Generac Holdings Inc (GNRC) 2019 Q1 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the First Quarter Generac Earnings Conference Call.

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

I would now like to turn the conference over to your host, Mr. York Ragen, Chief Financial Officer.

Thank you very much.

Good morning and welcome to our first quarter 2019 earnings call.

I'd like to thank everyone for joining us this morning.

With me today is Aaron Jagdfeld, President and Chief Executive Officer.

We'll 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, York.

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

Our first quarter results represent an outstanding start to the year for Generac as we experienced very strong core organic growth of approximately 15% in the quarter.

Overall net sales increased 17.6% compared to the prior year when including contributions from the Selmec, Captiva and Neurio acquisitions, which were slightly offset by unfavorable foreign currency impacts during the quarter.

EBITDA margins expanded by 60 basis points to 18.5% as compared to the prior year first quarter driven largely by favorable operating leverage on the higher sales volumes, which helped to counteract the impact of higher input costs.

EBITDA dollars on a trailing 12-month basis reached an all-time high of $440 million as we continued to demonstrate the earnings power of the company.

Strength in end-market demand underpinned the increases in the first quarter with interest in home standby generators in particular remaining very robust as increased power outage activity over the last 2 years, alongside the impact of our initiatives to grow the market, resulted in continuing penetration gains.

Shipments of C&I products were also significantly higher year-over-year as growth in demand for backup power increased, particularly from wireless carriers as they work to further harden their networks.

In addition, we experienced solid organic sales growth within the international segment as our Pramac subsidiary experienced year-over-year increases in spite of strong currency headwinds.

Awareness for home standby generators continues to benefit from elevated power outage activity in recent years and remained very strong for the first quarter as activations and in-home consultations both paced well ahead of prior year levels.

We have worked very hard over the last 2 decades to build-out the market for home standby generators through our efforts in developing distribution, creating targeted marketing and deploying in-home sales processes that have contributed to dramatically increasing the overall awareness and growth of the category.

These efforts have delivered a market for home standby generators today that is more than $1 billion annually, but much room for growth remains as penetration rates are still approaching only 4.5% of single-family unattached houses in the U.S.

Recall that we estimate every -- each additional 1% of penetration to represent approximately $2 billion of market opportunity at retail prices.

As the clear leader in this product category, we continue to focus heavily on growing the market as we believe substantial opportunity exists to further increase penetration, and accordingly, this remains a core tenet of Generac's Powering Our Future strategic plan.

Shipments of domestic stationary C&I generators were also very strong in the first quarter as solid fundamentals drove broad-based growth across a number of end markets.

In particular, orders and shipments for telecom-related applications continued to accelerate in the first quarter as nearly all of our major national account customers had various projects underway to harden their wireless networks.

As these carriers begin deployment of so-called fifth generation wireless technology, the need for a continuous supply of power to their network sites has never been more important.

The increased data speeds and stability of 5G connectivity will provide for a critical foundational layer that will enable some tremendously impactful future technologies.

Ensuring that these networks are able to continue without interruption even during power outages is essential for the new services and communications that will be dependent on this 5G technology.

Generac is a key supplier of backup power systems to every Tier 1 carrier in the U.S., which is a result of our ability to develop unique solutions and provide an unmatched level of support through our nationwide distribution network.

Additionally, we believe we are only scratching the surface of the overall global telecom opportunity that exists.

With the recent acquisition of Selmec in Mexico, we are now also the #1 provider of backup power for the telecom market in Latin America.

And our Pramac subsidiary has recently began to accelerate their efforts in serving this market as well.

We believe that, globally, we can position the Generac group of companies as the leader in telecom power.

And as this important vertical begins another extended investment cycle in the months ahead, we will be launching several new products specifically for the telecom market.

These will include a complete line of direct current, or DC, backup power systems to complement our already extensive line of gas and diesel alternating current, or AC power products as well as a number of continuous duty and hybrid solutions aimed at specific applications in countries where grid power is not only much less reliable but, in some cases, nonexistent.

In addition to our focus on globally developing certain higher growth verticals such as telecom, we have also worked hard over the last several years to further promote the benefits of natural gas power generators as a substitute for the diesel-powered systems that have traditionally been used in emergency backup applications.

Stricter regulation around diesel emissions have driven prices for generators that use these engines considerably higher over the past decade.

These higher prices, combined with the inherent drawback of these systems due to their refueling requirements as well as additional environmental concerns around potential fuel spills, have created an opportunity to use natural gas-powered generators as a cleaner, more economic alternative.

With our acquisition of Motortech in 2017 and with an aggressive new product introduction cycle here at Generac, we have brought a number of larger natural gas power nodes to the market and further -- and anticipate further expanding our product line in the years ahead.

We firmly believe that natural gas has far superior characteristics over diesel in power generation with its abundant supply, low prices, logistical advantages and environmental benefits all contributing to growth rates for gas generators that are roughly double that of diesel sets.

This is another area where global growth has only just begun.

The market for gas backup power has mainly been a U.S. phenomenon, developing over the last 30 years to the point where 40% of the backup power market annually is now gas versus 60% diesel.

Outside the U.S., the market for gas is not yet developed, but we see many of the same characteristics that have been driving the growth in the U.S. now beginning to exhibit themselves in many other parts of the world.

Higher diesel engine prices as a result of tougher environmental regulations, coupled with the tremendous overall economics of natural gas, are creating a dramatic increase in interest for these products.

Our Pramac subsidiary has had a number of recent successes selling gas gensets to customers in place of traditional diesel generators.

These are units that are now being assembled at our factories in Italy and Spain, and we believe this represents an excellent growth opportunity for the company going forward.

