Good day, ladies and gentlemen, and welcome to the third quarter 2017 Generac Holdings Inc. earnings conference call. At this time, all participants are in listen only mode. Later, we will conduct a question- and- answer session. An instruction will follow at that time. If anyone should require our assistance at any time, please press star then zero on your touch-tone telephone. As a reminder, this conference call is being recorded. I would now like to turn the conference over to Mr. Michael Harris, Vice President of Finance. Sir, the podium is yours.
Good morning, and welcome to our third quarter 2017 earnings call. I'd like to thank everyone for joining us this morning. With me today is Aaron Jagdfeld, President and Chief Executive Officer, and York Ragen, Chief Financial Officer. We will begin our call today by commenting on forward-looking statements. Certain statements made during this presentation, as well as other information provided from time to time by Generac or its employees, may contain forward-looking statements and involve risks and uncertainties that could cause actual results to differ materially from those in these forward-looking statements. Please see our earnings release or SEC filings for a list of words or expressions that identify such statements and the associated risk factors. In addition, we will make reference to certain non-GAAP measures during today's call.
Additional information regarding these measures, including 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. Overall third quarter results were very strong and significantly exceeded our expectations. We experienced record quarterly sales and robust organic sales growth of approximately 20%, with overall net sales increasing 23% compared to the prior year, including the contribution from the MOTORTECH acquisition. This sales growth translated into an overall 21% increase in adjusted EBITDA, along with a strong increase in operating and free cash flow compared to the prior year. With significant power outage severity resulting from three landed hurricanes, shipments of portable generators increased dramatically during the quarter as our team worked diligently with our channel partners to quickly get these products to customers in the storm-affected regions. End user activations of home standby generators were also strong, with broad-based growth across all regions, with particular strength in Florida, Texas, and Puerto Rico.
Demand for domestic mobile products also continued to be much stronger as compared to the prior year levels, as our rental equipment customers further replaced and upgraded their fleets during the quarter. We also saw healthy end market growth within the international segment as shipments increased 7% organically on a constant currency basis from strength in both C&I and residential products, primarily within the European and Latin American regions. The active hurricane season during the third quarter resulted in a surge in demand for portable generators and significant improvements in several home standby demand metrics, including in-home consultations. Despite the billions of dollars spent by utilities over the past decade on their electrical grids within the impacted areas of the hurricanes, there were millions of utility customers without power that resulted in hundreds of millions of outage hours.
Hurricane Harvey caused tremendous flood-related damage in Texas, but overall was a relatively minor power outage event. However, Hurricane Irma resulted in significant power outages across the entire state of Florida and was the second-largest outage event since we began measuring this activity in 2010. Hurricane Maria did not make landfall in the mainland U.S., this storm did have a devastating impact on the island of Puerto Rico, including widespread destruction of the island's power grid. These events adversely impacted millions of people, with cleanup and rebuilding efforts still continuing. As a company whose core products are focused very heavily on backup power generation, our business model is built around providing a very high level of service and support during these types of outage events.
I'm extremely proud of our teams at Generac as they stepped up their efforts by shipping products around the clock to the affected regions, addressing the large increase in call volume from customers, providing technical support to our distribution partners, as well as supporting field-based product repairs from our many teams that travel directly to the storm areas. The customer support tools, sales processes, and distribution that we have put in place since the last major event approximately five years ago allowed our teams to execute at a very high level. Importantly, Hurricane Irma essentially represents the first real opportunity to test our targeted marketing processes and PowerPlay in-home selling solution in a major outage scenario. We are leveraging these systems and processes to manage a significant increase in in-home consultations, or IHCs, as we refer to them, for home standby generators.
The IHCs have been trending at levels never previously seen before, and our distribution partners are incredibly busy trying to address these leads. I would also like to briefly comment on the difficult situation in Puerto Rico, with nearly 70% of the island still without power six weeks after Hurricane Maria's landfall. Much of our effort to date to help the people of Puerto Rico with temporary power has been centered around the logistics of getting products, service parts, and personnel to the island. The unprecedented level of power outages still being experienced follows a significant outage event that occurred on the island in September of last year, which has resulted in a dramatic increase in demand for our products. Puerto Rico remains a relatively small but growing portion of our business, with shipments to this U.S. territory primarily classified in our domestic segment results.
As the leader in residential backup power, we believe no other company in this industry offers the high level of support we've been providing to satisfy the needs of customers. Looking forward, we have ramped production for home standby generators to meet the current and anticipated increased demand for these products, and we're also early in the process of replenishing our portable generator inventories back to more normalized levels. An area of our business that continues to experience a cyclical recovery is our domestic mobile products offering, primarily serving the rental markets. After significant declines experienced during 2015 and 2016, demand for these products continues to rebound quickly as we experience significant year-over-year growth in shipments during the third quarter, with this momentum continuing so far into the fourth quarter.
We still believe this fleet replacement cycle is primarily being driven by the overall age of current equipment, with oil and gas-related capital spending still fairly muted in terms of impact. With oil prices averaging around the $50 level so far in 2017, we believe a meaningful recovery in the purchase of mobile equipment for use in this market has not yet gained traction. However, utilization rates for several of the product categories hit hardest during the oil and gas downturn are improving, which could potentially lead to some oil-and-gas-related opportunities in the near term. We are optimistic toward returning to sustainable long-term growth going forward for mobile products, given the current rental replacement upcycle, combined with the potential for a future recovery in the energy sector and the macro opportunity with increased infrastructure spending.
Shipments of stationary C&I products in North America through our distributors improved modestly as compared to the prior year, with more recent project quotation levels trending higher. Demand trends from our national telecom customers continued to be soft during the third quarter, resulting from their ongoing reprioritization of capital, in part due to the previously lower power outage environment. Historically, major outage events have been a catalyst for our domestic C&I products business by highlighting the awareness of the importance of having backup power for businesses, institutions, and other critical infrastructure during large-scale power outages. For example, the state of Florida recently announced new rules in the aftermath of Hurricane Irma, requiring nursing homes and assisted living facilities to have sufficient backup power to sustain critical care operations and maintain comfortable temperatures for a minimum number of days following a utility outage.
