Ladies and gentlemen, thank you for standing by. Welcome to the Lennox International Q1 2018 Earnings Conference Call. At the request of your host, all lines are in a listen-only mode. There will be a question and answer session at the end of the presentation. As a reminder, this call is being recorded. I will now turn the conference over to Steve Harrison, Vice President of Investor Relations. Please go ahead.
Good morning. Thank you for joining us for this review of Lennox International's financial performance for the Q1 of 2018. 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, unless otherwise noted. You can find a direct link to the webcast of today's conference call on our website at www.lennoxinternational.com. The webcast also will be archived on that 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, thanks for joining us. In the Q1 of 2018, Lennox International posted strong revenue and profit growth to set new first-quarter highs for revenue, total segment margin, and profit, and adjusted EPS from continuing operations. Revenue on a GAAP basis was a first-quarter record $835 million, up 5%. On an adjusted basis, excluding non-core refrigeration businesses in Australia, Asia, and South America that we're in the process of divesting as previously announced, revenue was up 6% to a record $788 million. At constant currency, revenue in both cases was up 4%. On a GAAP basis, operating income was $53 million in the Q1, including $13 million in pre-tax charges for the write-down of assets and the divestiture costs associated with the Australia and Asia transaction.
GAAP EPS from continuing operations was $0.90, including $0.30 in charges for the write-down of assets and the divestiture costs associated with Australia and Asia transaction. On an adjusted basis, total segment profit rose 12% to a first-quarter record $69 million. Total segment margin expanded 50 basis points for a first-quarter record 8.8%. Adjusted EPS from continuing operations rose 33% to a first-quarter record of $1.13. Turning to the key points on our business segments for the Q1. Residential established new first-quarter highs for revenue, segment margin, and profit. Revenue was up 8%, with replacement business up high single digits and new construction up mid-single digits. Residential had strong price performance and a richer mix than a year ago, with replacement business growing faster than new construction. Residential segment profit rose 21%, and segment margin expanded 120 basis points to 11.3%.
Turning to commercial in the Q1, revenue and profit hit new first-quarter highs. Revenue was up 3% at constant currency, and segment profit was up 2%. Segment margin of 9.5% was off 30 basis points from the record first-quarter level a year ago. In North America, commercial equipment revenue was up low single digits for the quarter. Replacement revenue was up mid-single digits, and new construction revenue was down mid-single digits. Looking at the equipment business another way, national account revenue was flat in the quarter, and regional and local revenue was up mid-single digits. On the service side, national account service revenue was up a strong mid-20% rate. In Europe, commercial HVAC revenue was down mid-teens at constant currency. In our core refrigeration business, revenue was down 5% at constant currency. In North America, refrigeration system revenue was relatively flat.
Refrigerated display case revenue was down high teens from a year ago. In Europe, revenue was up mid-teens at constant currency on strength in both food and non-food refrigeration business. Refrigeration segment profit was down 14%, and segment margin was down 100 basis points to 7.4%. To update you on the sale of our non-core refrigeration businesses, as announced in March, we signed a binding agreement for the sale of our Australia and Asia business to Beijer Ref. We expect the sale to close in the Q2. As I mentioned earlier, in the Q1, we had a $13 million pre-tax charge or $0.30 to GAAP EPS for the write-down of assets and divestiture costs associated with the transaction. In April, we signed a binding agreement for the sale of our South America business to Elgin, a privately held Brazilian company.
We expect the sale to close later this year. Subject to Brazilian antitrust approval in the Q2, we expect to take approximately $30 million in non-cash charges associated with the transaction which is approximately $0.73 factored into GAAP EPS guidance. We are also in the process of selling real estate in the Sydney Metro area that was formerly related to Australia operations and would expect that to be concluded before the end of the year. Given the low book value of the property and the strong Sydney real estate market, we would expect a sizable gain on the sale. As previously announced, we are broadly estimating total net proceeds from these transactions of approximately $110 million, which we expect to receive over the course of the year as the sales are closed.
