Welcome to the Lennox International first 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 would now like to turn the conference 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 first 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. 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 first quarter and key points on each of our businesses, and then discuss the accelerating recovery in our residential business from the tornado impact, as well as insurance proceeds for this year. On a GAAP basis, company revenue was $790 million, down 5%, including 10% of negative impact from the tornado and divestitures. Foreign exchange had a negative 1% impact on revenue growth. On an adjusted basis, excluding divestitures, company revenue was a first quarter record $756 million, up 1%, including negative tornado impact of 5%. Foreign exchange had a negative 1% impact on revenue growth. GAAP operating income rose 79% to a first quarter record $95 million. GAAP EPS from continuing operations was up 92% to first quarter record of $1.73.
On an adjusted basis, total segment profit rose 34% to a first quarter record of $99 million. Total segment margin expanded 330 basis points to a new first quarter high of 13.1%. Adjusted EPS from continuing operations rose 38% to first quarter record of $1.68. In our residential business in the first quarter, revenue set a new first quarter high of $466 million, up 3%, including 8% of negative tornado impact. Revenue was up in both replacement and new construction business. Residential segment profit rose 69% to $87 million. Adjusted for a $22 million net profit resulting from a $40 million of insurance proceeds against $18 million of negative tornado impact, residential segment profit was up 26% in the quarter. Residential segment margin expanded 730 basis points to 18.6%. Adjusted for the tornado impact insurance recovery, segment margin expanded 160 basis points to 12.9%.
Turning to commercial in the first quarter, revenue was down 3%. Segment profit declined 31%. Segment margin was down 360 basis points to 8.7%. Commercial revenue in the first quarter was driven by a mid-teens decline in new construction, well known for being a lumpy business. In both 2017 and 2018, for example, we had two quarters of strong growth and two quarters of a decline in new construction revenue. In replacement business, revenue was flat in the quarter, with planned replacement down a couple of points, but solid growth in emergency replacement up mid-single digits. In both new construction and planned replacement, we saw some National Account customers temporarily pause investment in the context of all the government and macroeconomic uncertainty in the market in the first quarter. Currently, however, we are seeing backlog up nicely heading into our seasonally largest quarters.
Operationally, we continue to focus on productivity improvements at our factory in Arkansas. We have been addressing labor shortages and inefficiencies in recent quarters. In the first half, we are continuing to focus on training for all the new employees brought on board full time and ramping up productivity further. Our VRF business saw strong double-digit growth in the first quarter. On the service side, Lennox National Account Services revenue was up mid-single digits. We continue to expect commercial segment growth and margin expansion on a full year basis, with revenue up the remainder of the year and margin expansion in the second half. In refrigeration for the first quarter, revenue was up 2% at constant currency. We had 4% of negative foreign exchange impact in the quarter. Regionally, North America was down mid-single digits due to the same dynamics as I mentioned for commercial.
We saw some customers temporarily pause investment in the context of all the government and macroeconomic uncertainty in the market. As in commercial, refrigeration backlog is building up nicely as we enter our strongest seasonal periods. In Europe, revenue was up low double digits at constant currency, with refrigeration down slightly and commercial HVAC up more than 20%. Both of these businesses can be lumpy on a quarter-to-quarter basis. Refrigeration segment profit was down 20% in the first quarter. Segment margin was down 180 basis points, 8%. Lower mix was a factor with the fast growth in Europe and volume was down for the segment overall. We continue to expect refrigeration segment growth and margin expansion on a full-year basis, with revenue up the remainder of the year and margin expansion in the second half. For the company overall, the second quarter is off to a solid start.
We are reiterating our revenue and adjusted EPS guidance as we look ahead to another year of strong growth and profitability. We are raising our guidance for stock repurchases this year from $350 million to $400 million. Before I turn it over to Joe for more financial details on the quarter and our outlook, let me summarize where things stand on the tornado impact and insurance recovery this year. Big picture, for core and non-core related to the tornado, we now expect total insurance proceeds of approximately $358 million, about the same as the $356 million in previous guidance. We have received $124 million of that of 2018, and expect approximately $234 million in 2019.
The non-core gain expected for the difference in book value and replacement value of assets is now approximately $91 million, down from the previous guidance of $109 million for 2019 due to lower estimated construction costs. Approximately $1.79 benefit to GAAP EPS versus a benefit of about $2.30 in previous guidance. From core perspective, our residential business continues to make significant progress. We're seeing acceleration in the recovery from the tornado. As I mentioned previously, we were back to full production across all three of our residential factories for cooling product by the end of the fourth quarter of 2018, and are there as well for heating products as of the end of first quarter 2019. We are taking back business as the market as we resupply dealers and are focused on fully refilling our company-owned regional and local distribution network.
The expected negative impact from the tornado is down from our prior guidance, as the team continues to perform operationally and take back business for Lennox in the market. From a core perspective in the first quarter, the negative tornado impact on revenue was $35 million versus guidance of around $42 million. The negative tornado impact on segment profit was $18 million in the first quarter versus guidance of around $21 million. For revenue in 2019, we now expect $70 million of negative tornado impact, down from the prior guidance of $85 million. We estimate $40 million of negative segment profit impact, down from a prior estimate of $43 million. The business interruption insurance recovery for lost profits is expected to be about $80 million in 2019, compared to $83 million in prior guidance.
