Generac Holdings Inc

NYSE:GNRC

Earnings Call Transcript 2022-Q2

[Operator]

Good day, and thank you for standing by. Welcome to the Second Quarter 2022 Generac Holdings Earnings Call. [Operator Instructions]. Please be advised that today's conference is being recorded.

I would now like to turn the call over to Mike Harris, Senior VP, Corporate Development and Investor Relations. Please go ahead.

[Michael Harris, VP, Corporate Development & IR]

Good morning, and welcome to our second quarter 2022 earnings call. I'd like to thank everyone for joining us this morning. With me today is Aaron Jagdfeld, President and Chief Executive Officer; and York Ragen, Chief Financial Officer.

We will begin our call today by commenting on forward-looking statements. Certain statements made during this presentation as well as other information provided from time to time by Generac or its employees may contain forward-looking statements and involve risks and uncertainties that could cause actual results to differ materially from those in these forward-looking statements. Please see our earnings release or SEC filings for a list of words or expressions that identify such statements and the associated risk factors.

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

[Aaron Jagdfeld, Chairman, President & CEO]

Thanks, Mike. Good morning, everyone, and thank you for joining us today. Our second quarter results were very strong with robust revenue growth, significant sequential margin expansion and all-time records in net sales, adjusted EBITDA and adjusted EPS. Shipments of home standby generators and global C&I products outperformed our previous expectations, primarily driven by continued progress on our capacity expansion and our team's ability to effectively manage the challenging supply chain environment.

Growth in adjusted EBITDA margins were also ahead of our expectations in the quarter, reinforcing our prior forecast of margins bottoming in the first quarter. Gross margins benefited from favorable product mix, largely driven by home standby generators. These dynamics drove adjusted EBITDA margin outperformance and sequential margin expansion, combined with impressive top line growth, resulted in an all-time quarterly record for adjusted EBITDA dollars.

Positive underlying demand trends led to continued backlog strength with C&I products and home standby backlog, both providing us with considerable visibility for the quarters ahead. Year-over-year, overall net sales increased 40% to $1.29 billion and grew sequentially from the first quarter of 2022, which was the previous all-time record. Strong momentum in core sales, which excludes the impact of acquisitions and foreign currency, continued in the quarter with 33% growth over the prior year.

Overall, residential sales growth was again very robust, driven by a substantial increase in shipments of home standby generators as well as the impact from recent acquisitions. The C&I sales increase was broad-based, led by growth across all channels domestically, all regions internationally and the contribution from recent acquisitions. Adjusted EBITDA margins expanded sequentially from 17.3% in the first quarter to 21% due to improved price realization and the moderation of input costs.

Importantly, we expect growing realization of previously announced price increases in the second half of the year, further execution on cost reduction projects and continued easing of input cost headwinds resulting in sequentially improving margins over the remainder of the year.

Now discussing our second quarter results in more detail. Shipments of home standby generators grew at an exceptionally strong rate over the prior year. Growth also accelerated sequentially from the first quarter as we continued to expand production and power outage activity in the U.S. as measured on a rolling 4-quarter basis at the end of the second quarter remained above the long-term baseline average. In addition to elevated baseline outage activity in the U.S., severe storms left more than 1 million utility customers without power in Ontario and Quebec in May, which resulted in robust leading indicators of demand in Canada as well.

Power grid stresses are expected to persist, with forecasts for the upcoming hurricane season pointing to another year of above-average activity and multiple grid operators warning of potential outages as a result of excessive demand coinciding with supply challenges. Home consultations or sales leads continue to point to strong underlying demand for home standby generators, growing at a mid-teens rate despite a prior -- a strong prior year comparable period driven by the Texas winter storm event in February of 2021. This demand was broad-based, with 4 or 5 regions experiencing year-over-year growth in home consultations in the quarter.

To frame just how much home standby baseline demand has grown over the last several years, second quarter home consultations were more than 4x greater than pre-COVID levels seen in the second quarter of 2019. Importantly, strength in this leading market indicator has continued here in the month of July. In addition, activations, which are a proxy for installs, continued to grow at a solid rate in the second quarter compared to the prior year, led by the South Central and Midwest regions as we further added to our residential dealer base as we ended the quarter with approximately 8,200 dealer partners.

We continue to make excellent progress increasing our production levels for home standby generators, with daily build rates dramatically higher as compared to prior year levels and ramping sequentially as our Trenton, South Carolina facility continues to expand capacity. As we have increased build rates, lead times have continued to improve, and we are getting product in the hands of our customers and channel partners in a more consistent and a more timely basis.

As a result of this progress, close rates on our sales leads have begun to improve, supporting our belief that reducing our lead times will improve our ability to capture more of the new and higher baseline of home consultations or sales leads within our sales pipeline. Our build rates and supply chain challenges have been the main growth constraint for the home standby category over the last few years. We have now ramped production capacity to the point that our lead times for the product category have materially improved.

However, the constraint has now shifted to the installation capacity of our dealer base, driven primarily by contractor labor availability, permitting and utility-related delays and shortages in certain materials needed to complete an installation. As a result, project lead times for homeowners, as measured by the time between the signed contract and the installation date, have not come down in proportion with our production lead times.

We have a number of initiatives focused on increasing installation bandwidth in the market, including aggressive campaigns to add new dealers to our network, cultivate and train non-dealer contractors on home standby installations and decrease the overall time associated with the project. Additionally, as housing construction activity begins to slow, we believe we have a greater ability to focus installing contractors on improving the pace of home standby installations.

I'd now like to discuss our increasingly diverse suite of clean energy products and solutions. With the closing and integration of the ecobee acquisition, and given the growing commercial sales synergies and cross-functional initiatives between residential energy storage and microinverters, monitoring and management devices and grid services solutions, we now have one of the broadest portfolios of clean energy products and solutions in the industry.

Net sales from these combined clean energy products grew well over 50% on an as-reported basis in the second quarter over the prior year. Macroeconomic uncertainty, input cost pressures, industry-wide supply chain and logistics challenges and lack of clarity around regulatory policy have impacted residential clean energy markets as of late. But rising prices for traditional energy sources and a growing focus on energy independence and security have the potential to more than offset these concerns and continue to drive adoption of alternative and emerging solutions over time.

Additionally, we're very encouraged by last week's announcement of the Inflation Reduction Act as a potential positive catalyst for demand, although it's still not fully through the legislative process. As we work to capture this demand, our residential clean energy installer network continues to grow as we ended the second quarter with approximately 2,800 trained and certified technicians, with approximately 1,150 registered dealers on our PowerPlay sales platform.

We remain excited about the new and innovative products we're bringing to market in 2022, including the recent product launch of PWRmanager and the pending launches of our PWRgenerator, which is the industry's only engine-driven battery charger, an AC coupling solution for our PWRcell storage product for use in retrofit applications and our new PV microinverter product called the PWRmicro. As expected, we began shipping PWRmicros for beta testing in June and are now working to expand beta testing with full commercial launch expected in the fourth quarter.

I'd now like to provide a quick update on ecobee. Integration is proceeding as planned, and we continue to make good progress in developing cross-selling opportunities for ecobee's hardware solutions through Generac's distribution partners. The ecobee team successfully launched 2 new thermostats with industry-leading features during the quarter. And high temperatures and rising energy costs across North America are driving increased interest in the smart thermostat category. Early reception on these new products has been encouraging, reinforcing ecobee's differentiated competitive position ,focused on intelligent, intuitive, feature-rich devices that maintain comfort while unlocking significant value creation and energy conservation for homeowners and grid operators.

This differentiation also drives significant market opportunity for ecobee's energy services offering, which has been further enhanced by synergies with Generac's grid services efforts. ecobee's installed base of more than 2 million connected homes is particularly valuable to grid operators seeking load flexibility and resilience. Consumer awareness of elevated energy market volatility is also driving potential growth for recurring services revenue as ecobee enables consumers to take advantage of variable rate pricing structures.

Additionally, we are beginning to leverage the amazing talent within the ecobee team to help accelerate the development of our residential energy ecosystem, a key element of our connected devices strategy.

