Earnings Call: Q1 2019

Apr 22, 2019

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. Good morning. Thank you for joining us for this review of International's financial performance for the Q1 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 and A, 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 Q1 and key points on each of our businesses and then discuss 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 $790,000,000 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 1st quarter record $756,000,000 up 1%, including negative tornado impact of 5%. Foreign exchange had a negative 1% impact on revenue growth. GAAP operating income rose 79 percent to a 1st quarter record $95,000,000 GAAP EPS from continuing operations was up 90 percent to a first quarter record of $1.73 On an adjusted basis, total segment profit rose 34% to a first quarter record of $99,000,000 and total segment margin expanded 3 30 basis points to a new first quarter high of 13.1%. Adjusted EPS from continuing operations rose 38% to a 1st quarter record of $1.68 In our residential business in the Q1, revenue set a new first quarter high of $466,000,000 up 3%, including 8% of negative tornado impact. Revenue was up in both replacement and new construction business. Residential segment profit rose 69 percent to $87,000,000 Adjusted for a $22,000,000 net profit resulting from a $40,000,000 of insurance proceeds against $18,000,000 of negative tornado impact, Residential segment profit was up 26% in the quarter. Residential segment margin expanded 7 30 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 Q1. Revenue was down 3%. Segment profit declined 31% and segment margin was down 3 60 basis points to 8.7 percent. Commercial revenue in the Q1 was driven by a mid teens decline in new construction, well known for being a lumpy business. In both 2017 2018, for example, we had 2 quarters of strong growth and 2 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 market in the Q1. 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. And on the service side, Lennox National account service 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 Q1, revenue was up 2% at constant currency, but 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 and 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 1st quarter and segment margin was down 180 basis points to 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 2nd 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 $350,000,000 to $400,000,000 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 $358,000,000 about the same as the $356,000,000 in previous guidance. We received $124,000,000 of that of 2018 and expect approximately $234,000,000 in 2019. The non core gain expected for the difference in book value and replacement value of assets is now approximately $91,000,000 down from the previous guidance of $109,000,000 for 20.19 due to lower estimated construction costs, approximately $1.79 benefit to GAAP EPS versus a benefit of about $2.30 in previous guidance. From a core perspective, our residential business continues to make significant progress. We're seeing acceleration in recovery from the tornado. As I mentioned previously, we are back we were back to full production across all three of our residential factories for cooling product by the end of Q4 of 2018 and are there as well for heating products as of the end of Q1 2019. We are taking that 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 Q1, the negative tornado impact on revenue was $35,000,000 versus guidance of around $42,000,000 The negative tornado impact on segment profit was $18,000,000 in the 1st quarter versus guidance of around $21,000,000 revenue in 2019, we now expect $70,000,000 of negative tornado impact, down from the prior guidance of $85,000,000 We estimate $40,000,000 of negative segment profit impact, down from our prior estimate of $43,000,000 And the business interruption insurance recovery for lost profits is expected to be about $80,000,000 in 20 19 compared to $83,000,000 in prior guidance. This results in a net segment profit impact of positive $40,000,000 in 20 19, the same as in prior guidance. Of the remaining negative tornado impact for 2019, we expect a hit of approximately $21,000,000 in revenue $13,000,000 in profit for the 2nd quarter. For the Q3, we expect a hit of approximately $14,000,000 to revenue $9,000,000 to profit. For the remaining $40,000,000 of insurance recovering our core guidance, expect that to flow evenly across the 3 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 Q1, revenue from Residential Heating and Cooling was a 1st quarter record $466,000,000 which was up 3%. Volume was flat, price was up 2% and mix was up 1% and Segment margin was 18 0.6%, up 7 30 basis points. Segment profit was favorably impacted by a net $2,000,000 of benefit from insurance proceeds relative to negative 22 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 and A expenses. Turning to our commercial heating and cooling business. Commercial revenue was $173,000,000 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 $15,000,000 down 31%. Segment margin was 8.7%, down 3 60 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 and 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 Q1. Volume and mix were flat and price was up 2%. Foreign exchange had a negative 4% impact on revenue. Refrigeration segment profit was $9,000,000 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 and A expenses. Partial offsets include favorable price and sourcing and engineering led cost reductions. Regarding special items in the Q1, the company had a net after tax benefit totaling $2,200,000 That included a gain of $5,200,000 from insurance recoveries, net of losses incurred, a benefit of $4,400,000 for excess tax benefits from share based compensation, a loss on the sale