Earnings Call: Q2 2021

Jul 26, 2021

Ladies and gentlemen, thank you for standing by, and welcome to the Lennox International Second Quarter Conference Call. At the request of your host, all lines are currently 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 Lennox International's financial performance for the Q2 of 2021. I'm here today with Chairman and CEO, Todd Bluedorn and CFO, Joe Reitmeier. Todd will review key points for the quarter, Joe will take you through the company's financial performance and outlook for 2021. To give everyone time to ask questions during the Q and A, Please limit yourself to a couple of questions or follow ups and re queue for any additional questions. In the earnings release we issued this morning, We have included the necessary reconciliation of the non GAAP financial measures that will be discussed to GAAP measures. All comparisons mentioned today are against the prior year period. You can find a direct link to the webcast of today's conference call on our website at www.lennoxinternational.com. The webcast will be archived on the site for replay. I'd 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. In the Q2, we continue to see strong momentum in our residential business, combined with continued rebound in commercial and refrigeration, As the overall company set new record highs for revenue and profit, company revenue is up 32% to new record of $1,240,000,000 constant currency, revenue was up 30%. GAAP operating income was up 59% to a record $216,000,000 GAAP EPS from continuing operations was up 72 percent to a record $4.51 Total segment profit rose 45 Percent to a record $222,000,000 Total segment margin expanded 160 basis points to 17.9 percent And adjusted EPS from continuing operations drove 54% to record $4.57 Looking at the business segment highlights for the Q2. In residential, we set new highs for revenue, margin and profit. Residential revenue was up 30% as reported and up 29% at constant currency. Segment profit rose 49% and segment margin expanded 290 basis points to 22.6%. Residential and comparable revenue growth in both replacement and new construction of Approximately 30%. Lennox brand revenue was up 30% as was our Allied and other brands combined. Broad strength across residential in the second quarter. Year over year comparisons become tougher in the second half, actually started in June. As we previously mentioned, the Q4 of 2021 will have a headwind of 6% from fewer days in the prior year quarter. But market demand remains high entering the second half. Our residential business continues to perform well perform as well or better than anyone in the market. Looking beyond the second half of the year to 2022 and future years, we remain extremely bullish on the residential market as we see the residential replacement cycle spinning Due to shorter equipment life, we analyzed the actual run time data on air conditioners last year with most with many people At home due to the pandemic. Adjusted for weather, air conditioners ran 30% more during the summer season last year. This summer, we may not be getting a run time impact of 30%, but there's still a lot of people working from home and many will continue to work from home full time or like hear Lennox on a flexible schedule a couple of days a week. If the runtime impact is 20%, that will reduce the medium life of an air conditioner Our original analysis of air conditioner lifespan, the years 2,005 through 2015. Since then, for the years 2016 through 2020, Weather as measured by average cooling degree days has been 5% hotter in the United States. For 2021, we are still in the middle of summer, The Q2 was even hotter than last year. Where runtime impacts equipment life on a linear basis, hot summers impact equipment life on an exponential basis. Another reason we are bullish on the residential replacement cycle for the coming years is that there will be more complete HVAC system sales taking place as old For those not familiar with the history, the EPA banned the sale and distribution Of equipment using the R-twenty two refrigerant effective January 1, 2010 and band of production or import of the R-twenty two refrigerant effective January 1, 2020. While R-twenty two refrigerant is still available in the market, it's significantly more expensive than 410A. In many cases, it is cheaper to replace with a new 410A system, which is also more efficient and comes with a new warranty than repair the old R-twenty 2 system. This also accelerates the replacement cycle. We expect all these dynamics to lead to a strong residential market condition for years ahead. On top of this, Lennox and Allied will be running their proven playbooks for market share gains. Moving on to our commercial business. 2nd quarter revenue was up 34% as reported and 33% at constant currency. Segment profit rose 27%. Segment margin was 17.9 percent, down 100 basis points on the timing of expenses and factory inefficiencies. Constant currency, commercial equipment revenue was up more than 30% in the quarter. Within this, replacement revenue was up more than 40% With planned replacement up 50% and emergency replacement up more than 20%, new construction revenue was up high teens. Breaking out another way, regional and local business revenue was up more than 20%. National account equipment revenue was up more than 50%. This market continues to rebound and benefit from the pent up demand created last year. Team wants 6 new national equipment customers The 2nd quarter to a total 9 in the first half. On the service side, Lennox National Account Services revenue is up more than 30%. BRF revenue was up more than 25%. In Refrigeration for the 2nd quarter, revenue was up 37% As reported and 32% at constant currency. North America revenue was up more than 30%. Europe Refrigeration