Good day, and thank you for standing by. Welcome to the Generac Third Quarter 2022 Earnings Results Conference Call. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question and answer session. [Operator Instructions] Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Mr. Mike Harris, Senior Vice President, Corporate Development and Investor Relations. Please go ahead.

Good morning, and welcome to our third quarter 2022 earnings call. I'd like to thank everyone for joining us this morning. With me today is Aaron Jagdfeld, President and Chief Executive Officer; and York Ragen, Chief Financial Officer. We will begin our call today by commenting on forward-looking statements. Certain statements made during this presentation as well as other information provided from time to time by Generac or its employees may contain forward-looking statements and involve risks and uncertainties that could cause actual results to differ materially from these forward-looking statements. Please see our earnings release or SEC filings for a list of words or expressions that identify such statements and the associated risk factors. In addition, we will make reference to certain non-GAAP measures during today's call. Additional information regarding these measures, including reconciliation to comparable U.S. GAAP measures is available in our earnings release and SEC filings. I will now turn the call over to Aaron.

Thanks, Mike. Good morning, everyone, and thank you for joining us today. Our third quarter was in line with the preliminary results we announced on October 19. Momentum in the commercial and industrial product category remains strong. The residential product sales while still growing compared with the prior year were weaker than expected in the quarter driven by lower shipments of home standby generators, and clean energy products relative to our prior expectations. Year-over-year, overall net sales increased 15% to $1.09 billion, primarily driven by core sales growth of 10%, which excludes the impact of acquisitions and foreign currency. Overall residential product sales grew 9% during the quarter led by sales of home standby generators and the impact from recent acquisitions, partially offset by lower shipments of PWRcell energy storage systems. C&I product sales increased 20% led by growth across all channels domestically, strength in the European region, and the contribution from recent acquisitions. Now discussing our third quarter results in more detail, home standby generator sales grew at a mid-teens rate over the prior year. Baseline power outage activity in the U.S. during the quarter remained above the long-term baseline average and Hurricane Ian, which occurred in the last week of the quarter drove total power outage activity well above the long-term average. Home consultations or sales leads were lower in the quarter when compared to the prior year, which included Hurricane Ida. However, the third quarter of 2022 was tied for the second highest total for any given quarter since we began tracking the metrics in 2013 and we experienced to return to year-over-year growth in the month of October resulting from Hurricane Ian. We continue to focus on expanding our distribution network as we experience sequential growth in our residential dealer base and ended the quarter with…

Thanks, Aaron. Looking at third quarter 2022 results in more detail, net sales increased 15% and to $1.09 billion during the third quarter of 2022, as compared to $943 million in the prior year third quarter. The combination of contributions from acquisitions and the unfavorable impact from foreign currency had an approximate 5% net back on revenue growth during the quarter. Briefly looking at consolidated net sales for the third quarter by product class. Residential product sales grew to $664 million as compared to $609 million in the prior year, representing a 9% increase over a strong prior year comparable. Contributions from the ecobee acquisition and the slight unfavorable impact of foreign currency contributed approximately 5% of revenue growth for the quarter. Home standby generator sales made up the majority of the residential product core sales growth, increasing at a solid mid-teens rate over the prior year. This was partially offset by weakness in shipments of PWRcell energy storage systems. Commercial and industrial product sales for the third quarter of 2022 increased 20% to $311 million as compared to $258 million in the prior year quarter. Contributions from acquisitions and the unfavorable impact of foreign currency provided a net headwind of more than 2% to net sales growth during the quarter. The strong core net sales growth was broad-based across most regions, internationally and across all channels domestically with particular strength in national rental equipment, telecom, industrial distributor and energy management channels. Net sales for the other products and services category increased 49% to $113 million as compared to $76 million in the third quarter of 2021. Core sales growth for the category was 17% due to strength in aftermarket service parts and extended warranty revenue recognition, along with strong growth in our services offerings in certain parts of our…

[Operator Instructions] And our first question comes from Michael Halloran with Baird. Your line is now open.

Hey, good morning, guys.