Now expanding a bit more on Generac Grid Services, the team continues to drive momentum in its increasingly impressive and diverse sales pipeline, building on the recent success across software-as-a-service, turnkey and performance contracts as well as experiencing an increasing mix of hardware sales, which are proving to be a competitive differentiator for our Grid Services business.

From distributed generation and storage to load flexibility assets, our grid services suite of solutions is unmatched in the market. We announced a number of recent contract wins since our first quarter call that highlighted our expanding capabilities, including EV charging, monitoring and optimization, a turnkey program for low- and moderate-income households utilizing PWRcell energy storage systems and a unique solution for the German power market.

Utilities and grid operators continue to warn of potentially significant disruptions to the power grid as a result of supply/demand imbalances, underscoring the need for new technologies to decentralize and digitize the power grid through the development of virtual power plants or VPPs. As an example, this need was on full display during the recent heatwave in Texas, as a number of home standby generators enrolled in the VPP program were autonomously controlled by our Concerto software platform to take demand off the grid and help keep critical community resources online.

The market opportunity for residential energy storage and microinverters, monitoring and management devices and grid services solutions remains extremely compelling and we believe will prove to be a key long-term future growth driver for Generac. For the full year 2022, we expect net sales of these clean energy products and solutions to approximately double from the prior year to more than $500 million in sales, with strong core and inorganic growth contributions and an even larger opportunity in the years ahead.

Now let me make some comments on our C&I products, which also grew at a strong rate in the second quarter across nearly all end markets and geographies. Specifically, global C&I net sales increased 22% on an as-reported basis and 16% on a core basis as compared to the prior year. Strong growth in net sales for domestic C&I products in the second quarter was led by national rental equipment and telecom customers as well as our North American distributor channel.

We saw continued strength in demand during the quarter, which contributed to a further increase in our backlog for C&I products and supports our expectations for solid growth to continue in the category. Shipments of C&I stationary generators through our North American distributor channel also grew significantly in the second quarter, and improving close rates helped drive growth in orders and backlog in this channel. Strong momentum in quoting activity has continued as of late, highlighting the sustainability of demand trends for backup power for C&I applications.

Shipments to national telecom customers increased again during the second quarter as compared to the prior year as several of our larger telecom customers further invest in hardening their existing LTE sites and begin to build out their fifth generation or 5G networks. Telecom infrastructure upgrades remain one of the key megatrends we expect to drive growth for our business in the coming years.

We also experienced substantial growth with our national and independent rental equipment customers during the quarter. These customers have been investing heavily in equipment to refresh and expand their fleets, to serve increased commercial construction activity as well as other infrastructure projects, supporting a resilient demand environment for mobile products and the megatrend of the critical need for infrastructure improvements.

We also continue to see material traction in orders for Off Grid Energy's mobile energy storage systems from our key North American rental channel partners as they work to reduce the carbon footprint of their equipment fleets. Momentum remains strong across our domestic C&I channels and is being supplemented by emerging capabilities that support the long-term growth profile of the category. Specifically, we're establishing a strong reputation and applications beyond traditional emergency standby projects, driven by our ability to deliver customized turnkey solutions to serve this market.

Our unique hardware and software portfolio in this vertical is highlighted by expanding smart grid-ready features that allow connection to grid services programs. Large C&I generators can provide enhanced resiliency and stability for grid operators while simultaneously providing a tangible and meaningfully improved return on investment for the asset owners, which is driving demand for these solutions across a diverse range of customers.

Strong momentum also continued in our international segment, with total sales increasing 43% year-over-year during the second quarter, with 34% core sales growth when excluding the benefit of the Deep Sea and Off Grid Energy acquisitions and the unfavorable impact of foreign currency. The core sales growth was driven by strength across all regions, most notably in Europe and Latin America. The European region has seen strong demand across product lines as the heightened focus on energy independence and security that emerged following Russia's invasion of Ukraine has continued. But longer-term implications are uncertain as geopolitical and macroeconomic conditions in the region remain volatile.

International energy security concerns are not unique to Europe, and we are evaluating additional opportunities for home standby generators across multiple regions as a result. External sales in the Latin American region continued to grow at a solid rate, while intersegment sales grew substantially as our Generac Mexico operations continue to ramp production of telecom products for the North American market.

In addition to strong core growth, our recent international acquisitions, Deep Sea Electronics and Off Grid Energy reported impressive results in the second quarter. Demand for Off Grid Energy's mobile storage systems continues to grow across our global distribution footprint as we integrate the product offering through our commercial sales branches and channels. In addition, we have several product development projects underway within the C&I energy storage category, including expansion of the power capacity range of the mobile product lineup as well as potential stationary applications.

Concerns around power security and energy prices in key international markets underpin the opportunity for an increasingly broad storage product portfolio for C&I applications. Deep Sea also benefited from healthy global demand for advanced generator controls during the quarter. And we remain very excited about the additional engineering capabilities Deep Sea brings as we leverage the team's electronics controls expertise to advance product road maps across our enterprise.

Our international segment has also experienced much stronger profitability despite inflationary headwinds and supply chain challenges. Second quarter adjusted EBITDA margins expanded to 14.5% from 9.7% in the prior year period due to the accretive margin profiles of the Deep Sea and Off Grid acquisitions, improved overhead absorption and better operating leverage on significantly higher volumes.

In closing this morning, I'm extremely proud of our team's continued ability to deliver record results and maintain our 2022 outlook despite the developing uncertain economic environment. Our strong sequential margin improvement reinforces our expectation that margins bottomed in the first quarter of 2022 and will continue to improve throughout this year. Additionally, our recent refinancing has provided further liquidity to accelerate our evolution into an energy technology solutions company.

We remain focused on executing against our Powering a Smarter World enterprise strategy, and the megatrends supporting this strategy are as compelling as ever, many of which have the potential to decouple from the broader macroeconomic environment. Structural supply-demand imbalances facing the grid are not impacted by inflation, and increasingly severe and volatile weather cannot be slowed by higher interest rates.

The energy ecosystems that we are building for the future will give our end customers the ability to take control of their power security, lower their energy bills and reduce energy consumption while also helping utilities and grid operators to balance supply and demand. With our broad portfolio of products and solutions, combined with our services, our distribution, our brand and importantly, our expertise, Generac is uniquely positioned to lead the evolution to a more resilient, efficient and sustainable energy future.

I now want to turn the call over to York to provide further details on our second quarter 2022 results and our outlook for the year. York?

[York Ragen, CFO & CAO]

Thanks, Aaron. Looking at second quarter 2022 results in more detail, net sales increased 40% to $1.29 billion during the second quarter of 2022, another all-time record, as compared to $920 million in the prior year's second quarter. The combination of contributions from acquisitions and the unfavorable impact from foreign currency had an approximate 7% impact on revenue growth during the quarter.

Briefly looking at consolidated net sales for the second quarter by product class, residential product sales grew to $896 million as compared to $600 million in the prior year, representing a 49% increase despite a strong prior year comparable. Contributions from our clean energy acquisitions and the unfavorable impact of foreign currency contributed approximately 7% of revenue growth for the quarter. Home standby generator sales made up the vast majority of the residential product core sales growth, increasing by more than 50% over the prior year as we continue to expand production capacity for these products.

Commercial and industrial product net sales for the second quarter of 2022 increased 22% to $309 million as compared to $254 million in the prior-year quarter. Contributions from the Deep Sea and Off Grid acquisitions and the unfavorable impact of foreign currency had a net impact of approximately 6% on net sales growth during the quarter. The strong core revenue growth was broad-based, driven by growth across all regions globally and all channels domestically.

Net sales for other products and services increased 31% to $86 million as compared to $66 million in the second quarter of 2021. Contributions from acquisitions and the impact of foreign currency contributed approximately 13% of this revenue growth during the quarter. Strength in aftermarket service parts continues to be a key driver of the core sales growth in this category due to a larger and growing installed base of our products in the field, which is also leading to higher levels of extended warranty revenue. Also contributing to the increase was continued growth in our services offering in certain parts of our business.

