Earnings Call Transcript
GENERAC HOLDINGS INC. (GNRC)
Earnings Call Transcript - GNRC Q1 2024
Operator, Operator
Thank you for joining us, and welcome to the Generac Holdings First Quarter 2024 Earnings Call. Please note that today's program is being recorded.
Kris Rosemann, Senior Manager, Corporate Development and Investor Relations
Good morning, and welcome to our first quarter 2024 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.
Aaron P. Jagdfeld, President and CEO
Thanks, Kris. Good morning, everyone, and thank you for joining us today. Our first quarter results were ahead of our prior expectations due to higher-than-expected C&I shipments, favorable input costs, and strong operational execution. We are reiterating our overall 2024 outlook this morning for net sales, adjusted EBITDA margin, and free cash flow conversion, which York will discuss more in detail later in the call. Year-over-year, overall net sales increased slightly to $889 million. Residential product sales increased 2% as compared to the prior year quarter as strong growth in home standby generator shipments was partially offset by a decline in certain other residential product sales. Global C&I product sales decreased 2% from a strong prior year period as a robust increase in shipments to our industrial distributor customers mostly offset weakness in the domestic rental and telecom markets. Significant year-over-year margin expansion and disciplined working capital management helped drive a substantial improvement in free cash flow generation from the prior year, while we continue to invest in our strategic initiatives. Home standby shipments were in line with our prior expectations during the quarter, increasing at a mid-teens rate from the softer prior year period that included a meaningful headwind from excess field inventory levels. As expected, shipments and activations were aligned exiting the first quarter, signaling that field inventory levels are reaching more normalized levels. The removal of the excess field inventory headwind is expected to support strong year-over-year growth in home standby generator sales in the coming quarters. Power outage activity in the U.S. during the first quarter was approximately in line with the longer-term baseline average as higher outages in January were offset by lower outage activity in the months of February and March. Activations, which are a proxy for installs, declined modestly from the prior year period, reflecting the softer outage environment over the last several quarters and resulting weaker home consultation performance, specifically in the fourth quarter of 2023. Home consultations did increase sequentially during the first quarter but declined on a year-over-year basis from a very strong prior year period. For historical perspective, home consultations in the first quarter were modestly higher than the first quarter of 2022 but were more than 3.5 times higher than the first quarter of 2019. Additionally, we experienced moderate sequential improvement in close rates during the first quarter as we continue to execute initiatives that we believe will drive further increases beyond this year, including data-driven lead optimization practices, sales tool enhancements, and improved lead nurturing practices. We are also making ongoing investments in engaging with our end customers and bringing awareness of the category to new and broader demographic categories to expand the overall sales funnel for home standby generators. We ended the first quarter with our residential dealer count at approximately 8,800, a net increase of 100 dealers during the period. We have also been experiencing good traction with nondealer contractors as we have seen steady increases in the number of installers in our Aligned Contractor Program, an effort that helps us better strengthen these relationships and improve our installation bandwidth while allowing contractors to purchase products through their preferred channel. We will continue to invest in growing our network of installers including both dealers and nondealer installers as well as in the tools and teams to support and optimize these distribution partners, which we view as a key competitive advantage for our business. Our teams have also continued to make incremental operational improvements within our home standby production facilities. These improvements contributed to the margin expansion that we experienced in recent quarters, and this momentum bodes well for future growth and profitability. We believe we are emerging from the recent field inventory challenges with a continued focus on quality and execution as well as an improved competitive position. We will continue to leverage our unparalleled scale and strength in manufacturing, sourcing, marketing, distribution, and our strong financial profile to drive growth in the home standby market in the years ahead as we grow the number of consumers engaging in the category, expand our industry-leading omnichannel distribution network, invest in customized sales processes and tools to drive close rates higher and expand the broadest product portfolio in the market. While home standby shipments were in line with our prior expectations during the first quarter, however, our overall residential product sales were lower than expected due to continued softness in global portable generator shipments as well as weaker domestic energy storage in EV markets and continued post-pandemic-related challenges with the market for chore products. We expect these specific softer end market conditions to impact our overall residential product category, sales growth for the full year 2024, but our expectations for home standby generator shipments are unchanged relative to our prior guidance. Now moving to our Residential Energy Technology Products and Solutions, our Ecobee team continued to drive year-over-year sales growth in the first quarter despite a challenging retail environment as performance with professional contractors remained strong. Ecobee's number of connected homes and services attached rate also experienced positive momentum during the quarter. Importantly, Ecobee's gross margin improved meaningfully on a year-over-year basis, primarily due to cost reduction initiatives and improvement in electronic component supply chains relative to the first quarter of 2023. Within our residential clean energy product suite, we continue to make progress on key product development objectives. And additionally, fleet health of our installed base has materially improved after substantially completing our warranty upgrade program in 2023 and with a continued laser focus on improving the quality of these products and solutions. We are also moving forward in our partnerships with the Department of Energy as we work to bring clean power generation and resiliency to Puerto Rico via our residential energy storage systems and through our participation in the grid resilience and innovation partnership program in Massachusetts, which demonstrates our ability to integrate multiple technologies to support our homes energy needs while also providing additional value