Generac Holdings Inc

NYSE:GNRC

Earnings Call Transcript 2019-Q1

[Operator]

Good morning, ladies and gentlemen and welcome to the First Quarter Generac Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at the time. [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.

[York Ragen, CFO]

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'll make reference to certain non-GAAP measures during today's call. Additional information regarding these measures, including reconciliation to comparable U.S. GAAP measures, is available in our earnings release and SEC filings.

I will now turn the call over to Aaron.

[Aaron Jagdfeld, President & CEO]

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 [ph] acquisition, 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 continue 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 two 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 worked 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 remain very strong for the first quarter as activation and in-home consultations both paced well ahead of prior year levels. We have worked very hard over the last two 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 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 exist to further increase penetration and accordingly this remains a core tenant 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 end markets.

In particular orders and shipments of telecom related applications continue 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 our 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 number one 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'll be launching several new products specifically for the telecom market.

These will include a complete 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 be given another cycle in the will be launching several new product specific for the telecom market is going to complete 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 power systems that have traditionally been used in emergency backup applications. Strict 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 power 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 anticipate further expanding our product lines in 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.

This is another area where global growth has only just begun. The market for gas backup power has mainly been a US phenomenon developing over the last 30 years to the point where 40% of backup power market annually is now gas versus 60% diesel. Outside the U.S., the market for gas has not yet developed but we see many of the same characteristics that have been driving the growth in the US now beginning to exhibit themselves in many other parts of the world.

Higher diesel engine prices is 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 sets 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 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 mix was out negatively in the quarter our international segment EBITDA margin on the last 12 month basis, have increased to 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 gen sets for commercial and industrial applications continuing to grow. As these markets become more familiar with our gaseous product line 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 Technologies [ph] and Pika Energy. Recall that we announced the deal back on March 13 and the Pika transaction earlier this week. Using the powering our future strategic plan as our roadmap, these transactions represent a bold and decisive step forward for Generac. The market for - 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 and 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 two 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 cost 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 and 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 from home standby generators and we believe our experienced inner 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 another 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 under grow dramatic changes in the decade ahead as a result of rising cost, 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 that 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 new 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 would now like to turn the call over to York to provide some further details on the first quarter results. York?

[York Ragen, CFO]

Thanks Aaron. Before discussing first quarter results in more detail, recall that effective January 1, 2018, Generac adopted the new GAAP revenue of recognition standard. Upon finalizing our accounting under the new standard, at the end of 2018, we 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 real 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 northeastern parts of the United States.

Looking at our commercial and 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 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 continue 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 to 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 and 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 non-controlling 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 two reporting segments, domestic segments 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 and 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 non-controlling interest 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 pre-tax earnings mix as we generate 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 rates of 17% for the full-year 2019 or the prior-year first quarter which 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 pre-tax 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 rate of use assets and lease liabilities related to operating leases on our balance sheet. As a result, we recognize 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 2.15 times 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.

[Aaron Jagdfeld, President & CEO]

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 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 forecasted.

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 of 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 non-controlling interests are now expected to be between 10.5% to 11.5% for the full-year with adjusted EBITDA margins also before deducting for non-controlling interest, 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 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 for the year 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]

[Operator Instructions] Your first response in the line of Jerry Revich of Goldman Sachs.

[Unidentified Conference Call Participant]

Hi, good morning everyone. This is Ben [ph] on for Jerry.

[Aaron Jagdfeld, President & CEO]

Hi Ben.

[Unidentified Conference Call Participant]

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 give us well, give us a timeframe of profitability across those different businesses?

[Aaron Jagdfeld, President & CEO]

Yes, it's a great question, Ben. And 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 seven 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 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 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 that could give us some additional opportunities there whether it be in the commercial and 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 that's going to ramp quickly, when we look at all 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 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 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.

[Unidentified Conference Call Participant]

Got it. And then in the mobile business, I believe in the prepared remarks you called out a shift in volumes of rental customers into later quarters. Can you just maybe elaborate on that. And can you give us an idea of how you give visibility of those volumes actually coming through in the coming quarters?

[Aaron Jagdfeld, President & CEO]

Yes, it's another good question. That industry is at least for us with our share, we're probably over index to the national account customers there. In fact in our prepared remarks, we actually we'd 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 I think we serve in places like the Telecom spaces 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, one or two 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 dialog 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.

[Unidentified Conference Call Participant]

Got it. Thank you very much.