Gross profit margin was 35.4% compared to 36.9% in the prior-year second quarter as the challenging supply chain and overall inflationary environment drove higher input costs during the quarter. Specifically, the lagging impact of elevated commodity prices and other surcharges, higher inbound logistics and expediting costs, increased labor rates, and continued plant ramp-up costs all pressured margins relative to the prior-year quarter.

The increasing realization of multiple pricing actions previously implemented and favorable sales mix partially offset these higher input costs. We're very encouraged that gross margins expanded 360 basis points on a sequential basis as pricing benefits increased and input costs began to ease during the second quarter, reinforcing our expectation that margins have bottomed in the first quarter.

Operating expenses increased $83 million or 53% as compared to the second quarter of 2021. This increase was primarily driven by higher recurring operating expenses from recent acquisitions and an increase in intangible amortization expense. Higher employee costs and additional variable expenses from the significant increase in sales volumes also contributed to the increase. Operating expenses, excluding intangible amortization as a percentage of revenue, increased approximately 75 basis points as compared to the prior year period due to the impact of recent acquisitions that have a higher operating expense load relative to sales as those businesses scale for future growth.

Adjusted EBITDA before deducting for noncontrolling interest as defined in our earnings release was an all-time record $271 million or 21% of net sales in the second quarter as compared to $218 million or 23.7% of net sales in the prior year. The decline in EBITDA margin versus prior year was driven by the previously discussed decline in gross margins and higher operating expenses. But again, we're very pleased with the 370 basis point sequential improvement in EBITDA margins relative to Q1 2022.

I will now briefly discuss financial results for our 2 reporting segments. Domestic segment total sales, including intersegment sales, increased 42% to $1.13 billion in the quarter as compared to $793 million in the prior year, with the impact of acquisitions contributing approximately 6% of the revenue growth for the quarter. Adjusted EBITDA for the segment was $242 million, representing a 21.5% margin as compared to $204 million in the prior year or 25.7% of net sales. The lower domestic EBITDA margin in the quarter was primarily due to higher input costs and the impact of acquisitions, partially offset by the increasing realization of previously implemented pricing actions and favorable sales mix.

International segment total sales, including intersegment sales, increased 43% to $203 million in the quarter as compared to $142 million in the prior-year quarter. Core sales, which excludes the impact of acquisitions and currency, increased approximately 34% compared to the prior year. Adjusted EBITDA for the segment before deducting for non-controlling interests was $29.5 million or 14.5% of net sales as compared to $13.7 million or 9.7% of net sales in the prior year. The significant expansion in international EBITDA margins was primarily due to strong margin contributions from the Deep Sea and Off Grid Energy acquisitions and improved overhead absorption and operating leverage on significantly higher sales volumes.

Now switching back to our financial performance for the second quarter of 2022 on a consolidated basis. As disclosed in our earnings release, GAAP net income for the company in the quarter was $156 million as compared to $127 million for the second quarter of 2021. GAAP income taxes during the current year quarter were $45.8 million or an effective tax rate of 22.5% as compared to $46.4 million or an effective tax rate of 26.6% for the prior year. The decrease in effective tax rate was primarily due to a discrete tax item in the prior-year quarter, resulting from a legislative tax rate change in a foreign jurisdiction that unfavorably revalue deferred tax liabilities by $7 million, which had an approximate 4% tax rate impact to the prior-year quarter.

Diluted net income per share for the company on a GAAP basis was $2.21 in the second quarter of 2022 compared to $2.01 in the prior year. Adjusted net income for the company, as defined in our earnings release, was $194 million in the current year quarter or $2.99 per share. This compares to adjusted net income of $153 million in the prior year or $2.39 per share. Recall from last quarter, and as disclosed in our reconciliation schedules in our earnings release, our adjusted net income and EPS for the current year no longer adjust for cash taxes due to the expiration of our significant tax shield that originated from our LBO transaction in 2006.

Cash flow from operations was $24 million as compared to $123 million in the prior-year second quarter. And free cash flow, as defined in our earnings release, was $6 million as compared to $96 million in the same quarter last year. The decline in free cash flow was primarily due to a much higher working capital investment in the current year quarter, partially offset by higher operating earnings. Inventory levels stabilized in the second quarter, so the higher working capital investment during the current year quarter was primarily driven by an increase in accounts receivable, given sequential sales growth and a reduction in accounts payable as we optimize inventory levels and purchasing patterns. We expect free cash flow conversion to return to the historical long-term average in the second half of 2022, resulting in approximately 90% conversion of adjusted net income to free cash flow.

We significantly enhanced our liquidity profile in the second quarter with the amendment of our existing credit facilities. This included establishing a new term loan facility in an aggregate principal amount of $750 million and a new revolving credit facility in an aggregate principal amount of $1.25 billion, which was unfunded at closing. Proceeds from the $750 million new term loan were used to prepay $250 million of the existing term loan B facility and to fully pay off the existing ABL revolving credit facility, which had $285 million outstanding at closing, with the remaining funds added to the balance sheet to be used for general corporate purposes.

Our new term loan A and revolving credit facility mature in June 2027. These new debt facilities will initially bear interest at SOFR plus 150 basis points through the end of 2022. And beginning on January 1, 2023, the applicable spread will range from 125 to 175 basis points, based on the company's total leverage ratio. Additionally, our existing term loan B does not mature until December 2026. We do not have any required principal payments on this facility until the maturity date, and it has a low cost of SOFR plus 175 basis points.

We also maintained our interest rate swap arrangements that fix our interest rate exposure on approximately $500 million of this debt through the maturity date of December 2026. As of June 30, 2022, we had approximately $1.72 billion of liquidity, comprised of $467 million of cash on hand and $1.25 billion of availability on our revolving credit facility. Also, total debt outstanding at the end of the quarter was $1.37 billion, resulting in a gross debt leverage ratio at the end of the second quarter of only 1.5x on an as-reported basis.

Before discussing outlook, I want to highlight that we've been repurchasing our shares opportunistically thus far in the third quarter. In fact, we have exhausted the remaining $124 million of share repurchase authorization that existed as of the end of the second quarter. As a result, on July 29, 2022, the company's Board of Directors approved a new stock repurchase program that allows for the repurchase of up to $500 million of our common stock over a 24-month period.

With that, I will now provide further comments on our outlook for 2022. As Aaron previously discussed, we are maintaining our sales growth and adjusted EBITDA margin guidance for the full year 2022. We continue to expect net sales to increase between 36% to 40% as compared to the prior year on an as-reported basis, which includes an approximate 4% to 7% net impact from acquisitions and foreign currency. This revenue outlook still assumes shipments of residential products increase at a mid- to high 40% rate during 2022. And revenue for C&I products is still expected to grow at a high teens rate compared to the prior year.

Looking at seasonality for the second half of the year. Revenue is expected to increase sequentially in both the third and fourth quarters, continuing the strong double-digit year-over-year growth trends, with fourth quarter sales levels up more modestly above the third quarter. Looking at our gross margin profile. As discussed, we expect that margins have bottomed in the first quarter. We continue to expect fourth quarter gross margins to recover back to first quarter 2021 levels in the 40% range, driven by increasing price realization, continued easing of inflationary pressures through the remainder of the year and further materialization of cost reduction benefits. This would result in gross margin percent for the full year 2022, to be approximately in line with 2021 levels, which is consistent with our previous expectations.

Operating expenses as a percent of sales, excluding amortization expense, for the full year 2022 are still expected to increase approximately 100 basis points compared to full year 2021, primarily due to the impact of recent acquisitions that have a higher operating expense load relative to sales as they continue to invest for future growth.

Adjusted EBITDA margins before deducting for non-controlling interests are still expected to be approximately 21.5% to 22.5% for the full year. From a seasonality perspective, adjusted EBITDA margins are projected to improve sequentially in the second half, primarily driven by improving gross margins as previously discussed, with fourth quarter 2022 adjusted EBITDA margins approaching 26%.