for grid operators. Finally, we remain excited about our collaboration with Wallbox as we will begin shipments of the company's best-in-class EV charging solutions during the second quarter. We continue to expect that the investments we're making to develop residential energy technology solutions will generate attractive returns in the years to come. Our teams are focused on deep integration of the products and platforms we have acquired while tightening our focus on building high-quality solutions where we believe we can create the most value for the consumer. With improved focus and execution and by leveraging our core competencies around sales and marketing, lead generation, distribution, customer support, and global sourcing, we believe we can create competitive advantages that will become evident over time as we continue to develop the smart energy home of the future. Switching gears, I now want to provide some commentary on our C&I products. Global C&I product sales declined 2% from the prior year, which was ahead of our prior expectations, driven by a decrease in sales to domestic telecom and rental customers, partially offset by continued growth in our North American industrial distributor channel and certain industrial and international markets. As a result of the strong first quarter outperformance, our expectations for full year 2024 C&I product sales are now higher. Shipments of C&I generators to our North American distributor channel again grew significantly in the first quarter. Quoting activity remained resilient in the quarter, and we continue to drive market share gains within our core product lineup. In addition, our operational execution helped to reduce lead times during the quarter. As expected, shipments to national telecom and rental customers declined in the quarter from the strong prior year period. Consistent with our prior expectations, we believe these end markets will remain soft in the coming quarters. However, despite the cyclical weakness in the rental channel, we continue to believe this end market has substantial runway for future growth given the critical need for future infrastructure projects that leverage our products. Additionally, leveraging our 40 years of experience serving the telecom market, we are confident in our ability to capture the future growth potential around the secular trend of increasing global tower and network hub counts and the increasingly critical nature of wireless communications and services that require significantly greater power reliability. Shipments of natural gas generators used in applications beyond traditional standby projects declined moderately during the quarter, as the higher interest rate environment impacted project ROIs and timelines. Longer term, we view these applications as an important opportunity for Generac, our end customers, and grid operators as reliability concerns, energy prices, and market volatility all trend higher. Additionally, we will continue to build a pipeline of multi-asset projects that utilize both our natural gas generators and our recently introduced C&I energy storage systems. While we are in the early innings of the growth opportunity, we intend to leverage our leading position in natural gas generators to drive market share gains in behind-the-meter energy storage in the coming years as our C&I customers seek to utilize energy storage for short duration outages, variable rate arbitrage, and grid service opportunities, while also leveraging our traditional generator offerings for a complete resiliency solution. We believe we are uniquely positioned to bring these solutions to market and continue to invest in the teams, technology, and processes necessary to deliver comprehensive solutions for the C&I market focused on energy resilience and efficiency. Internationally, total sales were lower year-over-year primarily related to declines in intercompany shipments from our Mexican operations to the telecom market in the U.S. as well as lower shipments in certain European markets, most notably for portable generators as energy security concerns eased relative to the first quarter of 2023. Strong growth in shipments to Latin American end markets partially offset this softness. Internationally, International adjusted EBITDA margins held at 15%, consistent with the prior year period as disciplined price-cost actions were offset by lower operating leverage on decreased shipment volumes. In closing this morning, we are encouraged by the ongoing improvement in operational execution reflected in our first quarter results as strong year-over-year performance in home standby generators and increased shipments of C&I products to our industrial distributor customers offset end market softness in other areas of our business. The return to our historically robust gross margin and cash flow generation profile allows for additional capital allocation optionality and further strengthens our confidence in executing our powering a Smarter World Enterprise Strategy. Additionally, the recent acceleration in data center construction activity, driven in large part by the emergence of artificial intelligence, has further increased the growing pressure on electricity supply/demand imbalances and underscores the relevance of the mega trends that underpin our enterprise strategy. Data centers will not only directly increase industry-wide demand for backup power, but have also served to raise public awareness of the looming electrical grid supply constraints. Accelerating demand for artificial intelligence and the deployment of energy-intensive data centers join the growing trends of electrification and the reindustrialization of North America, which is driving power consumption forecasts meaningfully higher than previously forecasted. At the same time, grid operators continue to add intermittent power generation sources and retire baseload thermal generation while also facing extensive siting and permitting challenges as well as critical equipment shortages. After multiple decades of very little electrical growth in electrical demand, the aging power grid in the U.S. is clearly not prepared for the future trajectory of power consumption needed to satisfy these converging trends. And this is even before considering the long-term trend of increasingly frequent severe weather events that are creating additional stress on the nation's electrical grid. Generac's backup power portfolio, in particular, is well positioned to provide home and business owners with the continuity and resilience they demand in an increasingly electrified world. In addition, our next-generation energy technology solutions across both residential and C&I product categories will further expand on our resiliency value proposition by helping optimize for efficiency, consumption, comfort, and cost. We believe our broad offering of products and solutions are uniquely capable in helping home and business owners solve the challenges resulting from this accelerating energy transition. I'll now turn the call over to York to provide further details on our first quarter results and our updated outlook for 2024.