Demand for our domestic mobile products was lower during the quarter, mainly due to the timing of capital spending by certain of our national rental account customers, which is expected to shift to the second and third quarters.

Largely offsetting the lower national account shipments was increased energy -- equipment purchases from independent rental businesses during the period.

With higher energy prices, a strong economy and the prospect for increased levels of spending on infrastructure projects in the U.S., we believe demand for our mobile products will be higher year-over-year in the quarters ahead and for the full year.

In addition to the overall growth we experienced domestically in the first quarter, our international business also grew with shipments to mainland Europe, the Middle East, China and Brazil all strong to start the year.

Although adjusted EBITDA margins for the International segment were slightly lower year-over-year, as certain product and regional sales mixes played out negatively in the quarter, our international segment EBITDA margins on a last 12-month basis have increased 130 basis points, and we remain confident in our ability to continue to deliver these margins to a targeted lower double-digit levels.

Additionally, we continue to see the benefit of our international expansion strategy with interest in home standby and natural gas gensets for commercial and industrial applications continuing to grow as these markets become more familiar with our gaseous product lines and our international sales teams gain knowledge and comfort in selling them in their respective regions.

I'd also like to make some comments this morning about our most recent acquisitions of Neurio Technologies and Pika Energy.

Recall that we announced the Neurio deal back on March 13 and the Pika transaction earlier this week.

Using the Powering Our Future strategic plan as our road map, these transactions represent a bold and decisive step forward for Generac.

The market for managing and storing energy is rapidly developing as it nearly doubled in 2018 and is projected to be a multibillion-dollar opportunity annually in the years ahead.

Our acquisition of Neurio gives us access to the energy monitoring and management hardware and software necessary to provide exciting new solutions to our existing standby generator customer base.

Neurio's development of high-functioning data algorithms around energy consumption allow customers to track their usage at a very granular level, which helps them identify significant savings opportunities.

When combined with Pika's expertise in power electronics, battery management software and proprietary inverter technologies, we believe that we can bring an intelligent energy-savings appliance to this brand-new market.

From the over 2 million homeowners that already have solar installed and are looking to dramatically improve the payback of their system to the millions of homeowners that want to take full control of their energy costs, while also providing added relief from short-term power outages, this new solution will be a natural fit.

Although very different than the backup power space we serve today, we believe that the market creation opportunity around energy storage is very similar to what we saw with the home standby generator market nearly 20 years ago.

In that instance, our ability to develop omnichannel distribution, consumer marketing content deployed in a targeted fashion and unique in-home sales tools to improve sales conversion was critical to creating the market for home standby generators, and we believe our experience and our competencies in these areas will be extremely valuable in growing the nascent energy management and storage market.

In addition, our strategic sourcing expertise and our ability to bring manufacturing scale to these types of products will ensure that we produce an affordable solution.

The combination of awareness, availability and affordability have been the key ingredients in growing the home standby generator market, and we believe they will be equally important in developing the market for energy storage.

Our continued investments in remote monitoring will also play an important role in connecting new and existing end-users of both our home standby generators and our energy storage systems to dealers and other channel partners, thereby ensuring a high level of customer satisfaction and allowing us to further develop unique new sources of revenue as we work to monetize these installed bases.

This is certainly a market that will be global in nature as well.

And with our manufacturing and distribution footprint now serving over 150 countries, we think that we are in the unique position of being one of the few companies at this stage with the ability to develop and serve the energy monitoring and storage market on a global basis.

The energy landscape is set to undergo dramatic changes in the decade ahead as a result of rising costs, grid stability issues and environmental concerns.

The days of a home or a business owner buying power from the local utility in the same manner that has existed historically are coming to an end.

We believe the development of on-site power from a number of potential sources, including solar, wind, geothermal and gas power generation, will supplement or possibly even replace the current centralized power model over time.

The need to manage, monitor and store the power that is generated in this decentralized fashion has the potential to develop into an enormous market opportunity, and our recent acquisitions will help us dramatically accelerate the growth of this market and cement our role as a key player as it develops.

I'd now like to turn the call over to York to provide some further details on the first quarter results.

York?

Thanks, Aaron.

Before discussing first quarter results in more detail, recall that, effective January 1, 2018, Generac adopted the new GAAP revenue recognition standard.

Upon finalizing our accounting under the new standard, at the end of 2018, we've made certain immaterial prior quarter reclassifications to our consolidated statements of comprehensive income related to extended warranties.

Therefore, the prior period in our earnings release has been updated accordingly.

See our press release for more information related to these reclassifications.

Now looking at our first quarter 2019 results in more detail.

Net sales for the quarter increased 17.6% to $470.4 million as compared to $400.1 million in the first quarter of 2018.

Excluding the $14.9 million of contribution from the Selmec, Captiva and Neurio acquisitions and the negative impact from foreign currency, core growth rate during the quarter was approximately 15%.

Looking at our consolidated net sales by product class.

Residential product sales during the first quarter increased 14.4% to $217.8 million as compared to $190.5 million in the prior year quarter.

As Aaron mentioned, the current year quarter experienced very strong growth once again in shipments of home standby generators as end market demand for these products continue to be robust coming into 2019.

Shipments of portable generators, while still strong, were down in the current year first quarter versus the prior year, which included the impact of multiple winter storms that affected millions of people in the northeastern part of the United States.

Looking at our Commercial & Industrial products.

Net sales for the first quarter of 2019 increased 19.4% to $209.1 million as compared to $175.1 million in the prior year quarter, with core growth being approximately 17% when excluding the M&A contributions from Selmec and Captiva and the unfavorable impact from foreign currency.

Domestically, as Aaron discussed, we continue to see very strong growth from our telecom customers as they continue to harden their cell tower networks to protect them from power outages.