[Aaron Jagdfeld, President & CEO]

You bet.

[Operator]

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

[Jeff Hammond, KeyBanc Capital]

Hey, good morning guys.

[Aaron Jagdfeld, President & CEO]

Good morning, Jeff.

[York Ragen, CFO]

Hey Jeff.

[Jeff Hammond, 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 would seem to be impacting a lot of companies, did it help or hurt you in terms of ability to install et cetera? Thanks.

[Aaron Jagdfeld, President & CEO]

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 IFC activity at this time last year. That being said, I mean we're holding our own on IFCs and 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 Q1 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 2500 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 schedule here in Q2 but we like the trends that we're seeing and as far as weather's impact, weather obviously is 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. If I call it anything in Q1, we actually didn't talk about in prepared remarks but our core business was softer in Q1, really as a result of just a slow start to Spring. It's especially 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's been off to a slow start with Spring and that was a little bit of a downer for the core products business which depends on that 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, I wouldn't call it a headwind nor a tailwind I think in Q1 and it was pretty, pretty balanced across the entire enterprise.

[Jeff Hammond, KeyBanc Capital]

Okay. And then just coming back to the acquisitions and the strategy, one can 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 and wondering how that all comes together as you pull it all together? Thanks.

[Aaron Jagdfeld, President & CEO]

Yes, and that's obviously the area of focus and one of things that we really like about this. So your first part of your question is 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 two 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 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. And that's and grid stability type issues. That's an industry, that's fundamentally different than what we see forming here with energy management 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 1400 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 and consumer marketing, targeted marketing that we have developed and we've developed that circuit 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 are 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 the 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, what we're already doing everywhere else.

[Jeff Hammond, KeyBanc Capital]

Okay, good color. Thanks so much.

[Aaron Jagdfeld, President & CEO]

Thanks Jeff.

[Operator]

Thank you. Your next response is from Christopher Glynn of Oppenheimer.

[Christopher Glynn, Oppenheimer]

Thanks.

[Aaron Jagdfeld, President & CEO]

Hi, Chris.

[Christopher Glynn, Oppenheimer]

Good morning, I was wondering if anything's happening with resale and upgrade. Curious what proportion of stand by today is replace and upgrade versus expanding the penetration rates and what kind of movement, you're seeing along those lines?

[Aaron Jagdfeld, President & CEO]

Yes, thanks Chris. It's another area we watch, we track it very closely. We have the ability to do that with all the data and 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 that's 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 experienced in home standby are four 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.

[Christopher Glynn, Oppenheimer]

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.?

[Aaron Jagdfeld, President & CEO]

Right. So I would say and I think I may have mentioned in my prepared remarks, an extended cycle and extended up cycle that we're entering here, when we've seen this in the past and we've been serving this market now for almost 30 years with backup power, so we have longstanding 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 of 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 projects cycle 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 that they harden those networks. It generally runs several years, so two to three years might not be out of bounds in terms of what to think about that and 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 is rationalization of network assets and things like that to be had in an acquisition or in M&A.

But we think it's going to we're headed into an up cycle here. Second part of your question on the international opportunity, how accessible is that. I'll address accessibility in two 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, footprint that didn't exist, four or five 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 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, classic example and we already owned a company down there Ottomotores, that we bought I think roughly five or six years ago, six 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 two companies has put us vaulted us to the number one position in Latin America in telecom. So you juxtapose adding it to our number one position in North America, U.S. and Canada serving the telecom market and we look at what Pramac is doing, Pramac 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 incumbent, we may not have to unseat somebody because the carrier themselves may be new to that market and we may already be our preferred supplier them either in Latin America or in the U.S.. So obviously we have a lot of work to do in the longer term play but we think that the telecom market in particular is just one of those verticals that is 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 a third but 5G if you're going to have 5G technology and if people are going to drive around and 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 it can have if a Hurricane comes through, you can lose mobility, you cannot drive or if you get 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.

[Christopher Glynn, Oppenheimer]

Thank you, helpful.

[Aaron Jagdfeld, President & CEO]

Thanks Chris.

[Operator]

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

[Chip Moore, Canaccord Genuity]

Morning, hey thanks. Congrats on the strong momentum. Maybe one area we didn't touch on was healthcare. I think you called out some good demand there. Maybe you can update us on some of the trends you're seeing in that market?