revenue is up more than 30% at constant currency. In Europe, HVAC revenue is up more than 25% at constant currency. Refrigeration segment margins expanded 90 basis points to 9.1% and segment profit rose 52%. With a strong performance for the company overall in the 2nd quarter and outlook for the second half, we have raised 2021 guidance. We now expect revenue growth of 12% to 16% on a reported basis or 11% to 15% at constant currency. We raised guidance for adjusted EPS from continuing operations to $12.10 to $12.70 for the year. We are raising free cash flow guidance to $400,000,000 for the year and stock repurchase guidance to a total of $600,000,000 for the year. So we'll talk about the specifics, but inflationary pressures continue to ratchet up this year. We're seeing headwinds from commodities, Components, LIFO adjustments and labor. We're capturing a higher yield from our first two price increases this year and now expect $110,000,000 of price benefit from those. In addition, we just announced a third price increase of up to 8% from most of our businesses that is effective September 1. This will yield even more price benefit than the $110,000,000 of guidance provided today. So 3rd price increase is not in our current guidance. This is a special year. Demand is blistering and supply chains are tight at this level of high demand, but the company continues Well or better than anyone in the industry. One thing to note in regard to our public guidance this year. We have been incrementally moving the earnings outlook up 1 quarter at a time After the Q1 and again after the Q2, so while our guidance is our guidance, given the unique uncertainty this year, we are remaining balanced on future guidance. Lastly, so I'm sure most of you saw, the company announced on July 14 that after 15 years, I plan to step down as Chairman and CEO of Lennox International by mid-twenty 22. There's never a perfect time for a transition like this, but with end market strong We think it's a good time. The Board has commenced a search for AllyEye's next CEO, and I will be here over the next year to ensure a smooth transition. 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 Q2, revenue from residential heating and cooling was a record $838,000,000 up 30%. Volume was up 27%, price was up 3% and mix was down 1%. Foreign exchange had a positive 1% impact on revenue. Residential segment profit was a record $190,000,000 up 49%. Segment margin 2 90 basis points to a record 22.6 percent. Residential profit was primarily impacted by higher volume, Favorable price, higher factory productivity, sourcing and engineering led cost reductions, freight savings and favorable foreign exchange. Partial offsets included unfavorable mix, higher commodities, tariffs and warranty costs, distribution investments and higher SG and A, including research and development and information technology investments. Now turning to our commercial heating and cooling business. In the Q2, commercial revenue was $253,000,000 up 34%. Volume was up 29%, price was flat And mix was up 4%. Foreign exchange had a positive 1% impact to revenue. Commercial segment profit was $45,000,000 was up 27%. Segment margin was 17.9%, down 100 basis points. Segment profit was primarily impacted by higher volume and favorable mix. Partial offsets included higher material, distribution, freight, tariffs and other product costs, factoring efficiencies and higher SG and A, including research and development and information technology investments. In Refrigeration, revenue was $148,000,000 excuse me, up 37%. Volume was up 30%, Price was up 2% and mix was flat. Foreign exchange had a positive 5% impact to revenue. Refrigeration segment profit was $14,000,000 up 52 percent and segment margin was 9.1%, which was up 90 basis points. And partial offsets included higher commodity, freight and other product costs and higher SG and A, including research and development and information technology investments. Regarding special items in the 2nd quarter, the company had net after tax charges of $2,000,000 that included a charge of $1,000,000 for restructuring activities, A net charge of $3,400,000 for various other items in total and a benefit of $2,400,000 for excess tax benefits from share based compensation and other tax items. Corporate expenses were $27,000,000 in the 2nd quarter compared to $19,000,000 in the prior year quarter, primarily on higher incentive compensation. Overall, SG and A was $168,000,000 compared to $130,000,000 in the prior quarter. SG and A was down as a percent of revenue to 13.5% from 13.8% in the prior year quarter. In the Q2, cash from operations was $192,000,000 up from $105,000,000 in the prior year quarter. Capital expenditures were $21,000,000 in the 2nd quarter compared to approximately $19,000,000 in the prior year quarter. We generated $171,000,000 of free cash flow in the 2nd quarter, Up from approximately $87,000,000 in the prior year quarter, the company paid $29,000,000 in dividends in the quarter and repurchased $200,000,000 of stock. The total debt was $1,240,000,000 at the end of the second quarter and we ended the quarter with a debt to EBITDA ratio of 1.7. Cash, cash equivalents and short term investments were $47,000,000 at the end of the second quarter. Now before I turn over to Q and A, I'll review our current market assumptions and our updated guidance points for 2021. We now expect the industry to see low double digit shipment growth in residential, Commercial unitary and refrigeration markets in North America for the full year, up from our prior assumptions of high single digit growth. This is an industry comment, including competitors who ship primarily to independent distributors unlike our model. As previously announced on July 14, We raised guidance for 2021 revenue