We believe this to be a prolonged investment cycle for these customers, which is underpinning our increased sales guidance for 2019.

Internationally, our C&I products grew 12% on an as-reported basis and 6% on a core basis when excluding the impact of the Selmec and Captiva acquisitions and the meaningful unfavorable impact from foreign currency.

This core sales growth came from market share gains and execution of synergies particularly from mainland Europe, the Middle East, China and Brazil.

In Latin America, we saw flat core sales growth during the quarter, given certain geopolitical headwinds that are impacting that region.

We also continued to make progress on fully integrating the Selmec acquisition into our Ottomotores subsidiary, resulting in the power generation leader in the Mexico market.

Net sales for the other products category, primarily made up of service parts and extended warranty sales, increased 25.8% to $43.4 million as compared to $34.5 million in the first quarter of 2018, with core growth of approximately 15%.

This strong core growth rate tracks with the rest of our business as the installed base of our products has expanded around the globe.

In addition, higher amortization of extended warranty deferred revenue also drove this increase.

Gross profit margin was 34.5% compared to 35.5% in the prior year first quarter.

A favorable sales mix shift towards higher margin home standby generator sales and price increases implemented since prior year were more than offset by the Selmec and Captiva acquisition mix and the realization of higher input costs.

In recent quarters, we have felt the impact of increased regulatory tariffs, logistics costs, labor rates and commodities.

Based on current market conditions, we believe many of these higher input costs are transitory in nature and should moderate as we enter the second half of 2019.

Over the long run, we attempt to mitigate the impact of higher input costs through pricing actions and profitability improvement initiatives.

Operating expenses increased $5.4 million or 6.3% as compared to the first quarter of 2018.

As a percentage of net sales, operating expenses, excluding intangible amortization, declined 180 basis points versus the prior year primarily due to improved operating leverage on the higher organic sales volumes.

The increase in operating expense dollars over the prior year was primarily driven by incremental variable OpEx on the strong sales growth, an increase in employee headcount related to our lead gas and connectivity strategic initiatives and additional recurring operating expenses from recent acquisitions.

These items were partially offset by lower international operating expenses, which were impacted by the weaker euro.

Adjusted EBITDA attributable to the company as defined in our earnings release was $85.1 million in the first quarter of 2019 as compared to $70.2 million in the same period last year.

Adjusted EBITDA margin before deducting for noncontrolling interests was 18.5% in the quarter as compared to 17.9% in the prior year.

This 60 basis point increase compared to prior year was mostly due to the previously mentioned improved operating leverage on the organic increase in sales, which helped to offset the impact of higher input costs.

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

Domestic segment sales increased 18.7% to $359.2 million as compared to $302.7 million in the prior year quarter.

As I previously discussed, this significant increase reflects strong end-market conditions for our home standby and C&I stationary generators driven by higher power outage severity and a favorable economic environment.

Adjusted EBITDA for the segment during the quarter was $81 million or 22.5% of net sales as compared to $65.5 million in the prior year or 21.6% of net sales.

International segment sales increased 14.1% to $111.1 million as compared to $97.4 million in the prior year quarter, including $14.3 million of contribution from acquisitions and a foreign currency headwind of approximately 6%.

Core sales growth was approximately 6% due to strong growth across our Pramac subsidiaries as we continue to drive market penetration across the globe.

Adjusted EBITDA for the segment during the quarter before deducting for noncontrolling interests was $6.2 million or 5.5% of net sales as compared to $6.3 million or 6.5% of net sales in the prior year.

Now switching back to our financial performance for the first quarter of 2019 on a consolidated basis.

GAAP net income attributable to the company in the quarter was $44.9 million as compared to $33.6 million for the first quarter of 2018.

GAAP income taxes in Q1 2018 were $11.4 million for an effective tax rate of 25.3%.

This compares to GAAP income taxes during the first quarter of 2019 of $15 million or an effective tax rate of 24.7%.

The modest year-over-year decline in the GAAP tax rate is primarily due to fluctuations in pretax earnings mix as we generated more profits in lower tax jurisdictions in the current year.

Diluted net income per share for the company on a GAAP basis was $0.76 in the first quarter of 2019 compared to $0.42 in the prior year.

The specific calculations for these earnings per share amounts are included in the reconciliation schedules of our earnings release.

Adjusted net income for the company as defined in our earnings release was $56.5 million in the current year quarter or $0.91 per share versus $46.1 million in the prior year or $0.74 per share.

The strong sales growth and related improvements in operating earnings just discussed were partially offset by higher cash income taxes during the quarter.

With regards to cash income taxes, the first quarter of 2019 includes the impact of a cash income tax expense of $10.5 million as compared to $5.4 million in the prior year quarter.

The current year reflects a cash income tax rate of 17% for the full year 2019, while the prior year first quarter was based on a cash tax rate of 13% for the full year 2018.

This increase in cash tax rate is due to a higher level of expected pretax earnings in fiscal 2019 versus fiscal 2018 at this point of time last year.

Cash flow from operations was $14.6 million as compared to $29 million in the prior year first quarter.

And free cash flow as defined in our earnings release was negative $600,000 as compared to $23.3 million in the same quarter last year.

Higher operating earnings in the current year quarter were more than offset by increased incentive compensation payments related to fiscal 2018 performance and higher levels of capital expenditures.

In addition, inventory levels increased approximately $44 million during the quarter as we continue to build stock for the peak season across the majority of our product categories and due to pull-ahead of purchases to avoid potential regulatory tariff increases.

We expect to monetize the majority of this inventory build in the coming quarters as demand picks up in line with normal seasonality.

Taking a look at our balance sheet.

On January 1, 2019, we adopted the new GAAP lease accounting standard.