There was a notable reduction in wireless communications in Florida, and particularly in Puerto Rico, as these networks lost power. As a result of these awareness events, we believe there will likely be an increase in demand for backup power by our telecom customers as they further work to protect the uptime of their wireless networks going forward. In general, following a major outage event, demand for C&I products builds at a much slower rate relative to our residential products, and our visibility with respect to quotation and order levels for these products should become clearer as we get closer towards the end of the year and into early 2018.
Rounding out the discussion of our domestic segment, the Country Home Products acquisition continues to perform very well, with shipments and margins further improving at a strong rate during the third quarter as compared to the prior year as this business benefited from the extended summer growing season. We are also making good progress in consolidating CHP's Vermont-based assembly and distribution operations into our Jefferson, Wisconsin facility, with the transition remaining on track to be completed by the end of the year. Let me provide some brief comments regarding the trends for our international segment, which have had solid core organic sales growth and margin expansion during the third quarter as compared to the prior year. Pramac continues to perform very well with strong sales growth during the third quarter as well as year-over-year margin expansion.
Pramac has been making good progress on important integration activities, including the combination of Tower Light commercial activities within its business, the consolidation of the Generac and Pramac locations in both the U.K. and Brazil, and the startup and first shipments from their newest sales branch in Australia. Our Ottomotores business, which serves the Latin American market, once again experienced strong growth for both C&I and residential products during the quarter and has leveraged this growth into improved margins on a year-over-year basis. This business also has a solid backlog entering the fourth quarter, and the project pipeline is encouraging as we look towards 2018. Lastly, our recent MOTORTECH acquisition, which closed on January 1st, has performed well during our limited time of ownership, with sales and margins exceeding our expectations on a year-to-date basis.
We remain excited about the opportunity to leverage MOTORTECH's deep technical capabilities related to gaseous fuel and ignition systems in order to better capitalize on this faster-growing segment of the generator market and to explore new market opportunities. I now want to turn the call over to York to discuss third quarter results in more detail. York?
Thanks, Aaron. Net sales for the quarter increased 22.5% to $457.3 million, as compared to $373.1 million in the third quarter of 2016, including $10.1 million of contribution from the MOTORTECH acquisition, which closed on January 1st, 2017. Looking at our consolidated net sales by product class, residential product sales during the third quarter increased 30.6% to $251.9 million, as compared to $192.9 million in the prior year quarter, with all this growth being organic. As Aaron mentioned, portable generators made up the majority of this increase, driven by the increased outage activity from Hurricane Harvey, Irma, and Maria during the quarter. As a leader in residential backup power, we hold a strategic investment in portable generator inventory coming into any given season.
With the large spike in outage severity in the third quarter, we were able to monetize this working capital investment as we satisfied the needs of our customers in the impacted regions. To a lesser extent, the increase in residential product sales was also due to higher shipments of home standby generators and DR branded outdoor power equipment from Country Home Products. Looking at our commercial and industrial products, net sales for the third quarter of 2017 increased 16.6% to $174.5 million, as compared to $149.7 million in the prior year quarter, with core organic growth being 8%. The core increase was primarily due to very strong growth in domestic mobile products, driven by the continuation of a fleet replacement cycle with our rental customers. The year-over-year core growth also benefited from increased organic shipments of C&I products within the European and Latin American regions.
Net sales for the other products category, primarily made up of service parts sales, was up slightly to $30.8 million, as compared to $30.6 million in the third quarter of 2016. Gross profit margin was 34.4%, compared to 36.9% in the prior year third quarter. This 250 basis point decline in gross margin as compared to the prior year was mainly the result of an unfavorable sales mix. The shift in mix was driven by the significant growth in shipments of portable generators and mobile products during the quarter, which carry lower gross margins relative to the consolidated corporate average. The higher commodity prices seen in prior quarters and recent strengthening of certain foreign currencies also negatively impacted margins. However, these impacts were largely offset by favorable overall pricing and improved leverage of fixed manufacturing costs on the higher organic sales.
Operating expenses increased $3.2 million, or 3.9% as compared to the third quarter of 2016. The increase was primarily driven by the addition of recurring operating expenses associated with the MOTORTECH acquisition and additional incentive compensation accrued during the current year quarter. In addition, intangible amortization expense declined $2.3 million over the prior year, with the prior year third quarter including a $1 million write-off related to a trade name as a result of a new product transition. As a result of the organic net sales growth during the third quarter of 2017, operating expenses as a percentage of net sales, excluding intangible amortization, declined 240 basis points as compared to the prior year.
Adjusted EBITDA attributable to the company, as defined in our earnings release, was $87.6 million in the third quarter of 2017 as compared to $72.1 million in the same period last year. Adjusted EBITDA margin, before deducting for non-controlling interests, was 19.4% in the quarter, as compared to 19.5% in the prior year. The approximately flat adjusted EBITDA margin compared to the prior year was due to the previously mentioned unfavorable gross margin impacts being largely offset by the improved overall leverage of fixed operating expenses on the organic increase in sales. I will now briefly discuss financial results for our two reporting segments. Domestic segment sales increased 21.8% to $364.3 million, as compared to $299.1 million in the prior year quarter, which were all organic sales.
The increase was primarily due to the substantial growth in shipments of portable generators, driven by the increased outage activity from the active hurricane season, along with the continuation of very strong growth for mobile products. Also contributing to the year-over-year sales growth were increases in home standby generators and specialty outdoor power equipment. Adjusted EBITDA for the segment was $83.1 million, or 22.8% of net sales, as compared to $69.3 million in the prior year, or 23.2% of net sales. Adjusted EBITDA margin in the current year was impacted by unfavorable sales mix due to the significantly higher sales of portable generators and mobile products. This unfavorable mix impact was partially offset by improved overall leverage of fixed manufacturing and operating expenses on the organic increase in sales.
