now like to turn the call back over to Aaron to provide additional comments on our revised outlook for 2015.

Thanks, York.

As a result of current end market conditions, we are revising our prior guidance this morning for full-year 2015 for revenue growth and adjusted EBITDA margins.

Net sales for 2015 are now expected to be approximately flat for the full year as compared to the previous expectation for net sales to increase in the low to mid-single-digit range.

This revised topline guidance is primarily the result of a power outage severity environment that we now expect will remain below normal during the entire first half of the year with the assumption of a return to more normalized baseline levels of outage activity during the second half of 2015.

As a result of the change in power outage assumption, we are reducing our forecast for residential product shipments in the first half of the year.

Our previous guidance assumed a normalized power outage environment for all of 2015.

Importantly, this topline outlook continues to assume no material changes in the current macroeconomic environment and no major power outage events occurring during the remainder of 2015.

With regards to seasonality of net sales, we now expect the first half of the year to represent approximately 43% of total sales and the second half approximately 57%.

The expectation of net sales to be weighted notably more toward the second half of the year is primarily due to the normal seasonality typically experienced with residential products and is being further magnified by the assumption of a normal power outage environment in the second half relative to below normal in the first half.

In addition, net sales for C&I products for 2015 are also expected to be weighted more towards the second half of the year across several of our channels and end markets, including industrial dealers, oil and gas and Latin America.

Looking at our guidance by product class, for residential products, we now expect net sales for 2015 to increase in the low to mid-single-digit range as compared to the prior year.

This represents a decline from our previous expectation of an increase in the mid to high single-digit range during 2015 which is the result of a reduced power outage expectation for the first half of the year.

With regards to C&I products for 2015, we expect net sales to decline in the low to mid-single-digit range as compared to the prior year on an as reported basis.

Strong headwinds in the oil and gas and telecom markets together with a modest foreign currency impact are expected to be partially offset by gains in our industrial distribution channel, improvements in Latin America, and contributions from the MAC acquisition.

Gross margins for 2015 are now expected to improve approximately 75 to 100 basis points over the prior year as compared to the previous expectation to improve by approximately 150 to 175 basis points.

The revision from prior guidance is primarily the result of reduced expectations for the first half of the year from a lower mix of residential products due to the change in power outage assumption previously discussed, and, to a lesser degree, more unfavorable manufacturing overhead absorption due to lower sales outlook.

Operating expenses as a percentage of net sales, excluding amortization of intangibles, are still expected to increase approximately 75 to 100 basis points as compared to the prior year.

We're holding this guidance despite a lower sales outlook through focused efforts to control spending in a variety of selling, general, and administrative costs.

As a result of the updated outlook for net sales, gross margins, and operating expenses, we were revising our adjusted EBITDA margin guidance for full-year 2015.

Adjusted EBITDA dollars are now expected to be approximately flat as compared to the prior year, resulting in margins of approximately 23% for the full year.

This compares to our previous margin expectation of 23.5% to 24%.

With regards to the seasonality of adjusted EBITDA margins during 2015, we now expect second-half margins to be between 675 and 700 basis points higher than the first half.

This expectation is primarily the result of net sales to be weighted notably more towards the second half of the year, as previously discussed, which is expected to result in more favorable product mix and better SG&A leverage on higher sales volumes.

We also anticipate an increasing benefit in product cost reductions during the second half, through an improvement in manufacturing overhead absorption and the realization of more favorable commodity prices and foreign currency exchange rates.

We expect that we will continue to generate strong free cash flow in 2015, given our superior margin profile, low cost of debt, favorable tax attributes, and capital-efficient operating model.

Due to revised seasonality of net sales and EBITDA margins previously discussed, free cash flow is also expected to be notably more weighted towards the second half of the year.

In closing this morning, although certain of our end markets are performing below our expectations, we remain focused on the numerous compelling secular growth opportunities for our products.

We have become a more diversified company in recent years with a strong balance sheet and the capability to generate significant free cash flow, providing us with the flexibility to drive our strategic initiatives.

In addition, we are confident in our ability to continue to invest in the future growth of the business, both organically and through acquisitions, as we further implement our Powering Ahead strategic plan.

This concludes our prepared remarks.

And, at this time, we would like to open up the call for questions.

Operator?

(Operator Instructions) Charley Brady, BMO Capital Markets.

On the gross margin, you called out a couple items [kept for] four specific parts.

I wonder if you could break out the impact, particularly on the port strike impact and the mark-to-market, which are presumably really transitory relative to the other two.