This new standard requires that we recognize right-of-use assets and lease liabilities related to operating leases on our balance sheet.

As a result, we recognized approximately $40 million of additional other assets and other long-term liabilities on our balance sheet in Q1 to adopt the new standard.

As of March 31, 2019, we had a total of $930 million of outstanding debt net of unamortized original issue discount and deferred financing costs.

Our gross debt leverage ratio at the end of the first quarter was 2.15x on an as-reported basis.

Additionally, at the end of the first quarter, we had $161.3 million of cash on hand, and there was approximately $285 million available on our ABL revolving credit facility.

Both our term loan and ABL facilities mature in the year 2023.

With that, I'd now like to turn the call back over to Aaron to provide comments on our updated outlook for 2019.

Thanks, York.

As we have discussed, our end market conditions for domestic, residential and C&I products remains strong and better than expected.

In addition, our recent acquisitions of Neurio and Pika have accelerated our entry into the energy management and storage market.

As a result, we are raising our guidance for revenue growth for full year 2019 as we now expect net sales to improve between 5% to 9% depending on the severity of power outages during the year, which is an increase from the 3% to 7% growth previously forecast.

On a core basis, full net year sales growth is expected to be approximately 3% to 7%, which is an increase from the 2% to 6% core growth previously expected.

Seasonally, we now expect net sales in the first half of the year to grow approximately 12% to 14% on an as-reported basis and 9% to 11% on a core basis.

For the second half of 2019, we expect net sales growth to be approximately flat to up mid-single digits on an as-reported basis.

The low end of the range would assume no major power outages and an average baseline outage environment, while the high end of the range would assume more elevated outage activity, which could include a major power outage event during the second half of the year.

Net income margins before deducting for noncontrolling interests are now expected to be between 10.5% to 11.5% for the full year, with adjusted EBITDA margins, also before deducting for noncontrolling interests, now expected to be between 19.5% to 20.5% for the year.

Importantly, the low end of the range would assume no major power outages and an average baseline outage environment, and the high end of the range would assume more elevated power outage conditions.

The modest decline in margin expectations compared to our previous guidance is primarily driven by the Neurio and Pika acquisitions and a higher mix of C&I product sales.

As we enter the market for energy management and storage, we plan to further expand our product development efforts and build-out the infrastructure needed to commercialize and penetrate this market.

While we expect these initiatives to be slightly dilutive to earnings in the near term, we believe the strategic importance to be significant as the macro opportunity for energy management and storage should grow quickly in the future.

Consistent with historical seasonality, we expect adjusted EBITDA margins in the second half of the year to be relatively higher to the first half, with the sequential improvement now anticipated to be approximately 250 to 400 basis points depending on the power outage environment experienced during the year.

This improvement in adjusted EBITDA margins in the second half is largely due to improved operating leverage and sales mix, realized benefits from our profitability enhancement program and favorable trends with input costs as we expect logistics, commodities and currencies to moderate into the back half of the year.

Lastly, stock compensation expense is now expected to increase to approximately $16 million to $17 million primarily as a result of our recent acquisitions.

The remaining guidance items previously provided during our last call are not expected to change.

For full year 2019, operating and free cash flow generation is once again expected to be strong and follow historical seasonality, benefiting from the solid conversion of adjusted net income to free cash flow, which is expected to be over 90% for the year.

This concludes our prepared remarks.

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

Operator?

(Operator Instructions) Your first response from the line of Jerry Revich of Goldman Sachs.

This is Ben Burud on for Jerry.

So just you guys were very active with M&A this quarter.

Going -- for the go forward, do you have the full suite of products that you think you need to execute on your strategic focuses?

And -- or do you still remain in the marketplace for any missing pieces that you need to fill out the portfolio?

And can you kind of, as well, give us a time frame of profitability across those different businesses?

Yes, that's a great question, Ben.

While we don't give specific comments on our pipeline, we have been very active.

I think the Neurio acquisition represented our 14th or 15th acquisition here in the last 7 years.

And more recently here, as indicated by our prepared remarks, we've been very focused on both building out our capabilities geographically but also into some of these newer spaces like energy monitoring and storage.

With respect to your question, do we have all the pieces, I think that we have a lot of great pieces.

In fact, I think the pieces that we have acquired really give us the position that we desired to go after this market with a lot of vigor.

That being said, I think there are some other areas that could be potentially bolted in to augment some of those things in energy management and energy storage.

I won't comment specifically on them here.

But we are continuing to look at that space, our pipeline is full of a number of potential companies that could give us some additional opportunities there, whether it be in the Commercial & Industrial spaces or whether it be in certain aspects of the management or monitoring, I think that there are a couple of things that we could do there.

Also geographically, I would say, Captiva, which we did in the first quarter, was a way for us to get an entry point into India, which we had not had prior.

There are a couple of areas of the world where we still feel we have -- where we lack representation.

So I would say that our pipeline also would have the types of acquisitions there that would give us the kind of manufacturing and distribution footprints that we think are important for us to be successful in these areas.

As far as the question of profitability on these acquisitions.

Again, most of them are fairly small in size.

So they don't have an outsized impact in terms of dilution.

We did call out a little bit of dilution here with EBITDA margins as a result of the recent acquisitions, but it's minor.

It's quite small.

I think in terms of the strategic importance of what we've done, we feel very good about that being a really solid investment for the company and for our future.

And that's going to ramp quickly.

When we look at all of the indications around the energy monitoring and the energy storage market, the people who have been tracking this for a number of years, I think what really caught our eye is just how quickly it expanded last year.

That entire market, which is admittedly small, so you're working off of a small base, but it doubled last year, and it's projected to double again this year.

And so we think that there is a -- there's going to be a pretty fast ramp here.

