Generac Holdings Inc (GNRC) 2017 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the First Quarter 2017 Generac Holdings Inc.

Earnings Call.

(Operator Instructions) As a reminder, this conference is being recorded.

I would now like to turn the conference over to our Vice President of Finance, Mr. Mike Harris.

Please go ahead, sir.

Good morning, and welcome to our first quarter 2017 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.

Thanks, Mike.

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

On a year-over-year basis, net sales in the first quarter increased 16% to $332 million as compared to $287 million in the prior year with core organic growth of 2% and a full 3-month contribution from the Motortech acquisition, which closed on January 1, and 2 remaining months of contribution from the Pramac acquisition, which annualized on March 1.

Overall, our first quarter net sales exceeded our expectations, led by a broad base of higher-than-expected shipments of commercial and industrial products.

We continue to see improving demand trends in a number of our C&I markets during the quarter as shipments of domestic mobile products increased at a strong rate as compared to the prior year levels due to demand from rental equipment customers as they began to upgrade their fleets.

Also, we are encouraged by the solid organic sales growth experienced within our international segment, led by a strong start to the year from the team of Pramac.

As we had expected, residential products shipments were lower in the quarter as compared to the prior year as higher field inventory levels of portable and home standby generators dampened demand from our distribution partners for these products.

The first quarter of 2017 experienced some improvement in localized power outage activity, particularly within the Midwest region in the back half of the quarter.

This has helped to improve the pace of home standby generator installations thus far in the second quarter, which is further reducing field inventories to more seasonally appropriate levels.

Capitalizing on the substantial long-term penetration opportunity for home standby generators remains a top priority for our team.

An important element of this goal is expanding the availability of these products to the many channels that we go to market.

To that end, we finished the quarter at our highest level ever in terms of the number of active residential dealers in our network, and we remain focused on further expanding our retail placement of residential products.

We also continued to drive leads for home standby generators to our dealers through our aggressive advertising of the product category.

Much focus has been placed on converting these leads to sales, and we are seeing some good progress in this regard as we continue to refine the algorithms we use to allocate these leads to dealers that have better close rates.

With a penetration rate for home standby generators in the U.S. at only approximately 4% of single-family households, including no major region of the country exceeding 6%, we believe substantial growth opportunities remain for this product category over the long term.

An area of our business that has begun to show encouraging improvement is our domestic mobile products offering, primarily serving our rental markets.

After the significant declines over the past 2 years, demand for these products is finally starting to improve as we experienced an increase in shipments that exceeded our expectations during the quarter.

The strength is due to higher replacement demand from rental equipment customers, and this momentum has continued to improve further here in the second quarter.

Accordingly, our outlook for shipments of domestic mobile products has been revised upward for the remainder of 2017 to reflect the strength we are seeing in this market.

We believe the improvement in demand for mobile products signals the beginning of a fleet replacement cycle for most of our rental equipment customers that is related more to the overall age of their fleets rather than to higher oil- and gas-related capital spending.

With oil prices averaging in the low $50 range so far this year, we believe that a meaningful recovery in the purchase of mobile equipment for use in these applications has not yet begun.

The beginning of a replacement cycle for general rental fleet equipment, combined with the potential for a future recovery in the energy sector and the longer-term opportunity with increased infrastructure spending, gives further validation to our belief that demand for mobile product equipment domestically has bottomed, and we look forward to returning to growth going forward for these products.

Shipments of stationary C&I products in North America through our distributors as well as direct to our national account customers also improved during the first quarter as compared to the prior year.

The continued expansion of our product lines, coupled with our execution on several key initiatives to improve the quality of our distribution and the acceptance of the Generac brand by specifying engineering firms, are an important part of the growth we are experiencing.

We expect to see further growth within the industrial distribution channel in 2017.

However, as we enter the second quarter of the year, we see the potential for continued softness in demand for emergency backup power and telecom-related projects resulting from the ongoing reprioritization of capital by -- capital spending by several of our national account customers.

Now let me provide a few comments regarding the trends for our international segment which experienced a solid improvement in organic sales growth during the first quarter.

In the Latin American region, sales volumes have been stabilizing over the past year with solid growth returning over the past several months.

We believe that better end market demand, the execution of several key initiatives as well as organizational changes we have made to our Latin American business are the primary drivers of the improved performance in this important region.

In the European market, we have seen early signs of a rebound in demand for our mobile products which suffered in the second half of last year from weakness in the British pound as well as reduced capital spending by our rental equipment customers due to uncertainty around the potential impacts from Brexit.

Also in the European region, Pramac has performed very well since our acquisition of a majority share on March 1 of last year.

We continue to be pleased with the company's overall financial performance with sales exceeding expectations during the first quarter of 2017 and strong growth in both sales and earnings compared to the prior year on a pro forma basis.

The integration of the Pramac business remains an important focus for us in 2017, and we're making good progress in evaluating and pursuing a variety of revenue and cost synergies.

Lastly on January 1, we acquired Motortech, which not only further expands our international sales mix, but is also an important part of our new Powering Ahead strategic initiative to expand our leadership within gas power generation products.

Headquartered in Celle, Germany, Motortech is a leading manufacturer of gaseous-engine control systems and accessories, which are sold globally to gaseous-engine OEMs and to aftermarket customers.

We remain very excited about the long-term strategic benefits of this acquisition as it gives us direct access to critical gaseous-engine control technologies as well as expanding our engineering capabilities necessary to help us further build out our product lines and our market opportunities for natural gas-related power generation applications.

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

York?

Thanks, Aaron.

Net sales for the quarter increased 15.8% to $331.8 million as compared to $286.5 million in the first quarter of 2016, including $40.5 million of contribution from the Pramac acquisition, which closed on March 1, 2016; and the Motortech acquisition, which closed on January 1, 2017.

Looking at our consolidated net sales by product class, residential product sales during the first quarter of 2017 were $154.9 million as compared to $159 million in the prior year quarter.

As expected, we experienced lower year-over-year shipments of home standby and portable generators due to excess levels of field inventory for these products entering the first quarter of 2017.