Very good morning, Mike.

So just kind of want to talk through what happened between second quarter to today is the first question. Obviously, in the second quarter, you talked about installation challenges potentially being a headwind but I think the magnitude caught a lot of people by surprise and how quickly that changed. And so could you maybe talk about the dynamic that got you misaligned with what was happening in the channel. That’s the first question?

Yeah, Mike, this is Aaron. Yeah, it's a great question and one that obviously not only caught us by surprise, but even our channel partners. I think we hit kind of our peak output levels with home standby. We've been working very hard over the last couple of years to – we've quadrupled the output and we really – we hit our stride as we predicted we would kind of as we exited the second quarter and began the third quarter. And so we’re producing at a really high rate. And we thought that was really important because we wanted to bring our lead times down, because we knew that that was having a negative impact on close rates, it's having a negative impact on our ability to sign new channel partners. So we really – we're working hard to do that and so we kind of open the floodgates on shipping to get all that product out in the market. And what we started to see at the end of the second quarter, and we mentioned it, as you said on the call, was that our installation, our activation rate, which is our proxy for installations, it was up year-over-year, but it wasn't increasing at the same rate commensurate with our output increase. And so we could see field inventory building. And we had been talking to our channel partners for several quarters about this coming. And we were trying to get them prepared for that, helping them hire people. We had a number of programs actually in place to get ahead of this, but in the end, it's just – that we have 8,500 channel partners, dealers and then obviously, a lot of non-dealer contractors who install these products. And it's a ton of one-off conversations, and we…

So, that's super helpful and related, if I think about the time it's going to take to sync the channel up. I guess I'm having a hard time thinking of the idea that the underlying pieces are still pretty healthy and you gave a lot of good metrics in the prepared remarks and in the press release around what's happening on the consultation side, the closures, et cetera with how long it's going to take to right-size the inventory and maybe it's just a bandwidth conversation with where the installers are at. But I'd love to have a sense for how I can kind of take that timeframe and sync it with what you're calling still pretty healthy underlying demand.

Yeah, I think probably the best way to maybe get your head around that is we believe that currently today, field inventory levels are about double where they should be. And so that's the bad news, right? That's the additional output that we’ve put into the market ahead of the installation capacity increasing to the right levels. We are modeling that installation capacity is going to increase next year. The challenge, of course, is that just seasonally, we're coming into – as we turn the page here and get into Q1 and Q2, we normally run into a seasonally low period of installations, because parts of the country like the Midwest and the Northeast where installations are much harder to do because of the cold weather because of winter. So unfortunately, even though we are targeting the installations are going to improve year-over-year, we have this seasonal challenge we've got to deal with. It's just nature. We can't really, that's a hard one to fix. And so it won't increase necessarily as quickly as we needed to in the first half. Now the good news is, when we pull our dealers, half of that field inventory that's out there today is spoken for, meaning it's got a customer contract against it. A customer has got a deposit on it. And again, it's indicative of the installation challenge, because we're now back to what we said in the prepared remarks is mostly normal lead times. We still have backlog. We have a couple of models - we're still out there, some liquid cool products, things like that. So that's supportive of where we're going here in Q4. But what ends up happening is that we have these mostly normal lead times for us to our channel partner, but if you are a homeowner and you call and you try and get a product, you still are being quoted longer lead times, because of these constraints, whether they’d be people constraints or permitting constraints or component constraints, gas meter upgrades, we've – there are localized issues all over the country where some of our channel partners are bumping up against just delays. And so they're working through that and as those ease, that will help. But we think that it's likely going to take the first half of next year to get through this and that's going to put pressure on the incoming order rate for home standby through the first half of next year and so that's really the challenge. We think that, again, in our prepared remarks, we said by the second half of the year, we're back to growing again in the category and really only down modestly for the year in total for the category. So anyway, so that's – it’s I think when you put it all together, we feel pretty good about longer term that the end market is supportive.

That makes sense. So basically, what you're saying is relatively normal sequentials on the home standby category for the next few quarters from a couple quarters from the run rate you're talking about in the back half of this year before there is a potential inflection as things start catching up and normalizing a little bit.