This is York, Charlie.

It's relative to gross margins, so was about 200 basis points off prior year, actually about 200 basis points off from expectation.

And if you'd parse off the pieces of that, about one-third of that was mix-related on the lower home standby mix relative to expectation.

There's -- probably about one-third of that was price in that given the softer demand environment.

Price had a slight impact there relative to expectation.

And then the last third is cost, and those are the pieces that you're talking about, the West Coast port, the copper mark-to-market; there was unfavorable overhead absorption as well, that came through, which, as we highlighted, are more temporary in nature.

So about one-third of that 200 basis points are more things that are temporary that would -- as we talked about, would moderate in Q2, and then in the second half of the year really become neutral factors.

It's just on the comment on the pricing impact, is that -- have you been seeing price pressure for some time?

Is that a new phenomenon?

Do you expect that to continue as you go through 2015, or is there a recovery you expect?

Hey Charley, this is Aaron.

From a pricing standpoint, that was versus our expectation, pricing was a bit of a headwind given the amount of additional promotion and things that we had to do to drive the market.

When you come off of a year -- and we see this is a pattern coming off of years without major events.

And it was exacerbated in the first quarter by -- in our prepared remarks, we said it was the lowest outage environment we had seen in the five years since we've been tracking detailed outages.

When you have environments like that, you are forced to drive the market harder with promotion and with other activities that end up getting characterized as price in terms of the characterization of the financials.

So those things are things that we would expect to not see as dramatically, obviously, if you were to get into an environment like what we're saying is going to happen in the back half of the year, with a more normalized type of power outage environment.

So it's really kind of related to the very low outage environment not -- coming off the year without any major events.

And to be clear, Charley, year-over-year price was not an impact because we had the same dynamic last year.

That's a good point.

It was a very similar dynamic.

My count was relative to expectation, but year-over-year there wasn't an impact on price.

All right, thanks for clearing that up.

And just one more -- on the portable side, can you talk to the inventory levels right now in the channel on portables?

And at what point does that -- assuming no other outages, major outages -- at what point does that kind of level out to where you are not seeing a headwind on that going forward?

Yes, the portable inventory is elevated right now.

It's both at channel and within our own warehouses.

We plan that inventory build and buy seasonally.

So we buy ahead of the season last year; we didn't get a season.

So then you typically would sell off at a normalized everyday rate.

Well, that everyday rate has also been lower than we would expect because of the low power outage environment to the normal levels.

So to answer your question directly in terms of burning it off, it's going to be longer than what we would have normally planned.

We would normally plan a season to be able to burn that product off over the next 6 to 9 months if we didn't get an event.

So that would be the normal plan.

Because we've been below normal in terms of regular everyday outages, that 6 to 9 months is probably going to fall more to the nine months or even carry us into the next season here.

So we would expect our build rates -- and it's somewhat what we're talking about here with some of the lower absorption, the overhead absorption that we're dealing with -- our build rates and our purchases of product will be lower going into the season because we've got plenty of product out there.

So it's going to continue to be a headwind for as long as we are below this normalized level of outage period.

But we are ready to go.

Should we get an event, we would be more than ready to be able to satisfy a pretty big spike in demand.

Great, thanks.

I'll hop back in the queue.

Thank you.

Mike Halloran, Robert W. Baird.

So Aaron, is it fair to assume that your residential expectations in the back part of the year are largely unchanged?

Did I hear that right in the comments?

That would be the right assumption, Mike.

And could you just give us a sense, if you don't see the normalized patterns materialize on the residential side, what that could mean from a growth perspective for you?

Are we just talking similar to this quarter on a couple points off of the growth expectations for the year?

Yes, I think we put a band around it, maybe 2% to 4%.

If we stayed at this kind of ultra-low level, below normalized, we could see a contraction on 2% to 4% on consolidated net sales as a result of that type of scenario.

Obviously it's not what we believe will happen, but it's been the case here for the last several quarters.

So I think -- and this is some of the difficulty in providing guidance for this business, both on a quarterly basis but also somewhat year-to-year -- as the impact of the residential business from outages which you just can't -- it's difficult to quantify both the exact impact from those outages or the exact impact when you don't get them.

So we have to go off of history.

There's a ton of variables that go in to that.

But our best guess is that you would see something on the line of 2% to 4% impact on consolidated net sales if we don't get those normal outages in the second half.

Just looking at where prior year played out.

Yes, kind of looking at prior year as our guidepost for that.