This results in a net segment profit impact of positive $40 million in 2019, the same as in prior guidance. Of the remaining negative tornado impact for 2019, we expect a hit of approximately $21 million in revenue and $13 million in profit for the second quarter. For the third quarter, we expect a hit of approximately $14 million to revenue and $9 million to profit. For the remaining $40 million in insurance recovery in our core guidance, we expect that to flow evenly across the three remaining quarters. A lot there. We have posted a tornado financial update chart on our website with the details reflecting prior guidance and the current view. Now I'll turn it over to Joe.
Thank you, Todd, and 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 first quarter, revenue from residential heating and cooling was a first quarter record $466 million, which was up 3%. Volume was flat, price was up 2%, and mix was up 1%. Foreign exchange was neutral to revenue. Residential profit of $87 million was up 69%. Segment margin was 18.6%, up 730 basis points. Segment profit was favorably impacted by a net $22 million of benefit from insurance proceeds relative to negative tornado impact in the quarter, as well as higher volume, favorable price and mix, and sourcing and engineering-led cost reductions. Partial offsets included higher commodity, freight, tariffs, and warranty costs, lower factory productivity, distribution investments, and higher SG&A expenses. Turning to our commercial heating and cooling business.
Commercial revenue was $173 million in the first quarter, down 3%. Volume was up 6%, price was up 2%, and mix was up 1%. Foreign exchange was neutral to revenue. Commercial segment profit was $15 million, down 31%. Segment margin was 8.7%, down 360 basis points. Segment profit was impacted by lower volume and factory productivity, higher commodity, freight, tariffs, warranty, and other product costs, distribution investments, and higher SG&A expenses. Partial offsets included favorable price and mix and sourcing and engineering-led cost reductions. In the refrigeration segment, revenue was down 2% in the first quarter. Volume and mix were flat, and price was up 2%. Foreign exchange had a negative 4% impact on revenue. Refrigeration segment profit was $9 million, down 20%. Segment margin was 8%, down 180 basis points.
Segment profit was impacted by lower volume and factory productivity, unfavorable mix, higher commodity, tariffs, and freight costs, distribution investments, and higher SG&A expenses. Partial offsets includes favorable price and sourcing and engineering-led cost reductions. Regarding special items in the first quarter, the company had a net after-tax benefit totaling $2.2 million. That included a gain of $5.2 million from insurance recoveries, net of losses incurred, a benefit of $4.4 million for excess tax benefits from share-based compensation, a loss on the sale of business of $5 million, $1 million for non-core business results, and a net charge of $1.4 million for various other items. Corporate expenses were $12 million in the first quarter. On a GAAP basis, overall SG&A was $146 million, or 18.4% of revenue, down from $155 million, or 18.6%, in the prior year quarter.
Net cash used in operations in the first quarter was $141 million compared to a use of $84 million in the prior quarter. Capital expenditures were $37 million compared to $23 million in the first quarter a year ago. We also had proceeds for tornado damage to property, plant, and equipment that totaled $7 million. In the first quarter, we used $171 million of free cash flow compared to a use of $106 million in the prior year quarter. The increase in use of cash for the quarter was the result of timing of payments tied to the reconstruction of Marshalltown and was in line with our expectations. Given our business seasonality, we use cash in the early part of the year and generate cash in the latter part of the year. The company paid $26 million in dividends in the first quarter and repurchased $100 million of stock.
Total debt was $1.3 billion at the end of March, and we ended the quarter with a debt-to-EBITDA ratio of 2.0. Cash and cash equivalents were $32 million ending the quarter. Before I turn it over to Q&A, I'll review our outlook for 2019. Our underlying market assumptions for the year are unchanged. For the industry overall, we expect North American residential HVAC shipments to be up mid-single digits. We expect North American commercial unitary shipments to be up low single digits, and we expect North American refrigeration shipments to be relatively flat. For the company in 2019, we are reiterating revenue growth of 3%-7% with neutral foreign exchange. We are updating GAAP EPS from continuing operations from a range of $14.30 to $14.90 to a new range of $12.65 to $13.25.
This incorporates the benefit from special items in the first quarter, lower estimated factory reconstruction costs, and the associated gain of approximately $91 million, which was the $109 million in the previous guidance for 2019 that results from the placement of value above book value, and a non-cash pension settlement charge of approximately $61 million pre-tax in the second quarter of 2019. The pension settlement charge relates to an agreement 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 will result in a $61 million non-cash pre-tax settlement charge in the second quarter of 2019 to write off the related accumulated actuarial losses.