of business of 5 $1,000,000 for non core business results and a net charge of $1,400,000 for various other items. Corporate expenses were $12,000,000 in the 1st quarter. On a GAAP basis, overall SG and A was $146,000,000 or 18.4 percent of revenue, down from $155,000,000 or 18.6 percent in the prior year quarter. Net cash used in operations in the Q1 was $141,000,000 compared to a use of $84,000,000 in the prior quarter. Capital expenditures were $37,000,000 compared to $23,000,000 in the Q1 a year ago. We also had proceeds for tornado damage to property, plant and equipment that totaled $7,000,000 In the Q1, we used $171,000,000 of free cash flow compared to a use of $106,000,000 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 used cash in the early part of the year and generate cash in the latter part of the year. The company paid $26,000,000 in dividends in the 1st quarter and repurchased $100,000,000 of stock. Total debt was $1,300,000,000 at the end of March, and we ended the quarter with a debt to EBITDA ratio of 2.0. Cash and cash equivalents were $32,000,000 ending the quarter. Before I turn it over to Q and 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 America refrigeration shipments to be relatively flat. For the company in 2019, we are reiterating revenue growth of 3% to 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 Q1, lower estimated factory reconstruction costs and the associated gain of approximately $91,000,000 which was the $109,000,000 in the previous guidance for 2019 that results from the placement of value above book value and a noncash pension settlement charge of approximately $61,000,000 pretax in the Q2 of 2019. The pension settlement charge relates to an agreement we entered into with Pacific Life Insurance Company in April to annuitize $106,000,000 of our defined benefit pension obligation. As part of this transaction, we also transferred $100,000,000 in pension assets to Pacific Life. This event required a remeasurement of the pension plan and will result in a $61,000,000 noncash pre tax settlement charge in the Q2 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 $12.60 And now let me run through our key points on our guidance assumptions and the puts and takes for 2019. We still expect to capture $80,000,000 of additional price for the year. We are planning for a $25,000,000 benefit from sourcing and engineering lead cost reductions and an $8,000,000 benefit from residential factory productivity. We still expect $30,000,000 headwind from commodities, and that's $15,000,000 from freight and $10,000,000 from tariffs. We continue to expect headwinds of $15,000,000 for distribution investments and $15,000,000 from SG and A. Net interest expense is still expected to be approximately $45,000,000 Corporate expenses are still targeted at $90,000,000 for 2019, and we still expect an effective tax rate in the range of 22% to 23% on an adjusted basis for the full year. Now a couple of updates. Capital expenditures are now expected to be $195,000,000 down from the $215,000,000 in the previous guidance. The change is due to lower reconstruction costs to complete the Iowa manufacturing facility. We now expect this to be $95,000,000 versus the prior guidance of $115,000,000 and will be funded by insurance proceeds. And finally, we continue to expect the weighted average diluted share count for the full year to be between 39,000,000 to 40,000,000 shares, which incorporates our plans to repurchase $400,000,000 of stock this year. And with that, let's go to Q and A. 1st from the line of Julian Mitchell with Barclays. Please go ahead. Hi, good morning. Hi, Glenn. 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. 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. I mean there were a couple of things though in the quarter for commercial above and beyond the factory. We had lower volume as well as lower factory productivity as we discussed, and the lower volume hurt us on absorption. And as I talked about in the scrap operation, we continue to focus on 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 'nineteen, we expect to have a larger positive gap between price and commodities, freight and tariffs. So on a full year basis, we're ahead as a corporation. In commercial, on a full year basis, we're ahead. But in Q1 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 announced at the end of the year. So 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 entered the quarter. And we as we enter a quarter in commercial, about 50% of our revenue is already in backlog and 50% we have to book and ship. And then 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 answer is or 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. So 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 Q1 revenue was up 3% at actual and residential. And then we said we had 8% of tornado impact, which implies we would have been up 11%. Residential is going 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. And market conditions are as you thought as well? Yes. I mean, it's always a little hard to tell as you go when you're this early in Q2, but we have events. We call them Lennox Live, but they're really dealer meetings where we meet with 1,000 of our largest dealers in 4 or 5 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 their own when we bring them in. But they're showing that with their spending. But more importantly, people are confident going into the spending season. I think you saw well, I don't think you saw you saw in our commercial refrigeration numbers, which I think are more tied to sort of concerns that you get by watching cable news. And 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 and all three of our businesses as we go into the summer selling season feels pretty good. Next, we'll go to Jeff Hammond with KeyBanc Capital Markets. Please