Generac Holdings Inc.
Q2 2017 Earnings Call Transcript

Published: 2 Aug 2017

[Operator:]

Good morning, ladies and gentlemen, and welcome to the Second Quarter 2017 Generac Holdings Inc. Earnings 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 that time. As a reminder, this conference call is being recorded. I would now like to turn the conference over to your host Mr. Michael Harris, Vice President of Finance.

[Michael W. Harris:]

Good morning, and welcome to our second quarter 2017 earnings call. I'd like to thank everyone for joining us this morning. With me today is Aaron Jagdfeld, President and Chief Executive Officer and York Ragen, Chief Financial Officer. We will begin our call today by commenting on forward-looking statements. Certain statements made during this presentation, as well as other information provided from time to time by Generac or its employees may contain forward-looking statements and involve risks and uncertainties that could cause actual results to differ materially from those in these forward looking statements. Please see our earnings release or SEC filings for a list of words or expressions that identify such statements and the associated risk factors. In addition we will make reference to certain non-GAAP measures during today's call. Additional information regarding these measures, including reconciliations to the comparable U.S. GAAP measures is available in our earnings release and SEC filings. I will now turn the call over to Aaron.

[Aaron P. Jagdfeld:]

Thanks, Mike. Good morning, everyone. Thank you for joining us today. Second quarter results were very favorable with solid core organic sales growth of 6% and overall net sales increasing 8%, compared to the prior year including the contribution from the Motortech acquisition which closed on January 1. This growth was leveraged into an overall 10% increase in adjusted EBITDA along with improved operating and free cash flow. Shipments of home standby generators experienced strong growth year-over-year primarily driven by increased activations during the second quarter as a result of higher power outage activity and successful targeted marketing initiatives. Demand for domestic mobile products also continue to be much stronger as compared to the prior levels as our rental equipment customers further replaced and upgraded their fleet during the quarter. We returned to generating a strong level of operating and free cash flow during the quarter and resumed activity on our share repurchase program to opportunistically buyback stock reflecting our confidence in our favorable long-term outlook for Generac. We also amended our term loan credit facility which is expected to yield attractive interest expense savings on an annualized basis. Although not experiencing a major power outage event for nearly five years, the fundamental demand environment for home standby generators improved during the first half of 2017 as compared to recent years due to a number of factors. During the first half of the year, power outage severity was more favorable along with improvements in several other key performance metrics that we monitor closely, including in-home consultations, close rates and activations. During the second quarter, activations in particular increased significantly over the prior year with all regions of the U.S. experiencing strong double digit growth. This strength in activations led to the anticipated reduction in field inventory with days on hand for home standby generators ending the quarter at similar levels to the prior year. We also continue to expand the number of our residential dealers and ended the first half at an all time high count of approximately 5500. These stronger end-market fundamentals combined with successful targeted marketing initiatives drove the strong increase in shipments of home standby generators during the second quarter as compared to the prior year. Despite the elevated power outage environment, we experienced a decline in shipments for portable generators during the second quarter as compared to the prior, primarily due to continued excess levels of field inventory related to last year's Hurricane Matthew along with stronger prior year comparisons driven by placement of several new products at certain retailers. Although the typical pre-season buying we would normally expect to see from our retail channel partners for these products has been disappointing, point of sale metrics have remained positive during the quarter and we now believe that field inventory levels for portable generators is more seasonally appropriate entering the second half of the year. Regarding the Country Home Products acquisition which closed in August of 2015, we are pleased with the performance of this business thus far as shipments for CHP's products improved during the second quarter over the prior year despite the cold and wet spring that deferred some demand for their specialty outdoor power equipment. The integration of CHP continues to progress as we've continued to pursue several interesting cross-selling opportunities for our combined product lines and certain cost synergies as we leverage our global sourcing and manufacturing capabilities. Toward this end, during the second quarter, we began to consolidate CHP's assembly and distribution operations in Winooski, Vermont into our Jefferson, Wisconsin facility with the transition expected to be complete by the end of this year. The move allows us to better utilize the existing facility in Jefferson and enable CHP to further focus on its B2C marketing and selling capabilities and other core functions that will remain at its headquarters in Vermont. An area of our business that continues to show encouraging improvement is our domestic mobile products offering, primarily serving the rental markets. After significant declines over the past two years, demand for these products has been rebounding quickly as we have experienced a strong increase in shipments that exceeded our expectations during the first half of the year with this momentum continuing so far into the third quarter. We believe this fleet replacement cycle is primarily being driven by the overall age of current equipment with oil and gas related capital spending still fairly muted in terms of the impact. With oil prices largely remaining below $50 a barrel, we continue to believe a meaningful recovery in the purchase of mobile equipment for use in this market has not yet gained traction. That being said, recent indications are that utilization rates for our customers gaseous-fueled mobile generators in the field are improving which could potentially lead to some oil and gas-related opportunities during the second half of this year. We are optimistic toward returning to sustainable long-term growth going forward for mobile products given the current rental replacement upcycle combined with the potential for a future recovery, in the energy sector and the macro opportunity with increased infrastructure spending. Shipments of stationary C&I products in North America through our distributors, as well as direct to our national account customers were lower during the second quarter, as compared to the prior year. The decline was largely due to timing differences experienced in the prior year as production lead times improved between the first and second quarter last year. However, when looking at the first half of 2017 as a whole, overall sales for these products improved as compared to the first half of 2016. In addition project quotation levels within our domestic industrial distribution channel have been trending higher in recent months as compared to the prior year. However, we continue to see persistent softness in demand for emergency backup power solutions in telecom-related projects resulting from the ongoing reprioritization of capital by several of our national account customers as they focus more on M&A activity and the roll out of their 5G networks. Now let me provide a few comments regarding the trends for our international segment. Pramac continues to perform well with sales consistently meeting or exceeding expectations on a quarterly basis since our acquisition of a majority share on March 1 of last year. And we currently expect net sales and adjusted margins to improve for the full year 2017 as compared to the prior year. There are important integration activities currently taking place involving the Pramac business, as we continue to combine the Tower Light commercial activities into Pramac, a consolidation of the Generac facility in Brazil into the existing Pramac Brazil location as well as expanding production capacity in China and the start-up of branch operations in Australia. In the Latin American region, the demand environment for both C&I and residential products continues to improve with solid growth in sales during the first half of 2017. The financial performance of this business in recent quarters has been positively impacted by the numerous process improvements and organizational changes implemented in recent years. Lastly, our recent Motortech acquisition which closed on January 1 has performed well during our short time of ownership with sales and margins exceeding our expectations during the first half of the year. Although we're still early in the integration process, our global engineering teams have begun to collaborate on how to integrate people, processes and products. We remain excited about the opportunity to leverage Motortech's deep technical capabilities related to gaseous fuel and ignition systems in order to better capitalize on this faster-growing segment of the generator market and to explore new market opportunities. I'd now like to turn the call over to York to discuss second quarter results in more detail. York?