And that make sense, and that helps band of outcomes.

Appreciate that.

And then on the oil and gas side, maybe you could talk about the puts and the takes in the market.

Obviously the mobile generation with some of the rental pieces, a little bit of a headwind.

You sounded more positive on some of the flaring-related regulations and what that means for your business.

Is that tracking about how you guys thought it would track at this point?

And how are those variables tying together?

Yes.

For us, as we look at it, I think we are somewhat new to the oil and gas market through our acquisitions here over the last two years.

So we haven't seen a down cycle like this.

All we have seen is up, which I think the first thing that we saw happen, and maybe this -- I think it caught everybody by surprise -- is just the rapid deceleration there of the capital equipment spending for the people who are directly associated with E&P providers that are directly associated with that, and their rental of that equipment as well.

Now what we're seeing is a greater impact for -- on the drilling activity side, the exploration and drilling side.

And frankly most of our equipment ends up in the production side.

So where production has remained online, we haven't seen quite the pull-back yet.

But what we are seeing is where equipment has had to have been reallocated because utilization rates are low.

The equipment that was on drilling and exploration activities in the Bakken or in the Permian Basin or in some of the other shale plays is being reallocated by rental companies into other areas of the country to improve their utilization rates.

And what that's doing is it's depressing purchases of new equipment really across the board.

So we've seen a general pull-back that's very tight in the areas associated with oil and gas, but a more -- a slowing down, if you will, in the rental market in general just as that kind of equipment gets reallocated out there.

And so that part of it was an interesting thing for us to watch and go through and understand.

And then where we are bullish -- and as you pointed out, and our comments kind of reflect that -- is the substitution effect that we are seeing happening of natural gas generators for diesel gen sets.

And that was really starting to come online even before energy prices dropped last year.

There were some flaring regulations both at the state and federal level that have come online here over the last year that create a situation where the flaring in the natural gas is -- needs to be greatly reduced or eliminated altogether.

So that gas either has to be contained and put into commerce, or it's got to be consumed on-site.

And so the ability to use that fuel in a generator, which these guys are already buying thousands of gallons of diesel fuel to power these diesel generators that are on-site producing temporary power, having a gas solution and allowing them to use that fuel basically is a free fuel source, and also solve the problem somewhat of the flaring to a lesser degree of course, but helping them with that challenge.

We are seeing that shift still occurring.

And we actually think that shift has been exacerbated somewhat by the cost pressures that the industry is seeing to reduce their costs of extraction and production.

So we think that that's a favorable trend longer-term.

We like where we are positioned for that, and we think that that is something that is going to benefit us going forward.

And just to clarify, we are effectively -- we talked about this on our last earnings call -- when we initiate guidance, we're not changing our guidance relative to oil and gas here.

We are holding that.

And as we talked last earnings call, we believe that will be down -- oil and gas related shipments will be down about 20% year-over-year, so we're holding that and feeling the same as we did last quarter.

Great.

Appreciate the color, guys.

Jeffrey Hammond, KeyBanc.

So I think you mentioned no change on oil and gas.

I think you're thinking about telecom down 20 as well.

Any change there?

And anything you are hearing from any of those large customers in terms of visibility for any kind of pickup into the second half?

Yes.

Jeff, it's Aaron.

We took down the telecom just ever so slightly in the back half of the year based on the conversations we are having with the telecom providers.

The capital spending that goes on in there, it moves in cycles and we're really at the back end of those cycles oftentimes, because the sites get either built or retrofitted and then a generator is added later on.

It's interesting; some of those key customers have continued to spend money.

Other key customers have really put the brakes on hard last year.

And we saw that, and it's in our results.

And obviously we had a really difficult comp we are up against here in the first half of the year, given that that was so strong, first half of last year.

The conversation we had had with these guys, they've got some inventory from buys that they made last year, so the first half of last year, that strength.

When they hit the brakes on their capital spending projects and some of the buildout projects that they were doing last year, they ended up having generators in stock which is unusual.

So they've got to burn through that first.

So that's ,why even though I think there's some early signs that telecom capital investment may be starting to come back online here ever so slowly here, in the first half of this year, there's a bit of inventory they have to work through first.

And that's really why we tempered our enthusiasm in the back half of the year around that.

These guys -- unfortunately, we don't get a lot of visibility to their cycles, and it can be a bit frustrating for us certainly from a manufacturing standpoint.

But I think that's one of the reasons why they like us as a supplier is we are able to react quickly to their needs, both up and down.