York Ragen, CFO
Thanks, Aaron. Let's dive into the first quarter 2024 results. Net sales rose to $889 million in the first quarter of 2024 compared to $888 million in the same quarter last year. Contributions from acquisitions and favorable foreign currency effects added approximately 1% to revenue growth. Looking at consolidated net sales by product class for the first quarter, residential product sales increased 2% to $429 million from $419 million a year prior, largely driven by a significant rise in shipments of home standby generators, although this was partially balanced by a considerable drop in portable generator shipments in the U.S. and Europe due to strong comparisons from the previous year, ongoing weakness in the domestic solar and storage market, and reduced chore product sales. Commercial and Industrial product sales for the first quarter of 2024 fell 2% to $354 million from $363 million a year earlier, with foreign currency and acquisitions contributing about 2% growth for the quarter. The core sales decline was primarily due to expected weakness in sales to domestic telecom and national equipment rental customers, although this was largely offset by strong increases in C&I product shipments through domestic industrial distributors and growth in certain international markets like Latin America. Net sales from other products and services increased slightly to $106 million, aided by about 1% from favorable foreign currency. The gross profit margin climbed to 35.6%, up from 30.7% in the same quarter last year, attributed to a favorable sales mix with stronger home standby shipments, improved production efficiencies, lower input costs, and higher pricing relative to the previous year. First quarter gross margins surpassed our expectations due to better-than-anticipated input costs and strong operational performance. Operating expenses increased by $21 million, or 9%, compared to the first quarter of 2023, mainly due to ongoing investments in our teams to foster future growth and higher marketing spending to elevate product awareness. Specifically, research and development expenses grew at nearly double the rate of overall operating expenses, emphasizing our transition to an energy technology solutions provider. Operating expenses were in line with our previous expectations as we enact strategic initiatives aimed at long-term growth. Consequently, adjusted EBITDA before accounting for noncontrolling interest, as outlined in our earnings release, reached $127 million or 14.3% of net sales in the first quarter, up from $100 million or 11.3% of net sales the previous year. Now, I will provide a brief overview of financial results for our two reporting segments. Domestic segment total sales, including intersegment sales, rose slightly to $720 million this quarter. Adjusted EBITDA for this segment was $99 million, which is a 13.8% margin compared to $68 million or 9.4% of total sales in the previous year. International segment total sales, including intersegment sales, fell 14% to $187 million compared to $216 million the year prior. Foreign currency and acquisitions contributed about 4% sales growth for the quarter. The approximately 18% core total sales decline for this segment stemmed from decreased intercompany shipments from our Mexican operations to the domestic telecom market along with lower shipments in specific European markets, particularly for portable generators. Adjusted EBITDA for this segment, before accounting for noncontrolling interest, stood at $28 million or 15% of total sales, in comparison to $32 million or 15% of total sales in the previous year. Now, switching back to our consolidated financial performance for the first quarter of 2024, as detailed in our earnings release, the GAAP net income for the company was $26 million compared to $12 million for the first quarter of 2023. The current period includes a $6 million noncash expense reflecting changes in the fair value of our warrants and equity securities in Wallbox, a minority investment made in Q4 of 2023. GAAP income taxes for the current year first quarter totaled $12 million, translating to an effective tax rate of 31.2%, compared to $8 million or 35.7% in the prior year. The decrease in effective tax rate was mainly due to higher pretax book income which reduced the impact of certain discrete tax items this year. Diluted net income per share on a GAAP basis was $0.39 in the first quarter of 2024 compared to $0.05 the previous year. The current period included a $2.7 million redemption value adjustment affecting our earnings per share, while the prior year had a $9 million adjustment. Adjusted net income for this quarter was $53 million or $0.88 per share, compared to $39 million or $0.63 per share in the previous year. Cash flow from operations for the first quarter was a positive $112 million compared to negative $19 million the year prior. Free cash flow was positive $85 million, up from negative $42 million in the same quarter last year, driven primarily by higher operating earnings, a reduction in primary working capital this year, and a significant one-time cash tax payment last year that did not recur. Total debt at the end of the quarter was $1.56 billion, resulting in a gross debt leverage ratio of 2.35 times, down from 2.5 times at the end of 2023. Now, I will share our updated outlook for 2024. As stated in our press release this morning, we are maintaining our overall outlook for net sales and adjusted EBITDA margin for the full year 2024. We still anticipate year-over-year growth of approximately 3% to 7% for top-line sales, with a slight positive impact from acquisitions and foreign currency. However, we now expect a slightly lower mix of residential products and a slightly higher mix of C&I products than previously anticipated. Our outlook for home standby generator shipments for the year remains unchanged. We expect a considerable year-over-year increase in home standby generator shipments as field inventory normalizes and shipments align with market demand. However, other residential products are experiencing softer end market conditions than we had originally forecasted. Lower expectations for