Right. Return to normal seasonality, return to growth in the second half.

Yes.

And then again, just the first half is going to be down considerably, second half will grow, still down kind of moderately for the category, only modestly for the company overall. That's kind of our overall guide for next year, but just to clarify that.

Yes. Makes a lot of sense. Thanks for that. Appreciate it.

Yes, thanks, Mike.

Thank you. And our next question comes from Jeff Hammond with Key. Your line is now open.

Hey, good morning, guys.

Good morning, Jeff.

Hey Jeff.

Hey just on kind of the – as you're thinking about the guide, I just want to kind of understand how you're thinking about like comping the backlog drawdown that you're seeing this year and then what that would imply for kind of underlying demand for the category.

Yeah, I mean, again, that's a big part of the headwind for the first half of next year is the comp, because we're – obviously, we were bringing that backlog down heavily in the first two quarters of this year and so we'll be comping against that without having the benefit of that backlog kind of as we get into next year. So that's a big part of it.

And then Aaron's point about the home standby category being down moderately in the second half, that's because you are trying to comp like some of that backlog headwind that we're bringing down here in the back...

Moderately in total, returning to growth in the second half, but yes, for 2023.

Yes, for the standby.

Okay, okay.

For standby. We're talking just standby.

Yes, yes. We're just talking standby. But that – we've got an headwind on the backlog that's driving that.

That's what's driving that, exactly.

And then, just what are you guys doing with your production levels as you get this reset? And just how should we think about destock of your own inventory? It looks like your own inventories are a bit elevated as well.

Yes, they are and you saw that read through just the work capital increase in the third quarter, driving free cash flow negative for the quarter. We see that coming back around in Q4. So, we basically slowed the factories down still have some material coming at us, but that's starting to slow as well. We should basically get into a better position in Q4 and then really working hard through the first half of next year to bring down those inventory levels, both raw materials and finished goods as it relates to the home standby category in particular. It's actually kind of a dichotomy, because in our industrial business, we're constrained still in certain components and our inventory levels are low and we are struggling to kind of feed our factories with materials there on our industrial side and we would be able to, in fact, go even higher, faster with our industrial business if we could get more engines and breakers and other things that are in shorter supply. But on the home standby side, we are definitely seeing a lot of material hitting our distribution centers as we slow production down.

Thank you. And our next question comes from Brian Drab with William Blair. Your line is now open.

Hi, thanks for taking the questions.

Hey, Brian.

Maybe shifting to clean, hey, good morning. Just shifting to clean energy for a minute. So, I think that the energy storage business in 2021 was around $220 million, $225 million. It looks like the guidance that you're giving us now for $300 million to $330 million implies that that's down something like 30% or so this year. Is that about right and what market is growing and can you clarify...

Yes, market is still growing, although there is some mixed comments out there about the market growth. But, yes, the loss of that major customer of ours in the second half of the year here, they really ceased operations in July. So we've got to do the hard work that, honestly, we should have been doing all along of continuing to expand our channel to more channel partners, but that hurts us definitely in the year, Brian. So, unfortunately, that's going to be down this year. Looking for that to return to growth next year. But as we kind of fill in with new customers and we kind of reset, so 2022 is going to end up being a reset year for us here on energy storage, which is disappointing, but I think – and a rather painful learning lesson for us on just some of the trials and tribulations of that market some of the customers and the dealer partners there, you're having to pick your partners carefully. Again, a lot of learning cycles we are going through there.

Okay. Thanks. And then, for my second question, can you just clarify exactly what you're saying about 2023 one more time in terms of – I think that you said total company in the prepared remarks, it's all about total company and that you'd be down modestly for the full year, up sequentially first half to second half. But I am just wondering, is home standby expected to be up year-over-year in the second half?