For adjusted EPS from continuing operations in 2019, we are reiterating guidance for a range of $12 to $12.60. Now let me run through our key points on our guidance assumptions and the puts and takes for 2019. We still expect to capture $80 million of additional price for the year. We are planning for a $25 million benefit from sourcing and engineering-led cost reductions and an $8 million benefit from residential factory productivity. We still expect a $30 million headwind from commodities, and that's $15 million from freight and $10 million from tariffs. We continue to expect headwinds of $15 million for distribution investments and $15 million from SG&A. Net interest expense is still expected to be approximately $45 million.
Corporate expenses are still targeted at $90 million for 2019, and we still expect an effective tax rate in the range of 22%-23% on an adjusted basis for the full year. Now a couple of updates. Capital expenditures are now expected to be $195 million, down from the $215 million in the previous guidance. The change is due to lower reconstruction costs to complete the Iowa manufacturing facility. We now expect this to be $95 million versus the prior guidance of $115 million and will be funded by insurance proceeds. Finally, we continue to expect the weighted average diluted share count for the full year to be between 39 to 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 *1. You'll hear a tone indicating you've been placed in the queue. If your question gets answered or you wish to remove yourself from the queue, please press the # key. Again, *1 if you have a question. First, we have Julian Mitchell with Barclays. Please go ahead.
Hi. Good morning.
Hey, maybe just the first question around the commercial margins. I know you talked on the last call about headwinds in Q1 from labor inefficiencies and factory productivity. I just wondered if the margin decline in Q1 that you saw was worse than you thought, and how you think about the timetable of getting through those productivity issues over the balance of the year.
It's quite frankly, a little worse than what we thought, and we now think it's going to be second half of the year before we see margin expansion. There were 2 things, though, in the quarter for commercial above and beyond the factory. We had lower volume as well as the lower factory productivity, as we discussed. The lower volume hurt us on absorption. As I talked about in the script operation, we continue to focus on productivity improvements at our factory in Arkansas. We've been addressing these labor shortages, and we continue to focus on training and ramping everybody up. Also, in second half of 2019, we expect to have a larger positive gap between price and commodities, freight, and tariffs. On a full year basis, we're ahead as a corporation. In commercial on a full year basis, we're ahead.
In first quarter in commercial, we were negative price cost, the elements I just said, because it takes a little longer for commercial to get price in the marketplace from the price increases they announce at the end of the year. Second half of the year will have a positive gap between those 2. As I mentioned on the script, margins are up nicely, which is up mid-single digits as we enter the quarter. As we enter a quarter in commercial, about 50% of our revenue's already in backlog, and 50% we have to book and ship.
Thanks. My second question on the residential business. Any update on sort of broad end market conditions, how you're feeling about Q2, and also if the market share progress you're making is in line with what you'd hoped coming out of the tornado impact?
Short and long answer is we're actually slightly ahead of where we thought coming out, or when we guided last time of winning back share, and you saw that in a lower tornado impact to core earnings. In other words, we sort of over-delivered on the revenue and EBIT side for residential ex the tornado. I'd look at our results for first quarter revenue was up 3% at actual in residential, and then we said we had 8% of tornado impact, which implies we would've been up 11%. Residential's still going very strong, and we're getting ready for the summer selling season. We continue to gain back the share that was borrowed from us, and we're confident as we go through the year we'll do that.
Market conditions are as you thought as well?
Yes. It's always a little hard to tell when you're this early in second quarter, but we have events, we call them Lennox LIVE, but they're really dealer meetings where we meet with thousands of our largest dealers in four or five locations around the country. The mood was extremely positive. People are excited, both loyal to us, at least that's what they tell us in the room when we bring them in. They're showing that with their spending. More importantly, people are confident going into the spending season.
You saw in our commercial refrigeration numbers, which I think are more tied to sort of concerns that you get by watching cable news. I think there was some softness that was attributable to our softness in commercial and refrigeration that was tied to sort of this macroeconomic overhang in North America or certainly in the U.S. I think that's now behind us. All three of our businesses as we go into the summer selling season feels pretty good.
Thank you very much.
Thanks.
We'll go to Jeff Hammond with KeyBanc Capital Markets. Please go ahead.
Hey. Good morning, Todd. How are you?
Good. How are you?
Good. Just going back to the kind of share recapture. Just what are your experiences as you talk to dealers, and are you expecting some dealer attrition? It just seems like some of your competitors were suggesting that they'd be able to hold some of this share shift.
Yeah. Short answer is yes. There's some dealers we lost that won't come back. At the same time, every year we have net hundreds of dealers that we bring on. We lose some, we bring new ones on. When it's all said and done, they can't hold all their dealers. They can't hold all their dealers plus the ones they took from us. We're attacking on a broad front, both winning back our dealers who they borrowed share from, but also going after their existing dealers. We're attacking on all fronts. We're real confident at the end of the year we're going to be in a good share position, and we're seeing it in the numbers.
Okay. Just on refrigeration, just confidence that steps up given some of the, I guess, pause or concern as we move into the latter part of the year?
Yeah. As confident as you can be when you have 50% of backlog for the quarter and you still have to book and ship, we're up double digits in refrigeration backlog entering the quarter. Like commercial, 50% of it we still have to book and ship, 50% of it's in backlog. Like commercial, it can be lumpy. Where we saw the softness was in North America, which was down mid-single digits. Our European business was actually up. I think that ties to the theory of the case that I said earlier. Again, we're confident going into the balance of the year. Like commercial, there'll be a lag on price cost. Margin expansion will be second half of the year, we expect revenue to be up second quarter.