[York A. Ragen:]

Thanks, Aaron. Net sales for the quarter increased 7.6% to $395.4 million as compared to $367.4 million in the second quarter of 2016, including $9.5 million of contribution from the Motortech acquisition which closed on January 1, 2017. Looking at our consolidated net sales by product class, residential product sales during the second quarter increased 9% to $198.1 million as compared to $181.7 million in the prior year quarter, with all of this growth being organic. As Aaron mentioned, shipments of home standby generator grew at a strong rate as compared to the prior year, which was primarily the result of higher power outage activity during the first half of the year, successful targeted marketing campaigns and improved close rates by our increasing base of distribution partners. To a lesser extent, the increase in residential product sales was also due to higher shipments of DR-branded outdoor power equipment from Country Home Products as well as growth in shipments of residential products into international regions. Partially offsetting this strength was a decline in portable generator sales due to higher levels of field inventory during the current year quarter, along with a stronger prior year comparison that benefited from the roll out of new portable business with certain retail customers. Looking at our commercial and industrial products, net sales for the second quarter of 2017 increased 8.9% to $170.8 million, as compared to $156.7 million in the prior-year quarter, with core organic growth being 1%. (10

[Aaron P. Jagdfeld:]

Thanks, York. We're increasing our previous guidance this morning for revenue growth for full year 2017 with net sales now expected to increase between 6% to 8% as compared to the prior year, with core organic growth of between 2% to 3%. The increase is primarily due to a more favorable outlook for domestic mobile products as well as higher international segment sales due to a stronger euro relative to the U.S. dollar. Adjusted EBITDA margin before adjusting for non-controlling interest is now expected to be approximately 18.5% for the full year reflecting the shift in sales mix, the impact of certain foreign currency exchange rate changes and higher operating expenses from the expansion of international branch operations. Our top line outlook assumes no material changes in the current macroeconomic environment and also assumes a power outage severity level for the remainder of the year similar to that experienced during 2016 excluding the impact of Hurricane Matthew. As a reminder, should the baseline power outage environment improve or if there is a major power outage event in 2017, it is likely we could exceed these expectations. For historical perspective, an average major outage event could add up to $50 million of additional sales depending on a number of variables, and would likely result in an improvement in consolidated margins due to a higher mix of residential products. We expect the third quarter and fourth quarter revenues to be approximately equally weighted, while adjusted EBITDA margins are expected to notably increase throughout the second half with third quarter margins expected to improve approximately 100 to 125 basis points as compared to the second quarter. Importantly recall that we have a majority ownership position in Pramac and as such there is a minority non-controlling interest with this acquisition that must be deducted when forecasting adjusted EBITDA, adjusted net income and adjusted EPS for the full year similar to the presentation reflected in the reconciliation schedules included with this morning's earnings release. Operating and free cash flow generation is forecasted to further improve during the second half benefiting from the strong conversion of adjusted net income which is expected to be over 90% for the full year. In addition, we're providing an update on several other guidance details to help model the company's earnings per share and cash flows for full year 2017. As a result of the amendment of our term loan credit facility, we now expect interest expense to be in the range of $44 million to $45 million. The forecast includes $40.5 million to $41.5 million of cash outflow for debt service costs plus approximately $3.5 million for deferred financing cost and original issue discount amortization. Cash taxes are now expected to be approximately $23 million to $24 million which translates into an anticipated full year 2017 cash income tax rate of approximately 14% As previously mentioned, our GAAP income tax rate is projected to be approximately 36% in 2017. Depreciation expense is now forecasted to be approximately $23 million to $23.5 million. GAAP intangible amortization expense in the year is now expected to be approximately $29 million to $29.5 million. Stock compensation expense is expected to be approximately $11 million to $11.5 million and capital expenditures for 2017 are now forecasted to be approximately 2% of our forecasted net sales for the year. When considering our term loan refinancing, adjusted outlook for cash taxes and updated share count from our share repurchase activity, we expect that our adjusted EPS will be favorably impacted relative to last quarter's forecast. As a result, despite the changes in our guidance this morning, we expect our adjusted EPS for the full year to remain in line with our previous forecast. This concludes our prepared remarks and at this time, we'd like to open up the call for questions. Operator?

