Generac Holdings Inc. (GNRC) Q1 2015 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen and welcome to the Generac Holdings 2015 First Quarter Earnings Conference Call. My name is Adrian and I will be your operator today. At this time all participants are in listen-only mode. We will conduct a question-and-answer session towards the end of the conference. [Operator Instructions] As a reminder this call is being recorded for replay purposes. I would now like to turn the call over to York Ragen, Chief Financial Officer. Please proceed, sir.

Thank you. Good morning and welcome to our first quarter earnings call. I'd like to thank everyone for joining us this morning. With me today is Aaron Jagdfeld, our President and Chief Executive 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 our SEC filings for a list of words or expressions that identify such statements and the associated risk factors. In addition, we will make reference to certain non-GAAP measures during today's call. Additional information regarding these measures, including reconciliation to comparable U.S. GAAP measures is available in our earnings release and SEC filings. I will now turn the call over to Aaron.

Thanks, York. Good morning, everyone and thank you for joining us today. Net sales in the first quarter of 2015 were $312 million as compared to $342 million in the prior year, primarily due to a decline in shipments of commercial and industrial products, and to a lesser extent, sales of residential products. C&I product sales were impacted by a decline in shipments of telecom national account customers and softness in oil and gas related capital investment. Residential products sales were impacted primarily due to a decline in power outage severity compared to the prior year which reduced shipments of portable generators along with harsh winter weather that slowed installations of home standby generators, in particular, in the key northeast region of the U.S. However, despite the adverse market conditions, shipments of home standby generators were approximately flat when compared to the prior year and product activations actually remained above prior year levels in every other region outside the northeast. We believe the conditions that contributed to a softer demand environment in the first quarter were mainly temporary in nature, and we are confident that the long term growth drivers for our business remain firmly in place. The power outage severity environment experienced during the first quarter continue to be well below normal baseline levels, and was down significantly relative to the first quarter of 2014. In fact, the outage environment in the first quarter of 2015 was the lowest we've observed in more than five years that we've been tracking outages on a detailed basis. Over the course of our long history in this business, we have observed that power outage activity runs in cycles. As we have said previously, we believe that growth in the home standby category occurs in a step function manner with the penetration rate for the category accelerating during periods following major outage events, and slowing again as the impact of those major outages subsides. Each successive step that the category takes is representative of a new and higher baseline rate of demand resulting from increased awareness and expanded distribution. We believe that the recent performance of the category clearly demonstrates that this pattern continues to play out as the penetration rate of home standby generators grew rapidly following the major outage events that occurred in the second half of 2011 and 2012, and we have been able to hold that new and higher level of demand despite a meaningfully lower power outage environment over the last two years. For some added historical perspective, shipments of home standby generators in the first quarter of 2015 were more than double compared to the first quarter of 2011 which was essentially the prior first quarter baseline before the multiple major outage events that occurred. The resiliency of home standby generators in the current backdrop of such a challenging power outage environment gives us continued confidence in the future growth prospects for this product category when outage activity eventually reverts back to normal levels. We believe holding this baseline level of demand for home standby generators during the current year first quarter has further proved that our initiatives are helping to increase the awareness of the product category including our innovative sales and marketing techniques put in place over the past several years. These efforts are highlighted by our four step system to identify and qualify sales leads and improve the sales closure rate for home standby generators, including our targeted marketing process, our increased use of media spending, the qualification of incoming leads, and the use of our PowerPlay in home selling solutions by our dealers to close sales. We have continuously refined and improved our sales and marketing methods over the past two years and we are seeing favorable trends on a number of metrics involving PowerPlay, including the number of dealers using this in home selling solution, the scheduling of in home consultations or IHCs as we refer to them, and the number of dealers participating in training programs designed to improve sales closure rates. We are also working on some important initiatives during 2015 to further increase sales leads and improve closure rates for home standby generators. In addition, we continue to drive participation in our PowerPro dealer program to further align our industry leading dealer network with the factory. The PowerPro designation is the most comprehensive program available to dealers who need a stringent set of requirements ensuring that our customers receive a best-in-class sales and service experience when purchasing Generac products. From a longer term perspective we continue to expect the trend of an increasing level of power outages to remain in place driven by an ageing and underinvested electrical grid and the frequency of severe weather that we will believe will continue to go into the future. With only approximately 3.5% of US households owning a stationary backup generator, we believe there remains substantial opportunity to grow this market over the longer term. Turning to the commercial and industrial portion of our business, as we expected entering 2015 the significant decline in energy prices experienced since mid-2014 is having a notable impact on demand from mobile equipment that is primarily used in upstream oil and gas applications. Although the steep drop in energy prices has reduced equipment spending in the near term, we believe investment related exploration and drilling activities will be impacted more negatively than spending associated with production activities which is where our products are generally used. In addition, more strict regulations limiting the flaring of natural gas is expected to continue to be a catalyst for increased demand for natural gas generators at these production sites. The waste gas now required to be captured or consumed can essentially serve as a free fuel source leading to a very attractive ROI and payback period for these generators. With the low level of energy prices seen during the past several months, EMP companies are under intense pressure to reduce their operating costs and we are seeing signs in the marketplace that this is leading to additional awareness and resulting substitution of natural gas generators and lure diesel generators within oil and gas applications. As a leader in natural gas generators, we believe we are in a strong position to capitalize on this opportunity. However, we continue to take a more conservative approach to our outlook for this end market for the remainder of 2015 as we gained further clarity on the impact of lower energy prices on the demand for capital equipment. We commented during our prior call in February that we expect the telecom capital spending environment to remain subdued throughout 2015, particularly during the first half of the year. Capital spending patterns of telecom national account customers are generally somewhat cyclical, and as we have commented many times on previous calls, it can be difficult to predict the timing of spending which can vary from quarter-to-quarter and year-to-year. However, we believe the long term secular penetration opportunity for backup generators at cell powers remains firmly in place due to the need for wireless providers provide to protect the revenue streams, as well as the increasing competitive and regulatory pressures they face to harden their networks. At only 30% to 35% penetration of generators on cell power side, we believe there is a significant runway to continue to penetrate this sector as the leader in this end market. Our Ottomotores towards the Latin American market through operations in Mexico and Brazil experienced solid growth in shipment during the first quarter of 2015 which follows a similar level of year-over-year growth experience during the fourth quarter of last year. Although we believe the general economic environment in Latin America has stabilized in recent quarters, the improved performance of Ottomotores is more attributable to the tangible progress we have made with our integration efforts and other actions we have taken over the past year. This includes the change in leadership made during the second half of 2014, the recent realignment of our Latin American commercial sales team, operational improvements, and the realization of several cross selling revenue synergies. Despite rejections from modest overall economic growth rate in the Latin American region in 2015, we believe Ottomotores will continue to benefit from an increase in larger project bid activity driven by improving infrastructure spending, as well as continued execution on strategic initiatives. The Ottomotores acquisition remains an essential platform for our international expansion efforts by providing a local manufacturing presence and access to the important Latin American market for power generation and other engine powered equipment. Lastly, we have commented over the past several quarters and the progress we've made during 2014 in building out and expanding our capabilities for large industrial generators. This includes the consolidation of our manufacturing footprint for larger output products into the Baldor acquired facility in Oshkosh, Wisconsin, and our focus on increasing our distribution partners product knowledge and sales bandwidth to better enable them to sell these larger generators and systems. We also have a number of new initiatives that are underway in 2015 focused on the continued optimization of our industrial dealer network, as well as various projects to improve our specification and closure rates that we believe will provide greater opportunities for growth in this market. Additionally, our 2015 outlook for C&I products includes the expectation of an improving and more favorable non-residential construction environment that should provide more sales opportunities for our distribution partners to increase their interaction with the engineering firms and electrical contractors responsible for specifying and selecting our products. I would now like to turn the call back over to York to discuss first quarter results in more detail. York?