Okay. Thanks a lot.
Thanks, Jeff.
Our next question is from Ryan Merkel with William Blair. Please go ahead.
Hey, thanks. First question is on second quarter. You said it is off to a solid start. I just want to confirm, is this true across all the segments?
Yeah. I'll give you the math again. Commercial backlog up mid-single digits. Refrigeration backlog up double digits, and residential, where backlog doesn't much matter. We are off to a solid/strong start. Again, the reminder, obviously, that you know, Ryan, but I'll say to others is April's about 20% of what we do. May is about a third, and June's half. Bottom of the first, we are doing well, but we still have eight innings left though.
Got it. Okay. Secondly, commercial margin expansion the second half of 2019. Maybe just give us some context on the second quarter. Should we be lowering our expectations? Is that what we're sort of hearing?
Yeah. What I'm trying to tell you is I think I would guide that margins will be flat to down in the second quarter, and they'll be up second half of the year. It's a combination of still ironing out some of the factory productivity issues we have. The roadmap's in place. We're executing. It's just a matter of when you have 1,500 people in a factory, and a lot of them are new, getting everyone trained up. The second is price cost was negative in commercial first quarter, will be relatively flat in second quarter. Second half of the year, we have positive price cost.
Got it. Maybe just quickly, lastly, it's good to hear you're taking back share in the resi business, are you having to do less discounting than you expected?
I think I'd answer it this way. We got 2% price in the quarter. We see it in the numbers, and we're real confident we're going to get 2% price. I won't necessarily get into what we expected, we're getting the price increases that we had hoped for and what we guided to, and we're sticking to price.
Okay, great. Thanks so much.
Good. Thanks.
Next, we'll go to Nicole DeBlase with Deutsche Bank. Please go ahead.
Yeah, thanks. Good morning.
Hey, Nicole.
Hi. With respect to the margin improvement that you guys expect for commercial and refrigeration for the full year, is it possible to get a sense of the magnitude? Are we talking about 10, 20, 30 basis points? Just to give us some conviction around what's embedded in the second half.
Yeah, this early in the year, I'm not going to guide to margins. I think I'm giving more than I normally do on segment guides. We're guiding that both will be up year-over-year for the full year. We'll be up second half of the year, and we'll be down first half.
Okay. Understood.
The way I frame it, I'm not breathless about the margins, but we're confident they're going to be up.
Okay, got it. Then on capital allocation, I know you guys raised the buyback guidance. Makes a lot of sense. It seems like it's deployment of Kysor proceeds. What does that indicate with respect to the M&A pipeline, if you could talk about that a little bit?
I think there's no read-through to the M&A pipeline. Our M&A pipeline, as we've talked about, the thing we'd be interested in would be HVAC North America. That would be large and lumpy. When that time comes, if that time comes, then we'll figure out how to finance it and take care of it in a shareholder-friendly way. In lieu of that, we're not going to let the balance sheet grow, and we'll give money back to shareholders.
Got it. Thanks.
Thanks.
Next question's from Robert McCarthy with Stephens. Please go ahead.
Good morning, everyone.
Hey, Rob. How are you?
Good. I guess maybe you could just augment some of your comments around the home building channel. I think you said positive growth there and what you're seeing there. Then, not to beat a dead horse, but it sounds like you're really typifying this as a pause as opposed to something worse, particularly in the commercial channel in North America. Obviously, you have a limited visibility, but maybe you could just reiterate what the strength of your argument is there.
New construction and residential is up low single digits for the quarter. Again, that's with the tornado impact. We didn't break out the 8% tornado impact between new construction and replacement, although I would tell you the vast majority of it was replacement. New construction was up sort of low to the mid-single digits, roughly in line with what we expected for full year. Again, when we talked to the builders going into the summer building season, they remained confident. In terms of commercial and also I'd extend it to refrigeration. It was an industry phenomenon. There were three or four months where the industry was down. We were part of that. We saw industry data for February that started to recover. As I said, we can see it in our order book and our backlog where our commercial business is up mid-single digits.
We talk to the customers, they're confident. We've seen last year in 2018, we had a couple of quarters where we were down and a couple of quarters that we were really strong. It's not unusual for that to be the case with this business.
Any comments you can make around the segments in terms of is there any change that we could see in terms of underlying incremental margin lift at refrigeration and commercial? Obviously, given the fact that you changed margin targets of refrigeration, that should be the case. Any kind of color how we should be thinking about incremental margins at the sub-segment level for those two, and then just in the context of resi?
I'm not going to at least I don't have any guide points that I'm going to share right now for 2019. The three-year targets, no. The three-year targets for resi are 2019 to 2021, and for commercial 2019 to 2021, and for refrigeration 2015 to 2017. I think about it roughly as a straight line between 2017 and 2021 to get there. Excuse me, 2018 and 2021 to get there. I think I've been pretty clear about, I've said it three or four times, that commercial and refrigeration will be back half of the year this year.