[Operator:]

Your first question comes from the line of Jeff Hammond from KeyBanc Capital Markets. Your line is open.

[Jeffrey Hammond:]

Good morning guys.

[York A. Ragen:]

Good morning, Jeff.

[Jeffrey Hammond:]

Hey, so just if you could unpack a little bit the changes in the EBITDA margin guidance from 19%-19.5% to 18.5%, sounds like there's a little mix FX transaction. Maybe just talk a little bit more about the marketing initiatives and commodity, just the moving pieces there would be helpful, thanks.

[York A. Ragen:]

Hey, Jeff. This is York. So you're right. So when you look at the margin guide mix relative to previous guidance, our mobile products business has really exceeded expectations. The stronger euro is translating our European businesses at a higher rate than they were – than our previous forecast. So just that alone, that mix shift should take margins down a bit. On the cost side, in our release we mentioned some transactional FX impacts with the euro strengthening, to the extent they're doing business in other currencies, that's just going to put some pressure on some of those margins on the international side. So those are the two main drivers. I think you mentioned the promotional environment, the promotional environment relative to prior year we're not expecting big differences from prior year in the promotional environment. So that's not as much of an impact. Commodities, if you look at steel, steel's actually – you know about flattish with where it was in prior year. We do have lags – copper has taken our leg up, but we do have lags with our supply chain and it's got to get through inventory. So – that will – any recent fluctuations in commodities will lag in into prior years. So you know, I think, – those are the moving parts when we looked at our forecasts for the updated outlook.

[Jeffrey Hammond:]

Great. And then it sounds like you're out with – with the warranty plus the service promotion. Any kind of feedback you'd been getting early traction on that promotion? Thanks.

[Aaron P. Jagdfeld:]

Yeah, Jeff, this is Aaron. Yeah, that promotion – we ran it, the first time we ran it was last year. And as I said before I think previously on some other calls, we've been changing our cadence. Most of our promotional activity frankly has been aimed at channel in the past. And so we've been, over the last, I would say, 12 to 18 months been gradually shifting to doing a little bit more what we refer to around here as pull promotion. So a little bit more targeted at the end user and consumer. And so – you'll see that the promotion you're referring to right now is a great example of one of those promotions where we're offering extended warranty with that – also with a free first year of maintenance on the product. It's been very well received. We just rolled it out a week ago so it's pretty early innings here in terms of receptivity. But all indications as we discussed with our channel partners ahead of rollout was that they believed that it would have a very favorable impact on end demand. And in fact, we've been seeing that as we mentioned in our prepared remarks, in addition to a stronger power outage environment in the first half of the year, we did a similar type promotion, not quite as aggressive as this one earlier in the year and it also had very good uptake. So we're optimistic that this one will also help us stimulate and get some people who might otherwise sit on the fence get them to buy home standby generator.

[Jeffrey Hammond:]

Great. Thanks, guys.

[Aaron P. Jagdfeld:]

Thanks, Jeff.

[Operator:]

Your next question comes from the line of Brian Drab from William Blair. Your line is open.

[Brian P. Drab:]

Good morning, Aaron. Good morning, York.

[Aaron P. Jagdfeld:]

Good morning, Brian.

[York A. Ragen:]

Good morning, Brian.

[Brian P. Drab:]

I'm just going to first build on the last question. In terms of other things that you can do to drive sales in the home standby market – you've done so much over the last five to seven years call it – with PowerPlay and other initiatives. You know what else is there at this point given all that you've done like what are the top two or three things maybe the sort of an analyst day preview I guess, but to drive sales and move the needle there?