growth from 7% to 11% to a new range of 11% to 15% at constant currency. We now expect a one point benefit from foreign exchange for revenue growth of 12% to 16% for the year at actual currency. We raised guidance for 2021 GAAP EPS from continuing operations from $11.33 to $11.93 to a new range of $11.97 to $12.57 And we raised guidance for 2021 adjusted EPS from continuing operations As we previously mentioned, the Q1 of 2021 had a 6% benefit from more days than in the prior quarter. In the Q4 of 2021, we'll have a headwind of 6% from fewer days than the prior year quarter, as Todd mentioned. For 2022, there are no days differences like this to highlight. Let me now run through the key points in our guidance assumptions and the puts and takes for 2021. First, for the items that are changing. We now expect a benefit of $110,000,000 from price for the year, Up from our prior guidance of a $90,000,000 benefit. The new $110,000,000 price guidance reflects the additional yield we are capturing from First two price increases this year. In addition, we announced a third price increase for up to 8% that is effective September 1st for most of our businesses. This will yield a price benefit on top of $110,000,000 we are currently guiding for full year price this year. Foreign exchange is now expected to be a $10,000,000 benefit, up from neutral of our previous assumption. And we now expect an effective tax rate of approximately 20% on an adjusted basis for the full year compared to the previous guidance of approximately 21%. Free cash flow is now targeted to be approximately $400,000,000 for the full year, up from prior guidance of approximately $375,000,000 on strong earnings performance in the first half and our current outlook. We are raising stock repurchase guidance for the year from $400,000,000 which we completed in the first half to $600,000,000 For the headwinds from prior guidance. Commodities are now expected to be a headwind of $80,000,000 up from our prior guidance of $55,000,000 With inflation in components, we are reducing our net savings sourcing and engineering led cost reductions to a $5,000,000 benefit down from prior guidance to be a $15,000,000 benefit. The higher material costs from inflationary pressures in 2021 are leading to a LIFO accounting adjustment of approximately $15,000,000 this year. Factory productivity is now expected to be a $10,000,000 benefit, down from a $20,000,000 benefit in our prior guidance, We are now planning for corporate expenses to be $100,000,000 up from $95,000,000 in our prior guidance, primarily due to higher incentive compensation. Now for the guidance items that remain the same. We still expect residential mix to be a $10,000,000 benefit. With 30 new Lennox stores planned for this year, our distribution investments are up from last year to a more traditional run rate level. Freight is still expected to be a $5,000,000 headwind and tariffs are expected to be a $5,000,000 headwind. We are planning on SG and A to be approximately Up approximately 7% for the year or a headwind of approximately $45,000,000 And within SG and A, we are making investments in R and D Now for a few other final guidance points. We still expect net interest and pension expense to be approximately $35,000,000 We still expect capital expenditures to be approximately $135,000,000 this year, about $30,000,000 of which is for the 3rd plant at our campus in Mexico. We expect construction to be completed by the end of 2021 and to have the plant fully operational by mid-twenty 22, And we expect nearly $10,000,000 in annual savings from the 3rd plant. And finally, we still expect the weighted average diluted share count the full year to be between 37,000,000 to 38,000,000 shares. And with that, let's now go to Q and A. Thank you. Our first question comes from the line of Jeff Hammond with KeyBanc. Please go ahead. Hey, good morning, everyone. Todd, first of all, congrats. It's been a good 15 years together. I agree. Just on price, it seems like the numbers you gave for 2Q Q were kind of low just given the higher yields. And I just wanted to understand how price you expect price to flow in Into the second half, particularly on commercial? Yes, I mean, I think you're pulling on the right thread. It steps up. 1, the second price increase in residential has a bigger bite in second half of the year than first half of the year, just sort of Timing of things, but for commercial and refrigeration, we got some price in second quarter, but we'll get significantly more second half of the year. And then as we talked about in There's a third price increase that's announced September 1. That won't have much impact on commercial and refrigeration just given the lead times, but it will have A material impact for residential and that's not currently in the guide. We're still sort of framing exactly what that will look like and we'll update it on after the Q3 call. Okay. And then just your inventory levels look a little bit low for the season and the demand. Just talk about Your ability to kind of keep up with demand and where you kind of frame inventory levels here as you go into this second half? We've been transparent about this from the beginning. I think the entire industry is facing challenges. I think all corporate America is facing challenges with integrated circuits, with steel, with lots of things that we're buying. But when we talk to our customers And our suppliers, the one thing that we're confident on and we see our own share position. So we know we're gaining share. We're doing as well or better than anyone in the industry. Look, we'd like to have more inventory right now. So you see that in the numbers and that's clear. We'd like to have more product and if we did, we'd probably sell more. Okay. Thanks a lot, Todd. Thanks. Thank you. