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 provided 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. Michael 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. 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. Commercial and industrial 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 a 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 experienced sequential growth in our residential dealer base and ended the quarter with nearly 8,500 dealer partners, a net increase of approximately 300 dealers sequentially. Activations, which are a proxy for installs, continued to grow in the third quarter compared to the prior year. However, as we mentioned in our preliminary announcement, installation capacity for home standby generators lagged our production output. The ability of installing contractors to fully service the demand for backup power from homeowners continues to be constrained by labor availability, permitting and utility-related delays, and shortages in certain materials needed to complete an installation. Furthermore, growth in our dealer base was constrained in prior quarters by our extended production lead times. All of this resulted in elevated levels of field inventory and lower-than-expected orders from our channel partners, despite the continued strength in end-customer demand. Importantly, to address these activation challenges, we are working on a number of specific initiatives to increase home standby installation bandwidth such as providing resources to help existing dealers expand their labor forces and additional installation training locally for non-dealer contractors. We are working to streamline home standby projects by creating universal permitting packages and replicating past successes in simplifying approval processes from certain local utilities. Other efficiency-related initiatives include dealer scheduling and quotation refinement to enhance the top of the sales funnel and optimize the allocation of sales leads within the dealer channel to favor those dealers that have capacity to install more generators. Importantly, we have also intensified efforts to further expand our overall dealer count and we expect another strong quarter of sequential growth in the fourth quarter. Our dealer count growth initiatives have recently benefited from our shorter production lead times, which have now mostly returned to normal levels as we ramped our production output of home standby generators in prior quarters. Although installation capacity constraints have resulted in lower orders from our channel partners, it is important to reiterate that underlying demand and market fundamentals of the home standby category remain strong, supported by meaningfully sequential improvements in a number of key dealer-related metrics during the third quarter. In-home consultations grew, close rates continue to rebound and while still elevated the time between contract signing and installation declined meaningfully as compared to the second quarter. Dealer productivity, as measured by activations per day per dealer, improved to an all-time high during the third quarter. In addition, our dealer survey data suggests approximately half of all the field inventory is allocated to an active customer contract, highlighting the need to further increase the pace of installs to close the gap between strong end-customer demand and installation capacity. While the previously mentioned sequential improvements provide evidence that our channel partners are beginning to make progress in working through their elevated backlogs and field inventory, we expect home standby order headwinds to persist through the first half of 2023 as field inventory levels normalize. Even when assuming no major outage events, in the second half of 2023, we expect significant sequential sales growth from the first half of the year and only a modest decline in sales on a year-over-year basis as we maintain a new and higher baseline level of demand. Over the last 30 years, the home standby category has grown in a step function pattern as penetration rates have expanded rapidly for several years at a time driven by notable major power outage events followed by periods of flatter growth as demand normalizes. With each successive growth period comes increased awareness around home standby generators and increased distribution for these products, both of which have been critical in helping the category reach new and higher levels of baseline demand. The latest growth steps that the product category has experienced were underpinned by an increase in power outage activity over the past several years with four of the top 10 major outage events since 2010 having occurred in just the last two years alone. This growth can be evidenced through a number of key market metrics in comparing the first three quarters of 2022 to the comparable period of 2019 as activations per day more than doubled, home consultations more than tripled and our dealer count increased by nearly 40% from 6,200 to 8,500. The approximate mid-teens compound annual growth rate in the category over the past several decades can be tied to the increase in power outages over that time as the nation's electrical grid has struggled to reliably supply power to homeowners and businesses. The aging and underinvested grid infrastructure has become more vulnerable to the increasing severity of high-impact weather-related events such as hurricanes, heat waves, ice storms and polar vortexes. Additionally, new megatrends have emerged that we believe will drive the next step of growth in the category. Grid resiliency concerns have been increasing as decarbonization trends accelerate causing a widening gap between supply and demand, leaving many utilities and grid operators scrambling to avoid rolling blackouts over the past several years, and we believe little has been done to rectify this situation. We also believe the home-centric megatrend will persist as the shift to remote or hybrid work remains intact. The electrification of homes continues to grow and demographic trends are driving increased levels of aging in place. With