Ladies and gentlemen, thank you for standing by. Welcome to the Lennox International second quarter 2019 earnings call. At the request of your host, all lines are in a listen-only mode. There will be a question and answer session at the end of the presentation. As a reminder, this call is being recorded. I will now turn the conference call over to Steve Harrison, Vice President of Investor Relations. Please go ahead.
Morning. Thank you for joining us for this review of Lennox International's financial performance for the second quarter of 2019. I'm here today with Chairman and CEO, Todd Bluedorn, and CFO, Joe Reitmeier. Todd will review key points for the quarter, and Joe will take you through the company's financial performance and outlook.
To give everyone time to ask questions during the Q&A, please limit yourself to a couple of questions or follow-ups and re-queue for any additional questions. In the earnings release we issued this morning, we have included the necessary reconciliation of the non-GAAP financial measures that will be discussed to GAAP measures.
All comparisons mentioned today are against the prior year period. You can find a direct link to the webcast of today's conference call on our website at www.lennoxinternational.com. The webcast will be archived on the site for replay.
I would like to remind everyone that in the course of this call, to give you a better understanding of our operations, we will be making certain forward-looking statements. These statements are subject to numerous risks and uncertainties that could cause actual results to differ materially from such statements.
For information concerning these risks and uncertainties, see Lennox International's publicly available filings with the SEC. The company disclaims any intention or obligation to update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise. Now let me turn the call over to Chairman and CEO, Todd Bluedorn.
Thanks, Steve. Good morning, everyone, and thank you for joining us. Let me start with an overview on the second quarter, which was significantly impacted by the adverse weather conditions. I will cover the key points on each of our businesses, our current view on the tornado impact and insurance proceeds, and our reduced outlook for commercial and refrigeration end markets, and update 2019 guidance.
For the second quarter, GAAP and adjusted revenue was $1.1 billion. GAAP revenue was down 6%, including 8% of negative impact from the tornado, divestitures, and foreign exchange.
Excluding the impact from divestitures, adjusted revenue was down 1%, or flat at constant currency, including a negative 3% impact from the tornado. GAAP operating income was $214 million, up 10%, and GAAP EPS from continuing operations was $2.81, down 17%, including a non-cash pension settlement charge of $1.14.
On an adjusted basis, total segment profit was $202 million, down 2%, and total segment margin was relatively flat at 18.4%. Adjusted EPS for continuing operations was up 2% to $3.74. Residential revenue was down 3% at constant currency and down 4% on a reported basis, with volume down 6% and down 3% adjusted for the tornado impact.
Residential profit was flat, and segment margin expanded 80 basis points to 22.3%. Price performance was strong at 3.6% yield. Our residential business in the second quarter was negatively impacted by the significantly cooler temperatures and higher precipitation across the U.S., especially in key central regions where cooling degree days were down more than 30% and precipitation was up more than 60%, areas that account for approximately 40% of our revenue.
We said over the years that a hot summer could add 10% to residential growth and a cold summer could subtract 10%, which was the case in the second quarter of this year. Adjusted for the tornado, our residential volume is down 3%. If you add 10% to that, you get a more normalized number in line with the overall residential market conditions.
Our residential business had negative tornado impact of $28 million to revenue in the second quarter and $16 million to segment profit, offset by $18 million of insurance recovery. Adjusting for the net impact from the tornado and insurance proceeds, residential revenue was flat, profit was down 1%, and margin was down 30 basis points to 21.1%.
The adverse weather in the second quarter led to slower-moving shipments in the industry, which slowed us in regaining market share following the tornado and extends our recovery timeline to include the fourth quarter. We remain confident we will resume gaining share in 2020.
For 2019 overall, we now expect $99 million of negative tornado impact to residential revenue, up from $70 million previously. We expect a negative $54 million impact to segment profit, up from $40 million previously.
We expect insurance recovery for lost profits of $94 million, up from $80 million previously. The resulting $40 million of net benefit to residential segment profit in 2019 is unchanged. On the remaining negative tornado impact for 2019, we expect to have an impact of approximately $22 million in revenue and $11 million in segment profit in the third quarter.
For the fourth quarter, we expect an impact of approximately $14 million to revenue and $9 million to segment profit. For the remaining $36 million of insurance recovery in our core guidance, we expect that to be split evenly between the third and fourth quarters.
Taking a step back and looking at the big picture for both core and non-core related to the tornado, we now expect total insurance proceeds of approximately $372 million, up from $358 million previously.
We have received $252 million of that as of the end of the second quarter and expect the remainder by the end of 2019. The 2019 non-core gain expected for the difference in the book value and the replacement value of assets remains approximately $91 million, or a benefit of approximately $1.73 per share to GAAP EPS.
We have posted a Lennox financial update chart on our website summarizing the guidance I just discussed. Turning to commercial in the 2nd quarter. Revenue was a 2nd quarter record $261 million, up 4%. Commercial profit was a record $54 million, up 6%, and the segment margin expanded 50 basis points to a record 20.6%.
Commercial revenue in the 2nd quarter was led by high single-digit growth in national account equipment business. Regional and local equipment revenue was up low single digits at constant currency.
Breaking out the business another way, commercial new construction revenue was up low single digits at constant currency, and replacement revenue was up high single digits. Planned replacement was up low double digits, and emergency replacement, which also was negatively impacted by cooler weather in the quarter, was down low single digits at constant currency.
Our VRF business was up high single digits in the second quarter. On the service side, Lennox National Account Services revenue was up low single digits. In refrigeration for the second quarter, adjusted revenue was up 5% at constant currency. Adjusted revenue profit was down 19%, and adjusted segment margin was down 340 basis points to 12.8%.