As discussed on our previous earnings call, this was caused by improved buying sentiment and effectiveness of our promotional programs with our distribution partners during the fourth quarter of 2016 in the wake of Hurricane Matthew.

Home standby and portable generator field inventory moderated during the current year first quarter and should continue to right size during the second quarter as we see the benefits of our full promotions and increased power outage severity.

The year-over-year decline in shipments of residential backup generators was partially offset by the additional 2 months contribution of portable generator sales from the Pramac acquisition, along with increased organic shipments of DR-branded outdoor power equipment from Country Home Products.

Looking at our commercial and industrial products, net sales for the first quarter of 2017 increased to $151.4 million as compared to $103 million in the prior year quarter.

The increase was primarily due the contribution from the recent acquisitions of Pramac and Motortech.

However, we also experienced strong organic growth in a number of our C&I markets during the quarter as well.

This strong organic growth was broad based as we saw improving demand trends for both stationary and mobile products in both domestic and international markets.

Net sales for the other products category increased to $25.5 million as compared to $24.6 million in the first quarter of 2016.

The increase was primarily driven by the addition of aftermarket part sales from the Pramac acquisition.

Gross profit margin for the first quarter of 2017 was 33.3% compared to 34.2% in the prior year first quarter.

Recall the prior year included $2.7 million of restructuring charges classified within cost of goods sold to address the significant and extended downturn for capital spending within the oil and gas industry.

Excluding the impact of these charges, gross margin in the prior year was 35.2%.

This 190 basis point pro forma decline in gross margin as compared to the prior year was mostly due to the mix impact from recent acquisitions and an overall unfavorable organic product mix, partially offset by modest net favorable pricing cost impacts.

Operating expenses increased $7.5 million or 10.6% as compared to the first quarter of 2016, in which the prior year included $4.4 million of restructuring charges classified within operating expenses to address the downturn for capital spending within the oil and gas industry.

Excluding the impact of these charges in the prior year, operating expenses increased $12 million or 17.9% year-over-year.

This increase was primarily driven by the addition of recurring operating expenses associated with the Pramac and Motortech acquisitions.

To a lesser extent, the increase in operating expenses was also due to increased promotional activities, including consumer [pole] programs that we ran during the current year quarter.

Adjusted EBITDA attributable to the company as defined in our earnings release was $46.7 million in the first quarter of 2017 as compared to $49.1 million in the same period last year.

Adjusted EBITDA margin before deducting for noncontrolling interests was 14.4% in the quarter as compared to 17.4% in the prior year.

The decline in adjusted EBITDA margin compared to the prior year was primarily due to Pramac and Motortech acquisition mix, overall unfavorable organic sales mix and the higher operating expenses, given the factors just discussed.

I will now briefly discuss financial results for our 2 reporting segments.

Domestic segment sales were $248.5 million as compared to $248 million in the prior year quarter.

The increase was primarily due to increased shipments of C&I stationary and mobile products, and to a lesser extent, DR-branded outdoor power equipment from Country Home Products.

These benefits were largely offset by expected lower shipments of home standby and portable generators due to the excess levels of field inventory entering the first quarter of 2017.

Adjusted EBITDA for the segment was $42.8 million or 17.2% of net sales as compared to $46.9 million in the prior year or 18.9% of net sales.

Adjusted EBITDA margin in the current year was impacted by overall unfavorable product mix and increased promotional activities.

These impacts were partially offset by the net favorable impact of higher pricing and lower costs, including realized cost savings from the previous actions taken within mobile products.

International segment sales, primarily consisting of C&I products, increased to $83.3 million as compared to $38.5 million in the prior year quarter.

The increase was primarily due to the contribution from the recent acquisitions of Pramac and Motortech.

Recall Pramac closed on March 1, 2016.

Therefore, January and February 2017 results for Pramac had not annualized yet.

We also experienced strong organic sales growth primarily coming from strong shipments of stationary C&I products in both the Latin America and European regions.

Adjusted EBITDA for the segment before deducting for noncontrolling interests was $4.8 million or 5.8% of net sales as compared to $2.9 million or 7.7% of net sales in the prior year.

The decline in adjusted EBITDA margin as compared to the prior year was primarily due to the Pramac acquisition.

The unfavorable foreign currency impacts from the weakness in the British pound as compared to the prior year was offset by improved operating leverage on the overall higher organic sales volume.

Now switching back to our financial performance for the first quarter of 2017 on a consolidated basis.

GAAP net income for the company in the quarter was $12.8 million as compared to $10.2 million for the first quarter of 2016.

The prior year net income includes $7.1 million of nonrecurring pretax charges relating to business optimization and restructuring costs to address the impact of a downturn for capital spending within the oil and gas industry.

Excluding this restructuring charges in the prior year, the decline in GAAP net income was driven by lower operating earnings as previously detailed and higher GAAP income taxes recorded during the current year quarter.

GAAP income taxes during the first quarter 2017 were $8.3 million or a 39.1% tax rate as compared to $5.7 million or a 35.9% tax rate for the prior year.

The increase in the GAAP tax rate is primarily due to a nonrecurring discrete tax item impacting the current year first quarter.

Adjusted net income for the company as defined in our earnings release was $25.8 million in the current year quarter versus $30.9 million in the prior year.

Diluted net income per share for the company on a GAAP basis was $0.21 in the first quarter of 2017 compared to $0.15 in the prior year with the prior year earnings impacted by the aforementioned $7.1 million pretax charge.

Adjusted diluted net income per share for the company as reconciled in our earnings release was $0.41 per share for the current year quarter compared to $0.46 in the prior year.

With regards to cash income taxes, the first quarter of 2017 includes the impact of a cash income tax expense of $3.1 million as compared to $1.8 million in the first quarter of 2016.

The current year cash taxes reflect an expected cash tax rate of approximately 15% for the full year of 2017, while the prior year first quarter was based on an expected cash tax rate of approximately 9% for the full year 2016.

As a reminder, our favorable tax shield of approximately $50 million through annual intangible amortization in our tax return results in our cash income tax rate being significantly lower than our GAAP income tax rate of approximately 36% for 2017.

Cash flow from operations was minus $4.5 million as compared to $22.2 million in the prior year.