Thanks, Aaron. Net sales for the first quarter of 2015 were $311.8 million as compared to $342 million in the first quarter of 2014. Looking at net sales by product class; residential product sales during the first quarter of 2015 were $156.8 million as compared to $164 million in the prior quarter. The decrease was primarily driven by a decline in portable generator sales as a result of a power outage severity environment that remained well below normalized and prior year levels. Shipments of home standby generators were approximately flat versus prior year despite the low outage environment and harsh winter conditions in certain key parts of the United States. Partially offset in the overall decline in residential products was the modest contribution from the Pramac acquisition. Looking at our commercial and industrial products, net sales were $133.8 million in the first quarter of 2015 as compared to $157.4 million in the press release first quarter. The decline over the prior year was primarily the result of an ongoing weakness in capital spending by certain of our telecom national account customers. In the prior year first quarter, shipments to these telecom customers were significant as they invested heavily in hardening their wireless networks with backup power. Starting in the second half of 2014 we experienced a sharp decline in demand from certain key customers as they deferred capital spending on these projects, and this has continued into the first quarter of 2015. To a lesser extent, we also saw reduced sales of mobile equipment going into oil and gas markets given the rapid decline in energy prices. Partially offsetting the weakness in telecom and oil and gas end markets were contributions from the MAC acquisition, as well as growth in Latin America shipments which increased at a solid rate over the prior year. Net sales for the other products category were $21.2 million in the first quarter of 2015 as compared to $20.7 million in the prior year. This modest increase was primarily driven by the addition of aftermarket part sales from recent acquisitions. Gross margin for the first quarter was 32.9% compared to 34.9% in the prior year first quarter. Temporary increases in certain product overhead related costs along with recent acquisitions were partially offset by a more favorable mix of residential products in the quarter. As mentioned in our previously earnings call, we continue to experience incremental costs associated with the West Coast port congestion, unfavorable absorption of manufacturing overhead related cost due to lower volumes, and mark to market adjustments on copper forward contracts. Once again we expect most of these costs to be temporary in nature and to moderate beginning in the second quarter of 2015, and into the second half of 2015. Operating expenses for the first quarter of 2015 increased $3.5 million or 6.4% as compared to the first quarter of 2014, an increased in marketing and advertising expenses and the addition of recurring operating expenses associated with recent acquisitions were the primary drivers for this increase. Overall, continued improvements and warranty rates although partially offset these OpEx increases. Adjusted EBITDA was $57.1 million or 18.3% of net sales in the first quarter of 2015 as compared to $77.5 million or 22.7% of net sales in the same period last year. This decline in adjusted EBITDA margins compared to prior year was attributable to the 200 basis point decline in gross margins combined with the 250 basis point increase in operating expenses as a percent of net sales, as a result of the factors just discussed. Adjusted EBITDA over the last 12 months was $316.9 million. GAAP net income for the first quarter of 2015 was $19.7 million as compared to $34.7 million for the first quarter of 2014. GAAP income taxes during the first quarter were $11 million or up 35.9% effective tax rate as compared to $19.5 million or 36% rate for the prior year. Adjusted net income as defined in our earnings release was $34.1 million in the current year quarter versus $50.7 million in the prior year. This decline over the prior years is the result of the overall decline in operating earnings as previously discussed, partially offset by $4.8 million in lower cash income taxes. Diluted net income per share on a GAAP basis was $0.28 in the first quarter of 2015 compared to $0.50 per share in the first quarter of 2014. Adjusted diluted net income per share as reconciled in our earnings release was $0.49 for the current year quarter compared to $0.72 per share in the prior year. With regards to cash income taxes, the first quarter of 2015 includes the impact of a cash income tax expense of $5.1 million as compared to $9.9 million in the prior year quarter. This year-over-year decline in cash income taxes for the quarter was primarily the result of lower pre-tax earnings along with a reduction in the expected cash income tax rate relative to the prior year. Relative to our previous guidance, our cash income tax rate for full year 2015 is now expected to be approximately 17% versus a previous expectation of approximately 18%, primarily due to the reduced full year outlook that we are reporting this morning. As a reminder, our favorable tax yield through annual intangible amortization and our tax return results in our expected cash income tax rate being significantly lower than our currently projected GAAP income tax rate of 36% for 2015. As we drive profitability overtime, cash income taxes can be estimated by applying a projected longer term GAAP income tax rate of approximately 36% on pretax profits going forward, and then deducting the approximately $49 million of annual cash tax savings from the tax shield each year through 2021. Free cash flow defined as net cash provided by operating activities less capital expenditures was $18.7 million in the first quarter of 2015 as compared to $31.4 million in the same period last year. The year-over-year decline was primarily the result of a decline in operating earnings during the current year quarter, partially offset by reduction in working capital use of cash as compared to the prior year. Free cash flow over the last 12 months was $205.6 million. As we mentioned in our earnings release this morning, we made a prepayment of debt during the first quarter totaling $50 million, this voluntary payment allowed us to maintain our credit agreement leverage ratio below our target of free times and it can be applied against any future excess cash flow payments that are required pursuant to our term loan credit facility. This $50 million debt prepayment resulted in the recording of $1.4 million loss on extinguishment of debt which is included within the other income expense section on the income statement. Updating our interest expense guidance as a result of this debt prepayment, we now expect total interest expense to be in the range of $45 million to $46 million which includes $38 million to $39 million of cash outflow for debt service cost, plus approximately $7 million of deferred financing cost in original issue discounting amortization for our credit facility. This interest expense guidance assumes no additional debt prepayments during 2015, our existing interest rate swap contracts remain in place, and that LIBOR rates then increase beyond our current LIBOR floor of 75 basis points. As of March 31, 2015 we had a total of $1.04 billion of outstanding debt, net of unamortized original issue discount, and $150.1 million of consolidated cash and cash equivalents on-hand, resulting in consolidated net debt of $887.1 million. Our consolidated net debt to LTM adjusted EBITA leverage ratio at the end of the first quarter of 2015 was 2.8X. Additionally, at the end of the first quarter 2015, there was approximately $150 million available on our ABL revolving credit facility. With that, I'd now like to turn the call back over to Aaron to provide additional comments on our revised outlook for 2015.