Several additional guidance -- themes that we provide to assist with modeling adjusted earnings per share and free cash flow require updating for the full year 2022. Our GAAP effective tax rate is now expected to be approximately 24% for the remaining quarters of the year, resulting in a full year 2022 GAAP effective tax rate of approximately 23%.

For full year 2022, we now expect interest expense to be approximately $52 million to $54 million, an increase from the previous guidance of $42 million to $44 million, reflecting our updated capital structure due to the refinancing of our credit facilities in June 2022. In addition, we have updated our interest rate assumptions to reflect the latest market expectations for SOFR in the second half of 2022. This assumes no additional changes in outstanding debt for the remainder of the year.

Depreciation expense is still expected to be approximately $54 million to $56 million in 2022, given our assumed CapEx guidance. GAAP intangible amortization expense in 2022 is now expected to be approximately $100 million to $105 million as compared to our previous guidance of the high end of the $95 million to $100 million range. Stock comp expense is still expected to be between $32 million to $34 million for the year.

Our full-year weighted average diluted share count is now expected to be in the low -- at the low end of the previous guidance range of approximately 65 million to 65.5 million shares, given our share repurchase activity in July 2022. Our capital expenditures are still projected to be approximately 2.5% to 3% of our forecasted net sales for the year. And as previously mentioned, free cash flow conversion is expected to return to historical norms of approximately 90% in the second half of the year. Finally, this 2022 outlook does not reflect potential additional acquisitions or share repurchases that could drive incremental shareholder value.

This concludes our prepared remarks. At this time, we'd like to open up the call for questions.

[Operator]

[Operator Instructions]. And your first question comes from Michael Halloran of Baird.

[Michael Halloran, Robert W. Baird & Co.]

So there's a lot of great content in there. Could you just help me triangulate with something? You're talking about backlogs that are starting to be filled, lead times coming down, at the same time, really good IHC consultations and you feel pretty good about the underlying demand environment. So could you maybe give some context to what that backlog bleed has looked like or what the inventory lead times look like? And maybe put that in context for the visibility that you have, how far out that tracks relative to a typical time line?

[Aaron Jagdfeld, Chairman, President & CEO]

Yes, Mike, this is Aaron. Yes, the lead times have come down now, on average, we're talking home standby category here, 8 to 10 weeks, which, again, is, I think, directly the result of our actions in increasing production and was always part of the plan, as we've talked.

What we're really encouraged by and what continues to pace ahead of kind of expectations here is the front-end kind of lead generation, the end market. I think there are a couple of catalysts there that we can point to that, I think, are probably at work.

The first would be the summer season here has come with it a number of high-profile kind of warnings, if you will, from utilities and grid operators about the potential for outages on shortfalls in supply, I mean, just raw supply not being enough to meet demand. So that's kind of 1 catalyst that's new this year.

A second one, obviously, we got a very aggressive forecast again here for hurricane season. It's been quiet so far but the season forecast was well above average. And then the third thing I would point to as a catalyst for why we think the end market is still very active in the category is really around this outage that happened in Canada. We don't talk about Canada as much as we probably should. It's a great market for us. It always has been. We have over 500 dealers up there.

It's actually -- it's a great market because from a demographic standpoint, fits quite well with the buyers of the category. But they suffered a pretty high-profile outage of 1 million utility customers in Ontario and Quebec about 1.5 months ago, it was. And that really has -- jumps off the page when you look at it in our statistics when we track by region.

We actually track some -- just a lot of data really down to the zip code level in areas. But it's interesting to see how much of an impact that had for us in that part of the world. So I would point to those things, again, end market demand very strong, but we continue to ramp production to bring that -- the lead times on the category down.

[Michael Halloran, Robert W. Baird & Co.]

The backlog part of that question then, Aaron? Where is the backlog rough and tough? And then maybe some thoughts on how far that visibility stretches out for you at this point?

[Aaron Jagdfeld, Chairman, President & CEO]

Yes. We've always said home standby visibility, usually, it's not very good, right, because we typically don't have a backlog. We've been in a backlog situation now for close to 2 years as we've been working to ramp production and tackle these supply chain challenges, which we've been doing. That backlog is still significant.

And in fact, we -- as we have said previously, we still expect to have a backlog by the time we exit this year. So even though we've got our ramp ongoing in production output, we're still not going to catch that by the end of the year. And we'll continue to bring the lead times down, but the backlog is still significant for home standby.

[Operator]

And your next question is from Julien Dumoulin-Smith, Bank of America.

[Julien Dumoulin-Smith, Bank of America Merrill Lynch]

So let me just come back to the gross margin question. Obviously, you guys reaffirming here the outlook and troughing off 1Q. Can you comment a little bit about some of the input cost reductions flowing through? How much latitude should that provide you as you look forward going into your longer-term outlook, '23-'24, et cetera? How much is that going to cascade? And also, can you speak a little bit more about repricing the backlog, the success and perhaps pricing trajectory given some of the moderation in the cost input here?

[York Ragen, CFO & CAO]

Yes, Julien, this is York. So we posted 35.4% gross margins in the second quarter. Very pleased with the sequential improvement off of Q1. And we are starting to see pricing read through. You mentioned repricing of the backlog. We did announce a price increase in April that repriced the backlog as of June 1. We still have some additional pricing that launched late last year that will flow through backlog into Q3.

But as our prepared comments said, if -- we posted 35.4% gross margin in Q2. Expect then to get closer to 40% by the end of the year. As we ramp that, what is that, 4% to 5% increase, about half of that sequential increase will be about -- half of that will be pricing, price realization continuing to come through, the other half being moderation of input costs.

When you look at commodities starting to roll over, we'll start -- we'll see the lagging impact of that. There's always a lag in our realization. As commodities move, there's always a lag. We'll start seeing some of that here in the latter part of the year. We're seeing inbound freight costs come down. Some of our expediting costs are coming down. Just getting our plants' absorption improve. We do have a number of just cost-out projects. We're working on our build and material of our products that will materialize in the second half. So all that supports and gets us comfortable with that progression of sequential margin improvement to the point where when we exit 2022 here, we'll feel very comfortable with our margin profiles, again back to where they were early part of 2021 before all this inflationary pressures happened.

[Julien Dumoulin-Smith, Bank of America Merrill Lynch]

Got it, yes. It sounds like maybe there's even more latitude there as you continue to compound with some of these benefits. But maybe just if I can pivot quickly, I know you said high teens for C&I. Just with respect to that business and obviously, there's a litany of reasons why you should continue to see some of that input. How is that trajectory going today? And how much is that helping some of the backlog commentary here to just continue to keep that at a robust level? I know that, obviously, the backlog here is normalizing for some of the factors from last year. But can you comment a little bit on C&I here and how that could complement the backlog?

[Aaron Jagdfeld, Chairman, President & CEO]

Yes. Julien, this is Aaron. The C&I business is -- we don't spend enough time talking about that business. It's a really great solid business that has been growing quite nicely and is really the benefactor of many of these megatrends we've been talking about. C&I products in particular, in a couple of areas, and I'll point them out.

Telecom, the telecom market for us, we are a significant share player in that telecom market. We supply all the major Tier 1 carriers here in the U.S. and many of the secondary and tertiary players as well. We have a diverse offering of product. We engineer and design specific solutions for specific network applications. So a lot of these gen-sets, you would think they're standard products and they are, but they're specific to a particular customer's network. So we'll customize around the needs of each network, which are different.

So that's 1 trend. And obviously, as the telecom companies are spending a lot of CapEx to harden their networks and build out the fifth generation networks, that -- we're benefiting from that trend and we think that, that will continue for the next several years at the very least.

The other 1 is in the rental space, the rental channel partners that we have, they're all re-fleeting. So they kind of went through a process after -- through the COVID cycle down where they reduced their purchases, obviously, with the uncertainty on what might happen. And then as the economy began to really come to life, as a result of a lot of the stimulus spending, they found themselves with fleets that were aged or undersized for the market requirements.