Yes, this is York. So yes, so total company, to clarify, we said weakness in the first half, total company, mainly driven by the home standby discussion we just had a little bit of, maybe a little bit of clean energy as we build growth there. But second half, I think important to note, total company returned to solid growth for total company in the second half. You put that all together then for full year, that would only be a modest decline for full year 2023. That's total company. So then home standby specifically, again, weakness first half, sequential growth from first half to second half and then a much more modest decline in sales growth over the prior year in the second half of the year. So maybe down a little bit, but it's much more modest decline relative to the first half for home standby.

Thank you. Our next question comes from Mark Strouse with JPMorgan. Please proceed with your question.

Yes, good morning. Thanks for taking our questions. York, curious if you can just talk about margins through the first half of next year? Just kind of the lower factory absorption with HSB, the lower mix of HSB and then kind of offsetting that somewhat easing of some of the supply chain issues that you've had. And how we should think about margins going forward?

Yes. No, I think Aaron mentioned a return to seasonality for the home standby business, meaning Q1 is usually the lowest point in the curve once you catch backlog, then you return to normal seasonality, Q1 is the lowest point. So, you would expect, just from a mix standpoint, that sequentially from Q4 2022 to Q1 2023, that gross margin should decline because – mainly because of that mix element. But, I mean, recall we were facing some pretty heavy inflationary pressures in Q1 of 2022. So I would expect just from a price cost standpoint, we are going to see some nice price cost benefit there. But yes, we are still putting our models together on how that's going to look, but I would expect just sequentially that given the mix - the mix changes going into the first half of next year, you'd see maybe a slight decline in gross margins relative to the runrate.

Okay. And then just to clarify on the Clean Power business. Is most of the reduction in the revenue outlook driven by needing to backfill for the customer that has gone bankrupt? Or is there a broader issue with the actual product itself that there is some actual reconfiguring of the solution?

Yeah the majority of the market is related to the loss of the customer. It was a really important customer for us and the diversification of our customer base is going to be the primary focus here going forward. And obviously, we've got to restore trust, too, right, in the market to some degree. There is probably a spillover effect there to a bit. But I will say this, and like I said, we've got a lot to learn in this market. That’s a painful learning lesson. But in speaking with a lot of the kind of national companies that are well established, the national solar sales and installation companies, almost every OEM has had challenges over the course of the solar kind of markets’ existence and storage being the new component here. So, again, I am not trying to indicate that people should expect that, but it's a pretty new market. I mean, penetration rates are very low on these products. The environment, being rooftop mounted, electronics is a severe environment. The warranty periods are very long. 25-year warranty periods for the rooftop mounter components, 10 years on the batteries. So you've got a pretty – you’ve got a pretty, there is a pretty high bar there quality-wise and a lot of companies have unfortunately struggled with that. Now, I think, we feel like we, a couple of things. One, we're very committed to this. We think it's the future. We think it's an important part of our strategy going forward. I think it represents some great opportunities for Generac in terms of what can fit with our brand. Our distribution and our expertise in some of these areas. So we're committed to it. We've got a great balance sheet to be able to finance this. The investment needed, obviously, is going to be greater than we had originally thought. You can't just take a start-up technology and try to scale it. That's clear based on our experiences here. So we are going to have to do a lot more work around that. We are going to have to put more talent in the teams. We've started to do that. We mentioned that in some of our prepared remarks this morning, and we're going to continue to do that. We think that this is, again, it's an important part of the future. We're committed to it and we are going to be a major player in it longer term. We are going to take our lumps here and the humility that comes with that. But in the end, I believe that we will have a lot of great success in this longer term..

Thank you. And our next question comes from Joseph Osha with Guggenheim Partners. Your line is open.

Thanks.

Hi, Joe. Morning.

I wanted to spend a bit more time on the clean energy business. We've talked a lot about storage, which is great. Ecobee is a good size business. So I'm wondering as you look into the next year. Obviously, you don't want to get too detailed, but maybe if you can give us a little bit of a sense as to the – roughly what the breakdown of that business might look like? And on a related note, now that you've got the safety couple products, we talked about this before, given some of the challenges that you've talked about with some of the other stuff, could we see you perhaps pivot more to selling that AC couple product alongside other people's inverters? So those are my two questions.