Positive pricing effects were offset by higher commodities and strengthening currencies versus the U.S. dollar. International segment sales increased 25.5% to $92.9 million, as compared to $74 million in the prior year quarter. When excluding the impact from the MOTORTECH acquisition, sales for the segment increased 11.8%, and when excluding the impacts of foreign currency, increased approximately 7% on a constant currency basis. This core organic growth was due to increased shipments of both C&I and residential products within the European and Latin American regions. Adjusted EBITDA for the segment, before deducting for non-controlling interests, was $5.6 million, or 6.1% of net sales, as compared to $3.5 million, or 4.8% of net sales in the prior year.
The improvement in adjusted EBITDA margin as compared to the prior year was primarily due to improved leverage of fixed manufacturing and operating expenses on the organic increase in sales, and to a lesser extent, the addition of the MOTORTECH acquisition. These impacts were partially offset by unfavorable foreign currency effects and higher commodity prices. Switching back to our financial performance for the third quarter of 2017 on a consolidated basis. GAAP net income for the company in the quarter was $39.7 million, as compared to $26.2 million in the third quarter of 2016. The prior year net income included a $3 million loss on change in contractual interest rate relating to our term loan credit agreement.
GAAP income taxes during the third quarter of 2017 were $20.6 million, or a 33.9% tax rate, as compared to $15.5 million, or a 37.4% tax rate for the prior year. The decline in the GAAP tax rate is primarily due to non-recurring discrete tax items that modestly increased our tax rate in the prior year and decreased our tax rate in the current year. Adjusted net income for the company, as defined in our earnings release, was $57.8 million in the current year quarter versus $53.2 million in the prior year.
Diluted net income per share for the company on a GAAP basis was $0.64 in the third quarter of 2017 compared to $0.40 in the prior year, with the prior year earnings impacted by the aforementioned 1 million intangible trade name write-off and 3 million loss on change in contractual interest rate. Adjusted diluted net income per share for the company, as reconciled in our earnings release, was $0.93 per share for the current year quarter compared to $0.82 in the prior year. Weighted average shares outstanding on a diluted basis were 62.3 million in the current year third quarter versus 65.1 million in the prior quarter. A 4.3% decline reflecting the impact of our share repurchase activity over the last year.
With regards to cash income taxes, the third quarter of 2017 includes the impact of a cash income tax expense of $10.9 million, as compared to $2.3 million in the third quarter of 2016. The current year cash taxes reflect an expected cash tax rate of approximately 17% for the full year 2017, while the prior year third quarter was based on an expected cash tax rate of approximately 6% for the full year of 2016. As a reminder, our favorable tax shield of approximately $50 million through annual intangible amortization in our tax return results in our cash income tax rate being significantly lower than our GAAP income tax rate of approximately 36% for 2017. Cash flow from operations was $67 million as compared to $48.3 million in the prior year.
Free cash flow, as defined in the accompanying reconciliation schedules, was $60.4 million as compared to $41.4 million in the same period last year. The year-over-year increases in cash flow were primarily driven by higher operating earnings in the current year quarter, along with a stronger reduction in working capital investment during the current year quarter as compared to the prior year. Free cash flow on a trailing four-quarter basis was $220 million, as compared to $210 million in the previous comparable trailing four-quarter period, demonstrating the strong cash flow capabilities of the company. As of September 30, 2017, we had a total of $1.039 billion of outstanding debt, net of unamortized originally issued discount and deferred financing costs, and $128.8 million of consolidated cash and cash equivalents on hand, resulting in consolidated net debt of $910.2 million.
Our consolidated net debt to LTM adjusted EBITDA leverage ratio at the end of the third quarter was 3.1 x on an as-reported basis, a decline from 3.9 x as compared to the same period last year, and 3.6 x at the end of 2016. Additionally, at the end of the quarter, there was approximately $142 million available on our ABL revolving credit facility. We did not repurchase any shares of common stock during the third quarter. However, since the inception of the initial share repurchase program in August 2015, a total of 8.1 million shares have been repurchased for approximately $280 million. This results in an average cost basis of approximately $34.50 per share, representing an attractive use of capital when considering the share's current trading levels.
Lastly, we entered into an additional $250 million in interest rate swaps during the quarter, which brings our total notional principal balance hedged to $500 million fixed beginning in July 2018 through May 2023 at a blended cost of approximately 2%. With that, I'd now like to turn the call back over to Aaron to provide comments on our updated outlook for 2017.
Thanks, York. We are revising upward our prior guidance for revenue growth and adjusted EBITDA margins for the full year 2017, which is primarily due to an increased outlook for portable and home standby generators as a result of the higher power outage activity experienced during the third quarter. The higher outlook for portable generator sales for the full year is due to the spike in demand from the significant hurricane activity during the third quarter, along with a certain amount of replenishment by our channel partners expected during the fourth quarter. Home standby shipments are expected to be at or near record levels during the fourth quarter, resulting from the anticipated higher demand following the recent outage events, coupled with our ability to ramp up production of these products quickly.
Full-year net sales are now expected to increase between 14%-15% over the prior year, which is an increase from the 6%-8% growth previously expected. Total core organic sales growth is now anticipated to increase 9%-10%, which is an improvement from the previous assumption of 2%-3% and is expected to be balanced between the residential and C&I product classes. Adjusted EBITDA margins before deducting for non-controlling interest is now expected to be approximately 19% for the full year, an improvement from the prior guidance of approximately 18.5%. The improvement in margin guidance is primarily due to the improved leverage of fixed manufacturing and operating expenses on the higher expected sales volumes, partially offset by an unfavorable shift in sales mix, the impact from certain foreign currency exchange rate changes, and higher incentive compensation costs.
Operating and free cash flow generation is forecasted to further improve sequentially during the fourth quarter, benefiting from the strong conversion of adjusted net income, which is expected to be over 90% for the full year. With our increased sales and adjusted EBITDA guidance for the full year 2017, we anticipate our consolidated net debt to LTM adjusted EBITDA leverage ratio to be well below 3x by the end of the year, which is within our long-term targeted range of 2x-3x In addition, we are providing an update on certain other guidance details to help model the company's earnings per share and cash flows for full year 2017. As a result of the expected improved earnings outlook, cash taxes are now expected to be approximately $34 million-$35 million, which translates into an anticipated full year 2017 cash income tax rate of approximately 17%.