And so while in the near term it may be dilutive, the impact, I think, certainly over the long term, our view is it's going to be very accretive to the overall enterprise.

Got it.

And then in the mobile business, I believe in the prepared remarks, you called out a shift in volumes at rental customers into later quarters.

Can you just maybe elaborate on that?

And then can you give us an idea of how you get visibility of those volumes actually coming through in the coming quarters?

Yes.

It's another good question.

That industry is, at least for us, with our share, we're probably over-indexed to the national account customers there.

In fact, in our prepared remarks, we actually -- we like to see some of the independent rental house growth that we saw, that's a good kind of, I would say, counterweight to the national accounts.

National accounts are great, we love them.

We serve them very well.

We think we have a unique formula to doing that.

It's why we think we serve, in places like the telecom space and others, we serve major customers like that in the retail spaces.

We do a very good job of that, and the rental space is no different.

But they were a little bit slow to get out of the gate this year, 1 or 2 of them in particular.

And what we've seen is we've seen order rates here pick up recently.

So that's why I think we have the confidence to say that that's going to be something that's coming in the back half of the year.

And we have a lot of dialogue with those rental houses as well.

So I think we have pretty good visibility on what's going to happen, it's not perfect, obviously things can change.

But at least based on what we see today, we would see quarter-over-quarter growth going forward -- year-over-year growth, excuse me, in the quarters ahead and full year growth, as a matter of fact, as well for that product line.

Your next response is from the line of Jeff Hammond of KeyBanc Capital.

Just good quarter in home standby.

Just can you just update us on what you're seeing in terms of activations and inquiries?

And what that suggests for kind of pipeline into 2Q?

And can you just talk about if weather -- weather seemed to be impacting a lot of companies.

Did it help or hurt you in terms of ability to install, et cetera?

Yes.

Good question, Jeff.

What we're seeing today, we continue to see strength in activation rates on home standby.

In-home consultations, a little bit of moderation there, but that's only because the comps got really large versus last year.

We had the nor'easters in the back half of Q1, so a lot of IHC activity at this time last year.

That being said, we're holding our own on IHCs, and when you -- in particular, when you compare it to previous years, it's quite a bit elevated.

So that gives us a lot of confidence that the trend is going to continue.

And probably more importantly is field inventories are extremely lean for home standby.

I think what has happened here is our teams have -- we've tried to be very disciplined around the promotional environment for that category.

I think in years past, we would have maybe scheduled a national promo in the Q1 type timeframe, we didn't do that this time around.

We did some promoting at our national conference this year, which was well attended, by the way, over 2,500 dealers, just an amazing conference, but we had -- we did a little bit of promoting there.

But by and large, it's really surprised us in terms of the underlying strength.

And so we've been disciplined here.

And that discipline, though, has worked to kind of drain some of the field inventories out as, I think, our channel partners maybe wait us out a bit for a more promotional environment.

And I think, if seasonality plays out the way that it would, we're going to do some promotion, of course, as we would seasonally, and we've got a national promotion scheduled here in Q2.

But we like the trends that we're seeing.

And as far as weather's impact, weather obviously, it's kind of an interesting thing, for some companies it hurts them.

For us, it can help as long as there's outages that go with it.

I think when it gets really cold and when there's a lot of snow, there's difficulty in installing products.

And maybe where it hurt our business this year, in fact, if I call out anything in Q1, we actually didn't talk about it in prepared remarks, but our chore business was softer in Q1 really as a result of just a slow start to spring, especially here up here in the upper Midwest, I'm not sure we're ever going to see spring.

But it actually snowed this past weekend, which to call the weather poor would be, I think, generous.

But the weather has been off to a slow start with spring, and that was a little bit of a downer for the chore products business, which depends on that warmer weather to really kind of kick into season here.

Thankfully, in the last couple of weeks, we've seen some nice signs there.

I think it's been quite a bit warmer in other parts of the country just not quite up here yet.

But weather, I wouldn't call it a headwind nor a tailwind, I think, in Q1, I think it was pretty balanced across the entire enterprise.

Okay.

And then just coming back to the acquisitions and the strategy.

One, just as you look at Neurio and Pika, like what's the mix of commercial versus res?

Is it mostly res?

Kind of how do they go to market?

How do you kind of put it together with your home standby and your dealer network?

And just trying to -- wondering how that all comes together as you pull it all together.

Yes.

And that's obviously the area of focus and one of the things that we really like about this.

So your first part of your question, residential versus commercial, the majority of what Neurio and Pika are focused on is residential in nature.

That being said, Pika has commercial-oriented products as well.

These are both pretty -- they're not necessarily new entities, per se, in terms of age, relatively young in terms of a decade old or sooner than that, but they haven't quite gotten a ton of systems out there.

Now Neurio has delivered a couple hundred thousand of their energy monitoring devices into the market, and their newer energy monitoring and management devices will be just hitting the market here more recently.

The go-to-market strategy is pretty clear, though.

What we're going to do is we're going to take that big page out of the playbook of home standby, and we're going to run those plays.

It's a student body right all day long there in terms of awareness, availability and affordability.

So focusing on omnichannel distribution, so taking these products to retailers, to wholesalers, on a direct basis to our contractors, our direct channel.

It's going to introduce us to new channel partners, potentially, in the solar industry.

The area of first interest for us is people that already have installed solar systems.

There are roughly 2 million solar installations around the U.S., and only 2% of those installations actually have a battery backup system.

The addition of a battery backup system has come down nicely in price over the last several years.

And with the addition of that, you can dramatically improve the payback on your -- the money you've already invested in solar.

And it gives you a lot more flexibility.

And you couple that with Neurio's monitoring and energy management, and what you get is not only a way for people to improve the payback on their solar systems and get more control, but in it can help them actually save on their energy bills.