[Aaron P. Jagdfeld:]

Yeah, Brian, it's a great question. And obviously we spend an inordinate amount of time at the company really pushing on that and prodding that in a number of ways. I think and we've talked about this and we'll talk more about it as you alluded to in the Analyst Day coming up in – the Investor Day that we've got coming up on September 7. But for us the probably the whitespace there that still exists would be around installation cost. So, obviously, the product we've done, as you mentioned, a lot to increase the awareness of the category, to increase the availability of the product by continuing to expand our distribution. And I think we've done a fair job of also trying to keep the total cost of ownership in a pretty tight range. We really think that, in order to unlock the next layer of demand with these products, we need to continue to focus on reductions in the installation cost. And that's not simply by shifting dollars out of our channel partner's pocket, it's really to try and improve the efficiency of the install, to frankly take what is today an 8 to 12 hour project for, generally, two contractors, and reduce that in some material fashion, so to make the product easier to connect to the home's fuel supply and electrical system. We believe that there are – we've made some incremental gains there, but we believe that there are some potential future opportunities to make the installation timeline shorter, that would have a significant impact on the overall total cost of ownership. So that's clearly an area where we need to focus. The other area continues to be on expanding our data efforts, our big data efforts, if you will. We've amassed a huge database, with PowerPlay now in the market for four years, our iPad-based selling solution, we've amassed a tremendous amount of data on proposals that our channel partners have done out in the market. And obviously, only a certain percentage of those proposals close. And it's definitely less than a majority of the proposals. So we have effectively created a ready-made database of potential customers who went through the proposal process. So they actually had an in-home consultation and we're talking, not just tens of thousands of proposals, but hundreds of thousands. And so those proposals remain a very rich opportunity pipeline for us to continue to mine, in particular as things change in a local market. So if an outage happens in a local market tomorrow, we can go into that local market and we can scrape our database to find proposals that didn't close. And so I think there's a very rich stream of potential opportunity there, to take people who have gone through the process and to re-acclimate them with the original proposal, maybe introduce product updates to them that have occurred since the last time they had the proposal, or promotional activity, as we've talked about already on this call. And maybe to tip them over into an owner of the product going forward, as opposed to a proposal. So those would be just two areas I would point to, Brian, that I think have a lot of really great potential upside for us in the category.

[Brian P. Drab:]

Okay. Thanks Aaron. Speaking of all the data that you have, I wonder if you can make a comment or tell us anything about the weather activity as measured by your database in the second quarter versus the first quarter, or versus second quarter last year.

[Aaron P. Jagdfeld:]

Yeah, I can speak to the – I don't know about second quarter in particular – was up in second quarter over the prior year, and the first half, it was up as well. So you know everything has been up. In fact, when you look at our long-term baseline outages levels, and really we've only been measuring, as we said, in this level of detail since 2010. But when you go back to 2010 and you look at that long-term baseline outage level, the first half of the year actually returned to that level. So you know, again, we felt pretty good about that underpinning kind of the overall demand environment for home standby generators. Unfortunately it didn't read through portable on gens because, as we said in our remarks, we had a field inventory situation, which we talked about in Q1. It really kind of dampened what I'll call the buying optimism or buying enthusiasm of our retail partners coming into season. Normally you have a pre-season buy from those channel partners, and it was a weaker preseason buy this year, and that preseason buy tends to straddle Q2 and Q3, so we've kind of reflected, in our forecast here, our guidance for remainder of the year, also kind of some muted demand around portable generators as we go into the third quarter. That could all change if the outage environment remains as it is right now, and that's not what our guidance contemplates. Our guidance contemplates the outage environment reverting back to the low levels of 2016, excluding Hurricane Matthew. So actually, we're being a bit bearish on the outage environment in the second half of the year, even though the first half was maybe a return to more normalcy there. But that's just the way we've decided to issue guidance. And I think it provides obviously some potential upside should outages continue on this trend, or should we get a major outage.

[Brian P. Drab:]

Okay. Can I just – is that first half activity back to baseline, does that put you up – and that's up strong double digits in terms of weather events year-over-year then? Or can you – can you put a number on that?

[Aaron P. Jagdfeld:]

So we don't really put a number on it as much as – we have, what we refer to as a severity index, which is the number of people impacted multiplied by the number of hours they were impacted, because we believe that the duration has as much impact on purchasing habits with these products as does frequency. So the combination of those two things, we can tell you that it was up strongly over the prior year. Double-digit, you can say that for sure over the prior year, back to that baseline average, but we just don't quote the raw numbers themselves.

[Brian P. Drab:]

Yeah. And by number, I just meant like percentage increase, but I'll take double-digit – strong double-digit.

[Aaron P. Jagdfeld:]

Got it.

[Brian P. Drab:]

One last question, York. Could you just clarify whether commodity costs in the second half of 2017 will be a headwind or tailwind versus the first half? I just wasn't clear on that.