Capital expenditures are now forecasted to be below 2% of full year 2017 net sales as a result of the improved top-line outlook for the year. This concludes our prepared remarks, at this time, we'd like to open up the call for questions. Operator?
Thank you. Ladies and gentlemen, if you have a question at this time, please press star and then the number one key on your touch-tone telephone. If your question has been answered or you wish to remove yourself from the queue, please press the pound key. Once again, if you do have a question, please press star and then the number one key on your touch-tone telephone. Our first question comes from the line of Jeff Hammond from KeyBanc Capital. Sir, the line is now open.
Hey, good morning, guys.
Good morning, Jeff.
Morning, Jeff. How you doing?
Hey. Aaron, I really wanted to just get a little more color. You've added all these selling tools which you talked about, and just as you've kind of experienced kind of early follow-through from the storm, just talk about how you think this plays out differently or where you think, which tools or where you think you're going to do a lot better relative to perhaps Sandy in terms of close rates, et cetera.
Yeah. It's obviously an area, Jeff, of intense debate internally here because we didn't have these tools in place previously. They all kind of came on board around 2013 after Sandy. We've never had a chance to pressure test them, and as a result, the data that we're seeing out of some of these tools is very different from the data that we've experienced over the last four years since we put them in place. IHCs, in our prepared remarks, I think we said dramatically higher. I mean, they're well above the rates we were seeing. The traditional kind of math that we were doing on conversion with close rate and what percentage of our home standby flow that IHCs represented, and we have to kind of recalibrate all that.
I think the one thing that I do know, is that first of all, we'll have better visibility. I think that, without a doubt, is just given these tools, we see not only the kind of leading indicators like IHCs, we see the pipeline of business because PowerPlay gives us, at least for those, sales leads that go through the PowerPlay tool, we get to see just how many proposals are being issued, what is the close rate on those proposals, how does that differ from what we've historically seen. We know that at least, with the PowerPlay tool in place, that close rates for dealers using PowerPlay are better than close rates for dealers that don't use PowerPlay.
That in and of itself, having the tool here in place today versus where we were at with Sandy, should lead to better close rates for at least those leads that go through the tool. I think the other comment that I'll make, aside from the sales tools and the targeted marketing, we also put a lot of time and effort after Sandy into our production capabilities, our ability to expand capacity, both at the supply chain level as well as in the factories here in Wisconsin. What we're seeing, it's interesting, the dynamic of this event, we'll just focus on Irma for a second, even though there were three events. Irma occurred from a calendar standpoint, purely from a calendar standpoint, six weeks earlier than Sandy did. Sandy was at the end of October. Irma was really mid-September.
That six-week window, coupled with our ability to ramp quicker because we're sized more appropriately for this size of event. We believe it's going to be reflected in the fourth quarter. We said that the home standby shipments are going to be at or near record levels in the fourth quarter, and we've had some big quarters. If you remember the first quarter of 2013, we came into the year with a tremendous amount of backlog coming out of 2012 off of Sandy. 2013 first quarter was a huge quarter for us for standby. We think that the fourth quarter of this year is going to rival that quarter and potentially exceed it. I think better visibility, the ability to better ramp, and I think better conversion on those sales, although I can't quite quote a statistic yet because we'll have to see how it plays out.
Okay. Very helpful. You mentioned Puerto Rico, which sounds terrible and devastating and long outages, but we thought it would be a relatively small opportunity. Can you just kind of size that opportunity? Is it more industrial? Is it more portable? And then also on the Florida nursing home opportunity, is there a way to frame the market opportunity there? Thanks.
Right. Yeah, let me tackle Florida first because it's a little bit more of a there's probably an easier answer there. In terms of the number of facilities, there's a little bit of more of a known kind of set of opportunity there. It's been estimated that could be upwards of a $240 million opportunity, just market-wise. Just very recently, the governor's emergency order there was effectively stayed in terms of the timeline. There's legislation being crafted in Florida that will tackle this for certain going forward, and it needs to be tackled because it's a very important element of the strategy around critical care facilities that the temperature control be also included in the backup strategy. That really wasn't a requirement previously. We're going to start to see that, I think, beyond Florida as well.
I think it'll potentially spread into other areas where temperature control has not necessarily been dictated to be part of critical care facilities emergency backup. That's the Florida opportunity. That should really come to bear fruit in that we're already engaging with a couple of large partners there. We've got one very nice project that we already are working on directly, for Florida that will probably, it's not going to ship this year, but it should ship in 2018. We think there's going to be a lot more of that. There's a lot of smaller critical care facilities in Florida that are also going to have to comply with this order or law, rule of law, whatever ends up forming, ends up taking. With Puerto Rico, just to step back from Puerto Rico, I mean, obviously the devastation there is unlike anything we've ever experienced before.
We deliver a lot of products into areas of the country and areas of the world for that matter, where you come in after a disaster. I mean, Puerto Rico, the isolated nature of it as an island has really hampered not only the recovery effort with 70% of the island still in the dark, but it's really hampered the logistics around being able to get products and people and support where it's needed. It's just a huge effort there that I think there's a lot of really good work being done now, but it's hard. I mean, it's an island. You've got about 3.5 million, 3.4 million inhabitants there. It's about like the size of Iowa. In terms of opportunity for us, you're right. We probably wouldn't have ascribed a ton of opportunity.
Traditionally it's been a decent market, but it's really small. It's like the entire Caribbean is not a huge market for us, but there's a need for backup power. The gas infrastructure on the islands is not great either, so it doesn't really fit well with a lot of our kind of gas solutions. What we're seeing is more to your point, we're actually seeing a lot of portable generators because you can get gasoline in portable generators or diesel fuel. We're also seeing large diesel generators. The request for large diesel generators is incredible right now. People want anything they can get. There's a lot of factories, a lot of pharmaceutical manufacturing and other factories that have moved into Puerto Rico over the years, and for whatever reason, didn't have adequate backup strategies.