So we're a leader in -- when it comes to power generation, temporary lighting, temporary dewatering, heating, those types of applications. We've got a great product assortment that we sell to, again, all the major rental accounts. And that has been a -- that's proven to be a really great business.

And then just 1 other point I'll make, the International side of C&I. Most of our International business is C&I. We do have a nice growing residential business in there and we don't talk a lot about that, but we're seeing home standby activations around the globe, which is, I think, an indication of some of the power security issues that exist not only here in the U.S. but certainly everywhere.

But internationally, that business has done just incredibly well, and they've been doing well for several quarters now. And that's on the back of some of the energy security issues in Europe. But just, again, power security in general, whether you're talking about the conflict, the Russia-Ukraine conflict or whether you're talking about challenges in other parts of the world, we need power. We need a continuous source of power, and backup generation is going to be in demand for a long time. So that C&I business is great. Book-to-bill was positive in the quarter and backlog grew again.

[Operator]

And your next question is from Philip Shen of ROTH Capital Partners.

[Philip Shen, ROTH Capital Partners]

So some of our checks suggest that lead flow has dropped in -- certainly in some regions. I think some regions have a healthy lead flow but others are a little bit down, some of the lead flow might be down 25%, 40% from maybe 4 or 5 months ago. Can you talk about how that might serve as a leading indicator at all? I know you were talking about healthy IHCs, but lead flow at some level is -- precede that.

And then if you can touch on lead flow for the solar business as well. To what extent are -- when you kick -- when you started the solar business or when you're early into it, generating lead flow was a key point of differentiation. Where does that stand with your ability to create value for your dealers and so forth?

[Aaron Jagdfeld, Chairman, President & CEO]

Yes. Thanks, Phil. I'll unpack that here with a lot of it around -- or all of it around leads. Let's talk a little bit about home standby leads. Four out of 5 regions, they were up quarter-over-quarter and up big in some regions. The only region we saw a pullback was in the South Central region and that's Texas. Texas is the -- you take that February 2021 winter event out there.

And that's where if you are doing channel checks, you may find in Texas, I mean, they were so high a year ago. In fact, I would just point out that when we look at all of our states, just individual states, Texas was still the top state on just an absolute basis for us in the quarter. So even though the South Central region was off as a region and Texas off big within that region, actually, on an absolute basis, the number of leads we generated in Texas was the highest of any of the 50 states.

So I would think that if you're doing channel checks, that's the only region, at least based on our data. I think as we said before, we're really pleased to see the kind of the lead activity because it's just -- it's such a great barometer of the market activity that is to come. We've proven this out. We've been tracking sales leads for almost 10 years now, and it's a pretty solid, reliable predictor of volumes in the future. So it's a great leading indicator.

Specifically to the clean energy business with leads, yes, as you indicated, that is and has been a differentiator for us vis-à-vis others in the marketplace. And it's really been helpful for us to help court new channel partners and new dealers. Giving those leads to customers in a market like the solar market, as a for instance, they historically has had very high customer acquisition costs, I think, is -- I think, again, it's an area that we excel at based on our experiences with it, and our channel partners are coming to find the real value in that.

That said, I think there's even more that we can do there as we dial in kind of how we go to market with our messaging. And that's everything from the type of media that we buy to the regions and particular markets that we target. But we've enjoyed some pretty good success out of that early on here in terms of the clean energy business.

[Philip Shen, ROTH Capital Partners]

Great. As it relates to backlog, we've talked about it a bit already, but some of our conversations with dealers suggest the 22- and 24-kilowatt are basically caught up. Basically, it's like a 1- to 2-week lead time. And so you can kind of get it when you need it. It seems like the long lead time generators are the liquid-cooled ones. And so I was wondering if that's true.

And then also in your backlog, to what degree have you received cancellations in your backlog? Were there -- because some of the people we've talked to, they are full in terms of inventory and they just don't need as much, given the situation. So just wondering if you're seeing any of that.

[Aaron Jagdfeld, Chairman, President & CEO]

Yes. On the backlog -- on the lead time question, I'll hit that here first. The category, it's about 8 to 10 weeks and that's air-cooled and liquid-cooled products. That's obviously average for the weighting of each of those products within there. We have certain SKUs where we're obviously -- we're performing better than that average and certain SKUs where we're longer. It depends on sometimes component supply challenges.

We have, as an example, we're launching the 26-kilowatt product here this month. And so that's been sitting in backlog. So those lead times look particularly long. And we have some other products within the air-cooled family, where either we have component shortages or other constraints that have manifested. And in the liquid-cooled side, that demand has been incredibly robust with liquid-cooled. And our ability to increase production output there has been a bit hampered by supply chain. So working to bring all of those lead times down.

And again, we've been speaking -- when we talk about lead times, we've been talking about the averages, and that's the average number of weeks of orders in backlog. And I think that's an important distinction, because when you talk to dealers, you're going to find different dealers are in different places, right? Some dealers are -- they can't get enough product, right? They'll take more product if we can get it to them. They either have the space or the financial capacity to do that.

You have other dealers, maybe don't, right? In particular, as you get into smaller dealerships. They don't typically have a warehouse so they run out of space more quickly. They don't typically have the financial capacity, right? A lot of times, they're paying with a credit card even in some cases.

And in the prepared remarks, I spoke to the fact that installation bandwidth, in particular, when you look at the smaller end of the dealer spectrum, they're struggling to find labor. They're struggling with some components that they need, things like propane tanks and other things. They're struggling with permitting delays or getting a utility to come out, to pull a meter or upgrade a meter. Those things are all starting to manifest themselves.

As we've kind of brought our output levels up to a significantly higher level year-over-year, now you're starting to see the constraints kind of move kind of downstream, if you will. And that's exactly what -- we're working with the channel partners to alleviate that, whether it's talking to individual AHJs about permitting issues or delays there or it's looking to -- we've even stood up. We've got HR efforts here to help hire contractors for our dealers or noncontractor labor for our dealers, depending on what their needs are. So kind of we're recruiting for our dealers.

And of course, we're bringing new dealers in all the time. We added another 100 dealers here this past quarter. We're now at 8,200 and we need more. That's something that we're working hard on. As far as cancellations, of course, we have -- our policy around orders has always been a pretty, I'll call it, a liberal policy that way. So the ability to cancel or defer an order is -- you'll see that in those smaller dealers that are coming up against some of those constraints as you point out.

I would say on balance, it's not a material number when you look at the total. But we work through that and it's kind of dealer by dealer. It's really kind of hand-to-hand combat down in the trenches in terms of working with the dealers on -- and again, this is where other programs are really, really helpful with -- our Wells Fargo program is a great program for dealers to stock product.

And so we encourage dealers if they're not already signed up on that platform, to get on that platform. That's a great way for them to be ready for the season. The last thing we want dealers to do is to not be ready for the season. And so that's the messaging that's going out in the field.

[Operator]

And your next question is from Jeff Hammond of KeyBanc Capital Markets.

[Jeffrey Hammond, KeyBanc Capital Markets]

Okay. If we could just get into battery storage. I think you said there's some noise and I know there's a lot of supply chain issues. So just talk about what's going on in that business and what kind of your growth expectation or updated growth expectation is on that.

[Aaron Jagdfeld, Chairman, President & CEO]

Yes. That's great. Thanks, Jeff. Appreciate it. Yes, on storage particularly, yes, supply chain challenges have been numerous. In fact, I would say we hit our most challenging quarter with that here in Q2. And it was not really about cell supply. It was actually challenges in all the electronics components that go into this gear from microprocessors to FETs to everything that we use in the inverter, in the storage cabinet and the storage devices themselves. So that was challenging in the quarter and we're hoping here for the second half to be better in supply of those components.

Demand has remained strong. Again, when you look at IHCs, again, sales leads, we're seeing good strength in lead volume in clean energy. So -- and obviously, there's been a lot of noise around the regulatory environment. Are we going to have "Build Back Better?" Are we not? Now you've got the Inflation Reduction Act, which still has hurdles to clear legislatively, but that could be, obviously, a catalyst for additional demand, as we said in our prepared remarks.