go ahead. Hey, good morning, Tom. How are you? Good. How are you? Good. So just going back to the kind of share recapture, are you finding just what are your experiences as you talk to dealers and are you expecting some dealer attrition? Because it just seems like some of your competitors were suggesting that they'd be able to hold some of this share shift? Yes. I mean, short answer is yes. There are some dealers we lost that won't come back. But at the same time, every year we have net hundreds of dealers that we bring on. We lose some, we bring new ones on. So sort of 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. And so we're attacking on a broad front, both winning back our dealers who they borrowed share from, but also going after their existing dealers. Dealers. And so 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. And then just on Refrigeration, just confidence that, that steps up given some of the, I guess, pause or concern as we move into the latter part of the year? Yes. I mean, as confident as you can be when you have 50% of backlog for the quarter and you still have to book and ship, but we're up double digits in Refrigeration backlog entering the quarter. And like Commercial, 50% of it, we stopped the bookingship, but 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. And I think that ties to the theory of the case that I said earlier. And so again, we're confident going into the balance of the year. Like commercial, there'll be a lag on price cost. And so margin expansion will be second half of the year, but 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. So first question is on 2nd quarter. You said it's off to a solid start. I just want to confirm, is this true across all segments? Yes. So 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're off to a solidstrong start. But again, the reminder obviously that you know, Ryan, I'll say to others is April is about 20% of what we do, May is about onethree and June is half. So bottom of the first, we're doing well, but we still have 8 in it. Go. Got it. Okay. And then secondly, commercial margin expansion in the second half of 'nineteen. Maybe just give us some context on the second quarter, though. Should we be lowering our expectations? Is that what we're sort of hearing? Yes. What I'm trying to tell you is I think margins I would guide that margins will be flat to down in Q2 and they'll be up second half of the year. And it's a combination of still ironing out some of the factory productivity issues we have. Roadmaps in place, we're executing. It's a matter of when you have 1500 people in a factory and a lot of them are new, getting everyone trained up. And then the second is price cost was negative in commercial first quarter, will be relatively flat in second quarter and that second half of the year we have positive price cost. Got it. And then maybe just quickly lastly, it's good to hear taking back share in the resi business, but 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. So I won't necessarily get into what we expected, but we're getting the price increases that we had hoped for and what we guided to and we're sticking to price. Next, we'll go to Nicole DeBlase with Deutsche Bank. Please go ahead. Yes, thanks. Good morning. Hi, Nicole. Hi. So, with respect to the margin improvement that you guys expect to for Commercial and Refrigeration for the full year, is it possible to get a sense of the magnitude? Are we about 10, 20, 30 bps just to give us some conviction around what's embedded in the second half? Yes. 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 guide. So we're guiding that both will be up year over year for the full year, will be up second half of the year and will be down first half. Okay, understood. The way I frame it, I mean, I'm not breathless about the margins, but we're confident they're going to be up. Okay, got it. And then on capital allocation, so I know you guys raised the buyback guidance, makes a lot of sense. It seems like it's deployment of Kaiser proceeds. But does that what does that indicate with respect to the M and A pipeline, if you could talk about that a little bit? I think it's there's no read through to the M and A pipeline. Our M and A pipeline, as we've talked about, will sort of most likely be the thing we'd be interested in would be HVAC North America. That would be large and lumpy. And 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. But 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. Next question is from Robert McCarthy with Stephens. Please go ahead. Good morning, everyone. Hey, Robert. How are you? Good. I guess maybe you could just augment some of your comments around the homebuilding channel. I think you said positive growth there and what you're seeing there. And 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 Obviously, you have a limited visibility, but maybe you could just reiterate what the strength of your argument is there? Construction new construction and residential was up low single digits for the quarter. And again, that's on 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. So new construction was up sort of low to the mid single digits, roughly in line with what we expected for full year. And again, when we talk to the builders going into the summer building season, they remain confident. In terms of commercial and also I'd extend it to refrigeration, it was an industry phenomena. There were 3 or 4 months where the industry was down. We were part of that. We saw industry data for February that started to recover. And as I said, we can see it in our order book in our backlog where our commercial business is up mid single digits. When we talk to the customers, they're confident. So we've seen last year in 'eighteen, we had a couple of quarters where we were down and a couple of quarters that we