global portable generator shipments, ongoing weakness in the domestic energy storage and EV markets, and decreased chore product sales now suggest residential product sales will grow at a low double-digit rate rather than the mid-teens previously expected. On the other hand, we anticipate C&I product sales to exceed previous expectations, leading to a mid- to high single-digit decline versus the prior year, an improvement from an earlier forecast of about a 10% decline. This positive revision is primarily due to stronger-than-expected shipments to domestic industrial distributors in the first quarter. For the second quarter specifically, we expect net sales to remain nearly flat compared to the same period last year, with growth rates expected to pick up in the second half of the year. Importantly, this guidance assumes a level of power outage activity for the remainder of the year consistent with the longer-term baseline average and does not factor in the potential for a major power outage event, which could boost shipments by $50 million to $100 million for the year. Our gross margin expectations for the full year 2024 have also increased slightly due to the strong performance in the first quarter. We now project gross margins to improve by approximately 300 to 350 basis points compared to the full year of 2023, up from the previously expected 300 basis point improvement. Gross margins are anticipated to rise sequentially throughout the year, with second half 2024 gross margins estimated to grow by about 200 basis points over the first half 2024 margins, driven by favorable mix, pricing, and cost developments. Adjusted EBITDA margins before accounting for noncontrolling interests are expected to remain around 16.5% to 17.5% for the full year. This guidance takes into account that better-than-expected gross margins will largely be counterbalanced by modestly higher-than-expected operating expenses to support enterprise-wide strategic initiatives. As a result, we now anticipate that adjusted EBITDA margins in the second half will be about 450 basis points higher than those in the first half, due to the combination of gross margin growth and operational leverage from increased sales volumes. This contrasts with the prior expectation of nearly 600 basis points of EBITDA margin improvement moving from the first half to the second half. As part of our usual practice, we will also provide updated guidance details to aid in estimating adjusted earnings per share and free cash flow for the full year 2024. For the year, our GAAP effective tax rate is still projected to be around 25% to 26%, in comparison to a 25.2% GAAP tax rate for the entirety of 2023. This suggests an effective tax rate of about 25% in each of the remaining quarters of the year. Importantly, when estimating adjusted net income and adjusted earnings per share, add-back items should be calculated net of tax using our anticipated effective tax rate. Interest expense is expected to range from $90 million to $93 million, up from previous guidance of approximately $85 million to $90 million, due to rising interest rate expectations for the remainder of the year, assuming no additional prepayments on our term loan or revolver principal. Our capital expenditures are still forecasted to be about 3% of our anticipated net sales for the year. Our overall cash flow generation forecast remains unchanged. We still anticipate cash flow from operations and free cash flow to follow the typical seasonal trend of being heavily weighted towards the second half of 2024. For the year, we expect strong conversion of adjusted net income to free cash flow at around 100%, as we continue to capitalize on working capital built in past years. Expectations for depreciation expense, GAAP intangible amortization, stock compensation expense, and diluted share count are consistent with last quarter's guidance. Finally, this 2024 outlook does not consider the possibility of additional acquisitions or share repurchases that could add further value for shareholders. This concludes our prepared remarks. We would now like to open the call for questions.
Operator, Operator
Our first question comes from Tommy Moll from Stephens Inc.
Thomas Moll, Analyst
Aaron, starting off on home standby, wanted to see if you could reconcile for us. I think I heard you say shipments are up mid-teens year-over-year, activations are down year-over-year. Can you just help us understand the two of those in context?
Aaron P. Jagdfeld, President and CEO
It's a great question, Tommy. Activations have been a bit slower this year compared to previous years. The recent outage environment has been weaker than the trend we've observed over the last couple of years. In Q1, we were actually in line with the long-term average for outages since we've been monitoring them. However, when looking at trends, it was a relatively quiet quarter. After January, things really slowed down in February and March. Additionally, Q4, as we mentioned earlier, was a particularly light quarter compared to historical trends.
York Ragen, CFO
And Q1 over the last year...
Aaron P. Jagdfeld, President and CEO
Yes, Q1 last year was really strong, making it a tough comparison. Activations were a bit down, but shipments are up because the field inventory challenges have mostly disappeared. We ended the quarter, and in February and March, activations and shipments were aligned, which is a positive sign indicating that field inventories are normalizing. This improvement helps us in comparing shipments more favorably, even though activations have been somewhat lower due to recent outage periods.
York Ragen, CFO
The field inventory drag was a bigger drag last year than it was this year's...
Aaron P. Jagdfeld, President and CEO
Exactly.
Operator, Operator
And our next question comes from the line of George Gianarikas from Canaccord Genuity.
George Gianarikas, Analyst
I was wondering, you talked about the tangential impacts of the surge in data center power demand. I was wondering if you could discuss maybe a little bit more in detail your strategy there? And any incremental you've seen direct demand directly from the needs of AI data centers?