Thanks, York. As a result of current end market conditions, we are revising our prior guidance this morning for full year 2015 with revenue growth and adjusted EBITDA margins. Net sales for 2015 are now expected to be approximately flat for the full year as compared to the previous expectation for net sales increase in the low to mid-single digit range. This revised top line guidance is primarily the result of a power outage severity environment that we now expect will remain below normal during the entire first half of the year with the assumption of a returned more normalized baseline levels of objectivity during the second half of 2015. As a result of the change in power outage assumption, we are reducing our forecast for residential product shipments in the first half of the year. Our previous guidance assumed a normalized power outage environment for all of 2015. Importantly, this top line outlook continues to assume no material changes in the current macroeconomic environment and no major power outage events occurring during the remainder of 2015. With regards to seasonality of net sales, we now expect the first half of the year to represent approximately 43% of total sales, and the second half approximately 57%. The expectation of net sales we weighted notably more towards the second half of the year is primarily due to normally seasonality typically experienced with residential products, and it is being further magnified by the assumption of a normal power outage environment in the second half relative to below normal in the first half. In addition, net sales for C&I products for 2015 are also expected to be weighted more towards the second half of the year across several of our channels and end markets including industrial dealers, oil and gas, and Latin America. Looking at our guidance by product class, for residential products we now expect net sales for 2015 to increase in the low to mid-single digit range as compared to the prior year. This represents a decline from our previous expectation of an increase in the mid to high single digit range during 2015 which is a result of reduced power outage expectation for the first half of the year. With regards to C&I products for 2015 we expect net sales to decline in low to mid-single digit range as compared to the prior year on an as reported basis. Strong headwinds in the oil and gas and telecom markets together with the modest foreign currency impacts are expected to be partial offset by gains in our industrial distribution channel, improvements from Latin America and contribution from the MAC acquisitions. Gross margins for 2015 are now expected to improve approximately for 75 basis points to 100 basis points over the prior year, as compared to the previous year expectation to improve by approximately 150 basis points to 175 basis points. The revision from prior guidance is primarily the result of reduced expectations for the first half of the year from a lower mix of residential products due to change in power outage assumption previously discussed, and to a lesser degree more unfavorable manufacturing overhead absorption due to lower sales outlook. Operating expenses as a percentage of net sales, excluding amortization intangibles are still expected to increase approximately 75 basis points to 100 basis points as compared to the prior year. We are holding this guidance despite a lower sales outlook through focused efforts to control spending in a variety of selling, general and administrative cost. As a result of the updated outlook for net sales, gross margin and operating expenses, we are revising our adjusted EBITDA margin guidance of full year 2015. Adjusted EBITDA dollars are now expect to be approximately flat as compared to the prior year, resulting in margins of approximately 23% for the full year. This compares to our previous margins expectation of 23.5% to 24%. With regards to the seasonality of adjust EBITDA margins during 2015, we now expect second half margins to be between 675 basis points to 700 basis points higher than the first half. This expectation is the primarily the result of net sales to be weighted notably more towards the second half of the year as previously discussed, which is expected to result in more favorable product mix and better SG&A leverage on higher sales volumes. We also anticipate an increasing benefit in product cost reduction during the second half through an improvement in manufacturing, overhead absorption and the realization of more favorable commodity prices in foreign currency exchange rates. We expect that we'll continue to generate strong free cash flow in 2015 given our superior margin profile, low cost of debt, favorable tax attributes and capital efficient operating model. Due to the revised seasonality of net sales in EBITDA margins previously discussed, free cash flow is also expected to be notably more weighted towards the second half of the year. In closing this morning, although certain of our end markets are performing below our expectations we remain focused on the numerous compelling secular growth opportunities for our products. We have become a more diversified company in recent years with a strong balance sheet and the capability to generate significantly free cash flow providing us with the flexibility to drive our strategic initiatives. In addition, we are confident in our ability to continue to invest in the future growth of the business, both organically and through acquisitions, as we further implement our head strategic plan. This concludes our prepared remarks, and this time I would like open up the call for questions. Operator?