It just can create a bit of choppiness from quarter to quarter in that sector for us.

Okay.

And then can you just talk about quoting activity and activations in home standby?

And any indications into April that you're seeing this normalization as weather normalized on activations in the Northeast?

Yes.

So this winter was again a brutal winter for installation of product and activation of product.

That being said, every region for us outside the Northeast, we actually saw activation rates improve year-over-year.

So I think it was spot-on with where the worst part of the winter was, in terms of snow and cold.

It was right in the Northeast.

And the unfortunate part is that's a really key market for us, just given the population density and the power quality in the Northeast and the awareness of the category, and everything else.

So it was probably disproportionate impact given the harshness of this winter versus maybe even last winter.

Last winter, arguably, it was cold in the Northeast, but it was actually worse in the Midwest.

We actually had a little bit better winter this year in the Midwest.

So activation rates outside of the Northeast were up everywhere in the first quarter.

We've actually seen IHCs as we refer to them -- these in-home consultations -- actually were up year-over-year in Q1, so that's a good trend for us.

We like that trend.

We do think that dealers continue to gravitate towards our PowerPlay selling system.

We are driving as much of that as we can with media spend.

There's some seasonality with that.

You don't want to spend a ton of media in the first quarter when the market is at a slower pace.

So your cost per IHC and other metrics that we watch can get away from you pretty quickly if you're not careful with that.

I think we're kind of tempering our enthusiasm for Q2, still, as we go into the quarter here.

Activations have -- while above last year's rate, I wouldn't say they have spiked as the weather has improved.

So there's usually a process there where you've got to wait for -- there's a bit of a lag.

So we will ramp up spending on our media spend and media buys coming up here into May in June, more towards the back half of this quarter.

So when you look at the front half of the quarter, I would tell you that we still see things pretty slow in April relative to residential.

And a lot of that is due to the fact that power outages have still remained very, very low in April.

A couple here recently in Texas and Louisiana, but nothing really to speak of; not much, anyway.

And so it's just been that kind of a quiet period around outages.

And that -- it's still a generator category.

And you need outages to drive interest and awareness in the product.

We can only do so much on our end.

I think we're doing a lot.

And I think we've done a lot to hold that new baseline that we created over the last couple of years.

But it's -- it gets more challenging if you don't have the kind of conditions that in the past have created outages.

Okay.

And then just two quick housekeeping items.

Can you give us a dealer count on what you did in terms of adds -- net adds, and then what the acquisition revenue was in the quarter?

I will deal with the net dealer adds.

We were flat basically from the end of the fourth quarter, so net adds and that deducts were roughly the same.

Yes, on the acquisition adds -- so we've got two acquisition -- bolt-on acquisitions that haven't annualized yet.

You have the Pramac North America acquisition which -- that's the portable generator manufacturer.

Given that our portable generator manufacturer there, they had a small contribution.

It was a negligible contribution; low, low single digits.

And then the MAC acquisition is the heater company we bought late last year.

And given they make heaters and we are off the heat season now, so for Q1, that contribution for MAC was also negligible.

So, combined, it was roughly low, low single digits.

And one of them in the resi channel, the other in the C&I channel or product category.

Okay.

Thanks, guys.

Brian Drab, William Blair.

Just wanted to talk about how you calculate the outage activity -- your baseline level of outage activity.

If you can just remind us, how far back does the data go?

And I understand you said this morning that we saw the lowest level in the last five years.

But do we know what it looks like as you go back eight years or 10 years?

I guess the point of the question is -- is there a chance that the baseline level of outage activity that we're expecting to revert to in the back half of the year -- is that the right baseline?

And I think it is.

And I know you have obviously an extensive database, but I just want to maybe ask you to remind us how you calculate that, and give us confidence that that is the right baseline.

Yes, that's great question, Brian.

And we've only been collecting detailed data since January of 2010, so it was about a five-year period.

So I unfortunately don't have eight or 10 year's statistics at this stage to give you, which obviously is challenging.

We can look at broader statistics but -- so what happens -- the way it's calculated is we look at detailed outages as best as we can track them.

And obviously over time -- over that five-year period that we've been tracking, we've improved our data-gathering methods.

So it kind of improves every quarter that goes by as we find more avenues to collect the data.

And, in fact, we believe we have one of the most comprehensive outage databases that -- it rivals anything that's out there.

It's actually -- we are pretty proud of it, and it's developed over the last five years.

Now what it does exclude -- that baseline normal -- the normal baseline we talked about excludes all major outages.