Aaron P. Jagdfeld, President and CEO
Thank you, George. Our product range generally falls below the level of products being used specifically for backup in the data center market. This market requires significant power supply and is largely dominated by large diesel engine manufacturers that provide directly to major data centers. Our offerings do not include products like that, nor do we plan to develop an engine lineup for such applications, which are typically used in tugboats, mine haul trucks, and trains, making them quite different from power generation. However, we do cater to some edge data centers where power backup needs are relatively smaller. We have also encountered opportunities related to natural gas backup solutions. Currently, the backup generator market for data centers is predominantly diesel, driven by major diesel engine companies. We are seeing challenges with siting and permitting related to high concentrations of diesel engines in certain locations, such as Virginia, where obtaining permits for substantial numbers of diesel engines has proven difficult. As a result, some data center EPCs and owners have started considering natural gas as an alternative. While natural gas has a lower energy density than diesel, it does offer a cleaner emissions profile, presenting a potential opportunity for us. We are actively growing our natural gas generator line to increase total output. However, we anticipate that possibilities will primarily arise in smaller edge data centers. In a broader sense, the significant growth in the number of data centers expected between now and 2030 is noteworthy. The power demand from these new data centers could triple from current levels, equivalent to adding 40 million households to the grid. This demand increase poses challenges for grid operators and utilities, as the process for citing and permitting new plants is complex and time-consuming. Adding new generating capacity is also likely to focus on intermittent sources like solar or wind, which complicates steady 24/7 operation. Utilities will need strategies for energy storage or alternative solutions to manage demand during peak times, which can be costly and will likely affect ratepayers. Interest among grid operators and utilities in these programs has been growing, but the processes to implement them can be complicated and time-consuming. Meanwhile, data centers and their operators cannot afford to delay; the rapid developments in AI create significant urgency. Overall, I foresee a structural challenge that could lead to a decline in power quality in the future. We are on the brink of significant power quality challenges and shortages over the next 5 to 10 years. This situation will not only arise from weather-related outages but also from a supply-demand imbalance. On the supply side, we are transitioning from traditional 24/7 thermal assets like coal and gas to intermittent sources like wind and solar. Simultaneously, on the demand side, we are electrifying more aspects of life and adding considerable load from data centers. This mix creates a concerning outlook for power quality in the coming years.
Operator, Operator
And our next question comes from the line of Mike Halloran from Baird.
Michael Halloran, Analyst
So just digging a little deeper on the C&I side of things. It sounds like a pretty similar outlook for the rental and telecom channels. Maybe talk to two things here. One, how you're thinking about the seasonality for the businesses in the areas where the outlook has improved. And then also the confidence in the sustainability of the run rate. And so more of the distribution side, some of the other areas? And any kind of evidence you would point to for the sustainability piece and why you think that might have some nice legs here relative to what you were thinking a couple of months back?
Aaron P. Jagdfeld, President and CEO
Yes, thanks, Mike. Our commercial and industrial business continues to perform well, despite the ongoing cyclical slowdown in the rental and telecom markets. The guidance for these sectors remains largely the same for the year. The significant change has been in our industrial distribution channel, which supports a variety of businesses and infrastructures like wastewater treatment facilities, school districts, healthcare, manufacturing plants, and even data centers. This channel has been a growing focus for us for nearly a decade, with substantial investments and strategic acquisitions aimed at increasing our market presence across the U.S. Our approach has proven effective, allowing us to capture market share. The industrial distribution channel has shown resilience, indicating a broader trend in power quality discussions. The ongoing supply-demand imbalance and challenges with reliable supply, along with increased electrification in businesses, highlight the critical need for continuous power. Today, nearly every business considers uninterrupted power essential, as outages can lead to inventory loss and revenue interruptions. These outages have been on the rise, further driving the demand for backup power solutions in the commercial and industrial market. We are encouraged by the resilience in this channel, which is helping to offset the anticipated weakness in rental and telecom. Overall, the trends we see in the industrial distribution channel remain strong.
York Ragen, CFO
Quoting is hanging in there...
Aaron P. Jagdfeld, President and CEO
Quoting is hanging in there. The quote-to-sale conversion process has continued to hang in there. And we continue to invest in it. And I think all of those things when you line them up are really what are helping us offset the broader weakness in those other markets.
Operator, Operator
And our next question comes from the line of Jeff Hammond from KeyBanc Capital Markets.
Jeffrey Hammond, Analyst
So just back on residential one, maybe just speak to destocking and whether you think it's done, if not how much left? And then it just seems like IHC activation trends were kind of still pretty weak. And so just want to come back to like, I know it was kind of in line in the quarter, but what gives you confidence, an unchanged view and kind of the ramp into the second half outside of just seasonality?
Aaron P. Jagdfeld, President and CEO
Yes, thank you, Jeff. From a destocking perspective, we concluded the quarter with activations and shipments during February and March aligning closely. Based on all the data we have and the prolonged period of destocking that started in the third quarter of 2022, we believe we are finally past that phase, which aligns with our previous expectations. This has contributed to the mid-teens year-over-year increases in home standby shipments, as we no longer face the field inventory headwind now that it has mostly dissipated. Regarding the recent weaker trends, activations in IHCs were slightly below our expectations, but not significantly off pace. Overall, we feel optimistic about the seasonally important January, which was strong with outages, whereas February and March were quite subdued. April, however, saw a strong recovery. As we enter the seasonal period for these products, we are observing the anticipated upticks in key metrics we monitor, both leading and lagging. We remain confident in our guidance for the year. Additionally, we want to reiterate that this category tends to be less impacted by interest rate fluctuations compared to other consumer discretionary categories. Power outages provoke a different response as they are often emotionally charged events. The typical demographic for these products skews older; they are mainly older American homeowners who are less influenced by interest rate shifts. While we may see demand decreases at the margins, particularly in the latter half of last year as interest rates have been elevated for some time, we believe the impact has largely been accounted for. Looking ahead to the rest of the year, I would also like to mention the recent forecast from Colorado State University indicating an unusually active hurricane season.
York Ragen, CFO
Ever.
Aaron P. Jagdfeld, President and CEO
So I mean we don't...
York Ragen, CFO
Preseason forecast.