And this is where we think the big differentiating factor between what we've done with home standby.

So this is where the playbook deviates.

Home standby is all about reliability, it's about long-term outages and major outages.

That's a -- and grid stability type issues.

That's an industry that's fundamentally different than what we see forming here with energy management and storage.

We see this as being about energy savings, we see this about -- being about the changing energy landscape that I mentioned in my prepared remarks.

And so, using our distribution, our 6,000 dealers, the 1,400 rooftops that we have for wholesalers, the thousands of points of light that we have in retail and other channel partners to push these products into.

We look at the people who are doing this today in energy storage and energy monitoring, they don't have nearly the developed distribution that we have.

They don't have nearly the capabilities in consumer marketing, targeted marketing that we have developed.

And we've developed that certainly because of home standby.

They don't have the in-home selling capabilities that we have.

The tools that we've developed like Power Play.

And so we think putting all that together is going to be really critically important in developing that market.

And I would say one last comment on this point.

The Western part of the U.S. is where you're seeing a lot of activity around storage.

That's not necessarily a strong market for us in home standby historically.

Power quality is a little bit better, although recently it's kind of broken down in California because of some of the issues around grid stability and issues with PG&E in particular.

PG&E made an announcement earlier this week that their grand plan for heading off wildfires is when the wind blows, they're going to shut off the grid to 5.5 million people for maybe days at a time.

That could obviously develop for us into a nice home standby market because a battery is not going to get you days of backup.

But that being said, I think we can have -- that market is going to be a great complementary market for us with home standby and with the storage markets to develop.

And so we're going to be very focused on growing a market that, up until this point, I don't want to say we've ignored it, but it just really hasn't been there for standby.

So I think it's going to be a nice complementary region of the country to what we're already doing everywhere else.

Your next response is from Christopher Glynn of Oppenheimer.

Wondering if anything is happening with resale and upgrade, curious what proportion of standby today is replace and upgrade versus expanding the penetration rates?

And what kind of movement you're seeing along those lines?

Yes.

It's another area we watch, we track it very closely.

We have the ability to do that with all the data in our activation data and homeowner file that we have here.

So I think we have a very good view on this.

And we see a reliable march upward in replacement.

The category's been around 20 years now.

And in fact, some of the older parts of the market are starting to hit that 20-year mark, and the life expectancy of these products is between 10 and 20 years pretty reliably.

And as we get into that, today it's -- about 5% of the sales that we experience in home standby are for -- that we can tie directly to replacement.

But every quarter that goes by, it is pretty cool because you can kind of see it just in the math, we see a reliable march upward in that number.

It sounds good.

And question on the dynamic around the kind of wave emerging around 5G and overall telecom backup.

What's your view of the duration of this?

It seems like it might be sticky for a while.

And corollary to that, how accessible is the international opportunity for telecom customers given your footprint and legacy incumbents outside the U.S.?

Right.

So I would say and I think I may have mentioned in my prepared remarks an extended cycle, an extended upcycle that we're entering here.

When we've seen this in the past, and we've been serving this market now for over 30 years with backup power.

So we have long-standing relationships, we have a lot of cycles we've been through both up and down.

And typically, when we enter a cycle like this -- and we really entered it kind of in the back half of last year, we really saw it start to pick up beginning last year into the back half, and it really has picked up steam here in Q1.

That has generally, historically, based on our experience, that's been a couple of years of a run as those -- just the project cycles themselves, for them to acquire the equipment -- the carriers to acquire the equipment, actually get the project management together and get the installations in as they build out those networks, as they harden those networks, it generally runs several years.

So 2 to 3 years might not be out of bounds in terms of what to think about that.

Now obviously things can come and go that can change that.

If there are economic conditions that change, if there are -- M&A activity sometimes can put a pause on those activities.

If there's rationalization of network assets and things like that to be had in an acquisition or in M&A.

But we think it's going -- we're headed into an up cycle here.

Your second part of your question on the international opportunity, how accessible is that.

I'll address accessibly in 2 ways.

One, accessibility in terms of our footprint, I think this is the beauty of what we've been doing internationally.

We have added a tremendous amount of footprint to the company in terms of manufacturing footprint and distribution footprint globally, a footprint that didn't exist 4, 5 years ago, we had none of that.

Today, it's over 20% of our total revenues are coming from outside the U.S. and Canada.

And that's the raw accessibility in terms of just having a physical presence there.

Now accessibility in terms of making those relationships and creating those partnerships and how do we win, how do we unseat some of the incumbents that may be serving the market today.

A good example would be Selmec, the acquisition we did down in Mexico, a classic example.

We already owned a company down there, Ottomotores, that we bought I think, roughly, what, York, 5 or 6 years ago?

6 years ago, we acquired that company, but they really weren't in the telecommunications space, they didn't have any relationships, they weren't serving that market with the right product.

Selmec on the other hand is -- that's squarely in the bull's eye of not only their customer base but also their product offering.

And so the acquisition, the combination of those 2 companies has put us -- has vaulted us to the #1 position in Latin America in telecom.

So you juxtapose that against our #1 position in North America, U.S. and Canada, serving the telecom market.

And we look at what Pramac is doing.

Pramac's always kind of dabbled in it, but they've never, I think, focused on it as much as we're intending to focus on it as a global enterprise here.

We're building a team globally that -- we have our regional teams, but we're building a team globally to both look at the products that we offer, because they do differ regionally, but also those relationships.

What we're finding is interesting is that you see some of the relationships with the international -- or the U.S.-based carriers.

Those U.S.-based carriers are actually starting to branch out internationally.

And so we're trying to leverage those relationships where it makes sense.