[York A. Ragen:]

Versus second half versus first half I think what you'll see is, if you look at the first half, second half, I'm looking for my...

[Brian P. Drab:]

Yeah. Take your time.

[York A. Ragen:]

...bridges. Got it. So it's going to be – we will – as you get improved overhead absorption, you know we do have a number of new products, in terms of cost reductions within product coming through from our sourcing efforts. You won't have this restructuring charge from the CHP announcement. So you put that all together with the commodity headwinds. We still think that probably it'll be a favorable variance on cost, relative – second half versus first half.

[Brian P. Drab:]

Okay. Okay. So commodities may be a headwind, but overall favorable in the second half.

[York A. Ragen:]

Yeah. Overall it will actually be an improvement....

[Brian P. Drab:]

Improvement on...

[York A. Ragen:]

When you factor in on all the factors I just mentioned.

[Brian P. Drab:]

Okay. Okay. Thanks.

[Operator:]

Your next question comes from the line of Josh Pokrzywinski from Wolfe Research. Your line is open.

[Josh Pokrzywinski:]

Hi. Good morning guys.

[York A. Ragen:]

Good morning.

[Aaron P. Jagdfeld:]

Morning.

[Josh Pokrzywinski:]

Just on some of the comments around home standby in the second quarter. Sounds like it came in a little bit better. And I guess could you square that away York with some of the margin expectations for full year that mix up from higher home standby is showing I guess in the more qualitative bridge that you discussed. It was a lot of the more negative mix or promotional or FX-type headwinds. Does that better home standby mix in the second quarter flow through at all?

[York A. Ragen:]

No. I think what more than offsets that is the, it's the more favorable outlook on the mobile side, that that international business being a higher mix. You know I think if you look at – you'll look at that on the resi side home standby while up, portables were offsetting that, so there's some offsets there that are causing that. So what's really driving the margin guide in the second half is really that higher mix shift towards the mobile and international sales on the increase in sales there.

[Josh Pokrzywinski:]

Got you. It's helpful. And then just on some of the promotional activity the kind of response or uptake that you're seeing from that, are you seeing better close rates on some of the smaller KW standby equipment or is it going really across the range? I guess where are you seeing that better attachment?

[Aaron P. Jagdfeld:]

Yeah, Josh. I mean we haven't really seen a shift necessarily in mix along the product range relative to the incentive. Although it's a great question because frankly, if our thesis here is that in order to unlock the next layer of demand, we need to see a material move down in total cost of ownership. One way to do that obviously is through the choice of a smaller product. I think a really good test of this, we are going to be launching a different promotion when we get to the third quarter that is oriented around testing a position of a an all-in price for a what I'll call a smaller KW machine with a fixed install price. And it's really – it's on the back of kind of the five year anniversary of Hurricane Sandy. We're going to refer to it as our heroes of Sandy campaign. We think it's going to have a – could have an interesting impact, but we're going to put an all-in price together on that package. And really push on seeing how real some of our elasticity of price testing that we've done over the years, how real that is in the market in terms of impact. So I think we'll have a better read on close rates. Close rates are up overall, answer your question, across all the lines. But I think that this promotion we're going to run later this year is more targeted at a fixed price which is significantly lower than the all-in average across the book of business today. I think that'll be a much better tell in terms of what close rates can do on something like that.

[Josh Pokrzywinski:]

Got you. That's helpful. And I guess just understanding there's a promotion that's tied to that initially, just more broadly is a smaller KW machine also lower margin or is it pretty similar across that portfolio?

[Aaron P. Jagdfeld:]

Margins in the category differ based on the different sizes, but not too materially. I mean it's I would say that obviously entry level price points don't carry the same margins as premium products or high level price points, I think in most product categories including this one. But by and large, I have to tell you the margins on the smaller KW machines are good. The margins on the large KW machines are a little better than that, but the spread's not dramatic.

[Josh Pokrzywinski:]

Got you. That's helpful. Thanks, Aaron.

[Operator:]

Your next question comes from line of Charles Brady from SunTrust. Your line is open.

[Patrick Wu:]

Hi, guys. This is actually Patrick Wu standing in for Charley . Thanks for taking our questions.

[York A. Ragen:]

Hey, Patrick.

[Patrick Wu:]

Good morning. Just sticking with residential, you guys mentioned activation rates in the second quarter obviously added a lot of color on that during your commentary. Can you talk a little bit about how that has trended so far in the third quarter? Yeah. I guess we can start with that. And then also on the portables side, is the inventory level, how should we think about the inventory level as you exit the second quarter into the third quarter, maybe even second half of the year.