the nationwide penetration rates still in the mid-single-digit range, and these megatrends firmly intact, we are confident that the long-term growth trajectory for the home standby category remains significant. I'd now like to discuss our residential clean energy products. Shipments of PWRcell energy storage systems in the third quarter were negatively impacted by the significant liquidity challenges of a large customer that ceased operations and subsequently filed for bankruptcy. Additionally, during the quarter, we continued to address certain warranty-related matters for the upgrade of a component within our PWRcell energy storage system. As part of this effort, we have engaged a number of third-party service companies to assist with the completion of these upgrades and these efforts are well underway. As a result of these items, we recorded a $55 million charge in the quarter, comprised of an $18 million bad debt reserve and a $37 million warranty charge. The challenges we experienced in our clean energy business from the third quarter were very disappointing, but we believe that the solar-plus energy storage market continues to represent an important strategic opportunity for Generac longer term. However, this quarter's results have demonstrated the need for us to further expand our distribution by focusing our efforts on partnering with high-quality, reputable sales and installation companies for these products. Importantly, we are committed to supporting the dealers that are participating in our warranty coverage upgrade program as they play a vital role in restoring our competitiveness in the residential clean energy space. In addition, we continue to broaden our product offering and bring new innovations to this market as we announced an update to the PWRcell energy storage system during the quarter that enables AC-coupled battery storage, as well as AC generator integration. Work also continues on our PV microinverter product called the PWRmicro, as our beta testing began late in the second quarter and will continue through the balance of this year. We anticipate a phased commercial roll out beginning in the first half of 2023 and a full commercial launch targeted for the second half of the year. I'd now like to provide a quick update on our ecobee acquisition, which we completed last December. During the initial period of our ownership, we have been focused on developing cross-selling opportunities for ecobee's hardware solutions through Generac's distribution partners and have seen positive indications of demand for smart thermostats alongside other clean energy products. Synergies between ecobee and Generac's grid services teams continue to be validated and we are identifying higher potential value creation for ecobee’s devices and demand response programs amid ongoing concerns around grid stability and rising energy prices. We have also begun leveraging the talented ecobee team to help accelerate our Connected Devices strategy, which is core to the development of our residential energy ecosystem that will ultimately be accessed and controlled by a single pane of glass user interface. I also want to provide some additional color on the efforts of our grid services team as they continue to execute on a growing and diversified sales pipeline. We have further expanded our efforts to extract synergies across our commercial teams as they work to offer an increasing mix of Generac hardware alongside our Concerto grid services software platform. Our comprehensive suite of solutions aimed at distributed energy resource management-related programs is unmatched and is proving to be a competitive differentiator for our grid services team as the number of devices and megawatts of capacity connected to the Concerto platform continues to grow. We announced a number of program wins since our second quarter call, including Software-as-a-Service contracts with Dominion Energy and U.K.-based Pearlstone Energy, as well as a performance contract with Arizona Public Service, which demonstrates Generac's unique ability to deliver end-to-end solutions in grid services programs. The long-term market opportunities for residential energy storage, microinverters, monitoring and management devices and grid services solutions remain highly attractive and core to our strategic vision. However, the loss of a major customer during the quarter, along with the specific warranty-related issue, has impacted near-term demand and our outlook for the full year 2022. We now expect the combination of clean energy technology products and services to deliver sales between $300 million to $330 million for the full year 2022, as compared to our previous guidance of approximately $500 million. Our continued investment in the people and processes involved in the development of these products remains a key focal area for the company as we work to further broaden our product offering while also improving the quality and performance of the technologies we've acquired and developed over the last three years. With that in mind, we're building a talented and focused clean energy management team beginning with the addition of Norm Tap in August as our new President of this organization, along with the new Chief Technology Officer, Senior Vice President of Finance, and a Senior Vice President of Policy. Norm and his team bring decades of industry leadership experience, as well as robust technical expertise that will help drive Generac's integrated clean energy technology solutions forward. Additionally, the policy backdrop for this market has never been more favorable with the Inflation Reduction Act providing the necessary visibility for long-term value-creating investments. We will continue to build out our energy technology leadership team and our suite of products and solutions as we expect to play an important role in the transition to a cleaner, more sustainable and more reliable electric grid. As a result of these investments and the strong outlook for this market, we expect clean energy technology sales to return to strong growth for the full year 2023 with sequentially improving