Free cash flow, as defined in our accompanying reconciliation schedules, was minus $8.1 million as compared to $15.1 million in the same period last year.

The year-over-year declines in cash flow were primarily driven by an increase in finished good inventories during the first quarter 2017 as home standby and portable generator levels were replenished to historical levels following the strong demand experienced during the fourth quarter of 2016 after Hurricane Matthew.

To a lesser extent, the timing of certain accounts payable payments also contributed to the decline in free cash flow during the quarter.

As a reminder, the first quarter is typically the seasonal low point for cash flows.

Looking at our performance over the last 12 months, we have generated $200 million free cash flow, demonstrating the strong cash flow capabilities of the company.

It's relevant to note that Motortech acquisition added approximately $7 million of primary working capital to our balance sheet as of March 31, 2017.

As of March 31, 2017, we had a total of $1.05 billion of outstanding debt, net of unamortized original issue discount and deferred financing costs and $57.5 million of consolidated cash and cash equivalents on hand, resulting in consolidated net debt of $993 million.

Our consolidated net debt to LTM adjusted EBITDA leverage ratio at the end of the first quarter was 3.6x on an as-reported basis.

Additionally, at the end of the quarter, there was approximately $138 million available on our ABL revolving credit facility.

With that, I'd now like to turn the call back over to Aaron to provide comments on our outlook for 2017.

Thanks, York.

We are maintaining our prior guidance this morning for full year 2017.

Net sales are still expected to increase between 5% to 7% as compared to the prior year with core organic growth of between 1% to 3%.

Adjusted EBITDA margin before adjusting for noncontrolling interests is still expected to be between 19% to 19.5%.

An important note, however, is that should the product and geographic mix as well as demand trends seen in the first quarter continue for the remainder of the year, it is possible that net sales could be toward the higher end of the guided range and that adjusted EBITDA margin could be toward the lower end of the range.

Our top line outlook assumes no material changes in the current macroeconomic environment and also assumes the power outage severity level for the remainder of the year similar to that experienced during 2016, excluding the impact of Hurricane Matthew.

As a reminder, should the baseline power outage environment improve or if there is a major power outage event in 2017 is likely we could exceed these expectations.

For historical perspective, an average major outage event could add between $25 million to $50 million of additional sales depending on a number of variables.

Furthermore, we still expect the seasonality of quarterly results to demonstrate a normal historical pattern, assuming no major outage events occur during the year.

As a result, our guidance remains unchanged for the first half of the year expected to represent approximately 45% to 47% of total sales, and the second half, approximately 53% to 55%.

By way of comparison, 2016 organic seasonality was 46% in the first half and 54% in the second half.

Similar to the pattern experienced over the -- past several years, second half 2017 adjusted EBITDA margins are forecasted to be appreciably better in comparison to the first half of the year.

This improvement is expected to be the result of the increasing benefit from product cost reductions, a more favorable product mix, improved pricing and SG&A leverage on higher sales volumes through the back half of the year.

Specifically, for the second quarter of 2017, adjusted EBITDA margins are expected to improve sequentially between 275 to 300 basis points as compared to the first quarter and then further increased sequentially during the third and fourth quarters.

Importantly, recall that we have a majority ownership position in Pramac.

And as such, there is a minority noncontrolling interests with this acquisition that must be deducted when forecasting adjusted EBITDA, adjusted net income and adjusted EPS for the full year 2017, similar to the presentation reflected in the reconciliation schedules included with this morning's earnings release.

For full year 2017, operating and free cash flow generation is forecasted to improve over the remaining quarters and be strong.

Benefiting from the conversion of adjusted net income which is expected to be over 90% for the full year.

Consistent with the historical seasonality of cash flows, operating and free cash flow generation is expected to be notably weighted toward the second half of the year.

In closing, this morning, we believe our results demonstrate the power of our continued transformation to a more diverse business as significant organic growth came from a number of areas across the company in the quarter.

We have also experienced a dramatic expansion of our addressable markets through this transformation which we believe positions us very well for future growth.

Additionally, our strong liquidity position gives us the flexibility to continue to further invest organically in new products, technologies and infrastructure across our businesses.

We remain confident regarding the overall long-term growth prospects for Generac, and we believe the recently announced enhancements being made to our Powering Ahead strategy will ensure that we are allocating our resources going forward to generate the best returns possible for our shareholders.

This concludes our prepared remarks this morning.

At this time, we'd like to open up the call for questions.

Operator?

(Operator Instructions) And our first question comes from the line of Mike Halloran with Robert Baird.

So let's start on the C&I side.

First time in a while, I think we've talked about couple of quarters now of some momentum seeing there a little bit, certainly this quarter.

How sustainable do you think that is?

It certainly sounds like you're more constructive.

And then related to the question to that, maybe just talk a little bit more about how you're looking at the rental channel today.

You've obviously talked about an aging fleet within the context of that.

But just maybe parse out demand versus age and just replenishment a little bit more thoroughly.

Sure.

So, Mike, on the C&I side, you're right.

I think our comments this morning a little bit more -- quite a bit more constructive than they've been, maybe in -- even in the last several quarters.

We've seen a really nice recovery.

A lot of that's driven by a really nice recovery in the mobile business as we said in the prepared remarks.

And again, that kind of goes to your secondary question of the rental fleets.

And our viewpoint and this is our viewpoint, but at least as we look at the data and as we talk to our national rental customers and we serve them all, the buying that's going on today is, in their minds and in ours, much more related to just simply a fleet that has aged due to reduced capital spending over the last several years, and that's aged out the fleet.

Usually there's a normal amount of fleet refresh buying that goes on every year by the different customers in that channel.

And over the last 2 years, it's just -- it's been pared back pretty dramatically and again precipitated, of course, by the pullback energy prices that occurred 1.5 years, 2 years ago.

That was really the catalyst for that pullback in buying.

As we've seen that return, it's come back kind of, frankly, more quickly than we were expecting.

As we said, it exceeded our expectations in the quarter.

And in fact, as we look at the balance of the year, we think that that's going to be a pattern that's going to stay intact.