So we take out major outages.

So we are only looking at what we refer to as normalized outage activity, ex- any major events.

So we take out all major weather events and all major outage events, ice storms, hurricanes, other major power failures, come out of that number, and we create an average.

And obviously as you -- mathematically, as you add quarters to that and if those quarters, as they have been for the last nine, are very low, that brings the average down.

So what we're looking at, and what our forecast is built on in the second half of the year is based on kind of a recalibrated average, the current average, if you will, the long-term current average.

Which is arguably a bit lower that was a year ago or even two years ago.

So we think we're using the right number.

It's not an exact science.

And obviously we qualify all of these statements by saying that outages really -- where they happen is an important part of that, and that's not really reflected in the severity index.

The severity index is purely a calculation of the number of households that are impacted, multiplied by the number of hours that they were impacted for.

So that is -- it's a finite number that we calculate.

But it does not take into consideration where those outages happen.

And the reason that's important is if an outage happens in an area where -- we refer to it as an echo effect.

If you have had an outage or several outages in a particular geographic region over a short period of time, say two years; and you get another outage, a successive outage -- follow-on outage in that same region, you'll get a much bigger effect to that outage because you will have greater awareness and conceivably more distribution in that area.

So that's the unfortunate side of the outage index.

It doesn't really -- there's not really an easy way for us to do that.

Now we are starting to use some pretty decent statistical data to help us understand with each outage we track, what do we expect the impact to be?

Because we're trying to get better visibility into the residential market.

Because obviously, as you have seen from our last several quarters here, it can be a challenging market for us to get our arms around in terms of the predictability of it.

So I think we just call it like we see it, but we are learning.

It's still a relatively young market.

The data is relatively new.

We think there's a tremendous amount of upside.

We like the long-term trends, but it can be a bit choppy quarter-to-quarter, as you have seen.

Okay, thanks for going through that.

I guess just one more follow-up to that as I'm thinking about the time period over which you have been collecting the data.

You've been collecting the data for that long, but you have been involved in a business that obviously has a lot to do with -- or that the weather can have a big impact on.

So when you look back, maybe just anecdotally, or just your personal sense for what the weather was like prior to 2010, is there any reason for us to think that the -- because obviously 2014 and the beginning of 2015 was light.

Is there any reason to think that the 2010 to 2013 time period was unusually strong?

How did that period -- what is your sense for how that period compared with 2000 to 2010?

You look at 2006 to 2010, there wasn't a major landed hurricane that occurred at all.

So that was a really, really low period, as well.

And --.

Baseline, I don't really --.

Baseline, I don't know the impact, because again, we were not collecting the data.

But again, to your point, we've been in this industry -- I've got two decades of experience in this industry.

And it is a step function business.

And the step function nature comes from the fact that power outages, as we mentioned in the prepared remarks, they run in cycles.

We don't pretend to be meteorologists here, but weather tends to run in longer-term annual cycles to multi-year cycles and it's impacted by a lot of things.

We think that -- as we think about the future and we think about what's driving our longer-term confidence in backup power as a category, it's really the underinvestment in the grid.

Skip the weather outages, and the timing of those outages, and the inability -- the cycles that they go in, the fact remains that there has been a massive underinvestment in this country's power grid.

And that has not changed.

Nothing structural has changed in that.

It's just basically you've got an environment for whatever reason over the last couple of years, as you said.

We had higher than normal activity in 2011 and 2012.

And then since 2013, we've had lower than normal activity.

So it runs in ways like that.

And it's part of the -- it's really just part of the makeup of this business.

And it's part of why we tried to diversify this company as well.

And we think there's pieces of our business now today that are much less sensitive to what goes on quarter-to-quarter or even year-to-year in terms of outages.

The commercial industrial market is much more -- it's a business decision.

It's much more of a code-driven market.

The mobile equipment space is a great space.

It's really not driven by those things at all.

It's driven by other cycles like nonresidential construction spending, oil and gas, and mining, and other things like that.

We are trying to desensitize a bit the Company's -- for lack of a better term, volatility -- around the residential business that can occur.

Thanks, as usual.

It was an extremely thoughtful response.

I know that you guys are being as thoughtful as you can about it.

It's just helpful to go through that and frame it again.

And then getting more granular, just one last question.

On the West Coast, the issues that you are having with the ports there.

I think, York, you said that that is something that might carry over in the second quarter somewhat but then subside.

Can you talk about exactly what those expenses were associated with the West Coast ports, and the timing of how that resolves itself?