We are excited about the streamlining our refrigeration portfolio to focus on our strong market position in North America and Europe and the market opportunities in these regions. Overall for the company in 2018, we will continue to invest in our core businesses, grow the dividend, and repurchase stock. We directed $150 million of stock repurchases in the Q1, and have announced plans for a total of $350 million of stock repurchases for the full year. The Q1 was a record start to the year, and as we enter our largest seasonal period, we continue to expect strong growth and profitability on our way to another record year in 2018. Now I'll turn it over to Joe.
Thank you, Todd, good morning, everyone. I'll provide some additional comments and financial details on the business segments for the quarter, starting with residential heating and cooling. In the Q1, revenue from residential heating and cooling was a Q1 record, $454 million, up 8%. Volume was up 5%, price was up 2%, and mix was up 1%. Foreign exchange was neutral to revenue. Residential profit was Q1 record $51 million, up 21%. Segment margin was a Q1 record 11.3%, up 120 basis points. Segment profit was positively impacted by higher volume and factory productivity, favorable price and mix in sourcing and engineering-led cost reductions. Partial offsets included higher commodity and freight costs, higher SG&A, and distribution investments. Now turning to our commercial heating and cooling business. Commercial revenue was a Q1 record $206 million, up 5%.
Volume was up 3%, price was up 1%, and mix was down 1%. Foreign exchange had a positive 2% impact on revenue. North America commercial HVAC equipment revenue was up low single digits. National account services revenue was up at a mid-20% rate. European commercial HVAC revenue was down low single digits. Commercial segment profit was a Q1 record $20 million, up 2%. Segment profit margin was 9.5%, off 30 basis points from the Q1 record level a year ago. Segment profit was positively impacted by higher volume, higher price, sourcing and engineering-led cost reductions, lower other product costs, and lower SG&A. Partial offsets included unfavorable mix, higher commodity and freight costs, and distribution investments. In our refrigeration segment, which now excludes the non-core businesses in Australia, Asia, and South America that we are divesting, revenue in the Q1 was $129 million, down 2%.
Volume was down 6%, price was up 1%, and mix was flat. Foreign exchange had a positive 3% impact on revenue. By region at actual currency on a reported basis, North America was down high single digits and Europe was up 30%. Refrigeration segment profit was $10 million, down 14%. Segment margin was 7.4%, down 100 basis points. Segment profit was impacted by lower volume and factory absorption and higher commodity costs. Partial offsets include higher price, sourcing and engineering-led cost reductions, and lower other product costs and lower SG&A. Overall for the company on an adjusted basis, the Q1 had net after-tax charges of $9.4 million. This included $10.3 million for the asset write-down and $1.9 million charge for the divestiture costs associated with the Australia and Asia transaction, $1.5 million for asbestos-related litigation, and a net total of $1.3 million for various other items.
As partial offsets, we had a benefit of $4.3 million for excess tax benefits from share-based compensation and profit of $1.3 million for non-core business results. Corporate expenses were $11 million in the Q1, flat with the prior year quarter. Overall, SG&A was $155 million, or 18.6% of revenue, down from 19.2% in the prior year quarter. Net cash used in operations in the Q1 was $83 million, compared to $180 million in the Q1 a year ago. Capital spending was $23 million, compared to $25 million in the prior year quarter. With respect to free cash flow, we used approximately $106 million in the Q1, compared to a use of $132 million in the prior year quarter.
Due to the seasonal nature of our business, the company uses cash in the first half of the year and generates cash in the second half of the year. We continue to target $395 million of free cash flow for 2018 overall. Total debt was $1.29 billion at the end of the Q1, and we ended March with a debt-EBITDA ratio of 2.2. Cash and cash equivalents were $57 million at the end of March, and the company paid approximately $21 million in dividends and $150 million for share repurchases in the Q1. Before I turn it over to Q&A, I'll review our outlook for 2018. Our market assumptions for 2018 are unchanged. For the industry overall, we expect North American residential HVAC shipments to be up mid-single digits.
We expect North America commercial unitary shipments to be up low single digits, and we expect North American refrigeration shipments to be up low single digits. Based on this underlying market environment and our targets for market share gains, adjusted revenue growth guidance for Lennox International is 4%-8%, including a positive 1% benefit from foreign exchange. Our prior guidance was 3%-7% growth with a minimal impact from foreign exchange. GAAP EPS guidance from continuing operations for 2018 moves from a range of $9.75-$10.35, to a new range of $8.79-$9.39 after incorporating Q1 results and the expected Q2 charges associated with the divestiture of the South American business. As Todd mentioned, we expect a sizable gain on the sale of our Sydney real estate, and this is not factored into our GAAP guidance for the year.