And so internally, the way we've adjusted our forecast is to take those numbers up a bit to reflect that strength.

On the balance of the other -- the rest of the C&I business, at least domestically, the stationary business for us, a little bit of a Tale of Two Cities.

Even though we had growth in the quarter year-on-year in both our distribution channel as well as our national account channels, we see the distribution channel continuing to improve here.

I think a lot of the fruits of our labor over the last several years in terms of just broadening our product line, getting ourselves in a position to win more with our -- with the contractors that make those decisions and the end users and operators of the equipment to make the decisions, we think we've positioned ourselves very well with the breadth of our product offering and also working with specifying engineering firms to improve our spec rate.

Getting yourself in a specification, named in a specification is really critical to improving your overall win rate.

And so that -- those have been focal areas for us and have done really well.

The other side of the coin will be our national account business, which is primarily our telecommunications business, and that has been a little bit -- even though it grew in the quarter, it's kind of off a low base last year.

So the growth wasn't -- the absolute numbers weren't like off the charts.

We just see telecom being, unfortunately, kind of caught in between this 5G upgrade cycle.

Generators are generally put in place kind of at the end of cycles like this, not at the beginning.

There's also obviously a lot to be said out there in terms of just where capital is being deployed by the telecom customers, and we just unfortunately don't see it probably being that strongly deployed towards emergency backup assets going forward.

There are a couple of bigger projects out there that may change that.

But right now, as we see it, we just -- I guess we're taking what we have as information and pointing it forward to say it's probably going to be a little bit softer there for the balance of the year in the national account sector.

That's a lot of good color there.

And then last one on the inventory side on the residential piece.

It feels like you guys are a lot more comfortable with where things stand today.

Maybe just talk about how that looks versus normal.

Seems like it's pretty close to normalize out.

Yes.

It's definitely coming in line with where we would consider -- it's kind of seasonally appropriate.

I think our hope when we got into the first quarter was that, that was going to happen by the end quarter.

And really what happened there is the pace of activations, it's really difficult to like pin down which month installations can get done and when they can't get done based on what weather is.

We started the year kind of in a cold snap in a lot of places around the country which kind of maybe delayed activations a bit.

We're definitely seeing here in April a very nice uptick in activations year-on-year, and so that gives us a lot -- and our forecasts, we've done a lot to try and refine our ability to get comfortable with an activations forecast that's out a number of quarters ahead of us here.

And we use a lot of inputs to get that.

And as we refine that over the years here, we've built -- I think we've got some confidence built around the fact that we think activations in the second quarter are going to be much improved.

Now some of that's from the Matthew event in the fourth quarter.

Some of it's some power outage activity that happened in March in Michigan.

We are running more [pole] promotions to kind of stimulate end market demand, and I think we're finding a better balance there on promotion activity.

In the past, a lot of our promotion activity has been aimed directly at channel partners.

I think that's one way to do it, but I think having a better balance of a mix of channel partner incentives to make sure that they're stocking around the right seasonal points in the curve where they should be and then also the right amount of promotional activity to the end market to stimulate demand at certain -- again, certain appropriate points in the year is something that we've struggled to maybe find the right balance.

I think we're coming into a better place on that, and those things are really helping to put that field inventory in a much better place here, certainly by the end of the quarter.

And our next question comes from the line of Brian Drab with William Blair.

Just on the guidance, I don't know if I missed it.

But last quarter, we got a little granularity in terms of resi and C&I.

Resi, you said, would be down most likely.

Just slightly organically in C&I.

I think it was my calculation or just backing into, I'd assume it would be around mid-single digits.

My sense today, and I don't know if this is correct, is that resi might be a little bit below the previous forecasting, C&I a little bit above.

Is that correct?

Brian, it's York.

I think you're right -- the qualitative commentary we gave on a product basis for our 2017 guidance was as you said on resi side down slightly given the Q1 destock that we've been talking about.

And really, once you lap to Q4 and not assuming another Hurricane Matthew, we would have a tough comp in Q4.

So that -- those were the drivers on the resi side to talk about down slightly.

We -- in terms of what we're looking at today, we still think that that's not materially different, still down slightly.

On the C&I side, we talked about strong growth on the mobile side.

Back in February, when we launched our guidance, we talked about solid growth elsewhere throughout the C&I channel that we sell through to end markets.

And given Aaron's commentary, not only in the prepared remarks, but in the Q&A here, we're seeing very strong upside on the mobile side.

We're taking that up.

And then we're still seeing good things on the C&I side, so outside of mobile.

So that's, I guess, the revisions there.

Okay, Okay.

So the overall organic isn't changing, but the pieces did move slightly.

But resi still, you would call slightly down?

Correct, yes.

Brian, it's not materially different on the resi side.

And I think if you we're to -- again, we gave a range, right.

So -- and within those ranges, there's going to be some variability.

So for us, it's just we felt with only 1 quarter under our belt, 3 quarters ago to change the ranges when obviously we've taken up as we've said because of the things that we're seeing on the industrial side, the C&I side, I think that, that was an appropriate kind of adjustment internally here and not really changing resi, I guess.

As our comments -- the prepared remark was pretty clear.

I mean, if the trends that we saw in Q1 continue to play out here, we could end up -- it's likely we'd end up at the higher end of the sales range, which from a mix -- just purely from a mix standpoint, would take you more to the lower end of the range in EBITDA guidance.

So -- but it's early in the year, and we didn't feel appropriate to materially change the guidance from -- that we gave a couple of months ago.

Okay.

And maybe one more question on C&I.

The oil and gas industry in the U.S. really is -- seems to have gained a lot of momentum.

I mean, the rig count has doubled from what it was a year ago.

Is your visibility getting a lot better in this business, even into 2018?

I mean, should we -- are you starting to expect that this is going to be some really sustainable growth in that business at this point?

Well, I mean, a lot of our comments over the last several years and actually prior to the breakdown in pricing in the energy sector, we are very bullish on oil and gas.

Domestic energy production, we think, is a long-term play.

It's a -- there's a secular trend there that is going to be punctuated by points in the curve that are going to -- there's going to be pullbacks.