Our position in storage, we still feel very good about our position there. But the supply chain has been a burden here in Q2. And so more to come on that. We've got, I think, a nice forecast here for the balance of the year. Our guidance -- I think when you think about just -- we've talked about this in the past.

We have -- we've gone away from like trying to talk about discrete numbers of megawatts and everything else. I mean, that business is so much more diverse for us in terms of clean energy and all the things that kind of work together there from the energy monitoring and management to the grid services elements to -- we've got our power generators. We've got our power managers, our load management controls. There's just a lot of stuff there. So we didn't feel it was appropriate to just talk about a single metric.

So what we've said here and what our prepared remarks said is that we're anticipating that entire kind of complex of products and services that we refer to as clean energy, smart thermostats, everything and go into that now, to be in excess of $500 million for the full year, which is basically double what it was last year. So feeling really good about that business and where it's going in the future.

[Jeffrey Hammond, KeyBanc Capital Markets]

Okay, great. And then a lot of my companies have kind of built a lot of working capital into the first half. And with all the supply chain and demand, et cetera, just -- I don't know if you updated the free cash flow guide and how you think working capital is -- how big of a source it can be in the back half?

[York Ragen, CFO & CAO]

Yes. No, Jeff. This is York. We did say that looking at -- basically, our performance to date, where we're coming into the second half from a working capital standpoint, we like that. We saw inventories stabilize in the second quarter. With that, we should get back to a more normalized free cash flow conversion in the entirety of the second half of the year.

Recall, normal cash flow conversion for this business is around 90%. So it'll probably be more weighted towards into Q4. But when you look at the second half in totality, free cash flow conversion should improve and return back to normal free cash flow levels for this business.

[Operator]

And your next question is from Brian Drab of William Blair.

[Brian Drab, William Blair & Company]

On home standby, field rates, you mentioned are up significantly year-over-year, obviously. Can you quantify how much we're up year-over-year for second quarter build rates? And where is your capacity now relative to what you feel you need in that business?

[York Ragen, CFO & CAO]

Well, we did mention shipments were up over 50% for home standby, which is indicative of our build rates for this category.

[Aaron Jagdfeld, Chairman, President & CEO]

Of our build rates. Yes, being free there. That's a good proxy for that.

[York Ragen, CFO & CAO]

Yes. No, I think our theoretical capacity, as we get Trenton up and running, and particularly another set of machine tooling here in the second quarter, that should -- basically, that gets us to what our projected capacity increases were expected to be. So it would -- and that actually even gives us room here from where we're at today to even surge, should we get a major event. So there's -- we're good from a capacity standpoint in terms of our expectations now.

[Brian Drab, William Blair & Company]

Okay. And is there anything you can tell us about the capacity expansion plans for the medium term? Are you -- I mean, are there -- is there another phase to capacity expansion coming over the next couple of years? Do you feel like you're going to need that?

[Aaron Jagdfeld, Chairman, President & CEO]

Well, there could be, Brian. We took the action last year of getting an additional machine, filling an order, even though we don't even have an address to deliver it to at this point. We'll kind of watch how the season plays out here. And if we do get the aggressive hurricane forecast that's been projected, none of that's in our guidance, obviously. So if that comes to fruition, we probably would need to find a home for that tooling.

Now it could be an expansion of our Trenton facility, which is expandable. We've talked about that. It could be another greenfield site. But we're kind of -- it's a little bit of a wait-and-see approach here to the market. But at some point, our belief in the category continuing to grow, there will be capacity adds that are needed at some point in the future.

[Brian Drab, William Blair & Company]

Okay. And then just lastly, you mentioned -- I mean, there's a lot of discussion on IHCs, obviously. Did you say specifically whether IHCs were up sequentially from first quarter to second quarter?

[Aaron Jagdfeld, Chairman, President & CEO]

I don't have that in front of me but we did not -- they were up, yes. Mike's pointing up. So yes, they were up sequentially. They've been on a tear here in Q2, specifically to the catalyst that I mentioned. But it's been -- we've been surprised by the robustness of the end market demand, to be very frank. I mean, it's something that has -- I think it speaks to how the category continues to move into more of a mainstream -- as more of a mainstream appliance, if you will, for homeowners.

[York Ragen, CFO & CAO]

In fact, they were up very nicely sequentially.

[Aaron Jagdfeld, Chairman, President & CEO]

Sequentially, yes.

[York Ragen, CFO & CAO]

Very nice.

[Operator]

And our next question is from Mark Strouse of JPMorgan.

[Mark Strouse, JPMorgan Chase & Co.]

I might be splitting hairs here a little bit, but I wanted to come back to the installation constraints with -- you mentioned dealer labor and permitting and other components. Is it a function of the -- those conditions deteriorating since your last call? Or is it more so they're just not keeping up with your increased manufacturing output?

[Aaron Jagdfeld, Chairman, President & CEO]

No, they are increasing. We said that activations increased actually year-over-year, so we are seeing installs increase. They're just not increasing at the same pace. So it's not a deterioration. It's more of a -- it's the pace is not increasing at the same rate proportionate to our output.

[Mark Strouse, JPMorgan Chase & Co.]

Okay, okay. That helps. And then just curious, within the home standby business for new construction, new homes, just curious what you're hearing from your partners within that channel.

[Aaron Jagdfeld, Chairman, President & CEO]

Well, new home construction is slowing, but again, our IHCs are up. So we've always been only marginally exposed to new construction. That's -- I think it was something 10% to 15% of our total volume goes into that. So it's not a huge thing. It never really has been. In fact, we've always said that could be a nice opportunity area if we could get it to grow. And it has grown from kind of that 10% range to more like 15% now.

But it's still -- it's kind of relative. I think it's mainly a retrofit category, kind of always has been. There's just a lot of housing stock out there in a lot of areas of the country that are struggling with power quality. So we don't really see -- and we're not hearing anything directly from channel partners about that. The only thing we do hear from them is that more home-builders want to offer the product as a feature, the potential -- not necessarily a standard feature but certainly as a feature to the people who are looking to build a home.

[Operator]

And your next question is from Jerry Revich of Goldman Sachs.

[Jerry Revich, Goldman Sachs Group]

Aaron, I wonder if we could just put a finer point around the order trends in standby. It sounds like based on your backlog comments, that net orders were about $200 million in the quarter compared to $500 million last quarter. Can you just comment on that? Because I know you look at it on a forward production basis when you quote lead times. And just put that into context for us because, obviously, a sharp pickup in-home consultations year-over-year. So would just love to get your thoughts on that disconnect if those numbers are right.

[York Ragen, CFO & CAO]

Jerry, this is York. We haven't necessarily talked orders historically. We are running up against tough comps on the order standpoint, just given the Texas outage last year. So comparing that and as well as some of the installed bandwidth comments that Aaron talked about. But I mean, you really have to look at the IHCs to really understand what's going on with the end market demand and having those up nicely year-over-year here in the quarter and up, what we said, what, 4x from...

[Aaron Jagdfeld, Chairman, President & CEO]

Over 4x, yes.

[York Ragen, CFO & CAO]

Over 4x pre-pandemic levels. So the underlying demand for the category is still very, very strong. But comparing that order rate is -- versus priority is probably not the right metric.

[Jerry Revich, Goldman Sachs Group]

Okay. And what we've seen is higher baseline post major outages. We've seen generally a 30% peak-to-trough decline as the second adopters, if you will, wind up installing gensets a year after the peak installation rate. Can you just talk about, based on your IHCs, how you feel like that might play out this year? I know we touched on it on the last quarter's call, but I'm wondering if you could expand on that, given we've got 1 more quarter of information across the board here.

[Aaron Jagdfeld, Chairman, President & CEO]

Yes, Jerry, this is Aaron. Again, I think when you think of the category, I don't know the historical context if the right place to look. I mean, the category has changed dramatically over the last several years. And I think all of the major kind of trends that underlie the demand in the category and the strength that we're seeing, in particular in IHCs, we believe, are going to remain intact here for the foreseeable future.