For adjusted EPS from continuing operations guidance for 2018, we are reiterating our range of $9.75-$10.35. Now let me run through some of the other key points in our guidance assumptions and the puts and takes for 2018. We continue to expect $50 million of headwind from commodities in 2018, which includes Section 232 tariff impact on steel and aluminum, and are confident in offsetting that with $50 million of price increases for the year. We continue to expect $35 million in savings from our sourcing and engineering-led cost reduction programs. We still see $7 million in savings from our residential factories as we focus on automation in our U.S. plants and other productivity initiatives.
We continue to expect a $5 million benefit from foreign exchange for the full year. Investments in distribution will still be a $10 million headwind this year. SG&A growth will be another $10 million headwind. Just a few more guidance points. Corporate expenses are still targeted at $85 million for this year. Net interest expense is now expected to be approximately $35 million for the full year, up from prior guidance of $32 million. Tax rate guidance remains 22%-24% on an adjusted basis for the full year. We are planning for capital expenditures of approximately $100 million for 2018. The expected average diluted share count for the full year is still expected to be 41 million shares-42 million shares, which includes our plans to repurchase $350 million of stock this year.
$395 million in free cash flow is still targeted for the full year. With that, let's go to Q&A.
Ladies and gentlemen, if you would like to ask a question on the call, please press star one. You'll hear a tone indicating you've been placed in the queue. If your question gets answered and you wish to remove yourself from the queue, please press the pound key. Again, star one if you have a question. First to the line of Jeff Hammond with KeyBanc Capital Markets. Please go ahead.
Hey, good morning, guys.
Hey, Jeff.
Good morning.
Hey, just on price, it sounds like you guys are, as it moves up, you're covering it. We heard chatter in the channel about a June price increase. Is that something you're contemplating? Would that be additive? Maybe just a little more color there.
Yeah. First just let me reiterate the facts, Jeff. We said it in the script, but I'll just reiterate it. We got $11 million of price in Q1, 2% of revenue of price in residential, where you get the price the earliest, and 1.5% for LII overall. I think that's as strong as I've seen since I've been here. We had $9 million of commodity headwind in Q1. For the full year, we're confident we're going to get $50 million of price to offset the $50 million of commodity, maybe even better given the traction that we got in Q1. As you know, it's both the announcing of price increases, but it's the yield you get on what you announce. We watch what our competitors do in terms of announcing an official next price increase.
Sort of the clear message is we're getting price in the marketplace. We're going to continue to get price in the marketplace. If commodity costs were to move up again, we would get additional price to offset that.
Okay. Then refrigeration. I think you're still saying the market's low single-digit, but you did come out of the gate here weak, and it seems like more on the display side. What gives you confidence that you start to see better trends there, and then maybe update us on margin traction expectations for refrigeration, just given that you started the year in the hole. Thanks.
The North America refrigeration market, we expect the industry, I think we're a little bit more conservative than what you said. We expect it to be up low single-digits, and we expect our business to be up a little bit better than that. The softness in Kysor Warren is just a reflection of the lumpiness of the grocery business, which is a large part of what they do on the display case side, and there was some lumpiness that had impact both on factory absorption and the volume impact. In terms of margins, we've driven nice margin improvement in refrigeration in the last couple of years, and there's more to come in 2018. In 2016, margins were up a couple of hundred basis points, and last year they were up about 50 basis points.
While we're down in Q1, we're still expecting our margins to be up 50 to 100 basis points full year within our refrigeration segment. Again, adjusted for the businesses that we're disposing of, sort of an apples to apples, we think it's going to be up 50 to 100 basis points.
Okay. Thanks, guys.
Thanks, Jeff.
Our next question's from Steve Tusa with JPMorgan. Please go ahead.
Hey, guys. Good morning.
Morning, Steve.
Hey, to further delve into the price cost hysteria out there, but on the refrigeration side, specifically, did you guys say what price cost would be there?
I'm just looking at some notes to make sure. We offset commodities with price in Q1 in all three segments, including refrigeration.