results throughout the year. Our commercial and industrial products continue to perform exceptionally well in the quarter, as global C&I net sales increased 20% on an as-reported basis and 23% on a core sales basis, which excludes the impact from acquisitions and foreign currency as compared to the prior year. Domestic shipments for C&I products in the third quarter were led by strength across national rental equipment, telecom and industrial distributor customers. We experienced continued strength in demand during the quarter as backlog for our C&I products remained at record levels and expanded further in the month of October, giving us excellent visibility that solid growth will continue in the category well into 2023. Shipments of C&I stationary generators through our North American distributor channel grew significantly again in the third quarter and order trends indicate this momentum will continue in the quarters ahead as backlog in the channel increased on a sequential basis. Quoting activity and close rates remain elevated compared to prior year levels, highlighting our market share gains as well as the durability of demand trends for backup power for C&I applications. Shipments to national telecom customers also increased again during the third quarter as compared to the prior year, as several of our larger national customers continue to invest in hardening their existing sites and in the build-out of their fifth-generation, or 5G, networks. These networks are increasingly considered part of the nation's critical infrastructure and require backup power for resiliency. Upgrades to telecom infrastructure remain one of the key megatrends that we expect to drive growth for our business in the coming years as global power and network hub counts continue to expand. We also experienced another quarter of substantial growth with our national and independent rental equipment customers as they continued to invest in equipment to refresh and expand their fleets. We anticipate the demand environment for mobile products will remain robust in the quarters ahead as the megatrend around the critical need for infrastructure improvements continues to play out. Strong customer interest for our natural gas generators used in applications beyond traditional emergency standby projects also continued in the quarter with sales of these products growing at an exceptional rate. We believe we are in the very early innings of growth for this exciting new market opportunity, as grid stability concerns and volatile energy markets are expected to further drive demand for these innovative solutions. We also took a significant step forward in our C&I generator connectivity efforts shortly after quarter end with the acquisition of Blue Pillar, an industrial Internet of Things platform developer that enables distributed energy generation monitoring and control. Blue Pillar's connectivity solutions can make previously stranded C&I backup generators available for use in grid services programs by connection to the Concerto software platform and will provide a foundation for our longer-term vision of creating a single user interface for a suite of connected C&I assets. Our International segment continued to experience very strong momentum, as total sales increased 14% year-over-year during the third quarter with 22% core total sales growth when excluding the benefit of acquisitions and the unfavorable impact of foreign currency. Core total sales growth was driven by strength across all regions, most notably in Europe and Latin America with intersegment sales also growing substantially in the quarter as our Generac Mexico facility further ramps production of telecom products for the North American market. The European region has seen remarkably strong demand across product lines, most notably in C&I and portable generators due to a heightened focus on energy independence and security. Concerns over power security amid the conflict in Ukraine have continued to rise and we are providing backup generators to the region through our European sales branches. Longer-term demand trends are less certain, however, as geopolitical and macroeconomic conditions in the region remain volatile, but end market awareness of the need for resiliency has increased across the continent in recent quarters. The subsequent effect of the war on Europe's energy complex has highlighted the dependence on continuous power sources for homes and businesses around the globe. Looking into 2023 for our global C&I products, given the strong demand fundamentals and existing backlog, our preliminary view anticipates continued strong year-over-year growth throughout the entire year. In closing, this morning, we were disappointed that our third quarter results were below our prior expectations. But we believe we have action plans in place to address the underlying challenges in the business. New clean energy technology leadership has brought an increased emphasis on quality and innovation, and we remain confident in the long-term growth opportunity for this strategic area of our business. Important initiatives to help ease home standby installation bottlenecks are well underway. And as the home standby market normalizes, we are confident that the new and higher baseline of end demand for the product category will become clearer. Hurricane Ian is the latest example of increasingly severe and more volatile weather patterns, and we believe the power grid's growing supply and demand imbalance is far from resolved as we add intermittent renewable generation sources while simultaneously pursuing the electrification of our homes, businesses and transportation. The secular growth themes and megatrends supporting the company's Powering a Smarter World enterprise strategy remain firmly intact, and as reliance on electricity around the world grows further, we will continue to invest in innovative products and solutions to lead the evolution to the next-generation grid. I now want to turn the call over to York to provide further details on our third quarter 2022 results, our outlook for the year and our preliminary views on 2023. York?