were really strong. And so it's not unusual for that to be the case this business. Any comments you can make around the segments in terms of how we 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. But any kind of color how we should be thinking about incremental margins at the sub segment level for those 2 and then just in the context of resi? I'm not going to give you at least I don't have any guide points that I'm going to share right now for 2019. The 3 year targets, no. And I would the 3 year targets for resi are 19 to 21 and for commercial, 19 to 21 and for refrigeration, 'fifteen to 'seventeen. And I think about it roughly as a straight line between '1721 to get there excuse me, 'eighteen21 to get there. But I think I've been pretty clear about I've said it 3 or 4 times that commercial and refrigeration will be back half of the year this year. Congrats on a solid start. Okay, thanks. Next, we'll go to Jeffrey Sprague with Vertical Research Partners. Please go ahead. Thanks. Good morning, everyone. Good morning, Jeff. Hey, just back to the share recovery, Todd, if we could. 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. I mean is the 8% unfilled orders or is it some other kind of mathematical construct? I mean, it's a couple of ways. I mean, and we sort of triangulate, and it's quite frankly how we're talking to the insurance company also. I mean, we understand what the market does and we understand what our share was going into the tornado. And so then we understand the delta between what our revenue would have been and what it was. So that's top down. The other way we do it is we know literally by customer who took 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. So we have a pretty clear line of sight of what was lost, who was lost with, how much was lost. Quite frankly, who took it, borrowed it from us. And so when it comes time as it is now to get it back, we know exactly who store to knock on and how to get it back. And to the extent that a portion 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 givebacks, rebates, things like that that show up at some point in the future? Or do the numbers fully reflect the competitive dynamic that's going on? It fully reflect the dynamic that's going on. In other words, just from the accounting, I mean, if we make a promise on some kind of spiff or kickback, then that's sort of reflected back share. But 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 reflected in the P and L. But as I said earlier, we did better on revenue and getting back to share in Q1 than we initially guided, and we stuck to 2% price. And so I would be nervous if we weren't sticking price, but we're sticking price. Great. Thank you. Thanks. Our next question is 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. I mean it was a little bit cooler than it had been last year, but sort of on the round, the same number. So weather really didn't impact much. Got it. And then if I pull out that $22,000,000 net benefit from the tornado and resi, which I think as you highlighted was kind of more than you expected. Kind of the underlying contribution margin there looks kind of, I don't know, kind of 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. Just talking resi overall, right? You're talking resi? Yes. Yes. I mean, I would subtract the $40,000,000 of the insurance proceeds, add back $18,000,000 of tornado impact and then add $35,000,000 of revenue. And I think if you do that, it shows incrementals of 28%, 29%. So 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. Got it. Yes. No, I'll definitely revisit the math there. On the commercial I think you were just testing my conviction, Robert. All right. 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. I mean, it was across the board. We're half national accounts, so predominantly the story, as you would expect, would be national accounts. But 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. It was just a matter of sort of pulling back a bit. And then new construction, same thing. Got it. 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 like 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 and L? I mean, I'll give the layman's answer and then I've got Joe Hirsiak in front of me. I mean, LIFO is just an accounting attempt to true up at the end of the year what should or could have flown through the P and L during the year. And it has to do with the timing of when the cost of inventory flows through the P and L. So if you had perfect information, obviously, it sort of set it up so there was no LIFO adjustment. The negative LIFO that you saw we saw last year was really more of we had really good or significantly good news in 'seventeen, we had less good news in 'eighteen, so it showed the change to the change was negative. When we think about LIFO during the year, we never guide to it. So we just sort of expect that it's going to be neutral during the year, and that's how I'd encourage you to think about it. Yes. What we expect it to be and 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. Our next question is from John Walsh with Credit Suisse. Please go ahead. Hi. Good morning. Hey, John. So 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 will impact us and then I'll make sure I capture the share impact at the end because the answer to that is, yes, there's some things that will take place with those of independent distribution. So on July 3 this year, there's a furnace fan efficiency rating, FER, excuse me, fan efficiency rating, FER regulation is scheduled to go in effect. This requires a move from standard efficiency, what are called PSC motors, to higher efficiency, what are called constant torque or variable speed motors. It's probably more technology than anyone that 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. And like we've done on other regulatory transitions, we're going to have a pre build of the standard units as well as are our competitors. And we'll continue to sell them past July 3. And the goal, and we're pretty confident we're going to do it, will be the same thing that happened on the 13 to 14 share transition that you sell you feather in the new units that are higher cost over time and so there isn't a step function change in pricing Better stated, there isn't this erosion of pricing on the older units. And so you sort of feathered in over time. And so 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 wintertime, but some of our competitors who are selling independent distributors, you'll see a big spike in furnace share, 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 3. 