A little bit amazing to me, an island that you can see a map in terms of storm activity. The island gets crisscrossed by a lot of storm activity over the last several decades. It's clearly a risk for anybody doing anything there, manufacturing or otherwise. We think that this will lead to opportunities in the industrial market. Telecommunications, the entire telecom network was brought down, and that is something that's being kind of rebuilt on a temporary basis right now. It'll remain to be seen just exactly how permanent everything is rebuilt with the grid and everything else. In terms of trying to frame the opportunity, it's really difficult. The numbers we're seeing out of Puerto Rico right now are well above historical averages. The question really is that sustainable?
As the grid is rebuilt, we're going to have to look towards. I think the commercial and industrial opportunities are real. There is some residential opportunity there, but certainly the demographics there are different than we would see in places like Florida or Texas, where some of these other events happen. That will likely temper also some of the potential upside as it relates to certain products like home standby. Nonetheless, they also had a major outage there last year. The utility company there being in receivership, they basically had a major outage last September. We were already seeing very good demand there. This has just taken it to a, frankly, a ridiculous place in terms of the amount of product that is being requested there and being shipped there. Now it's all about logistics.
It's just difficult. We don't have a tremendous amount of distribution on the island either. That's another, I think, important point in terms of what our potential upside is there. That'll build out over the next several years, but it'll take time.
Okay. Thanks a lot, Aaron.
Our next question comes from the line of Ross Gilardi from Bank of America. Your line is now open.
Hey, good morning, guys.
Good morning, Ross.
Morning, Ross.
Hey, I just want to make sure I understood the guide and the implied fourth quarter. I think basically you're implying flat-ish revenue Q3 to Q4, but you got EBITDA up like $20 million. Is that really just the mix impact from the standby business?
Yeah, there'll be a lot. This is York. There'll be a large mix shift. Q3, we mentioned the majority of the year-over-year increase on resi was portable-driven. That'll shift the other way in Q4 as we are in the process of replenishing our portables. We're ramping up home standby and shipping. Demand is high for home standby here with the afterglow of the events, and we expect to ship a lot of home standby in Q4. Big mix shift drives a big sequential improvement in gross margins, which drives the improvement in EBITDA margins.
Okay. In terms of the production ramp for home standby, do you think you'll get where you need to be in the fourth quarter? I think it's been highlighted in local press and so forth, you've got some local labor constraints and so forth, and it's been a while since you've had to really ramp up production. I'm just trying to get at whether or not with the ramp up, whether it stretches into 2018, or do you kind of get where you need to be by the end of the year?
Yeah. It's a great question, Ross. We were able to ramp actually very quickly. We do have access to some labor. You're right, the constraints that I think a lot of companies are facing, not only in this part of the country, but really with 3% unemployment, people have been some of the larger constraints. Historically, looking back like with Sandy, the constraint was clearly supply chain. We hadn't oriented our supply chain. We didn't have a safety stocking strategy around component strategies and things that allowed us to rapidly kind of expand production. We changed all that post-Sandy, and now obviously we've been waiting to test that. It's been four years, five years since we've been able to really put that into test.
We actually were able to ramp very quickly here in October, and we're going to sustain an elevated level through the end of the year and really into the early part of next year. We kind of watch, obviously, we're watching all these leading indicators. We'll see how they flow through to, as I mentioned before, to close rates to understand just how to translate into demand. We would expect, if you look at the normal cadence off of events like this, the year following a major event is going to have elevated demand for these types of products. They typically come in a couple of different forms.
Portable generators, which are primarily the domain in terms of distribution of the retail partners, tend to get replenished very aggressively, kind of in that Q2 range, post a year with heavy activity because stocks have been depleted, and generally, you won't see retailers, although we mentioned some replenishment in Q4 with portable generators, they won't replenish to the same level pre-storm because there's no reason to do that. You might get some winter events, but there really isn't a reason to buy ahead that much. They'll replenish in Q2 to a fairly decent level, so we would expect that. We would expect elevated home standby activity, and really culminating in the anniversary of these events next fall. We expect, as we said, Q4 is going to be very busy for us this year.
We'll keep the elevated production levels as long as it makes sense. Even though we have some labor constraints, we're able to make up for some of those constraints with overtime and working weekends. We're pushing the team pretty hard right now, but they're responding very well. Actually, really happy with how quickly they were able to ramp up and maintain the kind of expectations we have, the high expectations we have of an operating environment with high quality and high productivity. We're very pleased with that at this point.
Okay. Thanks, Aaron. Can you give me just some better sense as to what type of demand response you saw from standby outside of the storm-affected regions, just more broadly from a brand awareness standpoint in the rest of the country? Did you see a pickup in demand in the Northeast, for example, just because people were reliving the experience five years ago by watching the TV, and what was going on in the Southeast?
Yeah. It's interesting the spillover effect you get. We saw improved activations in every region. It was really interesting. The Northeast has been, as we've called out, up until I think maybe the second quarter of this year, I think the Northeast, we found a bottom there finally in terms of year-over-year comps, quarter-over-quarter comps, even with the Northeast. We saw the stabilization of that in Q2, and we saw it grow again in Q3. That was nice, really across all markets. The impact that we've gotten, category awareness is one that I'll just focus on here for a second. The home standby product category.
When we wind the clock back, and this is something that we metric every couple of years, we go out and we do a bunch of marketing research around the category just to make sure that we're understanding how it's trading, where it's going. Category awareness is a big one that we look at. You can go back 10 years ago, and category awareness for home standbys was 30% of people that were aware that the product even existed, that an automatic solution hooked up to your home's fuel supply and electric supply could be something you could have. Today, our latest survey, which was done earlier this year, actually, before these major events, it's 72% category awareness.
We look at that and we say, wow, that's tremendous. Now, obviously, major events like Sandy, this event like Irma, is going to have a positive impact and have had positive impacts on awareness. It's also had a major impact on the brand. The amount of coverage that we get from a PR standpoint, as well as our paid advertising that we do post-outage, has really raised the profile of the Generac brand, especially around this category. In fact, in many cases, you can go into regions of the country where the brand has become interchangeable. It's become synonymous with the category. A lot of times, customers will refer to the product as a Generac. They won't call it a home standby. They'll call it a Generac. Sometimes that's even if it's not our brand.