Thanks, Aaron. Looking at third quarter 2022 results in more detail, net sales increased 15% 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 drag 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 business, both domestically and internationally. Gross profit margin was 33.2% compared to 35.6% in the prior year third quarter as we continue to experience modest price-cost headwinds during the quarter. In addition, recent acquisitions and a less favorable sales mix, primarily driven by a lower proportion of home standby product sales, also negatively impacted margins in the current year quarter. Operating expenses increased $111 million, or 68%, as compared to the third quarter of 2021. This increase includes $55.3 million of pretax charges comprised of $17.9 million of bad debt expense related to a clean energy product customer that filed for bankruptcy and a $37.3 million charge for clean energy product warranty-related matters. The remaining increase was primarily driven by higher recurring operating expenses from recent acquisitions and an increase in intangible amortization expense. To a lesser extent, higher employee costs and higher marketing spend also contributed to the increase. Adjusted EBITDA, before deducting for noncontrolling interest as defined in our earnings release, was $184 million or 16.9% of net sales in the third quarter as compared to $209 million or 22.2% of net sales in the prior year. I will now briefly discuss financial results for our two reporting segments. Domestic segment total sales, including intersegment sales, increased 18% to $947 million in the quarter as compared to $802 million in the prior year with the impact of acquisitions contributing approximately 8% of the revenue growth for the quarter. Adjusted EBITDA for the segment was $160 million, representing a 16.9% margin as compared to $188 million in the prior year or 23.4% of net sales. The lower domestic EBITDA margin in the quarter was primarily due to continued price-cost headwinds. In addition, continued operating expense investments for future growth and the impact of acquisitions had an unfavorable effect on margins during the quarter, as operating expenses as a percentage of sales came in higher than expected on the lower shipment volumes relative to expectations. International segment total sales, including intersegment sales, increased 14% to $183 million in the quarter as compared to $160 million in the prior year quarter. Core total sales, which excludes the impact of acquisitions and currency, increased approximately 22% compared to the prior year. Adjusted EBITDA for the segment before deducting for non-controlling interests was $24 million or 13.2% of net sales as compared to $21.5 million or 13.4% of net sales in the prior year. This margin performance was impacted by a higher mix of lower-margin intersegment sales, which was mostly offset by favorable operating leverage on significantly higher volumes. Now switching back to our financial performance for the third quarter of 2022 on a consolidated basis: as disclosed in our earnings release, GAAP net income for the company in the quarter was $58 million as compared to $132 million for the third quarter of 2021. The current year net income includes the pretax charges totaling $55.3 million related to the clean energy bad debt and warranty-related matters. GAAP income taxes during the current year third quarter were $11.6 million, or an effective tax rate of 16.1% as compared to $32.6 million or an effective tax rate of 19.7% for the prior year. The reduction was due to multiple discrete tax items that drove the tax rate down versus prior year on a net basis. Diluted net income per share for the company on a GAAP basis was $0.83 in the third quarter of 2022 compared to $1.93 in the prior year. Adjusted net income for the company, as defined in our earnings release, was $112 million in the current year quarter or $1.75 per share. This compares to adjusted net income of $151 million in the prior year or $2.35 per share. Cash flow from operations was negative $56 million as compared to positive $74 million in the prior year third quarter. Free cash flow, as defined in our earnings release, was negative $73 million as compared to positive $42 million in the same quarter last year. The decline in free cash flow versus the prior year was primarily due to lower operating earnings, increased tax payments and higher working capital levels in the current year quarter, partially offset by lower capital expenditures. As of September 30, 2022, we have approximately $1.48 billion of liquidity, comprised of approximately $230 million of cash on hand and $1.25 billion of availability on our revolving credit facility. Also, total debt outstanding at the end of the quarter was $1.36 billion, resulting in a gross debt leverage ratio at the end of the third quarter of 1.6 times on an as-reported basis. Additionally, during the third quarter, we repurchased 536,006 shares of our common stock for $123.9 million, which exhausted our previously existing stock repurchase program. In July 2022, our Board of Directors approved a new stock repurchase program that allows for the repurchase of up to $500 million of our common stock over a 24-month period. With that, I will now provide further comments on our updated outlook. As previously disclosed two weeks ago within our pre-release, we updated our net sales growth and adjusted EBITDA margin guidance for the full year. In line with the pre-release, we still expect net sales in 2022 to increase between 22% to 24% as compared to the prior year on an as-reported basis, which includes an approximate 5% to 7% net impact from acquisitions and foreign currency. This revenue outlook assumes sales of residential and C&I products both increased at a similar rate in the low to mid-20% range during 2022 over the prior year. Also in line with our pre-release, adjusted EBITDA margins before deducting for noncontrolling interests are still expected to be approximately 18% to 19%. This EBITDA margin expectation reflects a modest sequential improvement in gross margins in the fourth quarter compared to the third quarter levels, with higher operating expenses as a percentage of sales partially offsetting the sequential gross margin improvement. Now I'd like to provide some further comments regarding our initial framework for net sales growth in 2023. Summarizing Aaron's earlier remarks, our preliminary view for 2023 anticipates that the first half of the year will experience year-over-year weakness on a consolidated basis. We expect to return to solid growth in the second half of the year, resulting in overall net sales to only decline modestly for the full year 2023 as compared to 2022. Again, as Aaron previously discussed, home standby generator sales growth is expected to face significant headwinds in the first half of 2023. But as field inventories normalize, we anticipate strong sequential sales growth and a much more modest decline in sales growth over the prior year in the second half of 2023. Clean energy technology is expected to experience robust sales growth for the full year as we continue to expand our presence, build out our distribution and launch new products into this market, resulting in sequentially improving results during 2023. Our preliminary view for 2023 C&I product sales growth anticipates continued strong growth throughout the year. This preliminary guidance assumes power outage activity that is in line with the long-term baseline average and does not assume a prolonged recessionary environment that meaningfully impacts consumer spending during 2023. Additionally, this is a preliminary early look into our 2023 forecast, and we will provide a more detailed update when we report fourth quarter results in mid-February of next year. Shifting back to 2022, we will now provide additional guidance details to assist with modeling adjusted earnings per share and free cash flow for the full year 2022. Our GAAP effective tax rate is now expected to be approximately 24.5% for the fourth quarter of the year, resulting in a full year 2022 GAAP effective tax rate of approximately 21.5%. For full year 2022, we now expect interest expense to be approximately $53 million to $55 million, an increase from the previous guidance of $52 million to $54 million, reflecting higher-than-previously-expected benchmark interest rates. This assumes no additional changes in outstanding debt for the remainder of the year. Depreciation expense is still expected to be approximately $54 million to $56 million in 2022. GAAP intangible amortization expense in 2022 is still expected to be approximately $100 million to $105 million. Stock compensation expense is still expected to be between $32 million and $34 million for the year. Our full year weighted average diluted share count is now expected to be approximately 64.5 million shares compared to the previous guidance of 65 million to 65.5 million shares. Our capital expenditures are now projected to be approximately 2% to 2.5% of our forecasted net sales for the year compared to prior guidance of approximately 2.5% to 3% of net sales. Free cash flow conversion is expected to be closer to 100% of adjusted net income in the fourth quarter as the investment in working capital begins to level off. Finally, this updated 2022 outlook does not reflect potential additional acquisitions or share repurchases that could drive incremental shareholder value. This concludes our prepared remarks. At this time, we'd like to open up the call for questions.