[Aaron Jagdfeld, President & CEO]

Yes, healthcare 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 healthcare market's been good. You know 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 and 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 and 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 talked this morning but also healthcare where we will 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 Healthcare 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'll 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, I mean it might be hard to argue that the critical care facility markets bigger outside of Florida than it is there.

That's a big market, there is 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 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.

[Chip Moore, Canaccord Genuity]

Absolutely, thanks.

[Aaron Jagdfeld, President & CEO]

Thanks Chip.

[York Ragen, CFO]

Thanks Chip.

[Operator]

[Operator Instructions] Your next response is from Brian Drab of William Blair.

[Brian Drab, William Blair]

Hey good morning. Thanks for taking the question.

[Aaron Jagdfeld, President & CEO]

Hey Brian.

[York Ragen, CFO]

Good morning, Brian.

[Brian Drab, 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 - I think what you're signaling is that these are going to add maybe about point revenue growth. These are each maybe like in the $5 million to $10 million revenue range. Am I far off there?

[York Ragen, CFO]

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.

[Brian Drab, William Blair]

Right. And I understand the point here is the technology in building the portfolio?

[York Ragen, CFO]

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

[Brian Drab, William Blair]

Right, right. Got it. Unfortunately, I have to build a model and nail down the details.

[Aaron Jagdfeld, President & CEO]

That is unfortunate.

[Brian Drab, William Blair]

Yes, we'd like to think longer term, 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 reduction activity in the Permian. And do you need there's 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 it not so much that specific event that's causing you challenge?

[Aaron Jagdfeld, President & CEO]

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 is more. Actually, I think the National account pullback was less about energy excuse me 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 week 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 pass through 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 and in the second, third and the remaining quarters, your 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 special rental companies have been we've seen a marked increase uptick here as we start 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.

And 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 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 recap, the general rental market kind of getting going here what gives us a lot of kind of confidence there is that the independent companies we're 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 markets there, I think it was just it's a purely in our view a timing issue mainly attributable to just these national rental accounts from just from Q1 shifting into the later quarters.

[Brian Drab, William Blair]

Okay. Got it. And then just quickly, York you mentioned the tariffs that 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?

[York Ragen, CFO]

Yes, I think well we've been paying the 10% tariffs on list three started up in September of last year. So we've been, we've been absorbing that for the last call it six months. So what we'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 that isn't in our - I guess we don't have that necessary in our math, in our outlook statement. But what we have - but what's running through our run rate today is that the 10% tariffs. So it's and we've been absorbing that through pricing actions and other cost reduction initiatives.

[Brian Drab, William Blair]

Got it, okay, thank you very much.

[Operator]

Thank you. Your next response is from the line of Stanley Elliott of Stifel.

[Stanley Elliott, Stifel, Nicolaus & Company]

Good morning guys. Thank you for fitting me in. A quick question on this energy management business. Just to make sure, I'm hearing it correctly it sounds like that there is 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 change there and then the R&D piece, probably don't need to see much of a change I mean 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?

[York Ragen, CFO]

Yes, thanks 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 like headcount there, although the western parts of the U.S. as I mentioned today we're pretty underrepresented. 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 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 is 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 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, 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 zero. 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 - we would say is probably reflected in our comments this morning in the way we've kind of phrase 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 what 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 5%, when does it hit 10%, you're probably realistically it's probably three, four or five 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'll go from being dilutive to being neutral or accretive, so I think that's realistic to think about and that 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.

[Stanley Elliott, Stifel, Nicolaus & Company]

Multi-billion dollar opportunity?

[York Ragen, CFO]

Yes, it's forecasted to be a multi-billion dollar market very quickly. So we're really excited about. 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've built in home standby and we've looked at a lot of different things and we've just we haven't really found the right thing that fit naturally that didn't distract from what we're trying to do in home standby and actually fit with the channel and everything else we're 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 times, not too long the time. So incredibly excited about it. We really like our 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 can be able to do it 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.

[Stanley Elliott, Stifel, Nicolaus & Company]

Very interesting, indeed. Well thanks for the time and best of luck to you guys.

[York Ragen, CFO]

Thanks Stanley.

[Operator]

I'm showing no further questions at this time. I would now like to turn the conference over to Aaron Jagdfeld.

[Aaron Jagdfeld, President & CEO]

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.

[Operator]

Ladies and gentlemen, this concludes today's conference. Thank you for your participation and have a good day. You may all disconnect.