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? Yes. No, that was a great detailed answer. Appreciate that. And then maybe just a quick follow-up here. I mean, 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 price to offset commodities. And so I prefer that all the commodities go down rather than up. But 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. And again, as copper moves, we'll adjust. Okay. Thank you. Thanks. Next, we'll go to Steve Tusa with JP Morgan. Please go ahead. Hey, guys. Good morning. Hi, Steve. So what was price in the Q1 for residential, price realized? Turning to selling to make sure we got the right number. It was a little more than 2% for the quarter. Yes, so it's 2% for the quarter. I know that. I don't know the exact number, but 2% for the quarter. Okay. And then just kind of like better understand the how you're calculating the tornado impact. I mean, your revenue was I'm turning to somebody, it's $11,000,000 Okay. Your revenue was up 3% or whatever, but you're just kind of like looking at just stripping out the impact of the insurance proceeds, which you could consider to be like totally non operational, if you will, your profits were down. So I guess if we're not adjusting, I guess the point is like 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 mean, I'll tell you how I think about it. I mean, we've been clear from the beginning that the drop through on the lost revenue is going to be a rich drop through. So the guide for the quarter or the actual for the quarter, which is better than our guide was 35,000,000 tornado and 35,000,000 someone in the background is yelling and agreeing with me. It was $35,000,000 of revenue impact and $18,000,000 of EBITDA impact from the tornado. And that's because it's our highest margin product. It's really rich mix coming out of Marshalltown. So if you take what our reported results were and subtract $40,000,000 from the insurance proceeds and add back $35,000,000 of revenue and $18,000,000 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 percent incremental. So that's how I do the math and it's the story just what I thought it would be. I think your math isn't taking into consideration $35,000,000 of revenue yielded $18,000,000 of EBIT and that's because it's such a rich mix of product. Okay, got it. So but I guess if we just look at it in kind of on a real world basis, that would suggest that your profits would have been down on kind of these lower mix units on growth, those lower mix units? Yes, exactly. So in essence, the tornado impact, we lost the cream off of the dock, right? So yes, we had lower margins. Okay, great. That's really helpful. Thanks. Thanks. Our next question is from Joe Ritchie with Goldman Sachs. Please go ahead. Thanks. Good morning, guys. Hey, Joe. Hey. So, 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. So we only have we don't sell in, sell out, we just sell out. So we don't recognize it until we sell the product. On our Allied business, there's some inventory loading with selling in. But the sell insale 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. And so 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. I mean we turned on full production at the end of the Q1. It's now April. And so we're still sort of running our residential factories hard to get ready for the summer selling season. Okay. And then 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 commodity, freight, tariffs, I guess, how should we be thinking about the cadence? Was there any like was there potentially a disproportionate impact in 1Q? 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 of we said that price will be 80,000,000 dollars and commodities, freight and tariffs will be 55,000,000. So we're going to be plus 25,000,000 dollars We think order of magnitude, a third of that will be first half of the year and 2 thirds of it will be second half of the year. And so it's going to be back end loaded. Okay. And 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. And next, we'll go to Deepa Raghavan with Wells Fargo Securities. Please go ahead. Good morning. 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 is a big month. And also like some other distributors called out, was Easter a benefit in the quarter and therefore probably a pull forward from Q2? Or just curious, any other puts and takes from a year on year perspective or a seasonality perspective as we think about Q2? Yes. I don't think Easter much matters. I mean, I understand Good Friday is a selling day, but so I wouldn't 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. I mean, the factories are roaring. We're producing all the product lines. We're sort of out there gaining back share. And so the momentum in the residential business is strong as we go into 2nd quarter. Got it. Can you 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? And what could some of the steps be that you should be taking to work around such an event? Thank you. Yes. We would be impacted by a Mexico border shutdown. And parenthetically so with most of corporate America. And so obviously, we