So I think that -- frankly, I just think the world's changed, so to speak, whether it's work-from-home or whether it's -- so that's our Home as a Sanctuary trend or whether it's the power quality trends that continue to be front and center for homeowners. I mean, you have homeowners who -- they're buying the category today or at least shopping the category today because they're worried about a potential outage. The category used to be all about outages happening.

And it's still largely -- that's an important demand catalyst, but all the rhetoric and dialogue around utility companies struggling with raw supply, as we work to electrify everything, as we're decarbonizing the grid, all of this kind of rapid shift in how we produce energy and consume energy is exposing the -- just massive vulnerabilities in supply and demand balancing. And that is something that is, obviously, a catalyst for not just home standby generators but also C&I products, our clean energy products, our grid services products.

Those are all directly in line to benefit from just the sheer chaos that the grid has become. It's a patchwork quilt, to begin with, but now it's a quilt with a lot of holes in it. And you're talking about massive concerns by people about just keeping their lights on, keeping their families safe, their home, their properties safe, their business, their livelihood safe, all of these things operating. So I think it's just -- I don't know that you can compare it to kind of what has happened historically in any of those categories.

[Operator]

And your next question is from William Grippin of UBS.

[William Grippin, UBS]

Just a simple 1 here, but wondering if you could talk about some of the puts and takes on the sequential margin improvement in the Domestic segment. And specifically, to what extent any product discounting initiatives may have been an offset to that?

[York Ragen, CFO & CAO]

No. That -- I mean, pricing -- price realization is actually going up. There's, if anything, very limited promotion going on. I mean, there's always some just general underlying -- undercurrent of some minor promotions.

[Aaron Jagdfeld, Chairman, President & CEO]

We have planned promotions that are there but...

[York Ragen, CFO & CAO]

But I mean, normally when we're not in a backlog situation, there's an ordinary course of promotions. But even when you're in backlog, you have some minor promotions going on. So sequentially, there's nothing going on there. And in fact, we've, obviously, raised price, repriced the backlog June 1. And I think partly maybe where you're going with that is did that price increase stick in the marketplace? And it did.

[William Grippin, UBS]

Got it. And just curious if you could quantify what the 8 to 10 weeks of backlog translates to in terms of value. I didn't hear you mention that on the call.

[Aaron Jagdfeld, Chairman, President & CEO]

Yes, we don't disclose that. That's why you didn't hear it.

[Operator]

And your next question is from Maheep Mandloi of Crédit Suisse.

[Michael Harris, VP, Corporate Development & IR]

So Chris, yes, I think we'd probably go the next question.

[Operator]

And that question is from Kashy Harrison of Piper Sandler.

[Kasope Harrison, Piper Sandler & Co.]

Aaron, just wanted to revisit lead times just 1 more time. You mentioned that now you're in the high singles versus 20 weeks last update. I know you had mentioned last time that because capacity is increasing, the relative dollar per week of lead times is different from what it was last time. So I was wondering if you could just give us maybe a sense of how to think about that rate of change dollar per week this time versus last time, even if it's just, like, a general percentage number.

And then maybe part and parcel of that, maybe just some thoughts around the length of time before these bottlenecks between the dealers and installs begin to clear along with the risks if the bottlenecks persist.

[Aaron Jagdfeld, Chairman, President & CEO]

Yes, those are great questions. I think it's also a good point that the -- and we've said this in the past, that as we increase our production rate, that the backlog, as we stated, weeks of orders is -- that grows, right, as the output grows per week.

[York Ragen, CFO & CAO]

We want to catch it.

[Aaron Jagdfeld, Chairman, President & CEO]

And we want to catch it. I mean, yes, we think that -- as we said in our prepared remarks, 1 thing we are seeing is we're seeing improved close rates off of IHCs because we are bringing down lead times. So that's part of our overall strategy here is if you're a customer and you're shopping the category and even if you hear 8 to 10 weeks on a product, you might be -- you might kind of sit on the sidelines and see what happens, right?

And even worse, kind of getting to the second part of your question is if a channel partner or a dealer is quoting something longer because their bandwidth to install has got them kind of at a fixed rate that keeps the lead time longer. So that gap, as we pointed out, kind of grew in the second quarter because of the increase in our production output. And they increased activations or installs but not to the same level. So we're working with them to bring that inside. We're going to need more dealers. We're going to need more installing contractors.

We have a lot of initiatives around trying to make installations easier and less time-consuming. Today, an installation, a typical installation still takes 2 individuals, about 8 hours a piece, so about 16 hours of labor in the installation. So if we could get that down, that obviously frees up some additional bandwidth.

So that's where our focus has been. And again, it's dealer by dealer so it's not widespread, but we are seeing dealers struggle with that. In particular, dealers that are in markets where either housing has been really hot in certain markets. That's where they're really struggling with labor for construction labor, contractor labor. So as, again, part of our prepared remarks, as the housing market cools, we actually think that will help us refocus installing contractors' attention towards the category and will hopefully improve lead times to the end market.

[Kasope Harrison, Piper Sandler & Co.]

And just a quick follow-up there. So the high singles, would that be 50% more than last time on a per week basis? 75%? Double? Just any rough sense of how to think about it on a relative basis would be great.

[Aaron Jagdfeld, Chairman, President & CEO]

No. I mean, again, it's -- we have to do the math. I don't have it in front of me.

[York Ragen, CFO & CAO]

We don't have a ratio.

[Aaron Jagdfeld, Chairman, President & CEO]

I don't have a ratio like that put together. But I think lead times, we quoted last time were in the 20-week range. They're roughly half of that now, 8 to 10. But again, that 8 to 10 represents a greater amount. So in terms of our production output, so it's not half of what it was before. So to your point, I think that's the point you're trying to get to, I just don't have the math in front of me on that.

[Operator]

And your next question is from Praneeth Satish of Wells Fargo.

[Praneeth Satish, Wells Fargo Securities]

I'm just trying to understand here with the constraints on the installer side. I mean, if there was some kind of major weather event in the second half of this year, what would be -- would you be in a position to benefit from that? Or would that be basically kind of adding to the '23 sales at this point?

[Aaron Jagdfeld, Chairman, President & CEO]

Yes. I mean, as we've said before, if we -- today, the plan is we're going to probably exit the year with some backlog remaining. So that -- because of that, there's not a lot of room for upside for the storm. There hasn't been all year for HSB. We've got some room on portable generators. We're in a good inventory position there, ready to serve the market if there is an active storm season.

But on HSBs, and this is, again, why we're working with the channel to increase their installed capacity because we've got to get that to a higher level longer term. We've got to -- we have seen opportunities for that to expand. But the backdrop right now, what we're hearing from these contractors that are struggling is primarily labor, some components and then some permitting and utility-related delays.

So we're attacking all of those things. We've got a broad slate of initiatives to get after those things and have been here for the balance of this year because we kind of -- we could see this coming. We needed to see the installation rate pick up. And while it has increased, it just hasn't increased enough at this point.

[York Ragen, CFO & CAO]

And you'd have to ramp your supply chain up further as well.

[Aaron Jagdfeld, Chairman, President & CEO]

That's a good point.

[York Ragen, CFO & CAO]

This challenging environment could limit that but definitely would help out 2023.

[Aaron Jagdfeld, Chairman, President & CEO]

It's a good point.

[Praneeth Satish, Wells Fargo Securities]

Got it. And then just switching gears, can you give us an update on the Grid Services business? How many deals did you win in Q2? And are you seeing an acceleration in that side of the business with utility rates going up and utilities kind of looking for any way to lower their costs?

[Aaron Jagdfeld, Chairman, President & CEO]

Yes. That has been a really active space for us. Really pleased with the sales pipeline that's building there. The challenge, of course, in that business, and as we've said before, is just the time it takes to get these programs through, not only the utilities themselves in terms of developing the programs, but also then the regulators for approval.