Okay. Going forward here over the course of the year, you're optimistic you can-
So-
get price in that channel?
Yeah. That's the short answer.
Okay. On the resi side, are you seeing everybody behave relatively well? Any holdouts so far? I know there have been, as Jeff said, a few of your peers have kind of gone out with letters, but maybe there's a couple guys missing there. Have you seen everybody kind of move forward?
I think I'd answer it this way. I'd say we had strong revenue growth in the quarter. I think we outpaced the market, and we got price. That means we gained share, raising price. That implies in an industry structure others are doing the same thing. As I've always said, our competitors have the same cost structure we do, and they hedge the same way we do, and they're going to pass on commodities just like we do. At any given point, if I talk to the sales guys, there's a city where somebody's being irrational on pricing. Across the board, the industry structure's a good one, and we all know we have to go get price.
Okay. That's fair. Then one last thing. I know aluminum has kind of moved up here recently. When you look at your commodity cost estimates, I assume that reflects kind of like what you know as of April 23rd as opposed to March 31st.
Correct. It's our best-
Okay
guess right now. Again, I mean, look, 50's a pretty round number. So it's ± that, to be totally sincere. 50's sort of the number, and if it goes up or down a material amount, then we update it. I think the high-level message I'd deliver, and I know there's concern about this in the marketplace, is we're confident we're going to offset commodities with price, and we had a very good Q1 and demonstrate at least for one quarter we're doing it.
Right. Just curious, how are April volumes kind of starting off here in resi?
Anytime the Cubs and the Mets are being snowed out it's not a good sign for air conditioning sales. The honest answer is that April started cooler than last year, but it's very early in the quarter. 80% of the quarter's in May and June, and we have plenty of time for the weather to warm up. It's been cool the first couple weeks of April, and last year, you may recall, it got hot early. We were hot in April, and then cooled off at the end of the quarter. We still have plenty of time for the heat to come, but it's off to a little bit of a slow start.
Yeah, as we always say, sticking your head out the window is not fundamental analysis, the weather is what it is. Thanks, guys.
Exactly. Right.
Our next question's from Tim Wojs with Baird. Please go ahead.
Hey, guys. Good morning.
Hey, Tim.
Just thinking about residential and maybe the business more broadly, too, but how are you guys thinking about mix in the context of just some of the price increases that you're seeing in residential? Anything that you've seen? I know the summer selling season is kind of ahead of us, but any context around any sort of trade down or anything like that you're seeing from a mix perspective or expecting?
No. We had positive mix in the quarter in resi, in part because add-on and replacement was up more than what new construction was, and that leads to it. Even within our add-on replacement, we continue to see mix up, and that's all part of the strategy around iComfort, and what we're doing with our Dave Lennox Signature Collection. No. Again, we've sort of talked about this. At the end consumer level, 2% of price based on something they bought 15 years ago where the equipment's half the cost and labor installation's the other half is to be unnoticeable. Once you get it past the contractor or dealer to accept it, the homeowner's going to take the price increase.
Okay. Great. Just in terms of the use of the cash proceeds on some of the refrigeration sales, is that incorporated into your guidance at this point, or how would we kind of think about offsetting some of the dilution as you work through 2018?
I think it's not explicitly incorporated into the guidance. If you're sort of asking a question of are we anticipating a share buyback that we haven't announced to lower the share count to get to the EPS guidance, that's not incorporated. Sort of the mantra is consistent of we'll be disciplined, we'll invest in the core business. We've sort of said what CapEx is going to be. We're going to have dividends grow with earnings. What's left, we're going to do share buyback with.
Great. Well, good luck on the rest of the year.
Thanks.
Next, we'll go to Julian Mitchell with Barclays. Please go ahead.
Hi. Good morning. Thank you.
Hey, Julian.
Hey. Just a question, maybe. You've talked a lot about commodity costs thus far. I just wondered on the freight costs. You called those out as headwinds in the residential and commercial businesses. Maybe any kind of sizing of how big a headwind that was in the quarter, and how you're thinking about the subsequent impact over the balance of the year from freight costs in the guidance?