Profit was impacted by unfavorable mix as North America volume was down and Europe volume was up in the second quarter. In addition, profitability was negatively impacted by the timing on the sale of refrigerant allocations in Europe compared to the prior year quarter.
Before I turn it over to Joe, I'll review the latest of our outlook for 2019 and provide a few early thoughts on 2020. For the industry overall, we still expect North America residential HVAC shipments to be up mid-single digits.
We are reducing the outlook for commercial and refrigeration end markets in North America. We now expect commercial shipments to be flat for the industry in 2019 and expect refrigeration shipments to be slightly down for the industry. That's for the market. We still expect our revenue to be up for both businesses in the second half of the year.
We expect year-over-year commercial margin expansion to continue in the second half and refrigeration margin expansion to resume in the fourth quarter. Looking ahead and thinking about 2020, we're still six months away, but the residential market continues to look robust, setting aside the second quarter weather. Commodity costs continue to trail down, and that is setting us up nicely for more positive price cost benefit in 2020 than we've had in 2019.
The investments we've made in equipment, controls, and distribution set us up well in 2020, as do the easier comps post the tornado impact to get us back on the share gain path. Let me turn it over to Joe.
Thank you, Todd. Good morning, everyone. I'll provide some additional comments and financial details on the business segments for the quarter, starting with residential heating and cooling. In the second quarter, revenue from residential heating and cooling was $689 million, down 4%.
Foreign exchange had a negative 1% impact on revenue. Volume was down 6%, or down 3% adjusted for the tornado impact. Price was up 4%, and mix was down 1%. Residential profit was flat at $153 million.
Segment margin expanded 80 basis points to 22.3%. Segment profit was favorably impacted by a net $2 million of benefit from insurance proceeds relative to the tornado impact in the quarter, as well as favorable price, sourcing, and engineering-led cost reductions and favorable warranty.
Offsets included cooler and wetter weather, tornado impact, factory productivity, unfavorable mix, higher commodity, freight, tariff, and other product costs, as well as distribution and SG&A investments and unfavorable foreign exchange. Turning to our Commercial heating and cooling business. Commercial revenue was a second quarter record $261 million, up 4%. Foreign exchange was neutral to revenue.
Volume was up 2%, price was up 2%, and mix was up 4% on the strength of national account growth. Commercial segment profit was a record $54 million, up 6%. Segment margin was a record 20.6%, up 50 basis points. Segment profit was impacted by favorable price, favorable mix, and sourcing and engineering-led cost reductions.
Partial offsets included lower volume, higher commodity and other product costs, tariffs, freight, and distribution, and SG&A investments. In the Refrigeration segment, adjusted revenue was $149 million, up 2% in the second quarter.
Foreign exchange had a negative 3% impact on revenue. Volume was up 1%, price was up 2%, and mix was up 2%. Adjusted segment profit was $19 million, down 19%. Adjusted segment margin was 12.8%, down 340 basis points.
Profit was impacted by lower mix and the timing on the sale of refrigerant allocations in Europe compared to the prior quarter, higher commodity, freight, distribution, and tariffs and other product costs, and unfavorable foreign exchange. Partial offsets include higher volume, favorable price, sourcing and engineering-led cost reductions, and lower SG&A expenses. Regarding special items in the second quarter, the company had net after-tax charges totaling $36.6 million.
This included a charge of $45.5 million for a pension settlement, a net charge of $1.5 million for various other items, and a gain of $10.4 million from insurance recoveries, net of losses incurred. Corporate expenses were $24 million in the second quarter compared to $23 million in the prior quarter.
Overall, SG&A on an adjusted basis was $152 million compared to $151 million in the prior quarter. Net cash from operations in the second quarter was $30 million compared to $49 million in the prior quarter. Capital expenditures and purchases of short-term investments were $18 million compared to $21 million in the second quarter a year ago.
We had proceeds for tornado damage to property and proceeds from the disposal of property, plant, and equipment of $6 million in the second quarter this year. Free cash flow was $20 million compared to $28 million in the prior quarter.
The company repurchased $150 million of stock and paid $25 million in dividends in the quarter. Total debt was $1.47 billion at the end of June, and we ended the quarter with a debt-EBITDA ratio of 2.3.
Cash and cash equivalents were $36 million ending the quarter. Turning to our guidance for the company overall in 2019. We are updating guidance for adjusted revenue growth from a range of 3%-7% to a new range of 2%-5%.
We are updating GAAP EPS from continuing operations from a range of $12.65-$13.25 to a new range of $11.91-$12.51. This incorporates special items in the first half of the year, including the $1.14 non-cash pension settlement charge in the second quarter.
As previously discussed, the pension settlement charge relates to an agreement that we entered into with Pacific Life Insurance Company in April to annuitize $106 million of our defined benefit pension obligation. As part of this transaction, we also transferred $100 million in pension assets to Pacific Life.
This event required a remeasurement of the pension plan and resulted in a non-cash $45.5 million after-tax settlement charge in the second quarter to write off the related accumulated actuarial losses.
As Todd mentioned, we continue to expect a total 2019 pre-tax gain of $91 million related to factory reconstruction costs and the associated gain from replacement value above book value. For adjusted EPS from continuing operations in 2019, we are updating guidance for a range of $12-$12.60 to a new range of $11.30-$11.90.
Let me now run through the other key points of our guidance assumptions and the puts and takes for 2019. First, the guidance elements we are updating. We are lowering the headwind expected from commodities for the full year from $30 million to $20 million.
We are lowering the guidance for residential factory productivity from a benefit of $8 million to being flat year-over-year due to the weather impact on production and the corresponding lower fixed cost absorption.