[Operator Instructions] Please standby for the first question, that comes from the line of Charley Brady of BMO Capital Markets. Please go ahead.

Thanks, good morning guys. On the gross margin you called out a couple items that can perform for specific parts, I'm wondering if you can break out the impact particularly on the port strike impact and the mark-to-market which presumably really transitory relatively to the other two?

Charley, that's relative to gross margin, so it was 200 basis points up prior year actually but 200 basis points from expectations and if you look at pieces of that about a third of that was mix related on the lower home standby mix relative to expectation, probably about a third of that was price in that given a softer demand environment price had a slight impact there were relative to expectations. And then the last third is costs and those are the pieces that you are talking about, the west coast port, the copper mark-to-market these was a unfavorable overhead absorption as well that came through which – as we highlighted more temporary in nature. So about a third of that 200 basis points or more thing that are temporary that would – as we talked about would moderate in Q2 and then in the second half of the year really become neutral factors.

Just about the comment on the pricing impact, is that you have been seeing price pressure for some time is that a new phenomenal or your expect to that it continue to go 2015 or there is a recovery

Yes, Charlie this is Aaron, from a pricing stand point you know the there was versus our expectations you know pricing was a little bit a headwind given a amount of the additional promotional thing and drive the market. When you come up of the year then you see this as a pattern and coming of the year without major events, and it was exacerbated in the first quarter by – in our preparatory remarks we said it was the lowest outage environmentally we had seen in the five year since we have been tracking detailed outages. When you have environments like that I you are forced to drive the market harder, with promotion and with other activities that getting to characterize this prices in terms of the characterization of the financial. So those things are things that we would expect to not see as dramatically obviously if you were to get into an environment like what we are saying is going to happen back after the year, with a more normalized type our power outage environment. So it’s really kind of related to the very low outage environment not coming off a year without any major events.

And to be clear Charley, year-over-year price was not an impact because we had the same dynamic last year, so my count was relative to expectation but year-over-year there wasn’t any impact on price.

Alright thanks for clearing that up and just one more on the portable side, can you talk to the inventorial levels in the channel on portables, and at what point does that assuming our outages – and what point does that kind of level out to where you are not seeing a headwind on that going forward?

Yes, I mean the portable inventory is elevated right now, it's both a channel and within our own warehouses, we plan that inventory bills and by seasonally, so we buy ahead of the season last year we didn't get a season, so – then you typically would sell off at a normalized everyday rate, well that every rates also been lower than we would expect because of the low power outage environment to kind of the normal levels. So to answer your question directly in terms of burning it off, it’s going to be longer than what we would have normally planned, we would normally plan a season to be able to burn that product of over the 6 to 9 months if we dint get an event, so that would be the normal plan. Because we've been below normal in terms of regular everyday outages, that 6 to 9 months is probably going to fall more to the nine months or even carry us into the next season here. So we would expect our billed rates and somewhat – what we're talking about here with some of the lower absorption, the overhead absorption that we're dealing with – are both billed rates and our purchases of product will be lower going into this season because we've got plenty product out there. So it’s going to continue to be a headwind for as long as we're below kind of this normalized level of outage period, and we're ready to go should we get an event, we would be more than ready to be able to satisfy a pretty big spike in demand.

Great, thanks. I'll hop back in the queue, thank you.

Your next question comes from the line of Mike Halloran of Robert W. Baird. Please go ahead.

Good morning guy. So Aaron, is it fair to assume that your residential expectations in the back part of the year is largely unchanged, did I hear right in the comments?

That would be the right assumption, Mike.

And can you just give me it to sense if you don’t see normalize patterns materialize on the residential side what that could mean from a growth perspective for you or we just talking similar to this quarter on couple of points of half of the growth expectations for the year.

Yes I mean, I think we put a band around a year may be 2 to 4% if we state that is kind of ultra-low level below normalized, you know we could see a contraction on 2% to 4% on consolidated net sales as a results of that type of scenario, I mean it’s not what we believe will happened but it been the case here for the last several quarters. So you know I think some of the difficult being providing guidance to this business both on a quarterly basis but also similar year-to-year is the impact from the residential business from outages which you just can’t, it's difficult to quantify the both the exact impact from those outages or the exact impact when you don’t get them, so we have to go up against history there are ton of variable going into that but our best guess is you see something on the line of 2% to 4% impact in consolidated net sales if we don’t get those normal averages in second half of the year. [Cross talks].

And then , the oil and gas maybe you could talk about puts and the takes in market, obviously the mobile generation with some of the rental pieces, little bit of a headwind you sounded more positive on some of the flaring related regulations and what that means to your business, is that tracking about how you guys thought it would track it at this point and how are those variables times together?