The oil markets have always been -- they've always had those kinds of sharp movements.

And over the long haul, we're very bullish about our position serving those markets.

And so as they recover -- and really, it's the capital spending that -- in the ancillary-type equipment that we would provide for temporary lighting, temporary power, temporary heat.

As that capital spending picks up in that market, we're looking for good things.

Now does it happen next quarter?

Does it happen in the back half of this year?

I don't know.

We are optimistic it's going to happen.

We just were -- I guess, we're being less discreet about when it happens.

It's just that it's a question of really not if but when.

And so for us, we like the market.

We think it's going to happen.

We're starting to see some signs.

You're right.

The green shoots are out there relative to rig counts and things like that.

As those production activities pick up, we really like to see oil prices elevate a bit higher because everything we've heard in the marketplace is that kind of that mid-50s to upper 50s range is really what gets the industry very excited.

Now they continue to bring down their costs per barrel, their production costs per barrel, so maybe that breakeven point or the point to make money moves down further.

And so maybe we need to recalibrate and we'd see better things at $52 than at $49, I don't know.

But we're bullish about the long term.

Our next question comes from the line of Jeff Hammond with KeyBanc Capital Markets .

Can you give us a sense of that $40.5 million or acquisition contribution what the mix would have been between commercial and res?

Just trying to kind of get a better sense of kind of organic commercial versus organic res.

Yes.

It was -- as we said, that Pramac business only has -- a small piece of that is portables.

So of the $40 million, again Motortech and Pramac, January and February for Pramac are in there.

And of the Pramac piece, a small piece is in resi.

It's small.

We haven't quantified it, Jeff, but it is small.

And on the resi side, they -- as reported number, it's only a little bit off that because of the Pramac contribution from acquisition.

Okay, Okay.

So just as you look at the installations in April -- sorry, it seems like res, maybe down mid-singles organically.

How does that kind of frame up going into 2Q given kind of the installation activity you've seen in April?

I mean, we would think that, that would lead to increased buying by channel partners.

Again, if we get our inventory levels, as we said, the pace of activations or installation as they're occurring, we would see that being at a much more seasonally appropriate level at the end of Q2.

And remember, coming into Q3, we want channel partners to have inventory because they need to be ready for season.

So there is -- what we talk about here as seasonally appropriate, those are levels that -- consistent with prior years, there are levels that would reflect that.

But we think that the activation data we're seeing today, Jeff, is frankly very supportive of what our second quarter and kind of the balance of our -- balance of the year for our forecast would be reflective of.

Okay.

And then just on -- so inventories, I think the comment was by the end of the quarter, just given the installation activity by the end of the quarter, you'd be pretty well balanced.

Correct.

Our next question comes from the line of Christopher Glynn with Oppenheimer.

On the C&I organic upside, it sounds like maybe you're kind of hedging the outlook relative to the momentum you see right now there.

Just been wondering if you could comment on how much maybe in the first quarter you saw some inventory normalization in your channels versus sustainability.

I know it's probably a tough question, but what's your feel there?

On the C&I side, there's not much in the way of field inventory at all.

I mean, you've got -- the rental partners have their fleets, obviously.

But in terms of actual inventory in the field, it's not -- that market doesn't have much of that.

Our field inventory comments, Chris, are almost always exclusively talking about the residential side.

Yes.

No, I meant just in terms of -- so it's all sell-through.

When you sell something, it goes right through to you?

Correct.

Yes, correct.

It's -- and the stationary C&I business is a very project-oriented business.

So when a piece of equipment is ordered, it's a lead-time business.

So there's a -- it's a book-to-bill business.

So there's a fair amount of lead time, and the sales cycle is very long on those stationary products.

The mobile products, a little different.

That's almost -- I don't want to call it a retail sale, but it's a -- it's being sold to a rental customer for use and almost immediately in a rental yard because they're very in tune with the return on the invested capital there.

And deploying those assets almost immediately into a rental application is what they're after.

Okay.

And then on building out C&I, you've been pretty busy for years and notably so recently.

Just wondering if you could discuss the medium- to long-term expectation on the EBITDA margins for the resi versus C&I and international versus domestic, how that opportunity you see that to kind of close the gap between those different splits?

Yes.

I mean, we've talked -- the international segment was really created over the last 3 or 4 years, starting with Ottomotores acquisition and Tower Light and Pramac and Motortech.

And as we've highlighted, those are businesses with lower EBITDA margins.

And the investment thesis there is that you buy a company with, call it, mid-single-digit EBITDA margins, and you want to double through synergies and driving the top line.

And getting that international segment is all about getting into that addressable market that we had not had access to prior to those acquisitions.

It's over $15 billion annual market, and why shouldn't we be playing in that market.

So we expect those margins to increase on the international side.

And we have a path to do that, and we believe they'll continue to increase over time here.

Our next question comes from the line of Jerry Revich with Goldman Sachs.

I'm wondering if you can give us some more color on the organic growth in C&I.

By the underlying businesses that you had, looks like about 8% organic growth in the quarter.

And I'm just trying to understand if growth was stronger in Brazil.

And it sounds like on the mobile genset side, those, I would guess, would be the categories that are top list.

But maybe you can just help us understand which businesses are up more significantly within C&I, just so we could get our bearings for the remainder of the year.

Yes.

Without getting too granular, Jerry, because we just -- we don't kind of break it down that way for competitive reasons.

But obviously, the mobile business for us was a big part of that.

We're talking in overall C&I kind of mid-teens growth there.

So -- and in terms of like -- you mentioned Brazil as kind of one area of the world, I mean, for us, the Brazil business for us is a very small business.

And it's a challenging market obviously, I think, as most would attest to.

But it's really not a meaningful part of the story here.

The really meaningful part of the story is the mobile products piece.

C&I, stationary growth is -- that's -- I don't want to say it's more pedestrian, but it's definitely -- it grew.

But it's a little bit more of a -- I don't want to say it's a GDP grower, but it's kind of GDP to 2x GDP-type grower.

So you're really looking at that kind of low to mid-single-digit type of growth normally in that business.

But really, the snapback in the mobile business is really what drove that.

Okay.