Aaron P. Jagdfeld, President and CEO
Personally, I don't place much trust in those forecasts because I struggle to understand how one can predict the weather for September when they can't even accurately forecast next Saturday's weather. However, we are focusing on long-term trends such as air and water temperatures and the easing of El Nino events. These factors are significant considerations for forecasters as they analyze the broader cycles related to hurricanes.
York Ragen, CFO
But our guidance assumes baseline outage activity, doesn't assume any majors.
Aaron P. Jagdfeld, President and CEO
Yes.
York Ragen, CFO
And I think it's important also to mention like the category is seasonal. So second half is always stronger than the first half.
Aaron P. Jagdfeld, President and CEO
Definitely.
York Ragen, CFO
If you assume a baseline level of outage activity, you would anticipate a good sequential increase in the home standby business from the first half to the second half to support our guidance.
Operator, Operator
And our next question comes from the line of Brian Drab from William Blair.
Brian Drab, Analyst
I was wondering if we could just focus in on energy technology for a minute. And I'm looking at the slide from the investor event last year and about 40% of the incremental revenue between 2023 and 2026 and the bridge here is from incremental revenue from energy technology, and C&I, and residential. Can you just give us an update on how you feel about capturing that $700 million incremental revenue? And what's the updated outlook, C&I and resi?
Aaron P. Jagdfeld, President and CEO
Thank you, Brian. We provided our guidance points last fall, and at this time, we are not prepared to update our expectations for the next couple of years. However, I can discuss our outlook for Energy Tech. Currently, the market for solar plus storage, EV charging, and related products is experiencing some weakness. Recent market dynamics have shifted negatively due to the pull ahead from NEM 3.0 in California and higher interest rates, which are impacting demand for these products. On a positive note, we are actively marketing our new products and are on track with our launch plans for later this year. We remain optimistic that as we move into 2025, interest rates are unlikely to stay high indefinitely. Additionally, the market appears to be easing some of the inventory challenges faced by original equipment manufacturers in recent quarters. This change may align perfectly with our market entry, allowing us to achieve better success. However, in the near term, we anticipate being slightly on the lower end of our range this year. This impact is relatively minor for us as it pertains to the residential sector where we are seeing some softness, particularly in solar plus storage and EV charging. Over the next two to three years, we do not expect significant changes, and we believe the market will recover by the time we are equipped to engage more robustly.
Operator, Operator
And our next question comes from the line of Jerry Revich from Goldman Sachs.
Jerry Revich, Analyst
Aaron, can you just expand on your comments around gross margins in the quarter? We were pleasantly surprised. It sounds like the cost came in better than you expected as well. So what's the magnitude of improvement that you're seeing from supply chain normalization and going back to normal efficiency levels, freight normalization? And to what extent can that continue? Can you flesh out that part of the gross margin performance in the quarter and opportunity from it?
York Ragen, CFO
Yes, we were very pleased with the gross margin performance, which exceeded expectations with over a 1% increase. We had anticipated that input costs would improve throughout 2024, and we were able to see that improvement materialize sooner than expected in Q1. This early realization in Q1 helps to mitigate the risks associated with our projections for the second half of the year, specifically regarding the anticipated gross margin improvement from the first half to the second half. Overall, this is what contributed to our better-than-expected gross margin results.
Operator, Operator
And our next question comes from the line of Stephen Gengaro from Stifel.
Stephen Gengaro, Analyst
So my question, I guess, it's two parts. And one is, has there been any change to the competitive landscape given that I think your biggest competitor has kind of been taken private? And then maybe if you can kind of blend into that answer, just sort of the margin mix question. I imagined the strength in home standby relative to other residential products is a margin positive for the balance of this year? And any way to sort of quantify or think about that?
Aaron P. Jagdfeld, President and CEO
Yes. I mean, definitely, that is the case, right? I mean the margin profile of the standby products for residential is greater than every product we offer here in the company, frankly. So it's a very strong margin product for us. And so the margin mix to that point would be favorable. I mean gross margins were up 5% year-over-year in Q1. I'd say half of that was a better mix as home standby grew mid-teens.
York Ragen, CFO
I mean gross margins were up 5% year-over-year in Q1. I'd say half of that was a better mix as home standby grew mid-teens.
Aaron P. Jagdfeld, President and CEO
So that's played out. In terms of the competitive landscape, there have been a couple of developments. One of our competitors is in the process of being taken private through private equity, while we are already a private company. We have not received confirmation that the transaction has closed yet, but it will be interesting to see how it unfolds. Going private like that can present challenges, especially with a significant debt load. We experienced this transition ourselves back in 2006, and operating with high leverage and a large amount of debt is different. For someone stepping into that situation, it requires an adjustment period, especially given the complexity of carving out a long-established company. I don't anticipate this will significantly impact the competitive landscape. That company competes strongly with us on the commercial and industrial side of the business, and they have a solid presence there, though they are smaller on the residential side. They may find opportunities, but we have successfully leveraged our scale to maintain our position. As we mentioned in our prepared remarks, we believe we have actually improved our market share over the past several quarters.
Operator, Operator
And our next question comes from the line of Donovan Schafer from Northland Capital Markets.