Yes. Joe, great questions. Just let me touch on the ecobee piece first and then I'll get to the AC coupled solution. So on ecobee, there – it's a great company, really well run. It’s - they've really struggled this year with component availability in the first half of the year. So they've under-delivered a bit to our expectations and their own expectations just around that. But things have really picked up here as they exited the third quarter. They're looking at fourth quarter being their highest quarter ever as a company and looking at big things. I think a lot of that, you can probably tie back to higher energy prices, right? Homeowners, I think, are looking for solutions to mitigate those higher energy prices, and smart thermostat is kind of a really cost-effective way to go after that. The paybacks are really strong, and you buy one of these products, inside of a year, you can pay that back. And that's even -- not even assuming the opportunity to connect that thermostat to a grid services type program, like a demand response program, which can enhance the payback even more. So really excited about that business. I think when we announced it, it's something like $125 million. It's grown nicely this year and will continue to grow and we're not going to break down the pieces because we don't want to get into doing that every quarter here going forward. So, but it's a great business, well run and a lot of upside there. And I think one of the bigger opportunities within that is just the team that they have, the expertise they have is going to be central to this single pane of glass initiative that we see as sitting at the heart of the smart home energy system that we've talked about, connecting whether it be generators or PV microinverters or storage devices or smart thermostats or water heater disconnect switches, load management, ultimately EV charging, things like that. We think all of that...

I did hear you say $125 million for this year, right?

No, that was what we said when we announced the deal back in December. That was their runrate.

Okay. All right.

They've grown nicely.

Yes, they've grown nicely since then. And then on the AC coupled – the AC coupling that is definitely a focal area and one of the things that we've been pushing to get into the market the microinverter or excuse me, the PV, the PWRcell with a firmware update can accept power from third-party ACQUISITION, our third-party inverters now. So we feel really good about that and that's going to be a focus area for our commercial teams as we go forward. So looking forward to that getting some traction in the marketplace and we think that that we'll see success of that.

Thank you.

You bet.

Thank you. Our next question comes from Jerry Revich with Goldman Sachs. Your line is now open.

Yes, hi, good morning, everyone. Aaron, I wonder if you could talk about the production rate for the standby business. In the fourth quarter, normal seasonality I think installs tend to be up low double-digits are we now at a normalized runrate where that business can be up sequentially in your term based on the visibility you have as of today?

Well, production rates won't be because we're bringing those down because of the field inventory issue, and we've got plenty of inventory, as well. So, that – if the question is around production rates, we won't be up in the fourth quarter. We'll be lower. So we expect that and that's built into our guide today. But again, installation capacity, that normally, seasonally does peak in the fourth quarter. And we continue to see, again, we added 300 new dealers in the quarter alone, which is helpful for that. We are pacing well, again, to add more dealers here in the fourth quarter and we need to be hitting our peak rates for installation by the end of the year, but that's all contemplated in the guidance. I don't know if I'm answering your question, Jerry or not, but.

Yes. And earlier, you mentioned production would be down as normal seasonality in the first quarter as well. And so I am just trying to understand, right, after every major outage event, there is a new and higher baseline, but that baseline is obviously down from the peak. And I'm just wondering, are we going to be running at that baseline based on the order rates that you see today without making any assumptions on installation capacity as we head into, call it, $400 million standby revenue quarter in the first quarter? Does that match the incoming order rate? Or is there a risk of additional step down?

No, no. So what we've said is that the order rate is going to continue to – we're going to have headwinds there as they work their field inventory down. So they've got – again, field inventory, which is about double where we should be at this time of the year, and "normal" in terms of days of field inventory is about double. But about half of that – so really the problem, right, the doubling is already sold. So they just have to get it installed. So because of that, we're not – the order rate is going to be artificially depressed until we get through that.

I guess, the hurricane will increase the backlog of our dealers basically that will...