Yes, sure.

There's a number of things we talked about, West Coast ports and overhead -- manufacturing overhead, underabsorption, and copper mark-to-market.

Specifically the West Coast is really just the inefficiencies of getting supply chain --

It's a lot of air freight.

To the [lives].

It's a lot of air freight.

It's a lot of air freight.

There's a lot of pre-buys on inventory.

So you've got inventory carrying costs that elevate because you've got to put that inventory somewhere.

You've got to handle it.

You've got to do things with it.

It is just inefficiencies in the supply chain that will cost you more.

And I think that the comments there -- we saw that building in the fourth quarter; and of course, as York mentioned, the impact that it had on first-quarter gross margin.

And we do expect there will be a little bit of that hangover here as we going to the second quarter.

But all in all, we've seen it start to abate.

The reason we've seen it abate is we've got a ton of inventories come at us here.

You see it in our raw material inventory numbers at the end of the quarter.

And we've seen a ton of containers shake loose from that logjam out there on the West Coast, and that has come at us now.

And obviously the with a slower residential business and a slower performance overall in Q1, there's also some elements of our inventory increase related to that.

So it was kind of a double whammy that way.

So not necessarily an ideal situation; put it that way.

And it's not what we had planned and not what we'd want to see, but we will work that down over the coming quarters.

Okay, thanks a lot.

John Quealy, Canaccord Genuity.

A little bit more qualitative questions.

Hey, York.

So first, just the topic of growing the addressable market, can you talk about how the homebuilder relationships are going in that side?

And then perhaps a little bit ahead of ourselves, but I think worth mentioning here, a lot of the distributed solar guys are starting to push -- not yet, but soon to be in home storage and residential type storage.

Can you talk about how you think that market evolves, if and when you would get involved, why you would get involved?

Thanks guys.

Sure.

So the addressable -- the market in terms of what we're doing there, we continue to push on that very, very hard over the last several years to try and move the needle there, if you will.

I think, John, the question -- just thinking through your question of the on-site storage, obviously there's supposedly some large announcement by one of the players in the industry there that's making electrical vehicles with an on-site storage system, which -- frankly, that's aimed at a completely different market than the market we serve with that storage system, from what we know of it.

And storage systems -- by the way, battery storage systems have been around for years.

That's not a new thing, per se.

It's been around for years.

I think the scale at which that company may be able to get from a cost perspective, it's still we believe -- probably be twice as expensive as our standby power generation solution, minus any subsidies.

And obviously it's up to the government to pick the winners and losers here, which they have a really poor track record of doing, but will consistently do anyway.

And that system really provides for only a couple of hours of backup in an outage.

So I think that's really aimed at people who are in the space of producing their own power through solar or through wind, and need a temporary storage area or want to enhance the existing temporary storage that they have, and really gives them the opportunity to play on the arbitrage between peak rates and non-peak rates with utility companies.

Using it strictly as an emergency backup, I see very few households that will buy that system for that alone.

I don't know why you would spend $13,000, $14,000 on a system that gives you a couple of hours of backup when you could spend -- our average ticket, with installation, is about $7500.

Why you would spend that kind of money and only get a partial solution -- I think that, over time, we've looked at -- obviously we keep a very close eye on technology and how it impacts all of our products, not just residential products, but our commercial industrial products.

In fact, we generally lead the market with innovation in new technologies.

Batteries are, I think, an interesting space and have been for quite some time, but there's no Moore's Law with batteries.

And there's no real breakthrough there for batteries at this stage of the game.

If there ever is, could we foresee a situation where the reciprocating engine -- the internal combustion engine is a very efficient, relatively speaking, a very efficient on a cost basis, way to produce power.

The combination of that engine with a battery -- could that be some kind of hybrid program?

Potentially, down the line.

That might be what is the more realistic outcome of this in the years ahead.

But to be very frank, a pure battery system that would give you the kind of backup that an existing generator would give you today would be just incredibly cost prohibitive, because homes use quite a bit of power.

And to be able to have that kind of storage around would be a massive system, large system, and an expensive system.

And it's just not something we see as certainly not economically viable, if not physically viable.

So we will watch it and we will keep an eye on it.

But I think that that's really aimed at different market than what we serve today.

And then quickly, back to today on the homebuilder market, are you guys happy with penetration and success there?

And that's it.

Thanks, guys.

Yes.

Sorry, John, I missed the first part of the question.

On the homebuilder side, no, we're not happy with that.