And then you folks made some comments about material costs in the back half of the year.

I'm wondering if you just provide some more context.

I know you have the engineering initiatives.

But on the flip side, raw material inflation should -- I think be accelerating for most assemblers.

So maybe just give us a breakout of the magnitude of the R&D-driven cost savings just to help us get an appreciation for what's allowing you to -- I think you mentioned more an offset inflation in your prepared remarks.

Jerry, this is York.

So the -- so I think when you think of commodities, a lot of that what were the higher inflationary pressures on the commodity side are -- that's going to be in the run rate here in the first half given the legs that we see with our supply chain and our inventory.

Same with -- on the flip side, you have -- we've had benefits on the FX side.

So those have helped muted some of that, those commodity pressures.

When you look forward to the second half of the year, our -- as seasonally, we've indicated EBITDA margins will increase.

A large piece of that is just leveraging your OpEx on the higher sales volumes.

There is price in there.

We've gone out with price increases.

As the market strengthens, we'll get more price.

We'll get that price.

On the cost side, that's a small piece of the puzzle bridging from first half to second half.

But there is still a similar cost improvements that we see from first half to second half, in particular the things you've talked about on our Strategic Global Sourcing group, our design improvements on our products to lower the cost of product.

So we do have a piece of that.

A small piece of the bridge is that.

But the bigger piece of the puzzle, going from the first half to second half, is going to be leveraging OpEx on the high her sales volume and then getting some price with the price increases that we've rolled out.

And the mix, I guess the other -- the last piece of the puzzle is improved mix with higher home standby sales mix in the second half versus the first half.

And our next question comes from the line of Charlie Brady with SunTrust.

Did you guys cover in your prepared remarks the commentary about your expectations for gross -- gross profit margin and the OpEx on a year-over-year basis?

We did not.

We did talk about, given the trends we're seeing in Q1 and should those trends improve, in particular on the mobile side, top the sales top end -- will be on the top end of our guidance range.

Margin -- EBITDA margin will be on the low end, so what -- if you just carry that forward into gross margin and OpEx, gross margin should be on the low end of any range that you had for gross margin.

And OpEx should be better because you leverage the increase in sales.

So when you net that all together, the gross margin moving down on the mix, OpEx improving a bit on the volume, you'd get to the low end of the range in EBITDA.

I've got some prior guidance having been up 25 bps from 36% in 2016 ex the charge in 1Q '16.

Yes.

Just like I said that layering in that upside for mobile should bring that gross margin down from a mix standpoint, but you'll leverage your OpEx a little bit.

Okay.

But the top line would be higher.

But the top line would be higher, too.

So...

Okay, understood.

On the mobile side that goes into the rental channel, can you give any sense -- can you give us any sense on the average age of that fleet inventory at the rental channel and kind of what an average fleet is.

I'm just trying to get a sense of how -- what kind of legs this replacement cycle might have on that part of the market.

Yes.

I mean, we get some third-party data that we track, Charlie.

So I mean, we're -- and -- I mean, we're prohibited from disclosing it, so it's -- because it's proprietary data, and it's sold.

We're a buyer of that data, so we can't give it here on a public call, but -- or on any call.

But it is older than it has been I guess is the best way I can say it.

And there's different ages for different customers for different equipment.

And as you can imagine, it's all over the map.

But in general, when you step back and you look at the average ages of the fleet, which is what we track, for both lighting towers and primarily for generators, we see an older fleet today than we saw last year and than we saw 2 years ago, so -- and that -- historically in that business, there are a couple of things that are really important to watch.

One is the age of the fleet.

The other is rental rates.

What are the average rental rates per day for the equipment, and then what are the used equipment prices, so secondary market prices.

So putting those kind of 3 data points together generally helps us triangulate a position of future demand with that market and with those individual customers.

So we take as much data as we can to try and feed into the -- kind of into the formulation of that forecast, and that's kind of what's helping us get more bullish here as we go through 2017 and have taken up kind of our viewpoints on that.

Our next question comes from the line of John Quealy with Canaccord.

So 2 questions, more macro.

Number one, how are you folks doing on integration of all the commercial businesses?

Seems like they've been integrated without issue, et cetera.

How much more complexity can you add to your organization around that supply chain, et cetera?

And then the second question is can you talk about and sketch out sort of organic R&D efforts where they're looking across the platform?

Sure.

John, from an integration standpoint, I mean, integrations are -- we've done, I guess, 9, almost -- maybe 10 acquisitions now over the last 5-plus years.

So we've gotten a little bit better at it.

I'd like to think every time we do an acquisition, I think we have an improved approach every time, continuous improvement like any company.

Some of the acquisitions also depends.

I mean, some of the acquisitions are operated more stand-alone.

Motortech is a much more stand-alone company.

It's a component supplier to the industry, and so the benefits of deep integration there are more limited.

It doesn't mean that we don't have synergies relative to cost structures and other areas where we can work together.

That was part of our thesis.

But other businesses, whether it be Pramac or CHP or other companies like that, I think we've done a very nice job of working through the integration programs.

And we're seeing actually in a lot of cases some really nice synergistic things occurring, both on the cost side and on the revenue side.

In terms of additional complexity, the business has become more complex.

There's no question about it.

As a result of the acquisitions, as a result of our expansion organically, we've had to adjust the way that we manage the business because we want to manage, obviously, that complexity in a more simple fashion and keep it simple if we can.

As it relates to supply chain and some of the other areas you pointed out, one of the things that a core tenet of the acquisition strategy here over the course of last 5-plus years has been to acquire companies where it was clear there were advantages synergistically in the supply chain.

And so that actually is pretty easy.

I mean, a lot of things -- almost all of the products and companies that we've come to acquire have an engine in the heart of them.

And so we become a very large, not only a producer of engines for our own use, but also a purchaser of engines in places like in diesel engines where we don't produce engines.

So we've become an important customer for many of that supplier -- that supply base which is what gives us the synergies that we look to when we make these acquisitions.

So again, I think it's -- we've gotten better at it.

I think it's -- we're managing it, and we can always continue to improve on that.

As far as organic R&D efforts, we have over 300 engineers on staff here, the core Generac does.