Yes, effectively right, exactly. And could accelerate some of the drawdown of field inventory in the Florida regions, in particular, where Ian impacted. But no, we think that the order rates that we are seeing today that we'll continue to see through the end of this year and in the first half of next year are artificially low as we right-size that field inventory.

And remember, we have some backlog in the fourth quarter here that we’re satisfying as well.

Exactly. That's a good point.

Thank you. Our next question comes from Maheep Mandloi with Credit Suisse. Your line is now open.

Hey. Thanks for taking our questions. Can you enough guidance on gross margins for the C&I – for the HSB projects in Q4 and the first half. But maybe if you could just opine on OpEx in Q4 and the first half given all the data points you're seeing on channel inventory and in-house consolidations? Should we expect any changes over there? And then I just have a follow-up on i should go.

This is York. OpEx, I think, I alluded to it. OpEx may tweak up a little bit here in the fourth quarter as a percentage of sales relative to Q3. Just there is actually just some seasonality on some spend in Q4, some accrual reversals in Q3 that won't repeat. So, just a modest increase in OpEx sequentially, both dollars and as a percentage of sales, what we're modeling in our guidance.

And any guidance on how should we think about it in 2023?

No. I mean, we're still – we're just – we gave the framework for the top-line. We're still working on the framework for gross margins and OpEx. So I think we are going to hold off on discussions on the margin side for next year until next quarter.

Thank you. Our next question comes from Kashy Harrison with Piper Sandler. Your line is now open.

Good morning and thank you for taking the questions. So just the first one from me, so the C&I and other segments, both quite strong. Can you maybe just dig into some detail on the strength in both of those segments in Q3? And then, maybe speak to the specific indicators you're seeing right now that gives you confidence of a continuation of strong growth entering calendar 2023 so early? And I have a follow-up.

Yes, Kashy, really, the C&I business has been ripping along here for a number of quarters and really hitting its stride. We are taking share in the market. We're seeing in our industrial distribution channel. Everything was up basically in C&I. So our telecom vertical that is a really important vertical for the company was up. Our mobile business was up as the national rental accounts continue to refleet and top off their fleets our business internationally, which is mostly C&I, was also up very nicely. Again, just a lot of the same opportunities there. Probably one area that I would call out that was up even more so than in past and I think we categorized that in the prepared remarks as early inning, was this kind of – we refer to it as beyond standby applications. So, mainly natural gas generators, large C&I natural gas generators that would otherwise have normally been sold into emergency backup-type of applications are being sold into applications where they are still used as emergency backup power, but they can also be called upon to support the grid during times of significant stress. So, heat waves, outages, things like that. So think micro grids or kind of energy-as-a-service types of programs, demand programs where the generator can be switched on remotely by a grid operator or a utility oftentimes connected through our grid services software platform, Concerto and we're seeing that market was up really large in the quarter for us. Now it's still pretty small in totality, but it's growing very quickly and the quality conversations we are having with people on projects, potential projects in the future, the pipeline here for that business looks really good. So much so that we are oriented around adding capacity in our C&I factories to…

And just the indicators you're seeing that give you the confidence for 2023 so early on?

Yes, so, the C&I business is a backlog business. I mean, that always has been a backlog business. So we look at that, you've got lead times on products there that, in some cases, go out 26, 36 weeks depending on the size of the product. It's custom built and it always has been this way. This is not the new kernel in the story over the last two years is the fact that home standby, which has never been a backlog business became a backlog business. But the C&I business has always been backlog, provides great visibility for us. So we feel very good about that. You are also seeing kind of some of the public statements, like if you look at the national rental account customers that we sell to, they are indicating that they believe their CapEx budgets and CapEx spends are going to continue to grow into 2023 as, again, some of these mega trends around the infrastructure investments that need to be made around the country. We had the investment, the Infrastructure Act that did get passed earlier this year. There's a lot of spending that's going to come through for that, for roads and bridges and airports and ports and all those types of massive infrastructure areas, our rental customers are going to serve that. The telecom business continues to – our telecom customers continue to tell us that their midstream and the build-out of their – not only hardening their existing networks, but the build-out of their fifth-generation or 5G networks. So that feels really good. And then, again, the quality of the pipeline, as I said, around some of these newer things like the beyond standby opportunities, the microgrid opportunities in C&I. We think that there is – those have a lot of legs yet going into 2023.