[Aaron P. Jagdfeld:]

Got it. Good questions, Patrick. Obviously, we don't necessarily talk about activation rates and things here in quarter until we get to the end. But again, as I said to one of the earlier callers, the promotion that we're running right now has gotten – early receptivity has been good. So we would anticipate that that would read through at some point at the activation level and there's a lag obviously from when we launch a promotion or when an in-home consultation is scheduled to when a product is purchased and then ultimately installed. So there's some time for that activation. The activation is actually a lagging indicator by all measures internally and the IHC would really be the leading indicator. But, so again, we won't comment specifically on where those levels are here through the first month of the quarter. But as it relates to your second question with portable gens, yeah, it's portable generators are – they've been for us for the last seven or eight years been a very good market for us. This year, we actually had coming into the year, the Hurricane Matthew events, which as we said was not a major event. There was quite a bit of portable generator load-in from the retailers during that event. And unfortunately the sell through on the backside in that region, the Carolinas specifically was just – was not up to what the retailers originally forecasted. And so as a result, we ended up kind of coming into the year and we suffered throughout the first quarter and really into beginning of the second quarter with higher field inventory levels. All along the while though, point-of-sale transaction information has been positive for the year. So, we like the sell through. It just unfortunately, there was way too much inventory on the back of that event. Now, as we exit the first half and come into the second half here, we feel that inventory levels are seasonally appropriate and that we have a lot of data historically to look at. So we feel pretty good about that. The challenge we run into is whenever inventory levels end up in a high position, and this is mainly transacted at the retail level, retail channel partners tend to look at their pre-seasoned buying just in more of a negative light. The pre-season buy-in that we would normally see in Q2 and as I said kind of straddles Q2 and into early Q3 here has just been weak. Rightfully so, because right now we feel inventory levels are appropriate. So we just don't think – and that's part of the story here in the second half is we've kind of – we've adjusted for that in our guidance, the portable generators, just in the absence of a major event, obviously, could come in weaker than prior year. And obviously, we've got the comp in Q4 to deal with as well. So you've got – that's going to put a lot of heavy weight against that as well in Q4 once we get to that point.

[Patrick Wu:]

Great. That's good color. I just want to follow up very quickly on one of your comments (45

[Aaron P. Jagdfeld:]

Yeah. Well, I mean, obviously Sandy, it was a regional event in Northeast, but it was really a national event in terms of – maybe even a global event in terms of the impact. So we're going to run it as a national promo. Obviously, we expect that the Northeast market would be the prime market. In fact, we'll probably over-index our average as we haven't nailed down all the elements of the plan at this point, but as we've done – we've actually tested this concept in some local markets and some other areas, obviously, didn't call it heroes of Sandy on the five-year anniversary, but we did some other testing around an all-in price point in some other local markets, and we had very good receptivity to it. So we're very interested to see what kind of impact this has. The Northeast for us, as we've said, has really been a challenging market. In fact, the first half of this year, it's finally up, on a combined basis for the first half in a long time. I mean, the Northeast market in terms of activations has been sequentially down every year since Sandy, since the year after Sandy, really, since 2013. It's been a really tough run. It was just – Sandy had that much of an impact on that region. So we expect that this promotion, although, a national promotion will have a probably an outsized impact, at least that's our initial forecast on that particular market.

[Patrick Wu:]

Got it. And then, you guys mentioned that, obviously, you went through replacement and the upgrade cycle was very strong on the C&I side. But it sounds like (47

[Aaron P. Jagdfeld:]

Well, these are just our views obviously internally and with our discussions with channel partners, but that $50 number is a – psychologically in terms of the price of oil is an important level, we think. Now, we also said in our prepared remarks that so far in Q3 here, we've actually gotten some really good feedback from some of the specialty rental companies that serve that oil and gas market. Some really good feedback around their fleet utilizations in particular as it relates to gaseous generators, which for us is a direct correlation to activity in those energy plays. And so we think that could lead to you know potential upside in the second half. We frankly haven't put a lot of oil and gas related upside in our mobile numbers although I would say that our guidance adjustment this morning, as York said, and as I think we said in our prepared remarks, is somewhat on the back of just general overall re-fleeting increases that are going on – or re-fleeting activities that are going on in that mobile space. But as far as timeline, it's hard for us to say – certainly we can't put a timeline on when oil will be at $50 a barrel and stay at $50. It touched it two days ago, dropped back below it yesterday. Your guess is as good as mine in terms of where that goes in terms of when, but I think the one thing I do know with this type of rental equipment is it continues to age. And so if utilization rates improve, as we're getting some evidence that they are, that means the equipment's going to continue to age – as a result of use. And that at some point in the future portends a future replacement date. So is that the second half of this year or first half of 2018 that part I can't get as specific on at this point. But it is something we watch very, very closely.

[Operator:]

Your next question comes from the line of Christopher Glynn from Oppenheimer. Your line is open.

[Christopher Glynn:]

Hey, good morning, guys.

[York A. Ragen:]

Good morning, Chris.