We are updating guidance for 2019 CapEx from approximately $195 million to $155 million as $40 million of capital to fully reconstruct the Iowa manufacturing facility damaged by the tornado has moved from 2019- 2020. We are updating 2019 guidance for free cash flow from approximately $420 million to $390 million for the full year. There are three moving pieces to the guidance.
The two headwinds are lower earnings guidance and higher working capital, and the benefit is a reduction in capital expenditures due to the project timing of the Iowa factory reconstruction between 2019 and 2020. For the guidance elements that remain the same, we still expect to capture $80 million of price for the full year.
We still expect a $25 million benefit from sourcing and engineering-led cost reductions. We still expect $15 million of a headwind from freight and $10 million from tariffs, and we continue to expect headwinds of $15 million for distribution investments and $15 million for SG&A.
Corporate expenses are still targeted at $90 million for 2019. Net interest expense is still expected to be approximately $45 million, and we still expect an effective tax rate in the range of 22%-23% on an adjusted basis for the full year.
Finally, we continue to expect the weighted average diluted share count for the full year to be between 39 million-40 million shares, which incorporates our plans to repurchase $400 million of stock this year. With that, let's go to Q&A.
Ladies and gentlemen, if you would like to ask a question, please press star one on your touch-tone phone. You'll hear a tone indicating you've been placed in the queue. If your question gets answered and you wish to remove yourself from the queue, please press the hash key. Again, star one if you have a question. First we'll wind with Julian Mitchell with Barclays. Please go ahead.
Thanks. Good morning.
Hi, Julian.
Morning. Maybe just the first question around commercial and refrigeration demand. You had talked about a temporary pause back in Q1, entered Q2 with good backlog growth in both pieces. Just wondered what changed as you went through the second quarter, and maybe how you're seeing the start to Q3 across the three segments in terms of demand.
As you can see, we had a nice second quarter revenue-wise in both segments, especially in commercial. We enter third quarter with solid backlog. Our commercial backlog is flattish from a year ago, and our refrigeration backlog is up mid-single digits.
Again, we expect the revenue to grow in both those segments. In some ways, we're just truing up what we're seeing. When you look at ARI data for commercial through May, market's up half a percent, 1%. We think it was down in June in part because of weather, we think calling flat is sort of a more realistic assumption.
What we're seeing in refrigeration is some of our larger customers sort of deferring, given some of the macroeconomic uncertainty. Again, it's on the margins. We're going from being up low single digits market call to sort of slightly down. Excuse me, flattish to slightly down. It's sort of a toggle of a couple points, if you will. Again, we still expect revenue in both those segments to be up second half of the year.
Thanks. Then sort of tied to that, maybe just any thoughts on residential, how that's trended the last couple of months, if you've seen any improvement in sell-through conditions recently?
It's certainly warmed up in July, from where it was in June, that's helped. We're off to a solid start. I'd remind everybody, third quarter last year was warm. If you recall, it was up, from memory, 25% above normal and 15% above the prior year. Last third quarter was pretty warm. The comps aren't so easy, but residential's sort of chugging along, and we're off to a nice start.
Thanks. My last question on that point would just be, in terms of the market share efforts at residential, maybe just walk through where you think you're falling short, or if it's really the external conditions of weather that have sort of held you back on that market share retake?
Again, we're gaining share back. We didn't gain it back as fast as we had hoped in second quarter, and I think it was largely driven by the weather. I think it's just an old business truism which I've always found to be true.
It's harder to get share in a down market than an up market. Some of our markets, the area that we're talking about, this sort of region in the center of the country, our revenue was down there even greater than it was overall in the business, and it was just tough to gain back share when things are down. We think that's the vast majority of the impact.
I think, to be honest and straightforward about it, full transparency, there are some sort of smaller dealers who, quite frankly, we're probably not going to get back, that we protected our most valuable customers.
Those we did protect, when we get to the other side of it, if they've had a good experience with their new vendor, some of them aren't coming back. We've gotten back the majority of the share. We've guided that as we go into 2020, we're confident we'll be back on the share gain track again.
Great. Thank you.
Thanks.
Next, we'll go to Steve Tusa with JP Morgan. Please go ahead.
Hey, guys. Good morning.
Hey, Steve.
Just on the commercial side, you had talked, I think, a bit about at a conference in early June about how you were seeing the order rates come back there, at that stage. Did something kind of happen later in the quarter, on this front to kind of tweak that lower for the year?
Again, I think I'm reflecting a guide on the industry rather than our share. What I said is we had a nice second quarter in revenue, and we expect revenue to up the second half of the year. Our backlogs are relatively just flattish, because we sort of delivered a lot in the second quarter.
We're still optimistic on the segment overall, but we're halfway through the year, and the industry's flat. I think the second half will sort of, the closer we get to election, the more these macroeconomic uncertainties hang, the less likely we're going to see growth in the end market second half of the year.
Right. Okay. On the resi side, you guys started to disclose in your Qs the difference between externally sold sales and sell through your own distribution, and I think that number was up. The external sales were up pretty nicely in the first quarter. Your sell through your own stuff was kind of down moderately.
I think the Q's going to come out today. Can you just talk about, was that the similar trend here in the second quarter? How should we read into that? Is that just you guys kind of restocking the channel from tornado impacts? What's kind of the framework with which to kind of look at that around?
It was even more pronounced in the second quarter maybe than it was in the first quarter. Our direct business, our Lennox business, which is 80% of what we do revenue-wise, is down 6%. Our Allied and ADP businesses, which are direct, was up 3%. I think it's a couple things. I think it's weather exposure. Our Lennox branded business is more in the center of the country than our Allied business. I think that's part of it.