For the quarter, it was a couple million, $2 million or $3 million. We've been able to offset that through distribution and transportation productivity in other areas, as well as broadly managing the cost of the business. Again, I would broadly say take that and multiply it times three and a half, four, and I think you'd get the full year impact of it. Again, we're offsetting it on other elements of cost on the P&L.
Very helpful. Thank you. My follow-up would be around the Commercial segment, in particular, how quickly you think we should see margins start to move up year-on-year, whether that's in the Q2 or we have to wait till the second half. Also whether you saw much impact from weather in the Q1 in terms of any kind of activity push-outs or project delays, that kind of thing.
No, there wasn't much. There's always sort of push-outs at the end of a quarter. There wasn't anything weather driven. What we saw in Q1 for our Commercial business is just the lumpiness of national account revenue. National account revenue's more profitable for us than our regional and local business. Our regional and local business grew faster than national accounts, and that caused the mix down. We're focused on driving margin expansion in Commercial. Again, we had a strong Q4. We had margins decrease in Q1, we're committed to having them grow for the balance of the year.
Great. Thank you.
Thanks.
Our next question's from Gautam Khanna with Cowen and Company. Please go ahead.
Thanks. Good morning, guys.
Hey, Gautam.
A couple questions. First, now with the refrigeration exits announced, are there any assets in that space you'd like to add to the portfolio, to the remaining refrigeration business to help shore it up? Or do you sort of have what you need and that's not really a focus of M&A from here?
I think there could be some opportunities, both in North America now that we've parsed our business back. Not in the display case business, but sort of in our more core traditional refrigeration business, there may be opportunities. We talk more broadly in Europe, both HVAC and refrigeration, there's opportunities. I wouldn't expect us to pull the trigger on refrigeration in the near term. I think we still have organic opportunities both for growth and to continue to grow margins to get to our three-year target. If we do something in refrigeration, I would look for that to be sometime next year or later.
Okay. Just as a follow-up, when you look at the industry landscape, it all seems pretty rational and everything, but are there any combinations out there that would, you think, pose a threat to Lennox? Because we've heard a little bit about UTX maybe splitting up their company eventually, and who knows what happens with JCI post the separation of the auto battery business. Are there any combinations, like would that combination be a threat or change the landscape significantly from where you guys sit?
No.
Anything out there that scares you?
No. I mean, short answer's no. I've said it three times, but I guess I'll underline it and say, where we play North America residential and North America light commercial or unitary, we're three in our end markets, and we're at critical mass and scale. If two of these other sort of large applied companies that also have residential businesses, and it's certainly in JCI's case, almost an afterthought, sort of combine, that doesn't bother us at all. Again, without being too snarky about it, having spent a lot of time at UTC, when these conglomerates combine, people are worried about are they going to still have a corner office and are they going to still have the VIP parking pass rather than customers. It doesn't bother me when sort of combination, I actually think we gain a lot of share if that happened.
Now that I guess is the snarky answer. The more constructive answer is, I do think there can be value created through combinations in this industry, I think we've demonstrated that we're pretty good operators here, if something becomes available, I think we could create value if we were part of the combination.
Appreciate it. Thanks a lot, Todd.
Thanks.
Next question's from Jeff Sprague with Vertical Research. Please go ahead.
Thank you. Good morning, everyone.
Hey, Jeff.
Hey. The good news is that aluminum's down 8% this morning on a little Russia relief. I've got a question about China, if you don't mind. You had made a point, Todd, historically about outsourcing significantly to China and highlighted that at the Investor Day. As you know, there's a lot of motors and compressors on that list that came out a couple of weeks ago. Can you give us a little color on how you might deal with that? Can you shift back to the U.S. or is there anything preliminary that you are doing, or do you just need to wait and see how these cards fall?
I think I'll answer the latter part of the question first. We have to wait and see how the cards fall. We've all learned you got to sort of see how it plays out. You can't react to the tweets or sort of to the early pronouncements. This is obviously more than a tweet. They've put it on paper, we've just got to see how it plays out. The answer is we have options. We have options both to move it back to North America, to move it other places in Asia. We'll wait and see how it plays out, we have multiple suppliers and flexibility on almost all the components, including the motors, and we'll just see how it plays out and react.
Can you give us a sense of how much of your sourcing is still in the U.S. on motors and compressors?