Our dealers have anecdotally given us examples where customers call to look for a repair or a service on a Generac, and they get there and it's a different brand. It's interesting to see how, and I think that's really a testament to the amount of effort that we put into creating category awareness and the amount of effort we put into building the brand. I think it's really paying off very well for us in a lot of cases here.
Got it. Thank you, guys.
Thanks.
Thanks, Ross.
Our next question comes from the line of Brian Drab from William Blair. Your line is now open.
Good morning. Thanks for taking my questions.
Thanks, Brian.
Hey, Brian.
I think, Aaron, you mentioned a very specific number. Did I hear you say $240 million opportunity in Florida? Could you just reaffirm what exactly that pertained to?
Yeah, that is a number that's not our estimate, by the way, just to be clear. It's a public estimate of the Florida healthcare advocacy groups and the other groups there in Florida. There are about 4,000 sites, roughly, that they are estimated that would need to comply with this order. Those 4,000 sites, it's estimated that the cost, and this will be inclusive of installation, so it's beyond just the machine. The cost of the installation and the machine to bring these sites into compliance with the governor's order would be about $240 million. Again, that's more of a public estimate.
Obviously, there's a component of that that's going to come to us, and I think the more important thing is we see evidence in other areas of the country where the same type of regulation over time could impact those areas as well and could be a tailwind to our C&I business. This happens after major events like this. We called this out in our prepared remarks, but we typically see the C&I business just takes longer. First of all, they're businesses. It's a business decision. If it's an institution that needs to comply with the regulation, there's time to get the regulations on the books. There's time to comply with those regulations, and the cycle's a lot longer than you would see with residential. The afterglow is the term we use. The afterglow for C&I extends much longer after major events, a couple of years.
Whereas with residential, it can last two to four quarters. The C&I business can go years based on either compliance with regulation or investments by businesses in their backup strategy.
Right. Got it. Okay. Thanks. If you look back at the analyst, if you look at the comment that you guys made around, I think the term that we used was average major event, and you gave us a rough estimate of this type of event could generate $50 million in revenue. Is this recent activity, the combination of these recent storms, something that is about what you'd expect to be an average major event, or does this far exceed that, or could you just comment on that? Also, in the context that you mentioned, you were talking about Sandy. At the time that Sandy hit, the street forecast was, say, X, then you ended up seeing X plus almost $300 million in revenue following that.
I think there were some other events, of course, going on that it's hard to parse out exactly which one drove the most demand or how much demand. Is this a $50 million type of opportunity or well above that?
Brian, this is York. If you look at our guidance statement and how we've taken it up. The implied guidance is about a $100 million increase versus the prior guidance, and that is predominantly residential products increasing as a result of these major outages hitting in the third quarter. There's multiple outages. There was Harvey, which hit Houston, but I think we said that was more of, unfortunately, a flooding event and didn't take out power to a lot of people. We sold some portables, but we'll see what the follow-on of that is into 2018. Irma, obviously, was millions of people without power for a week. Wasn't quite the size of Sandy. I think we measured the severity, actual outage severity in terms of hours out, it was about 80% of Sandy. That was the second-largest event we've recorded.
Hurricane Maria, Aaron's comments about Puerto Rico, we're shipping product to Puerto Rico, albeit it is a smaller market for us with more limited distribution. I think if you look at that $100 million increase in guidance, that was predominantly related to Irma. I think putting it all together, there was demand for all three.
Yeah. That $100 million, you're only looking through 2017, if you think.
Yeah, that's predominantly what we talk about is the impact on that year, because if you think about it, home standby, we've talked about new and higher baselines. When you have awareness events and major outage events, you have a new and higher baseline for home standby, which is then, I guess, an infinitely higher than if you have a new and higher baseline, the impact could-
The compounding effect.
-could be infinitely higher then. It's hard to quantify.
Right. It's hard to point that out.
The 2018 impact if there's a new and higher baseline established as a result.
Okay. Am I thinking about it correctly, though, that you raised the guidance $100 million for 2017 with Sandy, the home standby demand played out for the whole subsequent year, and that's really where I'm trying to gauge how much of an impact beyond $100 million you'd expect for next year.
Yeah, I think one thing with that, Brian, you got to remember my comments about, we came into 2013 with a very large backlog. That situation, we're not at the end of the year yet, so we don't know what the backlog will be, there'll probably be some backlog going into the year. The ability to ramp a lot faster and the fact that this storm happened six weeks earlier, the major event that is Irma, will have a pretty big impact on us taking care of a lot of the increase in demand directly from the storm in the current year. Q3, Q4. Q3 being portables, Q4 being primarily home standby. I think you just have to think about it differently. Because of the way the calendar works and because of our ability to ramp faster, I think the pacing of it's going to look a little different.
Our commercial teams are evaluating the impact of 2018 as we speak.
Yeah.
We're pulling together our numbers for 2018, it's hard to comment on 2018. We're evaluating it as we speak, your backlog, we'll take it from there.
Okay. Thanks. One last quick one, just your kind of underlying run rate of outage activity as you measure it, ignoring the major events, how does that look sequentially and year-over-year, if you could?
Yeah. I mean, it's up. The baseline averages are up nicely. They were up through Q2 when we reported. They remain elevated and I don't know, York, you got?
Yeah. Even if you just took out the month of September, which had Irma in it, baseline outages were up for the quarter. I think that bodes well for the category, the home standby category.
Yeah, exactly.
Right. Okay. Thank you very much.
Thanks, Brian.
Our next question comes from the line of Christopher Glynn from Oppenheimer. The line's now open.
Thanks. Yep, good morning.
Hey, good morning, Chris.
Hey, just wondering about the Northeast outages this week, if you have any early thoughts or assessment. I don't know the magnitude, but geographically it spanned Connecticut to Maine. I think it's a notably sensitive region in terms of category awareness. Curious your thoughts there.
Yeah, it's interesting that you ask that, Chris. Obviously, it's another example. At the peak of it, there were 1.5 million customers without power. As of 8:00 A.M. this morning, if you want the exact number, it's 436,000 customers that remain without power. We track it very closely. These are data points that we watch closely. I can tell you by state what they are. Maine is at the top of the list, to your point. We actually have a very good install base in Maine. It's a state that only has, what, 1.3 million, 1.4 million people.