I also think it's this issue that the independent distributors were able to hang on to their dealers because they had multiple brands, were able to juggle brands and sort of keep dealers happy, as we're able to reload our independent distributors with our product and are able to sort of seamlessly move back the dealers to that product line. No one sort of had a relationship turn them off. They were able to sort of seamlessly move it back in. I think that's part of it.
Okay.
It's both the weather and sort of the other issue I talked about, regaining share.
Okay, one last one. Are you at all considering monetizing some of your distribution, or is it still a very core part of who Lennox is, having this much captive distribution?
Did Al ask you to ask that of me?
Well, he was just very polite. He's very quick to compliment you guys on the comps call, which is warranted. You guys have done a great job, but just curious.
I heard that compliment and I thought it was a left. I kept my head up for the right. We have absolutely no desire to get out of distribution, as you've heard me say multiple times. I think it's a differentiator today, but it'll increasingly be a differentiator.
All the investments we've made in digitization, it's gone from a business where you needed local knowledge and sort of moving boxes to this business where you want to be able to leverage investments. Again, if I learned anything at business school, I want to have thousands, tens of thousands of small customers rather than one large customer. We have no desire to get out of it.
Got it. One last one for Resi. Was there any major difference in kind of parts versus equipment? Were parts up in the quarter? Any difference there?
No. The part of the business that was up the most was residential new construction.
Okay.
Less impacted by the weather. Parts and the add-on replacement trended the same direction, with the cool weather impacting them both, and parts and supplies maybe even a little bit more than equipment.
Okay, awesome. Thanks, guys.
Thanks.
Next question from Jeff Hammond with KeyBanc. Please go ahead.
Hey, good morning, guys.
Hey, Jeff.
Good morning, Jeff.
I already knew the answer to that distribution question.
I was just going to joke and say I'd be shocked if Al asked you that question, but go ahead.
All right. Just going through the $0.70 cut. I know you made adjustments to the commercial piece, can you maybe break out how you break out that 70% cut? How much is it this kind of soft 2Q residential versus how much is it the commercial piece being softer? It looks like the refrigeration margins seem to be coming in lighter as well.
I think order of magnitude, the way I think about it, Jeff, is we passed on the second quarter miss to the full year guide. We had sort of lowered the second half of the year because of the push out of the share gain, but that's offset by insurance. The third piece would be sort of a lowering of the end markets, and the corresponding revenue of the commercial and refrigeration businesses.
Okay, that's helpful. Can you just explain this refrigeration allocation dynamic and how big it was? I think you said refrigeration, the margins, you'll get expansion in the fourth quarter, which would suggest that maybe margins are down in the third quarter. What's going on there?
The issue, I'll do it in a reversal. The issue in the third quarter is the mix. I refer to it as mix. It's just this dynamic that our business in Europe is growing quicker than our business in North America. I think part of that's market. Part of it is we're sort of flat as share in North America refrigeration, organic share in Europe, and that hurts it.
The refrigerant issue was second quarter a year ago, we had about a $3 million gain on refrigerant. I'll come back to that in a second. In the second quarter this year, we had about $1 million. Net, a $2 million difference year-over-year. As you may recall, I'll simplify it's a cap and trade program in Europe for F-gases, fluorine-based gases, and we had an allocation.
You're able to resell parts of the allocation you don't use, and we were able to sell those again to a $3 million gain last year, second quarter, and a $1 million gain this year. Year-over-year, $2 million swing.
Okay, the third quarter margin comment on refrigeration is that this mix dynamic continues, and then it normalizes in 4Q?
Correct.
Okay,
I'd broaden the answer. Also, self-help will kick in in the fourth quarter.
Okay. Last one on this distribution growth versus direct decline in the first half of the year. How should we think about that impacting the second half of the year, just with kind of the pre-buy dynamic?
Which pre-buy dynamic are you talking about, the furnaces?
Yeah.
The reason I'm pausing is because I haven't quantified it yet in my own mind, so I'm going to real time think. I think, obviously, the way you asked the question, you're right. In the direct side, we'll be selling furnaces, where indirect, we've sort of stocked it already.
I would tell you, because of the tornado impact, we didn't do as much pre-stocking of our distributors as our competitors have done. I also think there'll be normalization as we get away from the weather impacts, especially in the second quarter.
Okay, thanks a lot.
Our next question is from Ryan Merkel with William Blair. Please go ahead.
Hey, thanks. First question from me. I'm guessing you don't want to give numbers by geography, but I'd just like to get a better sense of how weak the Midwest was in the quarter.
I won't give the exact numbers as you suggested, but it's about 40% of our revenue. It was maybe two or three points down in revenue in the add-on and replacement versus the overall market. I would contrast that.
I will give you exact numbers for something I want to say, which is, in a market like Florida where we had warm weather, our Lennox replacement revenue was up 12%. A market we had good weather, we did well. In large parts of the country where we didn't have good weather, we didn't do well.
Okay. That's helpful. Just to follow up to a prior question, so it sounds like you didn't assume that you would make up some of the 2Q resi shortfall in the second half. Am I hearing that right?
I think that's what the guide says. Yes.
Okay.
The short answer is yeah, and that's what's in the guide. Again, I often don't like to talk about weather, but I almost have to now given everything we've said so far. Sort of the conventional wisdom that I also believe is true is sort of the weather that you want now is hot, cool, hot, cool.
They sort of sell out, and then it cools down. Better said, it gets hot, our dealers get really busy, sometimes a week or two weeks planned out. Then you want it cool so they can catch their breath, get caught up and ready to take on new business. Then it gets hot again, they get the business, they order from you.