We do over half our compressors in the U.S. We have a joint venture from decades ago with Emerson that we have a base load of our scroll compressors come from there. Some of the premium motors we still source in the U.S., even our U.S. suppliers of motors make a lot of those in Asia and source them for us from there. Compressors, more than 50 in the U.S. Motors, more than 50 outside the U.S.
I just wanted some help thinking about incrementals too. Obviously, you're targeting kind of 35%, but as you know, the way the arithmetic works, right, if you're getting price offsetting cost dollar for dollar, that actually erodes margin, right? Works against the conversion rate, so to speak. Do you still see a path to drive to 35% incrementals? Maybe a little color on how you get there.
I'll parse a little bit and just say I think it's closer to 30 than 35. At least that's what we are attempting to do with our guide this year and longer term. I think it's more 30% is what we should see the drop-through on the model. Yeah, we're still pretty confident that we can do it. Prices are offsetting commodities, but we got SG&A productivity for the quarter, and we'll get SG&A productivity for the year. We're offsetting freight and distribution productivity, and we still have the $7 million of factory productivity we're getting in North America. We still feel pretty good, as long as we get the volume on the 30% incrementals that we've talked about.
Right. Just one final point of clarification. Is the freight of two to three in addition to the commodities of nine that you felt in the quarter? It's inclusive?
Yes. Yep.
Yeah. Great. Thanks a lot, guys. Appreciate it.
Our next question is from Robert Berry with Susquehanna. Please go ahead.
Hey, guys. Good morning.
Hey, Robert. How are you?
Good, thanks. Hey, thanks for the more detailed color this quarter on the price versus the mix breakout. Appreciate that. I did actually have a question on a couple of those metrics. That 2% of price in resi kind of expressed as a growth rate. How would you expect that to track as the year progresses?
I think in resi it will be relatively consistent, and I think on the commercial and refrigeration, we'll see it uptick a little bit. I think there'll be some lapping maybe in Q4 because we took sort of some preliminary actions going into the year as this commodity spiked up second half of the year. I think maybe I'm answering the question real time. I think maybe the 2% tails it out for resi a little bit second half of the year while commercial and refrigeration tails or starts to climb as we're able to get national accounts with some of our larger customers with pricing.
Yeah. Maybe there's some rounding there. It does look like you're off to a pretty solid start on that front.
Yeah. To state the obvious, if we do the math of it, if we do one and a half all year on $3.9 billion of sales or whatever you sort of have in your model, we're going to do better than what we've said, but that'd be good.
Yep. That mix component of the guide, that five, is that just resi?
It's primarily, I don't think it was Yes, primarily resi. The guide that we give is specifically resi. Yep.
Yeah. Similar question, 1% in the quarter is almost five just in this quarter. Is that just conservatism or do you see some offsets there as we go?
It's conservatism.
Yeah.
Let me give a more thoughtful answer. A part of that mix in the quarter was add-on and replacement outgrowing RNC for the quarter, residential new construction. That happens on a full year basis. We'll probably do better on mix than what we guided. If RNC sort of kicks back in and is growing at double digits and add-on replacement's more like high single digits, then we have negative mix the other way that we have to offset. I think that's sort of the math of it.
Got it. Fair enough.
In our models, we still think residential new construction on a full year basis will grow faster.
Got it. What was the kind of net net bottom line on how weather impacted resi growth in the quarter, do you think?
The degree heating days were up year-over-year. It was colder in Q1 than it was a year ago. I think net net it helped. It helped early, and it helped sort of on spare parts and supplies. As we've said before, when it's been warm in Q1, the weather in Q1 isn't near as impactful as it is second and Q3. Maybe a point or two, a percent or two of revenue.
Got it. Just one quick last one from me. In your cash flow guide of $395, do you contemplate any material kind of working capital headwind or tailwind in that number?
The tailwind we incorporated was last year. You recall at the end of the year, we had a disappointing end of the year on cash flow, and we pointed at payables and to a lesser degree receivables as the reason. We said that would flow into 2018. We added about $30 million to our initial cash flow guide to reflect that working capital tailwind. There's sort of nothing other than sort of normal working capital performance that's baked in other than that.
Got it. That normal would be just some modest incremental need given-
Correct.