So in terms of trying to unseat a new -- an incumbent, we may not have to unseat somebody because the carrier themselves may be new to that market, and we may already be a preferred supplier to them either in Latin America or in the U.S.

So obviously, we have a lot of work to do and it's a longer-term play.

But we think that the telecom market, in particular, is just one of those verticals that's -- it's not going away.

The U.S. market is 300 cell sites -- 300,000 cell sites, 100,000 of which have backup power, 200,000 don't.

So penetration is maybe 1/3.

But 5G, if you're going to have 5G technology, and if people are going to drive around in automated cars, and we're going to have all kinds of artificial intelligence and other high-functioning things going on technologically, 5G has to be completely uninterrupted, completely.

I mean, you can't have -- if a hurricane comes through, you can't lose mobility, you can't not drive, or if you've got a cell site that goes down.

So these networks, they're being architected differently, they're being hardened differently, and we see ourselves being a big participant in that on a global basis.

Your next response from the line of Chip Moore with Canaccord.

Congrats on the strong momentum.

Maybe one area we didn't touch on was health care.

I think you called out some good demand there.

Maybe you can update us on some of the trends you've seen in that market?

Yes, health care remains another important vertical for us.

And you're right, Chip, I didn't mention it this morning directly maybe out of respect of time for everybody, just we had so much to talk about.

But the health care market has been good.

It's been one of those verticals that continues to grow.

It's actually a vertical where we're focused on a more direct basis in engaging with those customers.

And this is maybe a bit different from our normal industrial distribution channel, where we would go through our fixed distributors, we've got about 25, 30 fixed distributors across the U.S. and in other parts of the world, for that matter, where we sell products through.

But there are certain verticals, telecom being one of them, as we've talked this morning, but also health care, where we'll sell on a direct basis because we believe that that's how those channels want to buy, frankly, in terms of -- and they need to be served because of the breadth of the offering they need and also the breadth of coverage that they desire.

More specifically, the Florida health care opportunity that we've talked about coming off of the events of the last couple of years, there were some regulations that were put in place.

A lot of companies had to comply with those regulations for critical care facilities by the end of the year so that they can have backup power that not only backs up certain critical circuits but also HVAC, which was, I think, the miss in previous regulations.

And the addition of HVAC obviously adds quite a bit of additional power needed -- power needs and the generators grow in size considerably.

That went into effect at the end of the year, but there were a lot of waivers issued to a good number of facilities down in Florida.

And so that leaked over here into the first quarter, we did see some more volume here.

And that will probably kind of run its course as we get through the second quarter of this year.

But we're starting to see, interestingly enough, as we kind of thought this might play out, there are several other states that are looking at adopting similar regulations as Florida.

Now, it might be hard to argue that the critical care facility market is bigger outside of Florida than it is there.

That's a big market there, there's a lot of -- just given the demographics and everything else.

But obviously, as we see that -- and what we think will probably play out over time is, on a national basis, we'll see regulations change in a similar fashion because, honestly, it's the right answer.

So we continue to talk to people about that.

What we really like about that is the traditional solution of diesel gensets, we're able to convince many of these critical care facilities that gas is a better solution.

There are some regulations on the books that make that a little harder, but we're working to change those as well to make gas an acceptable substitution both economically but also from a regulatory standpoint.

But it's a very good vertical for us in the future.

(Operator Instructions) Your next response is from Brian Drab of William Blair.

Just a quick modeling question, first, on Pika and Neurio.

You're not giving us the revenue, but I think what you're signaling is that these are going to add maybe about a point to revenue growth, so these are each maybe like in the $5 million to $10 million revenue range.

Am I far off there?

Yes, that's fair.

Like Aaron said, these are more startup businesses that are getting into this emerging category.

So their revenues are in that range, Brian.

Right.

And I understand the point here is the technology and building the portfolio.

I'm just...

The team and the technology, that's what we're after.

Right.

Got it.

Unfortunately, I have to build a model and nail down the details.

That is unfortunate.

And we'd like to think, longer term, when we've got to build these models as well.

So, on the mobile market, Aaron, you talked a little bit about that.

And can you talk about what percentage of total revenue now is tied to energy?

And are you seeing -- is this a lot to do with kind of the reduction activity in the Permian?

And do you need the -- as a lot of companies do, for that pipeline capacity to come on in the second half of the year and activity to start up before you see recovery?

Or is not so much that specific event that's causing your challenge?

Yes.

I mean, the energy piece is still a pretty small piece for us, Brian.

It's not -- I wouldn't call that out specifically.

It was more -- actually, I think the national account pullback was less about energy and more about just, I think, general rentals, the general rental market.

Just they were a little bit slow to get off the dime purchasing.

These guys have bought -- remember the national accounts have been doing -- they've been through a pretty strong re-fleeting exercise over the last couple of years.

So they're kind of absorbing all that fleet.

And actually, they would tell you their utilization statistics were a little bit soft in Q1 as they kind of were rationalizing some of this equipment.

So putting more out to pasture, so to speak, and getting out of the secondary market and kind of thinning out the herd a bit.

All indications are that they intend to be back in the second, third and the remaining quarters here, fourth quarter as well.

And I -- actually, that's on the back of firmer energy prices

What's going on in the Permian, we've actually been seeing a lot of opportunities in the Permian, actually, from our specialty rental guys who -- not the national rentals but actually the specialty rental companies have been -- we've seen a marked increase uptick here as we started the second quarter in natural gas gensets, which go -- are directly being used in those energy plays to generate power off of the flare gas and off the wellhead gas.

So we're seeing a nice lift there.

And I think, with the energy prices being in the ranges that they're at here, it's very supportive for a continued investment in the types of mobile equipment that we would typically see there.

And then that alongside, as I said, kind of the general rental market kind of getting going here.