Congrats on the solid start.
Okay, thanks.
We'll go to Jeffrey Sprague with Vertical Research Partners. Please go ahead.
Thanks. Good morning, everyone.
Hey, Jeffrey.
Hey, just back to the share recovery, Todd, if we could.
Yeah.
Could you still elaborate a little bit actually how you're calculating that at this point, right? I would imagine it's somewhat imprecise, but we're talking relatively precise numbers. Is the 8% unfilled orders, or is it some other kind of mathematical construct?
It's a couple ways, and we sort of triangulate then it's, quite frankly, how we're talking to the insurance company also. We understand what the market does, and we understand what our share was going into the tornado. We understand the delta between what quote-unquote, "our revenue would have been," and what it was. That's top-down. The other way we do it is we know literally by customer who left us, who we allowed to leave, how much business they took, and then we can tell how much we're winning back as we get it back. We have a pretty clear line of sight of what was lost, who it was lost with, how much was lost. Quite frankly, who took it, borrowed it from us.
When it comes time as it is now to get it back, we know exactly whose door to knock on and how to get it back.
To the extent that a portion of this is maybe a struggle for dealers as opposed to a struggle for volume within a dealer, are there non-price things going on in your business? Kind of pledges to dealers, some give backs, rebates, things like that show up at some point in the future, or do the numbers fully reflect the competitive dynamic that's going on?
They fully reflect the dynamic that's going on. In other words, just from the accounting, if we make a promise on some kind of spiff or kickback, then that's sort of reflected in the economics as we accrue the revenue against it. That's all in there. We're doing the basic things. Quite frankly, we always do when we convert dealers. In this case, it's getting back share. If somebody switched over to competitor X and they have a handful of furnaces or air conditioners, we'll buy them out. We'll take over the units from them. If they need some marketing support, we'll do that. There's lots of creative things we'll do, and we reflect it in the P&L. As I said earlier, we did better on revenue and getting back the share in first quarter than we initially guided, and we stuck to 2% price.
I would be nervous if we weren't sticking price, but we're sticking price.
Great. Thank you.
Thanks.
Our next question's from Robert Barry with Buckingham Research. Please go ahead.
Hey, guys. Good morning.
Hey, Robert. How are you?
Good, thanks. Maybe just to start with the weather, anything notable to call out there as either a headwind or a tailwind in the quarter?
No. It was a little bit cooler than it had been last year, on the round, the same number. Weather really didn't impact much.
Got it. If I pull out that $22 million net benefit from the tornado in resi, which I think as you highlighted, was kind of more than you expected. The underlying contribution margin there looks kind of, I don't know, mid-teens-ish maybe. I don't know if that's just seasonality or if there's anything mix going on in the quarter that you'd want to call out.
Here's how I think about it. It's just talking resi overall, right? You're talking resi?
Yeah.
Yeah. I would subtract the $40 million of the insurance proceeds, add back the $18 million of tornado impact, and then add $35 million of revenue. I think if you do that, it shows incrementals of 28%, 29%. I'm not sure where you get 13. I think it's 28%, 29%, and I think it shows margins up 150, 160 basis points.
Got it. Yeah, no, I'll definitely revisit the math there. On the commercial-
Hey, I think you were just testing my conviction, Robert. I don't think there's
Right. Well, I was also doing the math on the fly, so I'll check it. On the commercial, just anything from a vertical perspective in terms of pressure, any particular verticals under pressure?
No, it was across the board. We're half national accounts, so predominantly the story as you would expect, would be national accounts. I wouldn't bleed that over to the broader concern that we all have longer term about what's going to happen to retail. This is more people just sort of pulling back in and deferring. As you know, in replacement, for national accounts, the majority of the time it's planned replacement, so they have discretion that they can make decisions on, and it was just a matter of sort of pulling back a bit. New construction, same thing.
Got it. Just lastly, and I'll apologize in advance for kind of a more esoteric accounting question, but just looking through the K for last year, I think there was a fairly significant headwind in this kind of other product cost category. Which I think a lot of that was LIFO adjustments.
Correct.
Curious if there's any visibility there on, is that just going to expect it to be neutral this year or reverse or just any thought on how that might play in the P&L?
I'll give the layman's answer, and then I got Joe Reitmeier in front of me. LIFO is just an accounting attempt to true up at the end of the year what should or could have flown through the P&L during the year. It has to do with the timing of when the cost of inventory flows through the P&L. If you had perfect information, obviously, you'd sort of set it up so there was no LIFO adjustment. The negative LIFO that we saw last year was really more of. We had really good news or significantly good news in 2017. We had less good news in 2018, so it showed the change to the change was negative.
When we think about LIFO during the year, we never guide to it, we just sort of expect that it's going to be neutral during the year, that's how I'd encourage you to think about it.
Yeah. What we expect it to be, quite frankly, the way that we planned it and we're guiding is no impact in 2019 at this point. If that changes in future periods, we'll give you some heads up.
Got it.