(Operator provided instructions.) And our first question comes from Michael Halloran with Baird. Your line is now open.

Hey, good morning, guys. So I just want to talk through what happened between second quarter to today. 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. Could you talk about the dynamic that got you misaligned with what was happening in the channel?

Mike, this is Aaron. That's a great question and one that obviously not only caught us by surprise, but even our channel partners. We hit our peak output levels with home standby. We've been working very hard over the last couple of years to increase production; we quadrupled our output and hit our stride as we exited the second quarter and began the third quarter. We were producing at a very high rate and thought that was important because we wanted to bring our lead times down. We knew lead times were having a negative impact on close rates and on our ability to sign new channel partners. So we opened the floodgates on shipping to get all that product out into the market. What we started to see at the end of the second quarter was that our activation rate, which is our proxy for installations, was up year-over-year but it was not increasing at the same rate commensurate with our output increase. We could see field inventory building. We had been talking to our channel partners for several quarters about this coming and were trying to get them prepared, helping them hire people, and we had programs in place to get ahead of this, but with 8,500 channel partners and many non-dealer contractors who install these products, it requires a lot of one-off conversations and coordination. We could not change that inflection point on the installation rate to the degree we thought we could. The flaw in the model was that we modeled unconstrained installation bandwidth and that did not play out. In prior cycles we had not seen installation bandwidth be a barrier, so this was new. When you are shipping at very high rates but installing at only marginally higher rates, field inventory stacks up quickly and dealers began to run out of room and credit. We saw cancellations and deferrals on orders from those home standby dealers and other channel partners during the quarter, and that accelerated through the quarter. It became clear very quickly, which is why we issued the prerelease, so investors would understand. We have redoubled our efforts to increase installation bandwidth.