Right. Yeah. Got it. Okay.
Yeah. Sort of the core working capital metrics for good or for bad when cost of capital is this low, we'll spend working capital to drive revenue. Great. Thanks. Thank you.
Next, we'll go to Ryan Merkel with William Blair. Please go ahead.
Hey, thanks. Good morning, and thanks for fitting me in.
Yep.
First question, just back on residential new construction. Why was it slower in the quarter? It sounds like you think it'll still be strong for the year, but just what did you hear and why do you think it's going to pick up?
I think it's mainly weather driven. The flip side of it being colder this year rather than last year is job sites don't get started, and projects or houses don't get finished. I just think it's the reverse of the weather. At least so far, when we talk to our build, and I think continuing when we talk to our builders, big builders, they remain confident. They're not intimidated by the interest rates. They are sort of more constrained by making sure they have the property and the trades, and we still think it's going to be an up year.
Okay, that makes sense. That's helpful. Just to follow up on the commercial margins, it sounds like you think the national account mix is going to improve going forward, and that's going to be the big driver of why we should see margins starting to improve year-over-year. Is it also secondary that you should gain a little more price as the year goes on? I think you said that. Price cost actually starts to improve a little bit as well?
Yes. Exactly.
Very good. Thank you.
Okay, thanks.
Next question's from Robert McCarthy with Stifel. Please go ahead.
Good morning, everyone.
Hey, Robert. How are you?
Good. I'll try to keep it on point so you don't go from snarky to snide with me. In any event because I know it's a slippery slope with me in particular. In any event, number one, can we just talk about maybe the hurricane impact in terms of anecdotal, what you could see in terms of rebuild activity, and then maybe just the second part of that question is just level set us for the compare and the disruption in the Q3 as we kind of address our models as we're making the turn here.
When you talk to the team in Houston or to the team in Florida, what they'll tell you is we saw a spike in spare parts right after each of those events, we saw it for a quarter. I think the variable that's unaccounted for that we just have to see how it plays out is, those are places that it's hot year round, so they had to repair their units. The question is, will they replace them when we get into the summer selling season if there's another issue on the unit? I think it's still yet to be seen, but I think quite frankly it's on the round. I'll have to double check, Robert, what we said last year. I don't think we complained. Look, we had a weaker Q3.
We were down low single digits, we thought part of the impact of that were the hurricanes. As I recall from memory, it was much more about the weather in the Q3 than it was that. I don't think we blamed it when it happened, I don't think we were as bullish as others have been about how it's going to bounce back. I think it's on the round both times.
Moving around to some national accounts, definitely strong growth, obviously on a bit of a shoulder quarter. Could you talk maybe a little bit about, was there any compare benefit or as you're kind of weathering the retail Armageddon maybe in terms of trends overall? How should we think about national account growth playing out for the year?
I think it continues to be a good story for us. Again, as you know, Robert, we've made explicit efforts to diversify away from retail, and increasingly, our mix of business is less retail and more When you look at new accounts we've won over the last two or three years, a higher percentage of them are non-retail than retail. So we're working our way around it. Then the other point, as you've heard me talk about, is some of our customers are figuring out how to compete and have a business model that works, whether it's The Home Depot, whether it's Lowe's, whether it's Best Buy, and to continue to compete against Amazon.
There's going to continue to be brick and mortar, and a lot of those have rooftops that we put on place during the last big bubble of new construction and retail, which mirrored housing construction a decade ago. Those units are now aging and have to be replaced, and our business model is now a replacement model, two-thirds rather than a new construction model, which used to be two-thirds of our business.
Final question is just PartsPlus. Any update there on the trajectory of store adds and any trends, positive or negative, in terms of deployment and traction?
Yeah. Our focus, as you know, in 2018 was to not open the same 25-30 stores we've opened the last few years, to have it be more like five or six. I forget the exact number. We opened one in Q1, but we increasingly were talking about the need to drive parts and supplies as a mix of the sales. We had a nice, again, weather helped us because it was cold, but we had a nice growth in parts and supplies. We outgrew our total revenue growth in resi. Parts and supplies grew double digits rather than the high single digits overall, parts and supplies had a nice quarter. One quarter doesn't make a trend, but sort of our increased focus appears to be paying off, and we look forward to a good year in parts and supplies.