As we get into September, we want the weather to break and sort of stay cool, so they'll start loading up for furnaces. It's not just record heat now for the balance of the quarter, we're going to have to sort of have some things move. It's hard to make up the miss we had in second quarter due to weather.
Got it. Okay. Just lastly, residential price yield up 3.6%. That's a little better than I was thinking. Is this just the function of a double price increase still helping and maybe you didn't discount equipment to try to sell through, just given the lower shipments this quarter?
It's primarily the first point. Second quarter was the sweet spot where we were sort of getting carryover of both of them, if you will. The year, we think full year we're going to get two points, might do slightly better than that given the performance in second quarter.
Second quarter's sort of the high watermark of year-over-year price increases. Look, we were competitive in the marketplace, and so, it's not like we said, "Look, we're not going to do any pricing to regain share." Just, at some point you realize that's not the lever to pull, so we tried to pull a lot of other levers instead.
Got it. Okay. Thanks. I'll pass it on.
We'll go to Jeffrey Sprague with Vertical Research Partners. Please go ahead.
Thank you. Good morning, guys.
Hey, Jeff. How are you?
Hey, doing well. Thank you. Just coming around to kind of cash flow and absorption. Of kind of those three pieces Joe mentioned, clearly, working capital's got to be a chunk. Inventory looks high. I guess I really have kind of two questions. Was there some kind of absorption benefit in the quarter actually from building inventory?
There was, Jeff. There was some inventory build, but there's also some raw material that are at higher levels given the increased production between Marshalltown and Saltillo.
Conversely, I guess your guide would assume some under absorption in the back half as you're burning inventory down. Can you give me any context on the margin impact there, if there is any?
Once again, I think the margin impact is de minimis, and we're going to continue to level load production to optimize the impact on absorption.
Just back to price, Todd or Joe, do you see any indication anywhere that there is some pushback? We've heard that in some industrial channels. Watsco kind of mentioned it around some parts pricing. Obviously raw mats are coming down, volumes maybe not as good as people thought.
No. We've seen price stick in marketplace, obviously from the results we've had. We as always plan on passing on an annual price increase, and commodities have trailed down a bit. Labor's extremely tight in North America, and we've had to raise wages in our factories. Our suppliers have had to raise wages in their factories.
The tariff situation's still not settled. Freight and transportation is still, while down a little bit from last year, still high versus the last couple of years. There's still inflation in the system, and the need for us to pass on price, and our competitors are doing the same thing.
Would it be fair to assume, the double dip was obviously a bit unusual, but kind of normal year-end, beginning of year list price increases should kind of rule the day again into 2020?
Yeah. What we'll do going into 2020 is just, I'll repeat what you just said. We'll be announcing a price increase at the end of 2019 to set us up for realizing it in 2020. That's historically how the industry did it.
Not to bash Watsco, when Watsco's talking about price, they may be talking to their supplier, and letting them know what they want them to hear. From our perspective, we're still getting price in the marketplace.
Great. Thank you.
Our next question's from Robert McCarthy with Stephens. Please go ahead.
Good morning, everyone. How are you today?
Good. How are you?
Good. Maybe since you broke hearts a little bit on 2020 for your outlook, Todd, could you talk a little bit about just maybe the current environment? Are you seeing any chinks in the armor of the cycle? How do you think about 2020, and how do you think about your long-term targets from where you sit now, just so we get some comfort? Obviously some investors think that this could presage something worse than just bad weather.
No, I think it's bad weather. I think it's two things. It's bad weather in terms of cool and wet weather, and bad weather in terms of a tornado. Those are the dynamics. From a residential viewpoint, the market's still robust. U.S. consumer's still strong. U.S. consumer's still spending. I think you sort of see that in all the surveys and macroeconomic data. As we go into 2020, we expect that to continue.
We toggled down just a bit, the commercial and refrigeration end markets. I think that just reflects reality. We continue to gain share and expect our revenue to be up in those end markets. We think 2020's end markets are going to be good. 2021, my crystal ball's a little less clear. Our three-year targets still stand up, even with this second quarter drop because of weather.
In terms of the residential, excuse me, in terms of the refrigeration and commercial unitary, you did answer the fact that you do expect to grow and that there should be share increase. Do you think this is some conservatism that you're baking into the guide? Do you think you're just calling the market as you see it?
Yeah. The guide's the guide, is the way I think about it. I hope we're wrong, and I hope it does better, but that's our best call right now.
I'll spare you a question on your distribution and whether you want to sell it.
No matter what happens, you can write that down as we do not want to sell distribution. Thanks.
Sure.
Next, we'll go to Gautam Khanna with Cowen and Company. Please go ahead.
Yeah, thanks. Good morning, guys.
Hey, Gautam. How are you?
Doing well, thanks. A couple questions. First, I was wondering, any change that you would expect in the competitive environment given the CCS spin or anything else, the Ingersoll-Rand breakup? It doesn't sound like you've seen anything, but what might you expect in an environment that's going to be unfolding over the next year?
I don't think I'd expect any change in Trane Co. or whatever the new business is going to be called. As I understand that Lamach and the management team at the parent company are going to go with Trane Co., right? I assume they're going to compete the same way they've competed now.
At Carrier Co., it's unclear exactly. One thing I think about is the distractions aren't going to stop. Carrier Co., in and of itself, is a multi-industrial conglomerate that probably needs to be broken up.
I think there'll be continued internal discussions about what do they do with refrigeration, what do they do with some of their lower profit international businesses? What do they do with security business? I think all that will continue to be a distraction, and I think that's good for us.
Okay, that's helpful. Also, just what are your latest thoughts on North American HVAC consolidation? Do you think it happens? If it happens, when does it happen?