That's super helpful. Relatedly, on the time it will take to sync the channel up: you're saying the underlying pieces are still healthy and you gave a lot of good metrics in the prepared remarks. How long will it take to right-size the inventory and sync installation capacity with demand?

Probably the best way to think about this is that currently field inventory levels are about double where they should be. That's the extra output we've put into the market ahead of installation capacity increasing to the right levels. We are modeling that installation capacity will increase next year, but seasonally we have a period in Q1 and Q2 where installations are lower because of cold weather in parts of the country. So even though we are targeting increases in installation capacity year-over-year, that seasonal challenge will make the early improvement slower. The good news is about half of the field inventory today is spoken for; it is allocated to a customer contract. That highlights the installation challenge because lead times have mostly returned to normal for us, yet homeowners still are being quoted longer lead times because of installer constraints, permitting constraints, or other localized delays. We think it is likely to take the first half of next year to work through much of this, and that will put pressure on incoming orders for home standby through the first half. We expect a return to growth in the second half of 2023 and only a modest decline in the full year for the category and the company overall.

So basically you are expecting relatively normal sequentials on the home standby category over the next few quarters with a potential inflection as things start catching up and normalizing a little bit?

Right. A return to normal seasonality and a return to growth in the second half. The first half is expected to be down considerably, the second half will grow, and overall for 2023 the category is expected to be down moderately, with the total company only modestly down.

(Operator provided instructions.) And our next question comes from Jeff Hammond with Key. Your line is now open.

Hey, good morning, guys. As you're thinking about the guide, I want to understand how you're thinking about comping the backlog drawdown you're seeing this year and what that implies for underlying demand for the category?

A big part of the headwind for the first half of next year is the comp because we were bringing backlog down heavily in the first two quarters of this year. We'll be comping against that without the benefit of that backlog into next year, so that is a significant headwind.

And Aaron's point about the home standby category being down moderately in the second half is because you are trying to comp some of that backlog headwind that we're bringing down here in the back half of 2022.

Okay. And what are you doing with production levels as you get this reset? How should we think about destocking of your own inventory? It looks like your inventories are elevated as well.

Yes, our inventory is elevated and you saw that in working capital in the third quarter, which drove free cash flow negative. We see that improving in Q4. We have slowed factories down; we still have some material inbound, but that's starting to slow. We should get into a better position in Q4 and then work through the first half of next year to bring down inventory levels, both raw materials and finished goods, particularly for home standby. It's a dichotomy because in our industrial business we remain constrained in certain components and inventory levels are low; we are struggling to feed those factories. But on the home standby side, slowing production has led to more material hitting our distribution centers.

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

Hi, thanks for taking the questions. Shifting to clean energy, I think the energy storage business in 2021 was around $220 million to $225 million. The guidance you are giving for $300 million to $330 million for the full year 2022 implies a decline relative to prior run rates. Is that about right and can you clarify the market situation?

Yes, the market is still growing, although there are mixed reports. The loss of a major customer that ceased operations in July significantly hurt our shipments in the second half. We need to expand our channel to more partners, which we should have been doing more of earlier, and that affects results this year. We expect to return to growth next year as we fill in with new customers and reset the business. 2022 is a reset year for our energy storage business and a painful learning lesson regarding partner selection and scaling.

Okay. And can you just clarify your commentary on 2023 one more time? You said total company would be down modestly for the full year but up sequentially first half to second half. Is home standby expected to be up year-over-year in the second half?

Yes, to clarify: total company is expected to see weakness in the first half, driven mainly by home standby. Second half we expect total company to return to solid growth, resulting in only a modest decline for the full year. Home standby specifically will be weak in the first half, then sequentially stronger in the second half and only a much more modest decline year-over-year in the second half.

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

Good morning. York, curious if you can talk about margins through the first half of next year. With lower factory absorption in home standby, a lower mix of home standby, and easing supply chain pressures, how should we think about margins going forward?

Home standby seasonality means Q1 is usually the lowest point in the curve once you catch backlog, and gross margin should decline sequentially from Q4 2022 to Q1 2023 mainly because of mix. Recall we faced heavy inflationary pressures in Q1 2022, so from a price-cost standpoint we should see some benefit. We're still finalizing models, but sequentially, given mix changes into the first half, you might see a slight decline in gross margins relative to the current run rate.

And on Clean Power, is most of the reduction due to needing to backfill the bankrupt customer, or is there a broader product reconfiguration issue?

The majority of the reduction is related to the loss of that customer. It's an important customer for us and diversifying our customer base will be a primary focus. There is some spillover effect to market perception, but this is a relatively new market with long warranty periods and challenging rooftop environments. Many OEMs have faced similar challenges. We remain committed to this market, believe it's strategically important, and are investing in people and processes. We will need to invest more than initially anticipated to scale; we have started adding talent and will continue to do so. We expect to be a major player long term.

Our next question comes from Joseph Osha with Guggenheim Partners. Your line is open.

Thanks. For the clean energy business, can you give a sense of the rough breakdown of that business looking into next year, and now that you've got the AC-coupled capability, might you pivot to selling AC-coupled storage alongside other inverters?

On ecobee, it's a very well-run company. They struggled earlier in the year with component availability, but have picked up and are looking at a strong fourth quarter, potentially their highest quarter ever. Smart thermostats are a compelling product with strong paybacks and represent an important part of our single pane of glass strategy for home energy systems. We won't break down the pieces every quarter, but ecobee's run rate when we announced it was about $125 million and they have grown since then. Regarding AC coupling, the PWRcell update enables AC-coupled battery storage and integration with third-party inverters; that is a focal area, and we expect our commercial teams to pursue that opportunity.

They have grown nicely this year.

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

Good morning. Aaron, could you talk about production rates for the standby business in the fourth quarter? Are you at a normalized run rate where that business can be up sequentially in the fourth quarter based on the visibility you have today?

We will not be running production up in the fourth quarter; we are bringing production down because of the field inventory issue and we have plenty of inventory. That is built into our guidance. Installation capacity normally peaks in the fourth quarter seasonally and we continue to see dealer additions—300 new dealers in the quarter—which will help. We need to hit peak installation rates by the end of the year, and that cadence is contemplated in our guidance.

Earlier you mentioned production would be down as normal seasonality in the first quarter as well. After every major outage event there's a higher baseline, but that baseline is down from the peak. Are you going to be running at that baseline based on current order rates or is there a risk of an additional step down?

We believe the order rate we are seeing today and will continue to see through the end of the year and into the first half of next year is artificially low as dealers right-size field inventory. Field inventory is about double where it should be, but half of that is already sold and just needs to be installed. Hurricane Ian could accelerate drawdown of field inventory in affected regions. We also have backlog in the fourth quarter that we are satisfying.

Remember, we have some backlog in the fourth quarter that we are satisfying as well.

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

Thanks for taking the questions. Can you give any guidance on gross margins for home standby projects in Q4 and the first half? And op-ex trends in Q4 and the first half given channel inventory and consolidation efforts?

OpEx may tweak up a little in the fourth quarter as a percentage of sales relative to Q3. There is seasonality on some spend in Q4 and some accrual reversals in Q3 that won't repeat, so we are modeling a modest sequential increase in OpEx both in dollars and as a percentage of sales. For 2023 we are still working on gross margin and OpEx frameworks and will hold off on margin discussions for next year until next quarter.