I think we can be doing more.

New home construction, we have seen our penetration rate improve as housing has improved.

But we've said that that's really -- for us, it would represent a great opportunity to introduce a product category to people who have made the decision to build a new home, who presumably have a mortgage with which to finance that.

And you've got also a much lower installation cost as a result of all the trades being on-site and the walls being open, permits being pulled.

It's just a lot easier to do when you're building a home.

Where we are getting traction is more so, as we've said before, with the custom builders because they try and differentiate their product from the larger production homebuilders.

The production homebuilders are really more focused on trying to sell people more square footage.

So in terms of amenities, it gets a little bit challenging for us to make the argument to a production builder or a track builder who is -- to say, hey, you can make a couple bucks on selling a generator when frankly, their margin is better when they try and sell square footage.

So we're kind of moving in opposite directions in terms of what incentivizes those larger builders to offer the product.

So it's been challenging for us.

We are not giving up on it.

We do have an initiative that -- we have a sales team here that we've put back together after the housing market started to show signs of life a couple years ago.

And it had some success.

We've had wins where we've got whole developments that -- new developments of 10, 20, 30 homes that have a generator, or the option to add a generator very easily.

So they're manufactured or they are built as generator-ready.

We are having some success with that, but I'm not happy with it.

I think we could be doing more, personally.

I just think there's an opportunity there.

(Operator Instructions) Ross Gilardi, Bank of America.

I just had one quick one.

I just wanted to get a little bit more clarity on your inventory situation.

Your inventory to sales is pretty elevated relative to history in the last year.

You mentioned portables before.

Just curious if you've got any excess inventory in standby.

I realize it's more typically a made-to-order product.

But more generally, I'm trying to understand how you square an elevated inventory position with a significant margin ramp that you're baking in (technical difficulty) off of 2015.

Yes.

So the inventory position is really related, Ross, to two kind of major factors that I've called out.

One is we have elevated levels of raw material, mainly because we were buying ahead of the port congestion to try and keep lines flowing and not have to spend a ton on air freight.

But as that became an elongated event, that was more difficult.

And actually what ended up happening is we were -- in the first part of the first quarter, we were running thin on certain components, and that's why we had to air freight them in.

Unfortunately, as the port situation started to resolve itself towards the end of quarter, we saw a lot of inventory hitting our docks.

So it's really the timing of inventory.

We had to air freight parts in.

But then those parts arrived that were on the water, waiting out in the Pacific Ocean, idling off the coast.

So we saw that impact our inventory levels.

Raw material was a good chunk of that; and then the finished goods inventory as well.

Portables, which we've called out and we talked about, and then also standby -- our standby inventory levels are elevated, our residential standby.

Again, we deliver products -- those are stock products.

Those are delivered within 0 to 2 weeks of order, so we keep a certain level of stock at all times.

As we look at the channel -- which we have a very good handle on, what's in channel and what's in our inventory levels -- we are somewhat elevated here at the end of Q1.

A lot of that is related to the slowness of the market in Q1.

So even though home standby shipments were flat year-over-year, they were below our expectations.

And that's really what drove a lot of our challenges in Q1 in terms of the miss.

So that resulted in higher inventory levels.

We will have to burn that off over Q2.

And it's kind of why we are -- for a first-half standpoint, why we are also saying we are tempering our outlook here for the entire first half.

From a margin standpoint, too.

So Ross, your comment about the impact on margins on that, that will flow in through Q2 as well.

Got it.

Great.

Thanks, guys.

Christopher Glynn, Oppenheimer.

I had a question about smart grid potential impacts.

I think part of the concept of smart grid is to limit the scope and length of outages.

Do you think that's part of the pattern you have seen over the past nine quarters?

No.

(laughter) All the data -- the grid is only marginally smarter.

It's going to take a lot more money than what's been spent to make it really, really smart.

And I don't know, the smartest grid in the world is not going to help if a tree falls on the line that connects the major power line your home.

No smart grid in the world is going to save you from not having power.

So the issue of the grid being above ground is really the bigger issue.

Smart grid will certainly help to shorten the duration of outages to a degree, which we would think would show up in some of our numbers longer-term.

But we just look at the raw number of outages that are occurring in those -- and the number of outages occurring.

Again, smart grid is not going to keep that from happening.

The number of outages will be what they will be.

Because until the grid is put below ground, I think it's still going to be susceptible to all the conditions it is susceptible to today, but -- and frankly, the grid has got a long way to go to get really smart.

There's smart metering going on.