It's not a huge kind of market opportunity relative to other areas, obviously an area, as you pointed out, that's very in tune with the need to have backup power due to just the age of the grid there, the trees, everything else that comes into play when you get these types of windstorms and rainstorms like we had earlier this week. The answer to your question simply is, that wasn't obviously in anything we've talked about here. Unfortunately, our portable generator inventories are fairly depleted. We do have certain levels of strategic stock that we keep on hand with certain retailers, and they've been fulfilling, obviously, the demand increase to the best of their ability in that part of the country. Regrettably, most of the stock is down in the Southeast right now because of the response to the storms down there.
Logistics around moving it further north, I think what'll happen is we'll see a nice bump in home standby activity there as we get around the horn here in Q4 and into Q1. That only is going to be positive from a tailwind. It would only go to increase that outage activity over the baseline that we've talked about. It's been a very active year, and we've said for many years, weather moves in cycles like this, and it's just we've been in a bit of a cyclical low over the last several years, and now we're moving into a more active period.
Sounds interesting. Then usually give some other line item indicators for the guidance. I think D&A and stock comp are probably unchanged, your prior $44 million-$45 million interest looks probably a little stale, maybe going to be $43 million or so?
It's going to be slightly, yeah, in that range. Maybe at $40 million.
A tick lower, probably.
Yeah. A tick lower than the $44 million, $45 million previous.
Okay. Thanks, guys.
Thanks.
Our next question comes from the line of Charley Brady from SunTrust Robinson. Sir, your line is now open.
Thanks. Good morning, guys.
Hey, Charley.
Good morning.
I just wanted to ask, how much of the sales are going through PowerPlay right now? Can you update us on that?
Yeah, we haven't actually quoted what percentage of the flow runs through that. The reason why is that when you get events like this was our thesis, is that there could be a disproportionate amount that ends up going through it, more so than a historical level because of the concentrated nature of an event. We've got over 2,000 dealer salespeople that use the tool. That's expanded over the years that we've rolled it out. We get great visibility to the market. The tool gives us just an amazing insight into what's going on on the ground, just how long it's taking. We actually get to see the time lags very viscerally as well because we can schedule an appointment.
We can see the dealer's calendar of opportunity, its open slots, if you will, he or she's open appointments calendar. We know just how busy they are. Probably the biggest area of stress on it has been the normal algorithms we use to distribute the leads. They were kind of computer-driven before, driven off of the important things like customer sat and the proximity of a homeowner to that, the dealer's close rate. Obviously, the algorithm does what the algorithm does, which it gives leads to dealers who have better close rates, better sat scores, and are closer to the homeowner, which is great. We can't overload a dealer either.
We've had to unhook our algorithm from the PowerPlay app and take a step back and do some manual distribution of leads here because the amount of lead flow is just well above what we've ever seen. We've added a second call center. We've done a number of things to make sure that we're talking to all the customers that are interested in the category and that we're getting those leads to people that can take care of those customers in a timely fashion. Again, I think the PowerPlay tool is a great way for us to get really good visibility and insight on the leading end of the transaction to really understand what's going on with the market.
Aaron, I guess to that point on the visibility that you've got, you talked about not having as kind of a backlog, at least it doesn't look like it today, the way you did with Sandy because of a number of factors. I'm wondering, what kind of visibility do you have, at least into the early part of 2018? Because with Sandy in the Northeast, you had a backlog just from an installation standpoint of some people waiting months and months and months just to get a slot to have a guy come over and put the actual generator on. I'm wondering if you have sort of any sense of what that pent-up demand, just from a ability to have guys go out there and do the work, the install work.
Because it's so early, Charley, still in the process here, a lot of it's right now just the actual going and doing the IHC, the in-home consultation. Sitting down, pitching it, that's where the bandwidth constraint actually is right now, is just scheduling the time to get into somebody's home to actually do the consultation. Obviously, we'll have to see how the close rate matures over the next month or two or three months here. Again, we see very viscerally the lags, the time it takes normally from an IHC to occur to when a closed sale occurs, to when an installation occurs and when an activation occurs. We actually see, you plot it on a timeline. We know what that is.
It's different in different regions of the country, to your point with Sandy. It can be impacted by some kind of noted types of constraints. With Sandy, it was not only the bandwidth around dealer bandwidth, just getting to do the install, but actually meter upgrades, because the Northeast has notably lower gas pressure, and a lot of times, putting a generator on a home required a meter upgrade. The meter companies themselves, even before you get to the utility companies, the gas company, you're talking about the companies that make the meters, couldn't make enough meters. You had the gas companies had to actually schedule the installs. You had to have the inspectors come out and actually do the inspection, issue the permit and do the inspection. All of these kind of throttle points happen along the chain.
That'll be different in Florida. Florida has a notoriously, especially coastal regions, which is most of the Florida real estate, has very difficult, very cumbersome permitting processes for projects like this. Sometimes they're able to expedite them after storms as part of storm recovery, but it still can be very long. You have certain things around needing a propane tank if there's not a natural gas line. The ability to procure a propane tank and put it, a lot of times that tank has to be buried. You have to schedule equipment to come and do the excavation and bury the tank to comply with local codes. We see typically in Florida, installs take longer than anywhere else in the country in a normal environment. The good news is you can do installs in Florida year-round.
That's the one thing we didn't have with Sandy. We were constrained by weather with Sandy up in the Northeast. Once the ground freezes, it's a lot more difficult to do the installations. What we'll see in Florida is you'll still be able to progress with those installs, the permitting for the propane tank installations, there's a requirement in the state of Florida that the utility be present to disconnect a meter. That's not the same requirement. A lot of states, an electrician, a licensed electrician, can perform that activity. In Florida, FPL or Tampa Electric, has to be on-site to actually do that. That's just a Florida requirement. It's an anomaly, but it creates another potential point to slow the project down. We'll monitor it as we go forward, as we go into 2018, we'll provide updated guidance on that.