[Christopher Glynn:]

Hey. I have a question on some of your international seed planting around the resi standby, you know whether it's Australia or otherwise – if or if you aren't really seeing market traction there, what kind of wisdoms have you picked up in terms of the transferability and exportability of this concept?

[Aaron P. Jagdfeld:]

You know, I think our original thesis on that Chris was always that there isn't another market around the world probably that approximates the opportunity size that the United States does in terms of higher home values, higher disposable incomes and poor power quality. That there are elements of that that exist in places around the world, maybe one or two or three and also natural gas infrastructure which is the other piece of that that's really an important element of making it a viable category in other areas. But what we found and what our thesis was is there are pockets and those pockets we've seen them now in South America, we've seen them in Central America, in Mexico, Australia we believe given that the average home price in Australia is actually higher than most places in the U.S. It's a mainly coastal area subject to harsh weather conditions. There's a decent natural gas grid but unfortunately the natural gas grid in Australia doesn't extend into some of the rural areas where the outages tend to occur more. So you have a little bit of a mismatch there based on our research. But that being said, we still think there's an opportunity to sell product there. Russia has been an interesting area for us to have some very interesting conversations. The Middle East, where there is good gas infrastructure. Again, you see a theme here with that. I would say, even in Western Europe, there are parts of Western Europe where the grid is maybe little bit less stable, gas is present, and there's a need – a need case for these products where you've got – you just simply can't have an outage. So we're optimistic that there's places for this. The one thing that is proving to be a little more challenging is that the rules and regulations from you know – and I know you guys have never heard this from a business before, complaining about rules or regulations. But the rules and regulations around electrical systems, around gas systems, around products like this, around installations, is dramatically different from one region to the next. What is a requirement here in the U.S. is ,you know, looks completely different in Australia, looks completely different in Europe, looks different in Russia. So we've had to really try and increase our knowledge of each of these local markets ahead of time, and then make the localized adaptation of the products, which have proved in some cases, you know the product that we're going to launch in Australia has a significantly different gas train on it than it has here in the U.S., because of gas regulations in Australia. That in fact adds some cost to the product and adds some complexity that we don't see here in the U.S. as being a requirement. Why is that? Different regulations have developed at different speeds by different people in different areas. So we'll continue to adapt and learn, but it is proving to be a bit of a challenge in terms of rolling out these products and finding some headwinds that maybe didn't exist in our original thesis. So, we're happy with the distribution that we've gotten through Pramac so far. We're looking forward to the opportunity, but it just – it may be a little bit slower to roll, just as we make the right localization of the product that we need to have.

[Christopher Glynn:]

Sounds good. Thanks.

[Aaron P. Jagdfeld:]

Thanks, Chris.

[Operator:]

Your next question comes from the line of John Quealy from Canaccord. Your line is open.

[John Quealy:]

Hey, good morning folks. So just two questions.

[York A. Ragen:]

Good morning, John.

[John Quealy:]

Hey good morning, York. First question, can you just remind us, on the national accounts telco side. Just, I know it's a diminishing part of the business, based on your expansion and diversification efforts. But what's the size of that business right now? And is that just going to be on ice for a while, until we get some real CapEx on 5G? And then I just have one quick follow-up.

[Aaron P. Jagdfeld:]

Yeah. John, we really haven't quoted that as an independent. It's still an important part of our C&I business for sure. But it's – I would say this, relative to where the levels of spending, CapEx spending, were three, four years ago by the telecom companies, it's literally half of what it was at that point. And now what's going to kick it into the next gear, 5G certainly will be an important factor in that CapEx spending overall around 5G. At some level, these products are – they are, without a doubt, a critical part of that infrastructure going forward. You have got to have some backup power source on cell towers. There are far too many critical communications and critical data that traverse the wireless networks in the U.S. and in other parts of the world for those networks not to be hardened, not to be backed up, to be reliant only on utility power. And it's something that we see, it's not going away. The product is morphing somewhat into different outputs aligned with – as the size of the gear and maybe the tower construction changes, in terms of the requirements around the product may change, but we're adapting alongside of that. We've got some new products that have rolled out here for certain customers who are looking at – making some changes to the way they deploy their sites. But I don't think that's a market that's going to change. The one thing that could really materially change that market is if somebody else, i.e. someone in the regulatory space, decided that these networks – it was a requirement to have them hardened, not just an option. And so, we'll see if that comes to pass. There's been a couple of runs at that by the FCC, but I don't know, I don't hold my breath that – we're not waiting for regulation to drive volume there. We continue to engage very well with our partners there, and have for 25, 30 years, in developing solutions that are unique for them and that work for their networks and for their customers.

[John Quealy:]

All right, that's helpful. And then my last question, just on the dealer network and the characteristics of that network. Obviously, distributed generation in solar has – drove a ton of contractors and electrical engineers into that sort of last mile. What's your characterization? Do you see sort of a fresh new pot of faces to touch on your particular solution currently for DG, or is it the same dealer still doing the 80/20 rule, if I just put that in your mouth for now? So, what's the context for more dealers, in terms of the broader DG opportunity? Thanks guys.