Donovan Schafer, Analyst
I want to explore the industrial distributor channel a bit more because it showed positive development this quarter, balancing out some of the other commercial and industrial subsectors. Aaron, you've mentioned that this is an area you've been developing for nearly a decade, but it hasn't received much attention regarding the mechanics and background. I would like to understand its significance better. Can you provide a general sense of what portion of C&I revenue it constitutes? Additionally, how much of that revenue comes from distributors that you own? Also, does this situation allow for shipments to distributors without a direct end user, potentially leading to a buildup in the channel? Or do the dynamics differ in that whenever something is shipped through a distributor and revenue is recognized, there is always a project or end user involved? Please clarify how this functions in terms of size and significance.
Aaron P. Jagdfeld, President and CEO
Yes, that's a significant part of our total domestic commercial and industrial sales. When you look at it closely, it's about 70% of the total for domestic commercial and industrial sales. The remaining 25% comes from mobile and telecom products, which are currently down. As we've noted, these markets go through cycles. We play a large role in rental and telecom, and when those major customers reduce their capital expenditures, it heavily affects us since we provide a lot of equipment to those sectors. The growth in our industrial distribution channel is crucial as it acts as a counterbalance to the fluctuations with those larger customers in rental and telecom. We don't often discuss the industrial distributor business because we mainly focus on residential and consumer power sectors, including residential standby and energy technology. However, it's been a strong success story for us. We have an excellent team there that performs well. As you might remember, we announced the construction of a new factory in Beaver Dam, Wisconsin, because we believe in the growth potential of these products and recognize the need for additional capacity. We are producing larger products, and we've invested significantly in our research and development space in Waukesha, Wisconsin, targeting larger opportunities in the commercial and industrial space, particularly with natural gas. Even though interest rates have recently cooled off this sector, we see its importance. One of the key factors in our success, especially when the telecom markets cycle positively, is our ability to provide coast-to-coast service and support for large accounts' fleets. This is a vital aspect of our industrial distributor channel. The sales from this channel do not flow directly, but the service and support are essential for our operations. The sales within our industrial distributor channel are highly customized and unique to each project's electrical requirements, essentially making it a configure-to-order business with a lengthy sales cycle. This involves various stakeholders from specifying engineers to electrical and general contractors, all playing a role in selecting the right solutions for specific applications. Over the past decade, we've strengthened our distributor channel and engaged with decision-makers throughout the value chain. This has been instrumental in getting Generac recognized in specifications, which is crucial for visibility in bids. We're also promoting the benefits of natural gas over diesel, as we are the largest provider of natural gas generator sets for backup power globally. Our position gives us a competitive advantage, and we're keen to communicate this to our distributors. Natural gas backup power is growing faster than diesel backup power in the markets we serve, except for large data centers, which we do not target. In our served market, we see growth rates for gas outpacing those for diesel and have benefited from this trend, as has our distribution network. This growth is reflected in the strength we see in our industrial distributor channel.
Operator, Operator
And our next question comes from the line of Kashy Harrison from Piper Sandler.
Kashy Harrison, Analyst
So Aaron, I think you indicated that HSB activations were down modestly year-over-year. Can you just help us quantify that? What does modestly mean? And then you also indicated HSB shipments and activations were aligned in February and March. And so I was just wondering if, York, you could just help us think through 2Q residential revenues. I'm just trying to understand how we get from being up 2% in 1Q to being up low double digits for the full year.
Aaron P. Jagdfeld, President and CEO
Yes, from an activation standpoint, it’s modestly in the mid-single-digit range, which aligns with our year-over-year expectations. We anticipated it to be a bit softer due to lower IHCs in Q4 stemming from a weak power outage environment. Additionally, last year's Q3 lacked much of a season in terms of outages. Therefore, the latter half of last year didn’t perform as strongly as it historically might have, leading to fewer year-over-year installs this quarter. However, the decline isn’t drastic, which is encouraging. Looking at the historical data, the category is still significantly larger today compared to 2019 levels of activations, although it may be a little off in the near term due to the weaker power outage environment over the past few quarters.
York Ragen, CFO
Yes. Regarding the residential pace from Q1 to Q2, we still undershipped the market in Q1 as we continue to reduce field inventory. Towards the end of the quarter and into Q2, we believe we've returned to normal levels. We undershipped the market by approximately $300 million in 2023, with just under a quarter of that reflecting our Q1 performance. This means we shouldn't experience that undershipping in Q2, and the seasonality of our business typically increases from Q1 to Q2. Historically, this seasonality supports our future guidance for residential products.
Operator, Operator
One moment for our next question. And our next question comes from the line of Jon Windham from UBS.
Jonathan Windham, Analyst
I'll keep it quick as we're running a bit long. Just any sort of comments around you mentioned some weakness in the non HSB residential market. But one of the really strong markets right now is storage deployments. Residential storage deployments are up 200% year-on-year in California. Just some comments about the competitive landscape and your ability to compete in that market. I appreciate all the insights to that.