Yeah. My answer, Gautam, you've heard me say 1,000 times. I'll say it for people who are listening anew. We don't need to do anything. We're at scale. I think value could be created. If something would happen, we'd love to participate, and we think we'd be a good player to help drive the value.
I think over the long term, if there's value to be created, the financial markets find a way to have assets be combined. Right now, it's only a handful of assets, and someone who's in the business would have to decide they wanted to get out of the business, and I can't really control that. That question's better asked to somebody else rather than me.
Fair. Then you mentioned you're not going to retain 100% of the customers that you lost related to the tornado. Can you quantify that? Of the customers you had previously, what percentage do you think don't come back? Is there any way to quantify it so we can understand the hurdle you're overcoming as you do recover?
With some degree of uncertainty, the order of magnitude is we get back 90%, we lose 10%. If you do some of the backward math on that implies a point and a half, 2 points of resi revenue, maybe went away at the end of the tornado, versus closer to 10 points of resi revenue that was totally impacted by it.
I think of that kind of revenue change as a quarter of a point or so of share, maybe three-fifths or 0.3 points of market share. That's why I'm comfortable as we go into 2020. We'll pivot away from just footing out this piece that we still haven't gotten to more broadly talking about our market share gains. We've gained half a point or more of market share in resi up to the tornado during the prior five or six years.
As we go into 2020, we'll do the same thing, and this will be behind us.
Last one, sorry. Marshalltown, is it fully operational, fully up to speed? There's no lingering production interruption there?
No lingering production interruptions. We're up to speed. The push out of the capital, no one's asked the question, but I'll anticipate it. Push out of the capital has nothing to do with being up to speed on production. It's building the admin wing of the factory, adding in parking lots, and lesser priority things of what we needed to do to make it a full-time factory again. But production-wise, we're where we need to be.
Thanks a lot, guys. Appreciate it.
Thanks.
Next, we'll go to Deepa Raghavan with Wells Fargo Securities. Please go ahead.
Good morning. Can you talk about what's embedded in the high end and low end of your revenue or EPS guide? Is that now all just resi weather playing out next few months? It looks like you've already factored in some weakness in commercial and refrigeration.
It's that. It's also just there's always a range around commodities. There's a range around freight and transportation. There's a range around some of our execution in the factories. I think it's sort of a stacking of the operational bell shape curve or the range of outcomes around lots of initiatives that we have in place. I think the most important thing is maybe the weather impact, or more broadly stated, the overall residential market. There's other things in that guide.
Okay. Got it. Can you comment on a few puts and takes to Q3? How should we think about your EPS contribution versus prior years? Anything you think is worthy of being called out, just given all the noise this quarter and last year?
No. As you know, we don't give quarterly guidance. I don't want to give you a number, and you know that. I think, as I said earlier, we're off to a solid start. I gave the backlog outlook, sort of flat in commercial, up mid-single digits in refrigeration.
I've talked about residential. You can read a weather map, but you also got to read a weather map from last year to sort of understand it was hot last year, it's hot this year. Operationally, we're executing. I think that's sort of the color commentary I'd make.
Okay. Lastly from me, can you give us some color on what you're seeing in non-res? Some recent data points, not very favorable. You talked about markets, you obviously talked about your growth, but generally, is there anything else on a broad basis that you'd like to talk about in terms of office versus retail versus institutional? Is that concerning to you? Just any viewpoints there appreciated. Thank you.
No macro views that I would share that you couldn't get elsewhere. It's sort of overall commercial unitary markets flat. No additional color. Thanks.
All right. Thanks.
Our next question's from Joe Ritchie with Goldman Sachs. Please go ahead.
Hey, good morning, guys.
Hey, Joe.
Good morning.
Can we just kind of dive a little bit deeper into this market share dynamic? I just want to make sure I understand it. Your production was back and running in 4Q. It seemed like the recovery was getting better than expected last quarter. Is the way to think about your resi growth rate right now just chalking it up to weather and where you guys are based regionally, or is there more to it than that?
Well, I think the more to it is what we called out for the revenue tornado impact, or the tornado revenue impact in the quarter, which is $28 million. There's $28 million revenue impact in the second quarter associated with the tornado. Part of that was being at full production early in the quarter, and then part of it was, as I said earlier, that there's a portion of the share that left us that we haven't regained it all back yet. That's tied to the $28 million. The larger number in the quarter is weather, and that's by definition, it's weather, and it's 100% weather.
Got it. Okay. I guess as I'm kind of thinking about the portion you've discussed with the smaller dealers, there's a portion that you're not going to get back. I'm trying to understand, I guess, the increase in the expenses related to the tornado is related to the portion that you're not going to recapture in terms of your share. Is that fair?
I'm not sure I understand the question. You mean the additional gain of insurance proceeds?
Yeah, the gain on the insurance proceeds and the impact of the insurance proceeds this quarter. It's expected to go up by $14 million for the year. I guess, what is that related to?
That's lost revenue associated with the tornado.
Okay. I guess as we think through 2020 and just this concept, the whole business interruption insurance and how that's calculated, is there an expectation that there's going to be additional recovery in 2020? Do we get a clean slate in 2020, and we can just look at the core business and how the core business is doing in 2020?
That's a fair question. We're in the process of negotiating with all the insurance companies. They've worked very closely with us and have been fair, and we continue to sort of get back the money we expect to get back.
Our current expectation now would be that we would wrap things up by the end of the year with some forward look, maybe into 2020, but that will be a negotiation. At some point, we're just going to collect the money and move on. Right now, the guide expects that to all happen in 2019, but it may bleed over into 2020. I understand the desire to have clean numbers in 2020.