Yes, you know for us as we look at it I think we're somewhat new to the oil and gas market through our acquisitions over the last two years, so we haven't seen a down cycle like this, all we have seen is up. Which you know I think the first thing that we saw happen and may be just I think it caught everybody by surprise, it's just a rapid deceleration there of the capital equipment spending – for the people who are directly associated with EMP providers who are directly associated with that, rental of that equipment as well. Now you know what were are seeing is a greater impact on the drilling activity side, the exploration drilling side. And frankly most of our equipment ends up in production side, so where production has remained on mind, we haven't seen quite the pullback yet but what we are seeing is where the equipment has had to be – had to have been reallocated because utilization rates are low. The equipment was on drilling and exploration activities in the Balkan or in Permian Basin or in some of the other Shale Plays is being reallocated by the rental companies into other areas of the country to improve their utilization rates, and what that's doing is it's depressing purchases of new equipment in really across the board. So we see kind of a general pullback that's very tight in the areas associated with oil and gas but more – a slowing down if you will in the rental market in general just as that kind of equipment gets reallocated out there. So that part of it was an interesting thing for us to watch and go through and understand. And then, where we are bullish as you pointed out and our comments kind of reflect that is, the substitution effect that we are see happening of natural gas generators, for diesel gensets, so – and that was really starting to come online even before energy prices dropped last year, there were some flaring regulations both in the state and federal level that have come online here over the last year that created a situation where the flurry and the natural gases is greatly reduced or eliminated altogether, so that gas either has to be contained and put into commerce or it's got to be consumed on site. And so the ability to use that fuel in a generator which these guys are already buying thousands of gallons of diesel fuel to power these diesel generators are on site producing temporary power. Having a gas solution and allowing them to use that fuel basically is a free fuel source and also solve the problem somewhat of the flaring to a lesser degree of course, but helping with that challenge. We are seeing that shift still occurring and we actually think that shift is being exacerbate somewhat by the cost pressures that the industry is seeing to reduce their cost of extraction and production. So we think that's a favorable trend longer term, we like where we're positioned for that, and we think that's something that is going to benefit us going forward.

And just to clarify, we effectively talked about this in our last earnings call when we initiated guidance, we are not changing our guidance relative to oil and gas, here we are holding that. And as we talked last earnings call, we believe that will be down – oil and gas related shipments will be down about 20% year-over-year so we are holding that and feeling the same as we did last quarter.

Great, I appreciate the color guys.

Thanks, Mike.

Your next question comes from the line of Jeffery Hammond of KeyBanc. Please go ahead.

Good morning, guys.

Good morning, Jeff.

So I think you mentioned no change on oil and gas, I think you're thinking about telecom down 20 as well, any change there. And anything you're hearing from any of those large customers in terms of visibility for any kind of pick up into the second half?

Yes, Jeff this is Aaron. We took down the telecom ever since slightly in the back half of the year based on the conversation we are having with telecom providers, I mean the capital spending that goes on in there – it moves in cycles and we're really at the back end of those cycles often times because the sites get either built or retrofitted invertor generators added later on. It's interesting, some of those key customers have continue to spend money, other key customers have really put the brakes on hard last year, and we saw that it's in our results and obviously we had a really difficult comp, we're up against here in the first half of the year given that, that was so strong, first half of the last year. The conversation we have had with these guys, they’ve got some inventory from Baldor [ph] they made last year, so the first half of the last year that strength. When they hit the brakes on their capital spending projects, some of the build out projects that they were doing last year, they ended up having generators in stock which is unusual, so they’ve got to burn through that first, so that's why even though I think there are some early signs that telecom capital investment maybe starting to come back online here ever so slowly here in the first half of this year, there is bit of inventory they have to work through first and that's really why we kind of tempered our enthusiasm in the back half of the year around that. These guys – unfortunately we don't get a lot of visibility to their cycles, and it can be a bit frustrating for us certainly from a manufacturing standpoint but I think that's one of the reasons why they like us a suppliers is we are able to react quickly to their needs, both up and down, it just can create a bit of choppiness from quarter-to-quarter in that sector for us.

Okay. And then, can you just talk about quoting activity and activations in home standby and any indications into April that you're seeing this normalization as this weather normalize on activations in the northeast?

Yes, so – this winter was again a brutal winter for installation of product and activation of product, it was – that being said, every region for us outside of northeast we actually saw activation rates improve year-over-year. So I think it was spot on with where the worst part of winter was in terms of snow and cold, it was right in the northeast, and the unfortunate part is that's a really key market for us just given the population density and the power quality in the northeast, and the awareness of the category and everything else. So it was probably disproportionate impact given the harshness of this winter versus even last – last winter arguably it was cold in the northeast but it was actually worse than the Midwest. We actually had a little bit better winter this year in the Midwest. So activation rates outside of the northeast were up everywhere in the first quarter, we've actually seen – I see that we refer to them these in home consultations, actually we're up year-over-year in Q1. So that's a good trend for us, we like that trend, we do think that dealers continue to gravitate towards our PowerPlay selling system, we're driving as much of that as we can with media spends, there is some seasonality with that, you don't want to spend the media in the first quarter when the market is at a slower pace, so your cost for IHC and other metrics that we watch can get away from you pretty quickly if you're not careful with that. So I think what we're – what kind of temporary our enthusiasm for Q2 still – as we go into the quarter here, activations have – well above last year's rate, I wouldn’t say they have spiked as the weather has improved. So there is usually a process there where you got to wait for – there is a bit of a lag, so we'll ramp up spending on our media spend and media buys coming up here in the May and June, come work towards the back half of this quarter. So when you look at front half of the quarter I tell you that we still see things pretty slow in April, relative to residential and a lot of that is due to the fact that power outages still remain very low in April. A couple of here recently in Texas and Louisiana but nothing really to speak up, not much anyway and so it's just been that kind of a quiet period around outages. It's still a generator category and you need outages to drive interest and awareness in the product, we can only do so much on our end, I think we're doing a lot, and I think we've done a lot to hold that new baseline that we've created over the last couple of years but it gets more challenging if you don't have the kind of conditions in the past have created outages.

Okay. And then just two quick housekeeping, can you give us a dealer count on what you did in terms of ads, net ads, and then what the acquisition revenue was in the quarter?

I'll deal with the dealer ads, we're flat basically from the end of the fourth quarter, so net ads and net deducts were roughly the same.

On the acquisition ad, so we've got two acquisitions built on acquisitions that have an annualized yet the Premec North America acquisition which – that's the portal generator manufacturer, given they are a portable generator manufacturer, they have a small contribution with a negligible contribution, low single digits. And then the MAC acquisition, is the heater company we brought late last year and given there they make heaters and we're off the heat season now so for Q1 that contribution from MAC was also negligible. So combined it was roughly low single digits and one of them in the channel, the other in the C&I channel, product category.