Yes, the fact that book-to-bill remains strong is promising for next year.

Thank you. And our next question comes from Praneeth Satish from Wells Fargo. Your line is now open.

Thanks. Good morning. I guess if we could just focus only on the second half of 2023 for a second, you mentioned that HSB could be down, but I would have thought by then that the field inventory and the installation issues would have been resolved or normalized. So I am just wondering what's kind of driving that view for HSB in the second half of 2023, given that demand is so strong and is there a scenario where it could be up?

Yes. No, I think we alluded to it before that I mean, there is some backlog that were satisfying here in the second half of 2022 that won't repeat. So there is a little bit of a, I guess, year-over-year headwind when you're looking at 2023 versus 2022.

The guide also doesn't contemplate any major outages.

Yeah, that would be upside. So if you're looking for upside, where could we grow...

We did have some outages this year.

Yes, things happen. Mother Nature happens. So that would definitely be a scenario where things could grow. But that's an inherent – the backlog situation here, resolving that backlog here in the second half of 2022 is an inherent headwind for the second half of 2023. But I think sequentially, as we get through these field inventory challenges here in the first half, you definitely would see growth sequentially from first half to second half, at least in terms of how we're seeing it in our framework here for 2023.

Got it. That's helpful. And then, just switching gears on PWRcell, you mentioned that a certain component needed to be upgraded and so you're enlisting kind of third-party installers for repairs. Can you elaborate on what that component is? And then, has that component been fixed in new batteries that are being produced?

Yes. We have an upgrade path on that component. It's a rooftop mounted shutoff device and that device is the previous generation of that device, it has a higher failure rate than what we'd like to see. So we're proactively replacing those devices for customers. So they don't see an interruption of the production of their systems. So, but everything is – we've got path forward and have had a path forward here for some time. We just have to get the upgrades complete. And so to speed that up, we brought in a bunch of third-party, service companies that are going to help us do that. We were relying on some of our channel partners, but with the loss of that largest channel partner became obvious that we needed to enlist the help of others, and that's why the third-party folks are going to be in there. And that upgrade, the total effort there is what's reflected in that additional warranty reserve charge that we took here in the quarter.

Thank you. Our next question comes from Donovan Schafer from Northland Capital Markets. Your line is now open.

Hey guys. Thanks for taking the questions. Hi, can you hear me?

Yes.

Okay, okay. Good. So, on the home standby side, I was just curious, is there any kind of a pattern in the lower orders from the channel partners in terms of, is it more concentrated on the side of big-box retailers like Home Depot and Lowe's or maybe regional installers or even potentially kind of the longer tail smaller installers? I think the smaller installers tend to be limited, maybe more on warehouse space and access or willingness to use credit. So, I am just curious if it kind of is disproportionately in any one of those areas? And then I have a follow-up.

Not dramatically, so, Donovan. I mean, it's pretty much fits the historical in terms of just the channel, the mix, if you will, the channel mix within home standby hasn't changed dramatically. I mean, we do have some of this "stocking channels" right? Like if you look at a retailer or you look at a wholesaler for us, those are traditionally stocking channels where a non-dealer contractor comes in or a homeowner comes in and buys one of the products stock. Whereas our dealers, they generally only buy from us when they have a contract signed by a homeowner because they – and that's nothing has changed with that. That's kind of the way the business has pace. So I think to answer your question, there is nothing dramatically different about the mix channel-to-channel going on there.