All right. Thanks.
Yes.
Our next question is from John Walsh with Credit Suisse. Please go ahead.
Hi. Good morning.
Hey, John.
Talking to some dealers, we heard that there's some new fan efficiency rating requirements that are going to be coming online this summer. I believe it's more related to the heating side instead of the AC side, but just wanted to maybe understand that dynamic a little bit and if you're seeing anything outside of kind of the normal share recapture that would distort the way to think about this cooling season.
Why don't I talk about the regulatory change and talk about how it'll impact us, then I'll make sure I capture the share impact at the end, because the answer to that is, yeah, there's some things that'll take place with those who have independent distribution. On July 3rd of this year, there's a furnace fan efficiency rating, FER regulation is scheduled to go in effect. This requires a move from standard efficiency, what are called PSC motors, to a higher efficiency, what are called constant torque or variable speed motors. It's probably more technology than anyone would've called once, but from a business point of view, the regulatory change is going to add about $25 to $50 to the cost of a furnace.
This regulation is based on manufacturing stop date for the standard efficiency units, and companies continue to sell them after that date, i.e., you can build up inventory at independent distribution or company distribution to sell later. Like we've done on other regulatory transitions, we're going to have a pre-build of the standard units, as are our competitors, and we'll continue to sell them past July 3rd. The goal, and we're pretty confident we're going to do it, will be the same thing that happened on the 2013 to 2014 SEER transition, that you feather in the new units that are higher cost over time, there isn't a step function change in pricing. Better stated, there isn't this erosion of pricing on the older units, you sort of feather it in over time.
We're confident we're going to be able to protect margin and price when we go through this transition. I think the impact that you'll see in share will be, and you'll be able to pick it up on the AHRI data, that the April, May, June aren't big furnace seasons compared to the wintertime. Some of our competitors who are selling to independent distributors, you'll see a big spike in furnace share or furnace volume for them during that time period. That's them stocking independent distributors with these standard units that they can't build after July 3rd. You won't see that in our numbers because we'll carry the inventory ourselves, and we'll sell through the dealers during the furnace selling season that will come later in 2019. Was that clear enough, John?
Yeah. No, that was a great detailed answer. Appreciate that.
Yeah. No.
Maybe just a quick follow-up here. Given the move in copper, wouldn't necessarily expect any impact to 2019 given your hedges, but how do you think about that move and maybe further or around pricing potential?
We continue to remain confident we can get priced offset commodities. I prefer that all the commodities go down rather than up. If they go up, we'll price in the out years to do it. As of April, we're 73% hedged on copper for 2019, so we're pretty locked in. Again, as copper moves, we'll adjust.
Okay. Thank you.
Thanks.
We'll go to Steve Tusa with J.P. Morgan. Please go ahead.
Hey, guys. Good morning.
Hey, Steve.
What was price in the first quarter for residential? Price realized.
Turning to someone to make sure we got the right number.
It was a little more than 2% for the quarter.
Yeah, it's 2% for the quarter.
Yeah.
I know that. I don't know the exact number. 2% for the quarter.
Okay. Just to kind of better understand how you're calculating the tornado impact. Your revenue was-
I turn to somebody. It's $11 million.
Okay. Your revenue was up 3% or whatever, you're just kind of looking at just stripping out the impact of the insurance proceeds, which you could consider to be totally non-operational, if you will. Your profits were down. I guess if we're not adjusting I guess the point is you have extra costs that's just running through from all these things that kind of skews that kind of profit performance. It's not just kind of an incremental margin on the lost volume. Is that the correct way to kind of think about it?
No. I'll tell you how I think about it. We've been clear from the beginning that the drop-through on the lost revenue was going to be a rich drop-through. The guide for the quarter or the actual for the quarter, which is better than our guide, was $35 million with the tornado impact. $35 million. Someone in the background is yelling and agreeing with me. It was $35 million of revenue impact and $18 million of EBIT impact from the tornado. That's because it's our highest margin product. It's really rich mix coming out of Marshalltown. If you take what our reported results were and subtract $40 million from the insurance proceeds and add back $35 million of revenue and $18 million of EBIT. What you'll see is that our earnings were up 25% in resi, and that our margins expanded 150, 160 basis points.
We had a 28%, 29% incremental. That's how I do the math, and the story is just what I thought it would be. I think your math isn't taking into consideration $35 million of revenue yielded $18 million of EBIT, and that's because it's such a rich mix of product.
Okay, got it. I guess if we just look at it on a real-world basis, that would suggest that your profits would have been down on these lower-mixed units, on growth in those lower-mixed units.
Yeah, exactly.
Okay.
In essence, the tornado impact, we lost the cream off the top, right?
Yeah. Okay.
Yes, we had lower margins.
Okay, great. That's really helpful. Thanks.
Yep. Thanks.
Our next question is from Joe Ritchie with Goldman Sachs. Please go ahead.
Thanks. Morning, guys.
Hey, Joe.
Hey. Todd, your comments earlier on resupplying your dealers. I'm just curious, when you think about sell-in versus sell-through in the resi channel, how far along are you on the sell-in process?