Okay, thanks guys.

Thank you. Your next question comes from the line of Brian Drab of William Blair. Please go ahead.

Good morning. I just wanted to talk about how you calculate the outage activity, your baseline level of outage activity. You can just remind us how far back does the data go, and I understand you said this morning that we saw the lowest level in the last five years but do we know what it looks like as you go back 8 years or 10 years? And I guess the question is, is there a chance that the baseline of outage activity that we're expecting to revert to in the back half of the year, is that the right baseline? And I think it is and I know you have obviously an extensive database but I just want to maybe ask you to remind us how you calculate that and give us confidence if that's the right baseline.

I think it's a great question Brian, and we've only been collecting detail data since January 2010, so it's about five year period, I unfortunately don't have 8 or 10 year statistics at this stage to give you which is obviously is challenging, we can look at broader statistics. So what happens, the way it's calculated is we look at detailed outages as best as we can track, I mean obviously overtime – over that five year period we've been tracking, we've improved our data gathering message, so it kind of improves every quarter that goes by as we find more avenues to collect the data and in fact we believe we have one of the most comprehensive outage databases that – it rivals anything that's out there, I mean I – it's actually we're pretty proud of it, and it's developed over last five years. Now what it does exclude that baseline normal, the normal baseline we talk about excludes all major outages, so we take out major outages, so we're only looking at what we refer to as normalized outage activity, axe any major event. So we take out all major weather events and all major outage events; ice storms or hurricanes, other major power failures; come out of that number and we created an average and obviously – mathematically as you add quarters to that and if those quarters as they have been for the last nine are very low, that brings the average down. So what we're looking at and what our forecast is built on in the second half of the year is based on recalibrated average, the current average if you will – the long term current average which is arguably a bit lower than it was a year ago or even two years ago. So, I mean we think we're using the right now, it's not an exact science and obviously we qualify all these statements by saying that outages really – where they happen is an important part of that and that's not really reflective in the severity index; the severity index is purely a calculation of the number of households that are impacted, multiplied by the number of hours that they were impacted for, so that is – it's a finite number that we calculate but it does not take into consideration where those outages happen and the reason that's important is if an outage happens in the area where we refer to as an echo effect, if you've had an outage or several outages in a particular geographic region over a short period of time, say two years, and you get another outage, a successive outage, a follow on outage in that same region, you’ll get a much bigger effect to that outage because you will have greater awareness and conceivably more distribution in that area. So that's the unfortunate side of the outage index, it doesn't really – there is not really an easy way for us to do that. Now we're starting to use some pretty decent statistical data to help us understand with each outage we track, what do we expect the impact to be because we're trying to get better visibility into the residential market because obviously as you've seen from our last several quarters, it can be a challenging market for us to get our arms around in terms of the predictability of it. So I think we're just – call it like we see it but we're learning, it's still relatively a young market, the data is relatively new, we think there is a tremendous amount of upside, we like the long term trends but it can be a bit choppy quarter-to-quarter as you've seen.

Okay, thanks for going through that. I guess just one more follow-up to that, I'm thinking about the time period over which you've been collecting the data. I mean you've been collecting the data for that long but you've been involved in a business that obviously has a lot to do with – where the weather can have a big impact on. So when you look back, maybe just anecdotally or just your personal sense for what the weather is like prior to 2010, is there any reason for us to think that – because obviously 2014 and the beginning of 2015 was light, is there any reason to think that the 2010 to 2013 time period was unusually strong, just – how did that period – what's your sense for how that period compared with 2000 to 2010?

I mean you look at 2006 to 2010, there wasn't a major landed hurricane that occurred at all, that was a really, really low period as well. At baseline I don't know the impact, again we weren’t collecting that data but again, to your point, we've been in this industry, I've got two decades of experience in this industry and it is a step function business, and the step function nature comes from the fact that power outages as we mentioned in the prepared remarks, they run in cycles, I mean we don't pretend to be meteorologist here but weather tends to run a longer term annual cycles to multi-year cycles, and it's impacted by a lot of things. We think that as we think about the future and we think about what's driving our longer term confidence and act of power as a category, it's really the underinvestment in the grid, I mean just skip the weather outages and the timing of those outages and the inability on the cycles that they go in, the fact remains that there has been a massive underinvestment in this country’s power gird and that has not changed, nothing structural has changed in that, it's just basically you've got an environment for whatever reason and for the last couple of years as you've said, we didn't – we had higher than normal activity in 2011 and 2012 and then since 2013 we've had lower than normal activity. So it runs in ways like that and it's part of the – it's really just part of the make-up of this business and it's part of why we try to diversify this company as well, I mean we think there is pieces of our business now today that are much less sensitive to what goes on quarter-to-quarter or even year-to-year in terms of outages, I mean commercial industrial market is much more – it's a business decision, it's much more of a code driven market, the mobile equipment space is a great space, it's really not driven by those things at all, it's driven by other cycles like non-residential construction spending, oil and gas, and mining and other things like that but we're trying to desensitize a bit, the company – to use lack of a better term volatility around the residential business that can occur.

Thanks. As usual, an extremely thoughtful response, I know you guys are being as responsible as you can about this. And then getting more granular, just one last question, on the west coast, the issues that you're having with the ports there. I think York you said there something that might carry over in the second quarter somewhat but then subside. Can you talk about exactly what does expenses worse seeing the west coast ports and the timing of how that resolves itself?