Okay. And then, as - my next – my follow-up question is just, focusing on what's going on in Europe, because you guys – in commercial and industrial, and you really are kind of a global business and you've got a lot in Europe and India other parts of Southeast Asia, there is kind of just so much. But when I look at what's going on in Europe, it feels like there are a lot of puts and takes that could be kind of both tailwinds and headwinds because you've got the energy crisis and all the fees and stability around there, but then simultaneously, you are also going to have people saying, this is why we shouldn't be using natural gas. And so there might be resistance against natural gas infrastructure and installing more generator sets to rely on that. Maybe even if there's any diesel that might be seen as much more of like a short-term thing and so they don't want to invest the CapEx for a longer-term back up. So, it just seems like there is a lot of potential puts and takes there and the sort of differences of Eastern Europe versus Western Europe. So could you just go under a little bit more detail on like what exactly you are seeing specifically in Europe and how that's kind of unfolding for your businesses?

Yes, yes. It's a good question. I mean, Europe has and has always been a mostly diesel C&I generator market. So that's just to level set. We have seen growth in natural gas gen sets in not only the European market, but also India, here recently coming off a base of almost nothing. There is – there is nothing there. And I think on the margins, maybe on the edges, I should say not to confused with gross margins or anything like that, on the edges of the discussion, yes, there are some pipeline - people want to limit gas connections. Natural gas isn't going away. That is about the most foolish thing for people to think is the right answer for anything here. Natural gas is needed for heating, for cooking. It's plentifully available, it burns cleanly. We would do well as a society to continue to focus on further improvements in cleaning up the emissions that come from natural gas, whether it be the extraction emissions or it's the consumption emissions. But because I think it's a fuel that can really help us shift as a populous here, as a global populous, further away from more carbon-intense forms of energy generation like coal and other fuels. So again, it's not – it might be on the edges, you are going to see some natural gas limitation just like we are seeing here in the U.S. in places like California, Berkeley, other places like that where they've taken the – they've taken it on themselves to close off new natural gas connections. The reality of it is you can get a propane tank anyway. So I mean, it's kind of a fruitless effort the generators are off of propane as well. So you don't actually need pipeline. It's helpful, but you don't need pipeline gas. So, again, I think there is – our view is there is going to be plenty of growth in the C&I generator world, even the home standby generator world outside of North America and natural gas gens are going to be part of that natural gas and propane gens.

Thank you. And our final question comes from Saree Boroditsky with Jefferies. Your line is now open.

Thanks for fitting me in. So just going back to the home standby commentary, you talked about only a modest decline in the second half of the year. Could you just help frame how you're thinking about the magnitude of the decline in the first half of the year?

No, we didn't necessarily frame that out. I think what we're looking at is more – when you look at the total company returning to solid growth in the second half resulting in only a modest decline for the total company for the full year. So, you can sort of get the magnitude of – what that means for the first half on a total basis. You know that as based on our comments that C&I is going to continue to be strong in the first half. So you'll see growth there. We'll be sequentially improving our clean energy business throughout the year in 2023. And so that basically leaves you sort of – gives you some framework for how to put all the pieces together.

Okay. And then, it seems like sales grew faster at home standby than anticipated when you kind of gave out that 2024 guidance. Could you provide us with an estimate on where that puts you from a penetration rate at the end of this year and then any thoughts on where we could go from there?

Well, pen rate this year, we're around 6% is where we anticipate ending. So, it doesn't – it didn't change that dramatically and we are going to have to update our guidance on the long-range guidance. Again, I would point out, we did say at our Investor Day, that growth was not going to happen in a straight line. I know we have people who haven't been around the company that long and are learning kind of how the cycles work here. But we have, in particular with home standby, we have the dramatic increase cycles where you have these step functions up, then growth kind of levels off, comes off of the peak actually, comes down off of a peak and normalizes to a baseline level, a new baseline level that's materially higher than the previous baseline level. And then, you kind of – as you increase awareness and distribution then you are ready for the next step up in growth. So it's more of a step function grower. We'll have to review the long-term targets. We are not prepared to update them this morning. But we are going to have – we'll have another Investor Day next year for sure, if not before then in terms of updating the long-range guidance.

Thank you. I would now like to turn the conference back over to Mike Harris for any closing remarks.

We want to thank everyone for joining us this morning. We look forward to discussing our fourth quarter and [Audio Gap] in mid-February. Thank you again and goodbye.

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