What gives us a lot of kind of confidence there is that the independent companies were still buying in Q1.

We had inventory available, and we saw a nice -- actually a nice shift away from rental -- the national rentals and into the independent rentals.

So the market's there, I think it was just -- it's a purely a, in our view, a timing issue mainly attributable to just these national rental accounts from -- just from Q1 shifting into the later quarters.

Okay.

Got it.

And then just a quick -- York, you mentioned the tariffs that could come, that could create a new tailwind -- or new headwind.

Can you talk about what the worst-case scenario is there and what you're looking at?

I think what we've been paying -- the 10% tariffs on List 3 started up in, what, September of last year.

So we've been absorbing that for the last, call it, 6 months.

So what you're seeing run through our P&L is those tariffs.

Obviously, we reacted to those tariffs with pricing actions and whatnot.

But I guess, it's still yet to be seen if they negotiate away the threat of the 25% tariff.

But that isn't in our -- I guess, we don't have that necessarily in our math in our outlook statement.

But we have -- but what's running through our run rate today is the 10% tariff.

So it's -- and we've been absorbing that through pricing actions and other cost-reduction initiatives.

Your next response from the line of Stanley Elliott of Stifel.

Quick question on this energy management business.

Just to make sure I'm hearing it correctly.

It sounds like that with -- there's a stronger preference for M&A, one.

Two, on the SG&A side and then on the R&D side that, going through the distribution channel, we shouldn't see much of an -- a change there, and then the R&D piece, probably don't need to see much of a change.

I'm just trying to get a sense for how this business is going to look longer term.

Then, I guess -- then the last question would be kind of, with the growth rates that you're seeing right now, is there any way you could ballpark when maybe this becomes, I don't know, like 5% or pick a number of overall revenues?

Yes.

Stanley, just to kind of parse your question there.

So you're right, I don't think we need to add a ton in distribution in raw like headcount there.

Although, the western parts of the U.S., as I mentioned, today, we're pretty under-represented in in terms of distribution.

So I think, if we're going to put dollars towards distribution anywhere, it's going to be in that area.

I think, from the standpoint also, though, in sales and marketing effort, the way that we've built the home standby market, we developed in-home selling tools, we developed targeting marketing -- targeted marketing types of approaches, I think we can leverage a lot of what we've already created there, but we still will have to buy media to go out and develop that market, right?

So it's one thing to use what we already have.

It's another thing to deploy what we have aimed at a new market.

So it's not going to be at the same level of spend of what we're doing with home standby, but it will be an increase over where we're running today.

And that's what we've kind of, I think, at least begun to model here as we think about the future.

As it relates to product development, yes, we bought these companies because we like the products they have, the technologies they have.

But we need to continue to invest in that so we can build it out.

There are opportunities in the commercial space that we want to build out.

There are opportunities in new generations of products, battery costs continue to drop, technologies continue to change.

We've got to tie the products together with our existing home standby products.

So there is product development effort there and there's cost, obviously, whenever you talk about product development efforts.

So I wouldn't say it's 0, I wouldn't say it's massive because I think that's why we bought the companies.

But at the same time, it's something that we would say is probably reflected in our comments this morning in the way we've kind of phrased them.

Longer term, it's really hard to pin like what's 5%, but the market is forecasted to grow dramatically.

As I said, it doubled in 2018, that market is set to double again in 2019.

We're going to have an Investor Day later on this year, and I think we'll talk a little bit more about this market as we continue to learn about the trajectory there, how we want to approach it.

I think we have some really solid ideas on it, and that's why we've done what we've done here, and we're very bullish on the future.

When does it hit kind of critical mass, when does it hit 5%, when does it hit 10%?

You're probably, realistically, it's probably 3, 4, 5 years out before you're closing in on numbers like that where it's meaningful.

I do think that it's -- we think, in a couple of years' time, it will go from being dilutive to being neutral or accretive.

So I think that's realistic to think about.

And that won't take very long because we think the growth rates are such that we'll be on the other side of that equation pretty quick in our opinion.

It's a multibillion-dollar opportunity.

Yes, it's forecasted to be a multibillion-dollar market very quickly.

So we're really excited about it.

I mean, it represents a whole new area for us, and we -- look, we've looked for a long time for kind of, I'll call it, ancillary products that we could bolt into our -- this awesome thing we built in home standby.

We've looked at a lot of different things, and we just -- we haven't really found the right thing that fit naturally that didn't distract from what we were trying to be in home standby and actually fit with the channel and everything else we were trying to do in creating a market, market-creation type of activities.

This energy monitoring and storage market is spot on, and it could be huge.

It could be as big or bigger than home standby.

And if you look at the way it's projected it could be twice the size of home standby in not too long time -- not too long of a time.

So incredibly excited about it.

We really like where we're positioning here.

We think that the solution that we're putting together by taking Pika and Neurio and our expertise in power electronics, manufacturing and sourcing, putting all that together, we're going to get -- we're going to be able to bring to the market a very unique solution, a very differentiated solution from the solutions that are on the market today.

And that, I think, is going to give us a fantastic position to replicate what we've done with home standby.

I don't think it's going to take 20 years either.

I think we're going to be able to do it a lot faster because of all the learning cycles we have under our belt, and very bullish about that.

It's going to be pretty exciting stuff going forward.

I am showing no further questions at this time.

I would now like to turn the conference over to Aaron Jagdfeld.

Great.

Thank you.

We want to thank everyone for joining us this morning, and we look forward to reporting our second quarter 2019 earnings results, which we anticipate will be at some point early in August.

Thank you again for your time this morning.

Good day.

Ladies and gentlemen, this concludes today's conference.

Thank you for your participation and have a good day.

You may all disconnect.