produce a lot of production in CTO and as a percentage of our business even more than it was a year ago. And we source components from Mexico for our North America factory. So a shutdown would impact us. And so we're doing the things you might expect to do, looking at different options about buffering inventory and different ways to get it across the border. But short answer is if the border gets shut down, we're all going to be impacted and well scrambled. And next we'll go to Tim Wojs with Baird. Please go ahead. Hey gentlemen, good morning. Just two quick ones for me. So first, just on the CapEx reduction, is there any reason why that $20,000,000 shouldn't flow down into free cash flow for the year? And then secondly, just what's the right quarterly D and A number once Iowa is kind of fully in the the reconstruction Iowa plant is fully in the P and L? Tim, I'll take the capital spend comment. That's really tied to the D and A, Tom? Yes. Depreciation and amortization, we have $80,000,000 for the full year. That will impact us more as we get into 2020, but not so much in 20 19. Okay, great. Thanks, Tim. The next question is from Magdalena 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? Is that behind us or Yes, 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 we're a seasonal business. We bring in a significant amount of temp workers every year into the And so it has to do with attrition and absenteeism and training the workers we've had. 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 Q1, it would 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. Now the warranty reference was in the release, higher warranty year over year and other product costs. Yes. That's really more in the way. Yes, good catch. Okay. No, no. That's helpful. I appreciate it. And then just 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. But 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 2 ago? No. I mean price realization is always the asset 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 2 or 3 metaphors here, but you think about a fighter with an arm tied behind his back, that's what our sales force felt like and now their arms released. And the wild dogs chasing after raw meat in the marketplace after being held back. And so we're excited going in the Q2. And 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 going to 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 2 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. But man, we're really glad we had the Marshalltown team. They've done a heroic job and having all that experience allowed us to come back. And so 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. Next, we'll line up Josh Pokrzywinski with Morgan Stanley. Please go ahead. Hi, good morning, guys. Hey, Josh. Todd, can you just talk a little bit about the 2Q, 3Q, I guess, both changes and just how you're thinking about the lost profits there? It 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 loss profit. So anything you want to kind of monologue about there would be helpful. I mean, the guide is the guide. So I mean, it could be better, it could be worse. That's the nature of God. I mean, we're attacking or winning it back, but I mean, it takes time. And it also takes time, and I think you understand this is, our competitors have were smart when they went in and did this. They had rebates tied to sort of buying so much product or they try to get dealers to buy cooling product early in Q1 before we had the full capacity to meet people's needs. And so it's going to take us some time to win back. But if we do better like in 2nd Q3 than like we did in Q1, that's obviously very good news. Got it. And then I guess just related to that, I think Joe said that mix was up in resi in the Q1. 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? Because 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 the past few years. Yes, mix was up just slightly. The majority of it was price, but we did have slight favorable mix within the quarter. And we would expect and again, it was negatively impacted from the lost revenue of $35,000,000 because that was skewed to the highest profitable setting. The point is we'd had significantly better mix if we hadn't had the tornado impact. So 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 color. Thanks. Our final question will be from the line of Nigel Coe with Wolfe Research. Please go ahead. Thanks guys. Good morning. Hi Todd. Hey Nigel, how are you? Yes, good thanks. So just want to touch go back to inventories. Quite a buildup year over year and obviously these were unusual fairly unusual backdrop with the rebuild at Motel Town. But maybe just speak to that, Todd, and how you see inventories playing out, especially given the spinous switchover that's happening in July? Well, I think part of what's in that I think our inventory was up 7%. Order of magnitude of last Q1 versus the prior year quarter, we were up 18%. So when your revenue is 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. So 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. Okay. Okay. That's great. And then just quickly on new construction. We're seeing housing starts down double digits through the Q1. March was in February, February was in January. Does that suggest that your new builder channel will get worse before it gets better? I understand you said low to mid single digit growth for the full year, but does it get worse before it gets better? We were up lowtomidsingle digits. I think it was low single digits in the Q1 for resi. So we had a solid Q1, and we think it's going to be up low single digits for the balance of the year. Again, we'll see what happens. And where is that mix right now, Todd, between new build 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 2nd quarter is 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.