There's a lot of moving pieces as you can see, based on the way I'm describing it, and we really don't have perfect visibility into what those close rates are going to be going forward. A lot of that's going to become clear here over the fourth quarter.
Yeah, that's great insight. I appreciate that color. Just one quick one for me. The promotion you've been running in the Northeast, maybe an update on kind of traction you saw with that relative to maybe expectations.
Yeah. The promo was the Heroes of Sandy promotion that we did was very well received by the market there. We think that in the absence of these events down, the hurricanes hitting, we still would've had a very decent quarter around home standby, and in particular in the Northeast where the promotion ran. A lot of nice receptivity to it. We're going to sit down as a team. The promo just ended, we're going to sit down as a team here over the next couple of weeks. We probably would've done it faster if not for all the things that we're in the middle of in the ramp up around the hurricane response areas.
We'll do a kind of a postmortem on that promotion to understand just what was the take rate, what was the opportunity to move people up off of the initial offer to larger products because they were entry-level type products that we were promoting. I can probably provide more color on that directly in the next call, Charley. Just anecdotally and based on the number of submissions that we saw for the promotion, it was very well received.
Our next question comes from the line of Stanley Elliott from Stifel. Sir, your line is now open.
Hey, guys. Thank you for taking the question. Quick question, kind of going back to Puerto Rico, can you all ship there from Mexico, or does that have to come from the U.S.? I was just not sure exactly on what the EPA requirements would be there.
Yeah. It's kind of a moving target right now, but right now a waiver has been put in place for diesel generators for emergency use, really storm response during the next six months, basically. I'm going to paraphrase what the stated rule and requirement from the EPA is, because if I read you that, we'd be on the call for another two hours here, because regulations like that are obviously very thick. Effectively, we can ship from Mexico, or in this case, we're even sending some products from our facilities in Europe that would normally not be EPA compliant. They'd be targeted for other areas of the world with either other EPA levels of other emission levels of certification or no levels, as we see in certain regions of the world. We'll be able to do that for the next six months.
There is a requirement by the owner-operator of that equipment to either take that piece of equipment out of commission after that six-month period or move it completely off the island. They have to evidence that they can't use the equipment in a normal operating environment beyond the six-month period. For any non-EPA compliant equipment. Now, the bigger issue, of course, and this is one of the problems that I think Puerto Rico has, is as a U.S. territory, the downside of that is you get all the U.S. regulation alongside of that. That really limits the supply around UL-related products as well. If inspectors require UL, this is not something I don't think is going to be waived quite as easily as the EPA regulations for a period of time. UL compliant equipment, which we produce here in the U.S.
to UL, Underwriters Laboratories specifications, that is something that is unique to the U.S. U.S. manufacturing base will supply UL products into Puerto Rico, but it limits the supply. To answer your question, the majority of the supply is still going to come from the U.S. market. There could be some limited supply that comes from outside the U.S., but it'll only be for a limited amount of time.
Our next question comes from the line of Josh Pokrzywinski from Wolfe Research. Sir, your line is now open.
Looks like he dropped. Josh? I guess go to the next question.
Our next question comes from the line of Jerry Revich from Goldman Sachs. Sir, your line is now open.
Hi. Good morning, everyone.
Hey, Jerry.
Hey, Jerry.
You folks have spent a lot of time over the years focusing on total installed costs, and you've got some promotions out offering total installed cost effectively guaranteed. Can you just talk about where you stand in those efforts? How broadly is that available, and how are you folks implementing that given how much distribution varies across your footprint here?
Thanks, Jerry. We have spent a lot of time on the installation cost component of a home standby because that's roughly half the economics in terms of the bill to the consumer or to the business owner. For as much time as we've put on that, we've made a little bit of a dent on it, but it's not as great as we would've liked to have seen at this point. I think what's unfortunately going to happen, and I kind of watched this in the past, when you get periods of high demand like this, the sharpness of those quotations around installs tend to not be driven as low from a competitive standpoint because there's just a lot of opportunity out there. It's competition that really drives those lower.
We've got some things we've done to the product to improve the efficiency of the installation, and some of those have read through and have impacted the overall cost. The Heroes of Sandy campaign was really, and this is what I think you're referring to, the fixed install cost, was really a way for us to test a fixed installation price in a market. Again, working with our channel partners on that, the promotion itself was well-received. Obviously we had to work with our channel partners to remind them of the things that we've shared with them over the years on making these products easier to install and to get them to a point from an economic standpoint where it still makes sense for them to be involved, right? I mean, we don't want to take away their economics.
That's an important part of how our distribution channel makes money in this category. That's a really critical part, obviously, of them continuing to promote and be involved with the category. What we really are focusing the dealers on is the opportunity after the install for the maintenance opportunity with these products. These products need to be maintained year in and year out. The opportunity to do that maintenance is one that has been, I would say, undercapitalized on by the channel largely. I mean, we have some dealers who are very focused on it, and we have other dealers who would rather focus on the installation or the wiring job that comes with it. For us, it's about reorienting the channel around the importance of that recurring revenue stream opportunity down the line.
That'll become even stronger as we roll out the beginning of next year, Q1 of next year, we're going to roll out a remote monitoring package that's going to be standard on every one of these machines that'll allow for a level of visibility with the machine and a level of connectivity to the end customer that both ourselves and our dealers have not had in the past. That's kind of an exciting opportunity to try and help monetize the sale well beyond the sale for us of a product and beyond the installation for our dealers. More to come on that, Jerry, but we're not done focusing on it. There's a lot of work to still be done there.
We have a couple of things in our quiver down the line where we think there's some technical things that we can do with the product to make it easier to install a step further. That should continue to bring down the cost over time.
Now I'm showing no further questions. I would now like to turn the call back to Aaron Jagdfeld, President and Chief Executive Officer for any closing remarks.
Great. We want to thank everyone for joining us this morning, and we look forward to reporting our fourth quarter and full year 2017 earnings results, which we anticipate will be sometime around mid-February of 2018. With that, we'll let you go to your day. Thank you very much.
Ladies and gentlemen, thank you for participating in today's conference. This concludes today's program. You may disconnect. Everyone have a great day.