So we have a couple of really nice wins that we will -- you'll see some announcements here in the weeks ahead on that are, I think, really are a good example, both of the wins that you'll see are really good examples of the power of the hardware plus software approach that we've taken here. And I think that, as I mentioned in the prepared remarks, we're definitely beginning to see that there's a differentiator for us as a company, because we bring so much more to these potential programs by offering solutions that span everything from a smart thermostat program to a generator program to a battery program to a C&I generator program.

I mean, there's big chunks of load that come from C&I generators. And we can bring all of that hardware to bear alongside this really advanced software platform called Concerto that our team has developed. It's just -- it's a really interesting space going forward.

And to the point about utilities, we have seen a change in their attitudes over the last several months, several quarters really, in terms of the sense of urgency in which -- and they're asking questions and engaging with us. We were down in DISTRIBUTECH, which is kind of the utility markets trade show, if you will, down in Dallas a while ago, a couple of months ago. And I was struck by just the quality of the conversations, the quantity of the conversations we had with utilities and grid operators.

And they just feel like their back is against the wall. They can't solve their problems with traditional means, right? Like a traditional mean being if demand is going up because of more EV adoption in a particular market, a grid operator utility would simply have outlined a plan to add a gas peaker plant to cover those points in the curve where they need additional supply.

And so that's something that they can't do anymore. The regulators are saying, "Look, we're not going to allow you to add another thermal asset to your fleet for supply." And so they're finding themselves in the uncomfortable situation of having to -- it's kind of like a dual mandate. They have to decarbonize their grids because of that mandate, but the other mandate is they have to continue to provide resiliency. And so they're really struggling with ways to do that. So they have to have new tools in the toolkit.

And they see these virtual power plants and these distributed energy resources, like generators and batteries and load management and thermostats as ways to -- as really valuable ways to help them build out the additional supply or the reduction in demand that they need to provide the resiliency that they're charged with providing.

[Operator]

And your next question is from Donovan Schafer, Northland Capital Markets.

[Donovan Schafer, Northland Capital Markets]

This is Donovan Schafer. So it seems like there has been so much changing all over the world in the last few months. So I'm just wondering if we can step back and talk about some of this in terms of what it means for the megatrends you guys like to talk about.

So first, there's grid instability. But I do -- it does seem, on some, level, that in the United States, there are at least some bonafide grid investments with the Infrastructure Bill that was passed last year, plans to make it easier to permit transmission lines. It does seem like there's a bit of traction there. So on that front, I'm wondering if there are any risks or if there is any chance we could get kind of a reduced trend in outages, not near term but maybe say, 3 to 5 years out. I know MISO has been just recently approved, 18 high-voltage transmission lines to handle 53 gigawatts of capacity or something.

And then I also want to talk on the Russian situation. That does make the diesel to natural gas megatrends, certainly in Europe, to some people, look like a bad idea. I know you also sell diesel generators, so maybe you can kind of be agnostic there. But historically, the megatrend you've talked about has been the shift to natural gas.

And then kind of on the flip side, you've got growth in the LNG markets. Maybe that allows more HSB and natural gas generation elsewhere, increasing energy security concerns generally. I mean, nations like Japan, Taiwan, the Philippines really struggle with electricity generation, limited resources, having to import everything and they probably don't feel great about China right now. So those could be positive drivers.

So just I'm curious kind of, again, stepping back and looking at megatrends from these kind of big movements globally, we've been saying. Which ones are you watching? Which ones do you think -- which things do you think could really be material over a couple of years? Yes, any clarification on that would be very helpful.

[Aaron Jagdfeld, Chairman, President & CEO]

Yes. Donovan, from a megatrend standpoint, the grid's a mess. And I don't -- there's nothing in the next 3 to 5 years. I mean, you can talk to any utility company, any utility executive or -- and while they'll get some transmission lines approved and a couple of other things going in the right direction, maybe that will light a fire under regulators.

But there's so much deferred -- if you just -- if you didn't have the Electrify Everything trend, if you just took that away for a second, and you dealt with the more severe climate experiences that we're having and just the decarbonization of the grid in general and that kind of generating fleet, those sources being -- they're moving to a more intermittent nature, and because the technologies have not kept up, like battery technology is just not there yet commercially to be a viable storage technique.

And that's really what we need. We need storage if we're going to move to 100% of our power being generated from renewable sources. You've got to have the ability to store that power at times when those renewables are not able to perform. This is a massive challenge that grid operators and utility executives are trying to solve for. There's no silver bullet there. There's no easy way to do it. There's no technologies that have -- that are presented that allow for that in a commercial way, in a cost-effective way, certainly. And there's nothing in the next 3 to 5 years.

And they would tell you that even if they had an approved plan, all the resources necessary to execute that approved plan, it would be decades just to execute against it. The buildout of the transmission lines, the upgrade of all the equipment that needs to happen to modernize the grid. It's -- there's trillions and trillions of dollars behind in deferred spending and just the raw effort to do that is decades in the making. So we don't see anything on that front.

On your question on natural gas versus diesel, I mean, our -- almost 100% of our business C&I-wise outside of the U.S. is diesel. There's a little bit of natural gas, as we've said. And we think that, that's a trend longer term that'll improve. Where the gas to debt -- the diesel and natural gas trends have been more -- much more prevalent is here in the U.S. and where we have a lot of gas available and that's not an issue.

And I do think even in Europe, they need gas. So whether it comes from Russia or whether it gets imported from other areas, they're not going to move away from pipelines. That -- they've got the infrastructure. They're going to get gas.

[York Ragen, CFO & CAO]

Still be an important part of...

[Aaron Jagdfeld, Chairman, President & CEO]

They're not going to change how they heat. They're not going to change how they use gas for process. I mean, they need gas. So they'll get it from somewhere. It's probably going to be imported LNG coming into the countries. They need it.

[York Ragen, CFO & CAO]

And they may name natural gas as a clean...

[Aaron Jagdfeld, Chairman, President & CEO]

And natural gas will be redesignated in Europe as a clean -- as a clean fuel, which is great. So I think longer term, we feel really confident in those trends. Maybe shorter term, there'll be some noise around that. But again, that business today is mostly diesel. So it's really not a today impact.

And then you're right, you've got other countries where there's opportunities for us. You mentioned a couple of countries in Asia that have -- they're islands, right? So they import, whether it's Japan or whether it's Taiwan, those are all areas where they import. And we do see LNG becoming an important fuel. And this is where I think the United States is in a really good spot here to be able to provide a path for countries that need that important fuel source, whether it's baseload power generation or process or for energy security. That's going to be something that I think is going to be a -- that's a trend that's going to continue long into the future. Natural gas is a fantastic energy resource. It's going to be part of our baseload power structure here as a global populous for a long time to come.

[Operator]

And our final question is from Maheep Mandloi of Crédit Suisse.

[Maheep Mandloi, Crédit Suisse]

I hope you guys can year me?

[York Ragen, CFO & CAO]

Yes.

[Maheep Mandloi, Crédit Suisse]

So that -- 2 or 3 answers. Just 2 quick ones. One, just on the backlog. It said more than $1 billion the last quarter. Is it somewhere in line with that range or different? And I had a separate follow-up.

[Aaron Jagdfeld, Chairman, President & CEO]

Yes. Again, we've talked about 8 to 10 weeks of orders in the backlog and it's sizable. It's a big backlog. And we expect to still have backlog as we exit the year, even that's in spite of the increased production rate. So it's a sizable number. And we want to get that down because that's how -- we think that serving the market with shorter back -- with shorter lead times is really important to winning in the market, in particular, on those sales leads that we've talked about.

So that's a really important focus for us, Maheep, and we're going to continue to lean into that. And again, working on that installation bandwidth as well. But that 8 to 10 weeks is really how we would speak to the backlog.

[Operator]

And I would now like to turn the call back over to Mike Harris for any closing remarks.

[Michael Harris, VP, Corporate Development & IR]

We want to thank everyone for joining us this morning. We look forward to discussing our third quarter 2022 earnings results with you in early November. Thank you again, and goodbye.

[Operator]

And this concludes today's conference call. Thank you for participating. You may now disconnect.