And then you'd add in the Motortech engineering team as well on top of that, there's -- we got a lot of engineering horsepower.

And so there are a lot of things that are going on organically.

We've introduced a lot of new products over the years.

We're going to continue to introduce a lot of new products over the years.

We've got some very exciting product updates coming later this year, as a matter of fact, on the residential side where we'll have -- remote monitoring will be a standard feature of all of our home standby generators as we exit the year here in 2017.

That is going to be, in our minds, a very, very powerful tool in terms of data collection, in terms of homeownership experience, in terms of the customer sat experience, our ability to see power outages in real time, to see the performance of the equipment in real time.

There's just a tremendous amount of opportunities that are going to arise from that platform.

And we've been working very hard on building that out here over the last 2 years.

Really, today we sell a cellular-based service as an accessory, and we have relatively small take rate on that.

But it's growing to be a nice business for us.

From an EBITDA standpoint, it's actually a very nice business.

The dollars are smaller, but we think that there is a great place to expand that platform and really scale that up and sell a service here beyond just selling the product.

And I don't want to say that we're going to call this a shift in being a service company versus a products company.

We're still a products company.

But adding that recurring revenue stream on a service basis going forward in the residential market for us over the next several years we developed this out is -- I think is going to be a pretty exciting place for us to be.

And our next question from the line of Ross Gilardi with Merrill Lynch.

Aaron, I'm just wondering on the addressable market for the residential standby, I mean, I'm just -- have you reassessed the size of it at all?

You're now seeing penetration of 4% versus -- I think over the last 6 to 12 months, it's been more like 3.5%, which, of course, is a very subtle change, but if anything, shipments seem like they've been trending down for the last year.

So why would penetration be higher now than it was 6 months ago, unless you're sort of kind of framing the addressable market a little bit differently.

And I just have a follow-up to that.

Well, Ross, I mean, penetration grows with every single unit we put in the market.

So even the sales were down year-over-year, slightly it accumulates, right.

So penetration is an accumulation, so it's not an annual number.

It's an accumulation, a total amount of installed products on households.

And that's a little less than -- probably around 4% today.

Again, as we said in the prepared remarks, no single region where it's more than 6%.

So we think that there's a lot of runway left in terms of our -- we are constantly reassessing the addressable market to make sure that we're -- so that's really a function of marketing, right, to make sure that we're pointing ourselves in the right direction where the opportunities are.

As we've said in the past, we do believe that if you look at the first kind of fence post in the penetration curve, portable generators would represent kind of a nice place to start.

And those portable generators are in roughly 12% to 14% of U.S. households, all U.S. household today.

And growing.

And growing.

So we think that, that represents an opportunity area for us.

If people go out and spend, the average ticket there is $700 to a $1000 depending on the machine.

If they're out there spending that kind of money and if we can introduce them to this category, the installed product, which is clearly a step-up product, we think there's a great opportunity to convert those buyers into owners of home standby over time.

And that's really been the thesis, and there's -- it's multi-faceted, right.

We go after new construction where we see penetration kind of overindexed almost 2x what the overall penetration rate is here today overall.

And so we've seen people looking at home standby generators as they're building new homes, which is what you want to do because it reduces the installation cost.

We've been very focused on reducing the overall total cost of ownership for these products which we think helps continue to unlock additional layers of demand that -- and we've done a lot of testing, this elasticity modeling on price versus volume.

And what we see there is we can push price down the total cost of ownership.

That's equipment and the installation costs.

As we bring down that lower, there's more market to be had.

And so we're focusing on that with our channel partners first in the installation costs side of that.

As we've remarked over the last couple of years here, we think there's an opportunity within that to continue to improve the efficiency of an installation, to make the machines easier to connect to a home.

And so we think there's a fair amount of work to still to be done there, and so we're very bullish overall.

As we said -- I think that you just have to think in terms of the raw numbers here, every 1% of penetration, Ross, is a $2 billion market opportunity.

We believe our market share is somewhere in that 75% range.

So as we like to say around here, that's really good math.

So we're going to continue to focus on that.

(inaudible) the distribution.

And then just a follow-up to that was, how do you manage and avoid an overall market saturation issue?

Because as you explained here, your overall points of distribution right now, it sounds like they're at record levels.

And how do you deal what the potential channel conflict between your big retail partners, Internet distributors versus just your core bread-and-butter independent electrician that you've always relied so heavily on?

Yes.

It's great question.

And I think if you talk -- I mean, so our contractor channel, our dealer channel is a very important channel to us.

It's our largest channel.

And our -- it goes hand in hand, really, with all the other channels.

We use a very omni-channel approach to distribution and sales and marketing of the residential products.

We think that's very fundamental.

When you have a category like this, it's only 4% penetrated.

We don't think it's developed or mature to the point where it makes sense to pick a channel.

I think it -- and if you think of the individual kind of roles of each of the channels, they all have their role and their place in the market.

So our dealer channel is kind of a turnkey solution, right.

So if you, as a homeowner, you don't want to kind of project manage this on your own.

You don't want to go to Home Depot and put it in the back of a pickup truck.

You just want to have a turnkey solution, somebody who's going to do everything from the minor landscaping that has to be done, to the gas connections, to the electrical connections, to then maintaining the product down the line with a service contract, that's where the dealer channel comes in.

And they do very, very well at maintaining those customers.

In fact, it's our best customer experience.

But you do have people who want to buy and do these projects.

They want to project manage it themselves.

They want to save a few dollars so they might go to Home Depot, or they might buy a product online and manage that themselves.

Or maybe they have certain elements of the skill sets that they want to do themselves.

They want to have their own sweat equity into the project to reduce the total cost.

That's another -- that's the role that retail and our e-tail partners would play in that.

And then the wholesale channel, which is another very important channel for us, electrical wholesalers that we've been involved with for over a decade, they serve the broader contractor network that doesn't buy direct from us.

So our network of dealers, about 5,500 strong today, which is an all-time high as we said on the prepared remarks.

But there are over 70,000 electrical contractors in the U.S. There's over 100,000 HVAC contractors.