Yes sure, I mean there is a number of things we talked about west coast ports and manufacturing overhead under absorption and copper mark-to-market, specifically the west coast is inefficiencies of getting supply chain, there is a lot of air freight…

There is a lot of air freight, there is a lot of prebuys on inventory, so you've got inventory carrying cost that elevate because you've got to put that inventory somewhere you got to handle it, you got to do things with it but [Cross Talks], and I think the comments there – we saw that building in the fourth quarter and of course as York mentioned the impact that it had on the first quarter gross margin, and we do expect it will be a little bit of that hangover here as we go into the second quarter. But all in all, I mean we've seen it start to obey – the reason we've seen it abide is we've got inventories come back, you see in the raw material inventory numbers at the end of the quarter and we've seen a ton of containers shake loose from that logjam out there in the west coast and that's come at us now and obviously with kind of a slower residential business and a slower performance overall in Q1 there is also some elements of inventory increase related to that, so it was kind of double whammy that way, so not necessarily an ideal situation, put it that way, it's not what we had planned and not what we want to see but we'll work that down over the coming quarters.

Okay, thanks a lot.

Thanks, Brian.

Your next question comes from the line of John Quealy of Canaccord Genuity. Please go ahead.

Good morning guys, a little bit more qualitative question York. So first just a topic of growing the addressable market, can you talk about how the home builder relationships are going in that side and then perhaps a little bit ahead of ourselves but I think worth mentioning here, a lot of the distributor guys are starting to push not yet but soon to be in home storage and residential type storage, can you talk about how you think that market evolves, is and when you get involved, why you would get involved? Thanks guys.

Sure. So, I mean the addressable market, in terms of what we're doing there – we continue to push on that very, very hard over the last several years to try and move the needle there if you will. I think John, the question – just thinking through your question about the onsite storage and obviously there is – supposedly we had some large announcement by one of the players in the industry there that's making electrical vehicles, with an onsite storage system which – frankly, that's aimed at a completely different market than the market we serve, I mean – with that storage system from what we know and – by the way battery storage systems are around for years, that's not a new think per say, it's been around for years. I think the scale at which that company may be able to get from the cost perspective, it's still we believe probably twice as expensive as our standby power generation solution minus any subsidies and obviously it's up to the government to pick the winners and losers here which they have a really poor track record of doing but we'll consistently do anyway. And that system really provides for only a couple of hours backup in an outage, so I think that's really aimed at people who are in the space of producing their own power through solar or through wind and needed temporary storage area, or one hand, the existing temporary storage that they have and really gives them the opportunity to play on the arbitrage between peak rates and non-peak rates with utility companies. We are using it strictly as an emergency backup, I mean I see very few households that will buy that system for that alone. I don't know why you would spend $13,000, $14,000 on a system because you are couple hours of backup when you could spend average installation is about $7,500; why you would spend that kind of money and only get a partial solution. I think that overtime we've looked at – obviously, we keep a very close eye on technology and how it impacts all of our products, not just residential products but our commercial and industrial products, in fact we generally lead the market with innovation and new technologies. Batteries are I think an interesting space, and have been for quite some time, but there is no more slot with batteries; there is no real breakthrough for batteries – at the stage of the game if there ever is, could we foresee a situation where the reciprocating engine, the internal combustion engine is a very efficient – relatively speaking very efficient on a cost basis way to produce power. The combination of that engine with the battery, could that be some kind of hybrid program but potentially down the line, that might be what is the more realistic outcome of this in the years ahead but to be very frank, a pure battery system that would give you the kind of backup that an existing generator would give you today, it would be just incredibly cost prohibitive, because homes use quite a bit of power and to be able to have that kind of storage around will be a massive system, a large system and an expensive systems, it's just not something we see as – certainly not economically viable if not physically viable. So we will watch it and keep an eye on it but I think that's really aimed at a different market than what we serve today.

And then quickly back to today on the homebuilder market, are you guys happy with penetration and success there? And that's it, thanks guys.

Sorry John, I missed the first part of the question. On the homebuilder side, no, we're not happy with that, I think we could be doing more. New home construction – we have seen our penetration rate improve as housings improved but we've said that's really – for us it would represent a great opportunity to introduce the product category to people who are – have made the decision of building new home, who presumably have a mortgage with which to finance that. And you've got also a much lower installation cost as a result of other trades being on side and the walls being opened, permits being pulled; it's just a lot easier to do when you're building a home. Where we are getting traction is, more or so as we've said before with the custom builders because they try and differentiate their product from the larger production homebuilders. And the production homebuilders are really more focused on trying to sell people more square footage. So in terms of amenities it gets little bit challenging for us to make the argument to production builder, a track builder who is – to say, hey you can make a couple of box than selling a generator when frankly their margin is better when they try and sell square footage. So we're kind of moving in opposite directions in terms of what incentivizes those larger builders to offer the product. So it's been challenging for us, we're not giving up on it, we do have an initiative that we have a sales team here that we put back together after the housing market started to show signs of life a couple of years ago, and it had some success. We've had wins where we've got whole developments that – new developments of 10, 20, 30 homes that have a generator or the option to add a generator very easily. So they are manufactured or they are built as generator ready, we're having some success with that but I'm not happy with it, I think we could be doing more personally, I just think there is an opportunity there.

[Operator Instructions] Your next question comes from Ross Gilardi of Bank of America. Please go ahead.

Good morning, guys. Thanks.

Good morning, Ross.

I just wanted to talk a quick one, I just wanted to get a little bit more clarity on your inventory situation, your inventory sales is pretty elevated relative to history in the last year, you mentioned portables before, just curious if you've got any excess inventory in standby or realize it's more typically a made to order product but more generally I'm trying to understand how you squaring elevated inventory position with a significant margin ramp that you are bringing in 2015?