I won't press my luck. Thanks.
Thanks.
Next, we'll go to Christopher Belfiore with UBS. Please go ahead.
Good morning.
Hey, Chris.
In terms of residential, replacement picked up sequentially against a pretty tough comp from last year. Do you think that you guys are seeing any pre-buy ahead of price increases being fully baked in? With regard to that, are you seeing any channel inventory levels, or are they normal or higher than last year?
No, the price increases were effective at the end of the year, and so if we pulled anything in, we pulled it in the Q4 last year. The other is, I know you know, Chris, but I'll mention it for others. It's tough to do the year-over-year against a hard comp point because last year we were up significantly because we had more days in the Q1. The number of days versus last year, this year, difference of one, so it's on the round, where last year was up by four or five days from the prior year. It's hard to look at the percentages year-over-year and say it was up on a tough comp. The answer, I think what you're trying to probe is, we think it was real demand.
Underlying homeowner confidence to replace units when they break demand, that foreshadows, even with the weather being a little cool right now, confidence as we go in the Q2, both for us and for our contractors.
Right. Yeah, great. Thank you. You called out factory absorption negatively affecting profitability for the quarter. Was that only in refrigeration? How should we expect that to go through the year? Or is this kind of largely behind them at this point?
It's only refrigeration, and we think it's largely behind us. Again, we've sort of communicated that while the margins in refrigeration were down 100 basis points for the quarter, we're still confident that we're going to have margins up full year 50 to 100 basis points, and we look to grow margins the Q2.
Okay. Just one last on the commercial side in terms of mix. I think last quarter you guys talked about the mix improving there and trying to potentially gain some more share on the emergency replacement side of things with your product there. Just any color there in terms of what you're seeing or any trends there?
No. We continue to focus on growing not only our national accounts business, but our local and regional business. As I spoke about, we had a pretty good Q1 in our regional national account business, which actually grew quicker than our national accounts business. This sort of focus on regional and local is working out, and we're focused on growing it.
Okay, great. Thank you.
Thanks.
We'll go to Rich Kwas with Wells Fargo Securities. Please go ahead.
Hi, everyone. Just a couple ones. On that local regional piece, is that better margin than national account?
National accounts is actually better margin, believe it or not. So that's why we felt margin pressure in part. We had mix down in the quarter from that part of the business growing faster than national accounts. Again, you know this Rich, but for the broader audience, it's counterintuitive when you think about who our customers are on national accounts, but it's also our most expensive, most premium energy-efficient product is the product we sell to them.
Okay. All right. On mix for resi, a point benefit in the Q1. My recollection was last year you faced stronger growth on the construction side, so you're comping against that. Replacement was a little bit weaker. Should we expect this mix of, say, 100 basis points? Is that going to continue the next couple, three quarters?
Steve asked a question, or someone asked a question earlier, and I sort of talked all the way around it. The short answer is we are mixing up and always sort of mix up and add on a replacement. That's been the trend for the last two or three years. We expect that to be the trend this year. The variable that's offset it over the last couple of years has been Residential New Construction's grown faster than add-on replacement has, both as a market and our sales. If the rest of the year looks like Q1, which is our add-on replacement business grows faster than Residential New Construction, we're going to have nice mixed tailwind. We don't think that's going to be the case in our internal models. We think Residential New Construction was impacted by cooler weather in the quarter.
For the balance of the year, the market will probably outpace add-on and replacement.
Okay, that's potential upside when it's all said and done.
Correct.
On the mix side.
It's upside on mix.
Right
Maybe less volume.
Yeah.
We'd like both of them to be up strong.
Right. Of course. SG&A, should we still think of it half of sales growth?
Yeah.
Okay.
Although we're off to a good start, yeah, that's how I would model it.
Okay, cool. Thank you.
Okay, super. Thanks.
With no further questions, I'll turn it back to the company for closing comments.
Great. Thanks again, everyone, for joining us. To wrap up, Q1 was a record start to the year. We enter our largest seasonal period. We continue to expect strong growth, profitability, and cash generation for another record year in 2018. Again, thanks everyone for joining us.
Ladies and gentlemen, that does conclude your conference for today. Thank you for your participation. You may now disconnect.