We're 75%-80% owned distribution. We don't sell in, sell out. We just sell out. We don't recognize it until we sell the product. On our Allied business, there's some inventory loading with selling in. The sell in, sell out is really for people who are dominated or have large independent distribution. That's not us. Our numbers are 80% sell through. That's all we report.
Maybe asking that a little bit differently. In terms of getting your inventory levels back to where they need to be, do you feel like you're there at this point, or is there still some room to go?
There's still some room to go. We turned on full production at the end of the first quarter. It's now April, we're still sort of running our residential factories hard to get ready for the summer selling season.
Okay. Maybe one follow-on, as I kind of think about some of the cost headwinds that you guys outlined for the year, whether that's commodities, freight, tariffs. I guess, how should we be thinking about the cadence? Was there potentially a disproportionate impact in one Q, or how are you guys thinking about it as the year progresses?
We're thinking about it as that about a third of the benefit. We've said that price will be $80 million and commodities, freight, and tariffs will be $55 million, so we're going to be +$25 million. We think order of magnitude, a third of that will be first half of the year, and two-thirds of it will be second half of the year. It's going to be back-end loaded.
Okay. Do you guys have a number for 1Q at your fingertips for the cost impact?
1Q, we were slightly negative.
Slightly negative. Okay, thanks, guys.
Thanks.
Next, we'll go to Deepa Raghavan with Wells Fargo Securities. Please go ahead.
Good morning.
Good day.
Can you comment on your residential momentum in the quarter? I know backlogs don't matter. You spoke pretty extensively about residential, but just curious, how was the progression from March to April? March was a big month. Also, like some other distributors called out, was Easter a benefit in the quarter and therefore probably a pull forward from Q2? Just curious, and any other puts and takes from a year-on-year perspective or a seasonality perspective as we think about Q2.
Yeah, I don't think Easter much matters. I understand Good Friday is a selling day, but I don't think Easter. It's not like Christmas where it's a week of activity gets delayed or deferred. It's like a day of activity and not for lapsed Christians. I think in terms of the timing and the momentum of the business, I think the end markets remain strong and solid, but it's more about our performance. The factories are roaring. We're producing all the product lines. We're sort of out there gaining back share. The momentum in the residential business is strong as we go in the second quarter.
Got it. This is probably just a forward-looking question. Can you comment on if you would be impacted by any Mexico border closure, if that happens at all? What could some of the steps be that you should be taking to work around such an event? Thank you.
Yeah, we would be impacted by a Mexico border shutdown, and parenthetically so would most of corporate America. Obviously, we produce a lot of production in Saltillo, and as a percentage of our business, even more than it was a year ago. We source components from Mexico for our North America factory, so the shutdown would impact us. We're doing the things you might expect to do, looking at different options about buffering inventory in and different ways to get it across the border. The short answer is, if the border gets shut down, we're all going to be impacted, and we'll all scramble.
Okay. Thank you. That's all I had.
Thanks.
Next, we'll go to Tim Wojs with Baird. Please go ahead.
Hey, gentlemen. Good morning. Just two quick ones for me. First, just on the CapEx reduction, is there any reason why that $20 million shouldn't flow down into free cash flow for the year? Secondly, just what's the right quarterly D&A number once the reconstruction at Iowa plant is fully in the P&L?
Yeah, Tim, I'll take the capital spend comment. That's really tied to the reconstruction of Marshalltown, there'll be a direct reduction in insurance proceeds as well for the capital expenditures there.
Okay.
[Todd] , any comment?
Yeah. Depreciation amortization, we have $80 million for the full year. That'll impact us more as we get into 2020, but not so much in 2019.
Okay, great.
Thanks, Tim.
Next question's from Gautam Khanna with Cowen and Company. Please go ahead.
Thanks. Good morning, guys.
Hey, Gautam. How are you?
Doing well, thanks. A follow-up question on the commercial productivity comment you made in the warranty expense. Just, is there any amplifying color you can give on what's at the root of the problem there?
I don't remember saying anything.
if it's behind us or
Yeah, I don't remember anything about saying anything about warranty, but, I mean, the issue has to do with productivity, and it has to do with.
Productivity
We're a seasonal business. We bring in a significant amount of temp workers every year into the factory, and when unemployment's at record lows, but lows that none of us have seen in our business lifetime, it's much harder to get workers. It has to do with attrition and absenteeism and training the workers we have. We've made some adjustments. Quite frankly, we've raised the wage rates. We've changed the way we're operating with direct labor in the factory and, I'll be frank, I thought at the end of the first quarter it'd be behind us. It's lingered longer than what we had hoped, but I'm confident we're doing the right things and we'll get it better.
Okay. No, the warranty reference was in the release, higher warranty.
Yeah
year-over-year and other product costs, okay.
Yeah, that's really more of the absence of good news versus bad news in the year. That's what the difference is.
Okay, fair enough.
Yeah, good catch. Thanks.