The inventory position is really related roughly to two major factors, one is we have elevated levels of raw material mainly because we are buying ahead of the port congestion to try to keep lines flowing and not have to spend a ton on the air freight but has that became an elongated event that was more difficult. And actually what ended up happening is we were in the first part of the first quarter we were running thin on certain components and that's why we had to air freight them in. Unfortunately as the port situation started to resolve itself towards the end of the quarter we saw a lot of inventory hitting our dock. So it's really the timing of the inventory, we had the air fright parts in but then those parts arrived or on the water waiting out in Pacific Ocean idealing off the coast. So we saw that impact our inventory levels and raw material is a good chunk of that, and then the finished goods inventory as well. Portables which we've called out and we talked about and then also standby, our standby inventory levels are elevated, our residential standby. Again we deliver products there, those are stocked products, those are delivered with zero to two weeks an order; so we keep a certain level of stock at all times. As we look at the channel which we have a very good handle on; what's in channel and what's in our inventory levels, we are somewhat elevated here at the end of Q1. A lot of that is related to the slowness of the market in Q1, so even though I'm saying my shipments were flat year-over-year, they were below our expectations, and that's really what drove I think a lot of our challenges in Q1 in terms of the miss. So that resulted in higher inventory levels, we'll have to burn that off over Q2 and it's kind of why we're for the first half standpoint why we were also saying we were tampering our outlook here for the entire first half.

And from a margin standpoint too what's your comment about the impact on margins on that flow through in Q2 as well?

Got it, great, thanks guys.

Our next question comes from the line of Chris [ph] of Oppenhiemer. Thank you.

Thanks, good morning. I had a question about Smart Grid potential impacts, I think part of the concept of Smart Gird is that when the scope and length of outages, do you think that's part of pattern you've seen over the past nine quarters?

No. I mean all the data – the grid is only marginally smarter, it's going to take a lot more money than what's been spend to make it really, really smart. And I don't know the smartest grid is not going to help if a tree falls on the line that connects the major power line to your home, no smart grid in the world is going to save you from not having power. So the issue of the grid being above ground is really the bigger issue. Smart grid will certainly help to maybe shorten the duration of outages to a degree which we would think would show up in some of our numbers long term but we just look at raw number of outages that are occurring in those – the number of outages occurring. Again, smart grid is not going to keep that from happening, the number of outages will be what they will be because until the grid is put below ground I think it's still going to be susceptible to all the conditions it's susceptible to today but – and frankly, the grids got a long way to go to get really smart. There is smart metering going on and I think we are starting to see something’s happen as with the utility companies beginning to put some – finally digitization of their monitoring and other things to help identify issues but it's a long road and again, I think our long term perspective here is nothing’s going to be really solved on this front and either somewhat mitigated perhaps but I just – there has been such an underinvestment cycle that there is going to be power outages for the foreseeable future. I mean I'm saying I'm talking decades, I'm not talking years, even if we had a plan today that trillions and trillions of dollars will be needed to bring the grid into this kind of – from a reliability standpoint to five or six times of reliabilities is decades away and in terms of just even be able to execute against the plan even if we had funding, and we have neither the funding nor the plan, so I don't see any changing on that front any time soon.

I understand the decades concept for overall automation of the grid, it just seems like maybe penetration of things like reclosers and such have the potential to have an impact under the surface. Thanks.

Your next question comes from the line Stanley Elliott with Stifel. Please go ahead.

Quick question on the margins and the back half, if I heard correctly 700 basis points higher. Is that just a normal mix of business and then also I would expect copper raw materials to be a pretty good tailwind for you guys in the back half year, how much of that is kind of baked into this kind of outsized margin you’re guiding to?

There is actually a lot going on there 600 or 650 to 700 basis point increase first half versus second half EBITDA margins. So quickly just to try to bridge it for you. So there will be a slight mix improvement as you go into the second half of the year with the resi increase on the assumed normal outage environment so with the higher resi volume there will be maybe about 100 basis point increase in margin, first half second half related to that mix. There might be about a 100 basis point price improvement given some of the discounting environment and modest price realization that we’re rolling out. So first off half second half there will be a 100 basis point in price, and then to your point there will be about 200 basis point improvement on the cost side, so we will moderate these temporary cost increases with the West Coast ports and copper mark to markets and some of the unfavorable overhead absorption that we have experienced in the first half we will moderate in the second and then you pointed out commodities, the realization as we get through lags on lower commodities as well as FX, I mean we do a lot of buy a lot of components in euro if you will which will cost less in the future, as we work through those legs and the supply chain that should be a tailwind relative to margins so and then we’re always looking at other cost reduction initiatives internally here with our supply chain team and engineering team. So put that altogether that’s about a 200 basis point increase first half, second half and then the rest of that EBITDA increase is about a 300 basis point increase in OpEx as a percent of sales as you leverage the fixed SG&A infrastructure that’s how you get to that 700 basis improvement in EBITDA first half second half.

Your last question comes from the line of Jerry Revich of Goldman Sachs. Please go ahead.

I'm wondering if you can just update us on how the Baldor distribution integration is coming along and what have the early results been for you folks as you transition that network?

So that was a project we really worked on really all of 2014, we started it in early 2014, made our decisions around representation in key markets in second quarter of last year and work to build that up and introduce those either new partners or the changes that we have made to kind of get those things point in the right direction in the back half. I think our comments about stronger second half of C&I this year versus the first half, some of that is that industrial distribution piece continuing to kind of progress. Unfortunately if you change distribution partners or bring new one-board it takes a while to get those new sales team up to speed, to make the relationships in the local markets that need to be made. To get the quote logs, get the quoting activity brought up to a level where I can start to convert orders, it's a very long sales cycle in C&I on that side of the business and we believe that we made some really good decisions last year. We think we have some continued decisions to make around distribution this year, in the beginning of this year and then now we’re just working with those distributors to really make them more effective in their markets and a lot of that is through education and lot of training. There is quite a bit of support being given at those distribution partners in the of developing a sales process a more robust sales process for them that’s not just unique to each distributor but more across the board for all of our distributors to use. So we got some tools that we’re putting together for that and again our comments would be that we think it's going to pick up steam here as we roll through the year and have a bigger impact in the second half of this year than it had in the first half.

I now would like to turn the call over to Aaron for closing remarks.

We want to thank everyone for joining us this morning and we look forward to our second quarter 2015 earnings release which we anticipate will be some point at late July, so with that we wish you a good morning. Thank you.

Thank you for your participation in today's conference this concludes the presentation. You may now disconnect. Good day.