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

Good morning. C&I and other segments were strong. Can you dig into the detail on the strength in both segments in Q3 and the indicators you see that give you confidence that this continues into 2023?

The C&I business has been strong for several quarters and we are taking share in the market. Industrial distribution was up across the board. Telecom was up as customers invest in hardening and 5G build-outs. Mobile business was up with national rental accounts refleeing and expanding their fleets. International, which is mostly C&I, was also up. An area seeing outsized growth is beyond-standby applications—natural gas generators used not only for emergency backup but also to support the grid during stress events, microgrids and energy-as-a-service programs, often connected to our Concerto platform. That market is still small but growing quickly and the pipeline looks strong, enough that we are planning capacity additions in our C&I factories. The opportunity is driven by compressed reserve margins in certain markets and the need for flexible generation to support grid reliability amid decarbonization and electrification trends. Book-to-bill remains strong and customer feedback, public statements from our customers on CapEx, and the strength of our pipeline make us confident in continued C&I growth into 2023.

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

Our next question comes from Praneeth Satish with Wells Fargo. Your line is now open.

Good morning. Focusing on the second half of 2023: you mentioned home standby could be down, but I would have thought that by then field inventory and installation issues would be normalized. What is driving the view for home standby in the second half, and is there a scenario where it could be up?

There is some backlog we are satisfying in the second half of 2022 that won't repeat in 2023, which creates a year-over-year comparison headwind for the second half. That is part of what is driving the outlook. Sequentially you will see improvement from first half to second half. If outages occur, that would be upside to our view.

We did have outages this year. If major outage events occur next year, that would be upside. The baseline situation and the backlog drawdown are the factors in our current view.

On PWRcell, you mentioned a component needed upgrade and you enlisted third-party installers. What is the component and has it been fixed in new production?

The upgrade path is for a rooftop-mounted shutoff device. The previous generation had a higher failure rate than we want, so we are proactively replacing those devices for customers to avoid interruptions. We have a clear upgrade path and have brought in third-party service companies to accelerate completion. That upgrade effort is included in the warranty reserve charge we recorded this quarter.

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

Hi, thanks. On the home standby side, is the lower order activity concentrated among big-box retailers like Home Depot and Lowe's, regional installers, or the longer tail of smaller installers? The smaller installers might be more limited on warehouse space or credit, so is it disproportionate in any one area?

Not dramatically. The channel mix hasn't changed materially. We have stocking channels like retailers and wholesalers that traditionally stock product for non-dealer contractors or homeowners, whereas our dealers typically buy when they have a signed contract. The pattern we are seeing fits historical channel mix.

And on Europe, there are many puts and takes: energy crisis and security concerns are tailwinds, but there could be resistance to natural gas infrastructure. What are you seeing in Europe specifically?

Europe has historically been a mostly diesel C&I generator market. We are seeing growth in natural gas gens in Europe and India off a small base. On the edges you will see some limits on gas connections in certain municipalities, but natural gas remains an important fuel for heating and cooking and it burns cleaner than other fossil fuels. Propane remains an option where pipeline gas is limited. We believe there will still be growth in C&I and home standby outside North America and natural gas and propane gens will be part of that growth.

Our final question comes from Saree Boroditsky with Jefferies. Your line is now open.

Thanks for fitting me in. Going back to home standby: you talked about only a modest decline in the second half of the year. Could you help frame the magnitude of the decline in the first half of next year?

We did not provide a detailed numerical split for the first half. We gave the framework that total company returns to solid growth in the second half resulting in only a modest decline for the full year. C&I is expected to continue strong in the first half and clean energy should sequentially improve throughout the year, which gives you a way to frame the pieces together.

It seems sales grew faster at home standby than anticipated when you gave your 2024 guidance. Can you provide an estimate of penetration rate at the end of this year and thoughts on where it could go from there?

We anticipate ending the year around a 6% penetration rate. Growth in this category does not happen in a straight line; it happens in step functions with periods of rapid penetration after major outage events, followed by normalization to a new baseline. We will review long-term targets, but are not updating them this morning. We plan to hold an Investor Day next year to update long-range guidance.

(Operator provided instructions.) 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 results in mid-February. Thank you again and goodbye.

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