And I think where you are starting to see some things happen is with the utility companies beginning to put some -- finally, some digitization of their monitoring and other things to help identify issues.

But it's a long road.

And again, I think our long-term perspective here is nothing is going to be really solved on this front.

It will be somewhat mitigated, perhaps.

But I just -- there's been such an underinvestment cycle that there's going to be power outages for the foreseeable future.

And I'm talking decades; I'm not talking years.

Even if we had a plan today, the trillions of trillions of dollars that would be needed to bring the grid into this kind of -- from a reliability standpoint to five or six nines type of reliability is decades away, in terms of just even being able to execute against a plan even if we had funding.

And we have neither the funding nor the plan, so I don't see anything changing on that front any time soon.

Yes, I understand the decades concept for overall automation of the grid.

I just -- it seems like maybe penetration of things like [re-closers] and such have the potential to have an impact under the surface.

But thanks for the help.

Stanley Elliott, Stifel.

Quick question on the margins in the back half.

If I heard correctly, it was 700 basis points higher.

Is that just a normal mix of business?

And then also, I would expect copper raw materials to be a pretty good tailwind for you guys in the back half of the year.

How much of that is baked into this outsized margin ramp we are guiding to?

Thanks, Stanley.

This is York.

There actually is a lot going on there in that 650 to 700 basis point increase, first-half versus second-half EBITDA margins.

So I will quickly just try to bridge it for you.

So there'll be a slight mix improvement as you go into the second half of the year with the resi increase on the assumed normal outage environment.

So with the higher resi volume, it will be maybe about a 100 basis point increase in margin, first half, second half, related to that mix.

There might be about a 100 basis point price improvement, given some of the discounting environment and modest price increase realization that we were rolling out.

So first half, second half will maybe be about 100 basis point in price.

And then to your point, Stanley, there will be about a 200 basis point improvement on the cost side.

So we will moderate these temporary cost increases with the West Coast ports and copper mark-to-markets.

And some of the unfavorable overhead absorption that we experienced in the first half will moderate in the second.

And then you pointed out commodities.

The realization, as we get through those lags on lower commodities as well as FX, we do a lot of -- buy a lot of components in euro, if you will, which will cost less in the future.

As we work through those lags in the supply chain, that should be a tailwind relative to margins.

And then we're always looking at other cost reduction initiatives internally here with our supply chain team and engineering team.

So put that all together, that's about a 200 basis point increase first half, second half.

And then the rest of that EBITDA increase is about a 300 basis point increase in OpEx as a percent of sales, as you leverage the fixed SG&A infrastructure.

So that's how you get to that 700 basis point improvement in EBITDA margins, first half, second half.

Perfect.

Thank you, guys.

Jerry Revich, Goldman Sachs.

I'm wondering if you could just update us on how the Baldor distribution integration is coming along.

And what have the early results been for you folks as you transition that network?

Yes, absolutely, Jerry.

So that was a project we really worked on -- really all of 2014.

We started it in early 2014; made our decisions around representation in key markets in the second quarter of last year; and then worked to build that up and introduce those either new partners or the changes that we made to get those things pointed in the right direction in the back half.

I think our comments about a stronger second half of C&I this year versus the first half, some of that is that industrial distribution piece continuing to progress.

It's a -- unfortunately, if you change distribution partners or bring a new one on board, it takes a while to get those new sales teams up to speed, to make the relationships in the local markets that need to be made, to get the quote logs -- get the quoting activity brought up to a level where it can start to convert into orders.

It's a very long sales cycle in C&I on that side of the business.

And we believe that we made some really good decisions last year.

We think we have some continued decisions to make around distribution this year -- in the beginning of this year.

And now we're just working with those distributors to really make them more effective in their markets.

And a lot of that is through education, a lot of training.

There is quite a bit of support being given to those distribution partners in the way of developing a sales process, a more robust sales process for them that's not just unique to each distributor, but more across the board for all of our distributors to use.

So we've got some tools that we are putting together for that.

And again, our comments would be that it would have a -- we think it's going to pick up steam here as we roll through the year, and have a bigger impact in the second half of this year than it had in the first half.

Thank you.

I would now like to turn the call over to Aaron for closing remarks.

We want to thank everyone for joining us this morning.

We look forward to our second-quarter 2015 earnings release, which we anticipate will be at some point in late July.

With that, we wish you a good morning.

Thank you.

Thank you for your participation in today's conference.

This concludes the presentation.

You may now disconnect.

Good day.