Aaron P. Jagdfeld, President and CEO
Yes, thanks. Storage attachment rates have increased significantly. We have observed that while the installation rates for solar plus storage are rising, new solar projects have declined by about 50% to 60% year-over-year in California. This has contributed to higher attachment rates due to the NEM 3.0 position. However, California is a market primarily dominated by Tesla, and we haven’t historically been strong there, so our participation has been limited. That said, our storage business is growing year-over-year, though not doubled; it's showing some improvement from a low point over the last few years. The larger challenge lies in other residential products, particularly portable generators. We haven't focused much on that but I mentioned in our prepared remarks that domestic demand has softened due to reduced outages in recent quarters. International sales of portable generators also saw a sharp decline in Q1 year-over-year, largely due to decreased power security concerns in Europe compared to the previous year, which was impacted by the Russia-Ukraine war. Additionally, our chore business has struggled significantly last year. The long-term trends, particularly following the pandemic, have shown that there was considerable advance buying of equipment at both the end market and distribution levels. Many public companies in the residential chore product sector have faced challenges over the past year and a half. We had hoped that a mild spring would help, but distribution partners were hesitant to invest in spring chore products due to weak snow season sales and high snow inventories. Fortunately, weather conditions are improving, and there are some positive near-term trends for chore products, but the overall situation has been difficult. Therefore, the softer performance in the chore and energy tech markets, along with the decrease in portable generator demand, have posed challenges for us this quarter.
Operator, Operator
And our next question comes from the line of Jordan Levy from Truist.
Jordan Levy, Analyst
Appreciate all the comments on gross margins here. And I just wanted to see on the cost side, if you could give us some more specifics around what the input cost reductions were that you're realizing in the first quarter? And as a quick second part of that question, just curious on the sensitivity of costs overall to copper prices, specifically given what that commodity has done over the last month or 1.5 months?
York Ragen, CFO
Yes. I believe it's a combination of factors. Steel is likely our largest input, and over the long term, steel costs have decreased. As we move through our higher-cost inventory, we’re beginning to see the benefits of these lower steel costs, potentially even quicker than we expected. Steel plays a significant role. Additionally, logistics and freight costs have also reduced over the past year, and as we progress through that inventory, we're recognizing the impact of those lower freight costs, contributing to our improvement alongside better plant efficiencies and absorption resulting from strong execution. These are probably the main reasons we were able to achieve better gross margins sooner than anticipated. In terms of copper, it does have some effect, but it is less significant compared to other factors.
Aaron P. Jagdfeld, President and CEO
And there's lags. I mean...
York Ragen, CFO
If you add to the steel side, yes. So copper has gone up. But that, I would say, is in terms of lower impact relative to steel.
Operator, Operator
And our next question comes from the line of Vikram Bagri from Citi.
Vikram Bagri, Analyst
I wanted to inquire about the noticeable increase in R&D expenses this quarter. Could you provide insights on where those R&D funds are allocated? In your earlier response, you mentioned that there are no plans to launch products specifically for the data center market. Therefore, I assume that a significant portion of R&D is directed towards energy technology. Could you update us on the progress of your next-generation MLPE storage products? Are you aiming to compete in that market with a lower price point, reduced failure rates, easier installation, or specific new features that would give you a competitive advantage? Finally, you noted last quarter that operating expenses would be approximately 23% of sales, but did not address this today. I wanted to confirm that guidance remains unchanged in light of the R&D spending and your comments on lead generation expenditures for this quarter.
York Ragen, CFO
Yes. Regarding the OpEx guidance, we mentioned in our prepared comments that the strong performance in Q1 regarding gross margin would be mostly balanced out by slightly higher OpEx, as we continue to invest in our strategic initiatives. It's still early, so we have maintained the EBITDA margin guidance from last quarter, with the gross margin outperformance being slightly countered by the OpEx.
Aaron P. Jagdfeld, President and CEO
Yes. Regarding R&D, we are significantly investing in various areas, particularly in our energy technology products. We're focused on developing next-generation storage devices for residential use, which we plan to launch later this year. In addition, we're continually investing in our rooftop solar, power generation, and inverter products, with new versions of those expected to reach the market in early 2025. There’s a substantial effort underway, including team building and recent announcements about opening a tech center in Reno, Nevada, and adding tech offices in various cities like Portland, Vancouver, Bend, L.A., and Denver. This broad approach is necessary to compete with some strong companies in both storage and inverter technology. From a unique selling proposition perspective, we will share more about our product launches as the dates approach, but we believe we have innovative strategies for integrating these technologies into a cohesive platform. Currently, assembling a solar system with storage, EV charging, thermostatic controls, and backup generators requires multiple apps, and we're working on a project to unify these technologies using the Ecobee experience, which was central to our acquisition strategy. We aim to leverage the machine learning and artificial intelligence that they utilize in their thermostatic controls to enhance the user experience across all our products. We believe our offering will stand out in the market. Overall, we feel that our combination of products will empower homeowners with better resilience, comfort, and cost control, especially as utility rates continue to rise. This will encourage homeowners to explore distributed solutions that offer greater information and control over their energy generation and usage. We anticipate that as these products become available, the value of our approach will become increasingly clear, and we are confident in our brand, distribution, and marketing capabilities to drive long-term success.
Operator, Operator
This does conclude the question-and-answer session of today's program. I'd like to hand the program back to Kris Rosemann for any further remarks.
Kris Rosemann, Senior Manager, Corporate Development and Investor Relations
We want to thank everyone for joining us this morning. We look forward to discussing our second quarter 2024 earnings results with you in late July. Thank you again, and goodbye.
Operator, Operator
Thank you, ladies and gentlemen, for your participation in today's conference. This does conclude the program. You may now disconnect. Good day.