Got it. That makes sense. Okay. Thanks, guys.
Thanks.
Next, we'll go to Nicole DeBlase with Deutsche Bank. Please go ahead.
Yeah, thanks. Good morning, guys.
Hey, Nicole.
I just want to start on Europe. I think during the first quarter, you talked about low double-digit growth ex FX. A lot of that was driven by commercial HVAC, and it sounded like Europe was kind of strong again this quarter. If you could just give us a little bit of update on what you're seeing in the region.
In Europe, we were up mid-single digits. Our HVAC was sort of low end of that, and our commercial refrigeration was the high end, but sort of on average, mid-single digits in Europe. We're primarily in France, in Spain, and in Germany. Those are our major end markets, and that's where we've seen our strength.
Okay, got it. Commercial HVAC margins, I think when we got the last update in the first quarter, you had guided for flat to down in the second quarter, but we saw some improvement there. What was better? Was it the top line was a little bit better than you expected, or was it that the operational improvement was the driver of the upside?
It was both. I'd say it was equally split between the two. We did better in the factory, and then we did a little bit better on revenue and mix than we had hoped or had guided.
Understood. Okay. Last one from me, just price cost, impact on margins in the second quarter, and then if you still expect to see improvement there in the second half?
I'll turn to the folks to see if we have that in front of us. I got too many numbers in my head right now. I'll get back. The answer is, we were positive. Let me see. I'm turning, and I've got it right in front of me.
For the quarter, we had $32 million in price and $15 million headwind of commodities, freight, and tariffs. We were positive 17 for the quarter, and that's obviously the high watermark for the year.
Got it. Thank you. I'll pass it on.
Thanks.
We'll go to Robert Barry with Buckingham Research. Please go ahead.
Hey, guys. Good morning.
Hey, Robert.
Good morning.
Lots of ground covered. I guess just a few things to follow up on. Todd, I think earlier in the quarter or late in the quarter in June, you had alluded to, at a conference, potentially price and also material costs tracking better, but, saw that you kind of kept the guide for those two components the same. Any kind of reason for that?
I think we lowered commodities. It went from a $30 million headwind to a $20 million headwind.
Sorry, the material costs. It was price, commodity, and material costs.
I think maybe I tried to lump all those together just by saying that the total of the three would be better. I didn't mean to say each element would be better. All three of them, I think, used to be 55 and are now 45, if I have the math right.
Got it. That number you gave for the replacement volume in Florida, that up 12-
Yeah.
How same store is that? Is that a same store number, or are you adding stores in Florida contributing to that growth?
I don't think we added any PartsPlus stores, if that's the question, because I don't think we added any in Florida. I don't really think about it for our business quite that way, Robert. I think we had more dealers than we did last year because that's how we gained market share. I don't view it as sort of same store sales. I view it as, did we gain share or not, and we did.
Got it.
The market was up.
Right. I guess just lastly, following up, I think, with Joe's question about the way the share recapture is included in the numbers. That $28 million of revenue in this quarter is not just volume lost, it's net of what you've estimated is recaptured share. Is that right?
Correct.
I guess too, same thing at the EBIT line?
Correct.
The fact that the EBIT tracked a little bit better on insurance recoveries, even though the revenue was, or the share recapture was lower, is just kind of out of period items?
Correct. In some way, we gave rough guides last time, but the $18 million of insurance proceeds in Q2, I would tie to the $18 million lost profits we had in Q1, so it sort of lagged, not sort of, it lagged it by a quarter.
All right. Thanks for clarifying all that.
Thanks.
Next, we go to Josh Pokrzywinski with Morgan Stanley. Please go ahead.
Hi, good morning, guys.
Hey, Josh.
Todd, I wonder if you could calibrate something for me. We've kind of touched around a few of these elements with the pre-buy around the furnace standard and some of the growth differential between the independents and the company-owned.
I guess, how should we think about that into the second half? Do the independents go the other direction? Can you size up the magnitude of what you thought was maybe pre-bought there versus underlying?
I don't have the math in front of me, Josh. We'll put it together. The pre-buy versus our competitors was dramatically less just because we didn't have the factory capacity to be building the pre-regulatory furnaces like others may have done. I think that's part of it.
I think Allied doing better or our independent distribution doing better during second quarter was, I think, more driven by the ability not to be impacted by the tornado to the same degree, that the independent distributors were able to hang on to dealers with other brands, which our Lennox distribution, by definition, wasn't able to.
Got it. That's kind of where I was going with this is, obviously, your competitors who don't have substantial company distribution are able to fill the channel a little bit more. I think Carrier was still taking pre-buy orders through May.
Does that mean then that it's not just a timing flip where they've already made the sale in the first half, they can't in the second half. Through company-owned, you can make that in the second half. I guess, in the absence of a big pre-buy or the notion of that, maybe not as big of a flip into the second half is how I should read that?
I'm not sure I follow the question.
Yeah, so the-
If you're a company like Carrier who's selling to independent distribution, the revenue first half of the year will be overinflated, and the revenue second half of the year will be deflated by that fact.
If you're company-owned distribution like we are in Lennox branded, our revenue versus competitors would have been understated during the first half of the year and overstated during the second half of the year.
The reason I haven't spent a lot of time talking about that is that's like a third-order equation after the tornado, after the weather, I think that's sort of a rounding issue of a couple point share there. I think on Allied, again. We got some tailwind from selling furnaces first half of the year, and that'll be a headwind second half of the year.
I think the amplitude of that was less than our competitors because we didn't pre-build as much. That the greater driver of the disparity between our Lennox brands and our Allied brands during second quarter was driven more by this issue of regaining the lost share more seamlessly through independent distribution than company-owned distribution, because independent distributors were able to avoid losing dealers by using alternative brands.