No, no, that's helpful. I appreciate it. If you could just comment on the competitive environment across the three segments, if there's been any change more. Obviously we understand the resi dynamic of temporarily donating some share. If you could just talk about, have you seen any incremental price pressure? Is the industry still quite disciplined in terms of kind of raising price to offset commodity and holding it? Anything you've seen that would signal any sort of change relative to a quarter or two ago?
No. I mean, price realization's always the acid test of an industry dynamic, and we continue to get price in the marketplace across all three of our segments, and we're confident that we'll do it. I mean, residential is sort of now fun again. I mean, I think about the analogy, I'll mix two or three metaphors here, but you think about a fighter with an arm tied behind his back, and that's what our sales force felt like, and now their arm's released. They're wild dogs chasing after raw meat in the marketplace after being held back. We're excited going into the second quarter.
Last one for me. Just now that Marshalltown is back online, any change to how you guys, the production system, if you will, and how you're gonna source more or less from Marshalltown relative to South Carolina and Mexico? Anything you can comment about how that might change relative to pre-tornado?
No, I think it's what I said earlier about this, that we've built capability at our other two factories to do premium product, and we're glad we now have that capability there, and we don't plan on sort of eliminating that capability. Man, we're really glad we had the Marshalltown team, and they've done a heroic job and having all that experience allowed us to come back. We're excited about the Marshalltown team, but obviously we're excited about continuing to grow our Mexico facility and our South Carolina facility also.
Thank you, guys.
Thanks.
We'll go line of Josh Pokrzywinski with Morgan Stanley. Please go ahead.
Hi, good morning, guys.
Hey, Josh.
Josh, can you just talk a little bit about the 2Q3Q, I guess, both changes and just how you're thinking about the lost profits there? Seems like with heating and cooling now being both at full strength, I get that there's some temporary share shift that comes back and forth. But just any reason why those numbers couldn't be lower still? I think, just case in point in your table, you had it actually going up in 2Q in terms of lost profit. Anything you wanna kinda monologue about there would be helpful.
I mean, the guide's the guide, I mean, it could be better, it could be worse. That's the nature of guide. I mean, we're attacking, we're winning it back, but I mean, it takes time. It also takes time, and I think you understand this, is our competitors were smart when they went in and did this. They had rebates tied to sort of buying so much product or they tried to get dealers to buy cooling product early in first quarter, before we had the full capacity to meet people's needs. It's gonna take us some time to win back, but if we do better in second and third quarter than like we did in first quarter, that's obviously very good news.
Got it. I guess just related to that, I think Joe said that mix was up in resi in the first quarter. I guess a little surprising just given that some of the higher mix product was what was most impacted. Is that something that was more of an anomaly, or how should we think about mix over the balance of the year? I think both price and mix, if you didn't know that the high margin stuff was the one that was offline, it would read like any other quarter of the past few years.
Yeah. Mix was up just slightly. The majority of it was price, but we did have slight favorable mix within the quarter.
We would expect, it was negatively impacted from the lost revenue of $35 million because that was skewed to the highest profitable. I think the point is we'd have had significantly better mix if we hadn't have had the tornado impact.
Mix should accelerate over the balance of the year, I guess, is one other way to interpret that?
I think I'd interpret it, we'll have a strong mix here in 2020.
Got it. All right, thanks for calling.
Thanks.
Our final question will be from the line of Nigel Coe with Wolfe Research. Please go ahead.
Oh, thanks, guys. Good morning. Hi, Todd.
Hey, Nigel. How are you?
Yeah, good, thanks. Just want to go back to inventories. Quite a build-up year-over-year, and obviously these are unusual backdrop with the rebuild at Marshalltown. Maybe just speak to that, Todd, and how you see inventories playing out, especially given this furnace switchover that's happening in July.
I think our inventory was up 7%. Order of magnitude at last first quarter versus the prior year quarter, we were up 18%. When your revenue's growing, you tend to build inventory. You also lay in the cost impacts that we've had on commodities. That's also part of what's building into our inventory number and the pre-build of the furnaces. We're still ramping up our factories, still driving production, and inventory will continue to build until we get to the other side of the summer selling season.
That's great. Just quickly on new construction, we're seeing housing starts down double digits through the first quarter. March worse than February worse than January. Does that suggest that your new builder channel will get worse before it gets better? I understand you said low to mid-single digits growth for the full year, does it get worse before it gets better?
We were up low to mid-single digits. I think it was low single digits in first quarter for resi. We had a solid first quarter, and we think it's going to be up low single digits for the balance of the year. We'll see what happens.
Where is that mix right now, Todd, between new builds and replacement for resi?
We're probably 15%-20% new construction to balance out on replacement.
Great. Okay, thanks a lot.
Thanks.
I'll turn it back to the company for any closing comments.
Thanks, operator. To wrap up, our recovery from tornado impact continues to accelerate as we enter our largest seasonal quarters. Overall for the company, the second quarter's off to a solid start. We're reiterating our 2019 revenue and adjusted EPS guidance. We look forward to another year of strong growth and profitability. I want to thank you all for joining us today.
Ladies and gentlemen, that does conclude your conference for today. Thank you for your participation. You may now disconnect.