So those contractors who don't buy from us in a direct basis, who don't necessarily want to be in the category as dealers, still want access to the product.

Because for them, it's a project that they have, they can put their labor into on the installation side.

Having access to the product through wholesalers is an important part of the market.

And so in terms of managing the conflict, we use a number of strategies for that.

We use pricing.

We use brands.

We use product assortment.

We think we found an optimal mix to not only minimize conflict but actually create the interplay between the different channel partners that is more complementary than it is a conflict.

So it's a dance.

It's something we've been doing for 15 years, and I think we're very good at it.

And I think we don't have enough points of light, to be honest with you.

I think we need more.

If we're going to get above 4% penetration over time, we've got to grow the channel.

And our next question comes from the line of Jeff Hammond with KeyBanc Capital Markets.

Just back on international margins, I think you said -- I think they run around mid-single digits, And I think you said over time you think you can double them.

What's like a reasonable time frame?

And what are kind of the big bridge items to get to that level?

I think it's a couple of years, Jeff.

I mean, we can pick on one example with Pramac, which, as we have said, I think we've made public comments.

It's kind of mid-single-digit margin kind of company, and we think that the opportunity there to expand that to something closer to the low teens.

Now that can take time.

That doesn't happen overnight.

A company like -- each one is different, right, so -- but a company like that internationally, they have a very broad footprint.

They have 14 sales offices serving 150 countries.

So there are fixed costs layer to serve that the rest of the world is expensive.

So -- but it's established, and it's good.

What we have to do is help them grow the top line.

They've done a nice job of that even without our help, frankly, over the last several years, and they continue to do very well in that regard.

For us, it's about how can we help them not only leverage some of products that we manufacture, whether it be gas products or other mobile products and put that into those distribution -- those established distribution channels and established distribution branches.

But then also, how do we consolidate on our supply chain side to get some of the -- squeeze the juice out of some of that.

And so it's going to come from both sides of that, but it's going to take a number of years before we see that.

And our next question comes from the line of Stanley Elliott with Stifel.

Two quick questions.

One, on the telecom business.

I mean, obviously at one point, it was a nice, very profitable business.

It seems that because of the reprioritization of those providers, there just doesn't seem to be as much activity.

I mean, has something fundamentally changed from a mindset perspective with the cell tower owners, do you think, as far as having backup power?

Or do you still see this as kind of a low end until they kind of reprioritize this back into the picture?

I think it's a combination of things.

Stanley, personally, the -- not having the specter of having had any major outage events here in the last several years doesn't help, right.

I mean, there's no sharp points around network quality when it comes to power outages.

If outages are low as they've been historically here over the last 5 years or so, there's no real sense of urgency around having that backup asset.

So that doesn't help.

I will say this, the -- we don't think that fundamentally anything has changed other than their focus, right.

Their focus being pulled in a lot of different directions right now, everything from what's going to happen with some of the net neutrality rules, what's going to happen if they spend to buy more spectrum, what's going to happen as they buy other assets, that conversion to 5G.

There's just a lot of -- I would call it almost uncertainty around what the network of the future is going to look like.

And so with that level of uncertainty, I think, just comes a natural level of, "Okay, we're not exactly sure what assets we're going to buy." And frankly, if you're looking at deploying capital, you -- they always historically have deployed it first for the site, and then they come back around and add a generator later.

You can operate the site without the generator.

You just take the risk that if power goes out in that area, that you may not.

I think the one thing that really continues to be in our favor -- certainly 2 things, it's [call] quality, just longer term, is going to continue to be poor because of the fundamental problem with the electrical infrastructure in this country.

Nothing has been done to address that in any material way at this point, so that's going to remain out there.

And secondarily, this has now become from an economic standpoint, you're buying -- we're all buying -- our wireless plans are all paid by the drink basically, right.

So if a site goes down, it's not as simple as us not being able to make a call anymore, which is true, but the data can't be transmitted either.

And because you're billed on a data basis, actually there's actually an economic penalty to many of the telecom carriers when the site is dark.

So they have an incentive, obviously, to make sure that there's as much uptime.

You want 5 or 6, 9s of uptime quality on each site simply for that very reason economically.

That's fair.

And then talking about the C&I business, the momentum you see there.

I mean, I obviously understand kind of how that could move to top line and then the margin impact from that.

Would you think about the residential business -- any activations that you're seeing kind of pick up post some of the storm activity.

Is that within that same calculus of higher revenues and maybe lower end of the margin frame?

Or was that a potential surprise to the upside when we think about things, absent any sort of major storm in the back half of the year?

No.

Certainly not lower margin.

The mix to resi would put you towards better margins, not worse within the category.

It's really -- our guidance kind of contemplates the fact that there was this field inventory overhang a bit, which extended here into the beginning of the second quarter just because of the raw timing of the activations and when they happen.

Instead of happening in March, that lift is happening in April instead on the back of, again, some of these [pole] promotions and then some of the outage activity we saw.

But I think for us, as we said, the residential guidance remains largely unchanged.

I mean, it just -- it didn't -- still kind of down a bit for the year is what we're pacing towards.

We said, I think, the surprise upside potential there is if you do get a normalization back to kind of normal outage rates or maybe a larger outage event.

Those things are -- we've always said that in this company.

It's kind of an -- it's an embedded upside opportunity within owning GNRC shares is that you've got this kind of unpredictable thing, but it's all upside.

So -- and it's -- and frankly, when that does happen, as you guys have seen historically with the company and as I've seen over my 20-plus years with the company, it happens fast, and it generally is a very, very positive thing for the company.

So those things just haven't happened in the last 4 or 5 years, and we do believe that there would be a normal return to that cycle eventually.

It's just a -- it's a question of when.

And that is all the time we have for Q&A today.

I would now like to hand the call back over to President and CEO, Mr. Aaron Jagdfeld for closing remarks.

We'd like to thank everyone for joining us this morning, and we look forward to our second quarter 2017 earnings release, which we anticipate will be sometime in early August.

With that, we'll say goodbye.

Thank you very much.

Ladies and gentlemen, thank you for participating in today's conference.

This does conclude the program: you may all disconnect.

Everyone, have a wonderful day.