Got it. Just one more point on this. I don't mean to belabor it. I'm trying to pull it out. You know what? I'll follow up on it. It's a little overcomplicated. I'll leave it there. Thanks for the color.
Thanks.
We'll go to John Walsh with Credit Suisse. Please go ahead.
Hi, good morning.
Hey, John.
Hey. Just a question around the strong price realization. Obviously, a lot of different things are going into price right now, whether it's general inflation, tariffs, right? You mentioned earlier about consumer confidence.
Wanting to kind of understand how much of that price is driven by maybe people mixing up to a higher SEER or going kind of beyond that opening price point. Any way you kind of want to articulate it would be helpful.
I think most of it's just straight price. There's a little bit of mix in the quarter, but given the tornado impact, given the weather, the mix sort of wasn't on its normal trajectory. That's just two price increases being passed on.
Got you. I think in refrigeration you made this comment, you're seeing the customers defer some spending, just kind of given the macro. Any more color around that? Is it which kind of vertical you're seeing that in, and if it's kind of we're pushing it one to two quarters or if it's kind of they're actually waiting to see if the capital project moves forward?
I think it's just on the margins, and I think we're primarily exposed to grocery and cold storage, and the question is do you build new Not so much on stores, but on cold storage facilities. Do you build new cold storage facilities? Do you invest the capital? I think it's sort of the macro investment decisions we're seeing across sort of corporate or industrial America.
All right. Well, thank you.
Thanks.
Our next question is Nigel Coe with Wolfe Research. Please go ahead.
Thanks, guys. Good morning.
Hey, Nigel. How are you?
Good, thanks. Obviously covered a lot of ground here. Just want to understand the market share dynamics in 2Q, because you didn't actually lose any share in 2Q 2018. Therefore, to be talking about regaining share seems illogical. I'm just wondering, are we talking here about dealers that went away in the second half of the year that haven't come back? Is that how you're measuring the market share loss in 2Q?
Yeah, exactly. The 28 is in that number, dealers who we lost in fourth quarter, if we hadn't have gained them back, the impact in second quarter would've been significantly greater than $28 million.
Okay, that's great. I think you called out 40% exposure to the Central States, Midwest states. Would that include the Central Southwest as well? We're talking here about Texas, Oklahoma, those systems, or not just the classic Midwest?
Yeah. The swing regions, I'll call it out, is the traditional Midwest, which is, for you football fans out there, the Big Ten. It's Illinois, Indiana, Michigan, Ohio, Wisconsin. The Central Plains, which is really Missouri, Iowa, Minnesota, Nebraska, and obviously to much less degree, the Dakotas. South Central, to your direct question, Texas, Louisiana, Arkansas, Oklahoma.
Okay. That makes total sense. Then just two more quick ones to tick off here. You talked about the insurance negotiations for FY 2020. I understand this is a somewhat sensitive topic, but conceptually, do you get compensated for one full year of lost profits, or is it not that simple?
It's not that simple. We're in detailed negotiations where we're justifying everything, both sort of impact to the factory plus lost revenue. In some ways I would call speculative lost revenue, and it all gets thrown up in a mixer and at the end of the day, we'll work out a number.
We've guided to the best of our ability publicly of what that number is and how much we've set, how much we've gained so far, and what we expect that number to be. I'm looking around because I got so many numbers. I think it's 472, right? 372.
372.
Not a 400.
372.
We've received 252 to date, so we still have 120 to negotiate, and that's our best estimate.
Okay, great. Just a quick one on pricing. We covered pricing in a fair amount of detail. There's been a little bit of chatter about dealer incentives picking up during 2Q, towards the end of 2Q. Have you seen that? Is that a risk in any dimension for the back half of the year?
It's not a risk for the back half of the year. It's when the weather's that cool and the volume's that soft and people start spiffing to try and move volume. Quite frankly, we did the same thing.
Okay. Thanks, guys. Good luck.
Thanks.
Our final question will be from Damian Karas with UBS. Please go ahead.
Hey, good morning, guys.
Hey, Damian.
Appreciate you fitting us in here.
Of course.
Just a clarification on plant capacity. You had shifted some additional production down to Mexico as a result of the tornado. Where exactly do things stand now with respect to the production split across your three facilities comparing to before the tornado in Marshalltown? Is there still some shifting that you'll be looking to do in the future?
We're always looking to shift in the future. That's still out there, and that continues to be out there, and we'll continue to look at our footprint and try and drive the lowest cost. In terms of the shift of the volume for the tornado, we moved capability both to South Carolina and to Mexico. That capability still remains there. We're up and running all the products in Marshalltown that we were producing prior to the tornado also.
Got it. Just curious, have you felt any pushback from customers on having some of that Dave Lennox signature branded product coming out of Mexico now?
No. Zero pushback. We've been building in the Mexican facility for almost a decade now. Many of our largest dealers have visited the facility. They know how the quality is. They don't care whether it's made in Mexico or whether it's made in the U.S. It's the exact same quality.
Very helpful. Thanks.
Thanks.
With that, I'll turn it back to the company for any closing comments.
Thanks a lot, operator. To wrap up, we've reset guidance after significantly adverse weather in the second quarter and have reduced the outlook on commercial and refrigeration end markets in North America for the year. Looking ahead, weather aside, the residential market continues to look robust.
Commodity costs are trending down for more price cost benefit moving forward, and the investments we have made in products and distribution set us up well for 2020 and for the second half of 2019. Thank you all for joining us today.
Ladies and gentlemen, that does conclude your conference. Thank you for your participation. You may now disconnect.