[Aaron P. Jagdfeld:]

Yeah, it's a great question. I would say this. On the broader DG opportunity, there may be some of our dealers in our existing distribution network today that will adapt to those types of products as they begin to hit the market, and who are involved with it today, frankly, whether through solar or through other means. But frankly, for us, we view it as kind of a ripe space for potential new dealers who today aren't involved with power generation as a DG source, right? They're involved with other sources. We see those – whether they're solar installers or some other channel that's developed to accommodate some of those alternative sources of power, or nontraditional sources of power. We're beginning to engage with those partners on the potential for our views on where we can go with distributed generation, with either products that look like products we have today, or products that we may or may be developing for the future. And so, I see it as kind of – in addition to our existing network, or certain parts of our existing network, an extension of that, with potentially new channel partners.

[Operator:]

Your next question comes from the line of Jeff Hammond from KeyBanc Capital Markets. Your line is open.

[Jeffrey Hammond:]

Good morning, guys.

[York A. Ragen:]

Hey, Jeff.

[Jeffrey Hammond:]

Just to follow-up on kind of the margin cadence. I think you said sequentially 100 to 125 basis points, and that would leave a big ramp into 4Q, and I think you said sales are going to be comparable 3Q to 4Q. So, can you just kind of walk me through the bridge from 3Q to 4Q on similar sales?

[York A. Ragen:]

Yeah, I think when you look at it, that the ramp from Q3 to Q4 probably about half of that is going to be mix related, Jeff. And we'll – on a mix basis we'll sell more home standbys and less portables and less power washers. I think seasonally that mobile business Q3 is very strong, Q4 is not as strong. So there'll be a de-mix of the mobile business. So that's probably half of the delta is mix, and then just on the OpEx load you tend to spend less in Q4 seasonally as you're in the heart of the season. So you know you're going to get some incremental margin on the lower OpEx spend that way on the other half. So that's the bulk of the mix.

[Jeffrey Hammond:]

Okay. Thanks guys.

[Operator:]

Your next question comes from the line of Michael Feniger from Bank of America. Your line is open.

[Michael Feniger:]

Hey guys, filling in for Ross. Thanks for taking my question. On the...

[York A. Ragen:]

Good morning.

[Michael Feniger:]

Good morning guys. On the margin cadence, I'm just curious on the Q3, I think you said you expect 100 to 200 EBITDA margin improvements versus Q2. Can you give us an idea of how to think about that with domestic versus international?

[York A. Ragen:]

So, we said EBITDA would improve 100 to 125 from Q2 to Q3 I think is what you're saying. We didn't really guide that you know domestic versus international, so I don't have that level of detail to provide you on this call.

[Michael Feniger:]

Okay, fair enough. And then I believe you guys said in the beginning that you signed up more dealers and maybe at a record right now. Activations are up double digits and that's helping you clear inventory. Are you guys talking about your own inventory or are we talking about the inventory with dealers? And is it now back down to normal levels? I was hoping you can give us some color there.

[Aaron P. Jagdfeld:]

Yeah Michael, our comments as it related to the inventory were related to field inventory which is something that we have we have a really sharp eye on obviously. And so really the two pieces there you mentioned you know the additional dealer count, which is at an all time high by the way at 5500 dealers and which is fantastic because I think it's really an important part of the long-term strategy there. But also the increased activations that we experienced in the first half of the year have helped to really put that inventory in a place that, as we exit the first half, as we exit the second quarter here, we look at the field inventory levels on it. When you adjust for those higher activation levels kind of we look at field inventory in terms of days on hand and so that days on hand in terms of activation level we feel very good that it's seasonally appropriate. In fact it's very much in line with where we were last year at this point and is what we believe to be the right level going into the second half.

[Michael Feniger:]

That makes sense. And then just some clarity I think you had mentioned on the other segment, you guys provided some color on the aftermarket part. I was hoping you can just provide about a little bit more color about. What were you guys seeing there in the second quarter?

[York A. Ragen:]

Yeah one of the things I highlighted in the prepared remarks is that mobile business has really been very strong. They've been – the rental guys have been focused more so on replacing old equipment with new equipment as opposed to fixing old equipment. So we saw that as a reduction in their service parts sales here year-over-year on the mobile side that was what I was referring to.

[Michael Feniger:]

Perfect. Thanks, guys.

[Aaron P. Jagdfeld:]

All right. Thanks, Michael.

[Operator:]

I'm showing no further questions at this time. I'd now like to turn the conference back to Aaron Jagdfeld, President and Chief Executive Officer.

[Aaron P. Jagdfeld:]

Thank you. And we want to thank everyone for joining us this morning. We look forward to our third quarter 2017 earnings release, which we anticipate will be at some point in late October. With that, we'll release you to your morning. Thank you very much.

[Operator:]

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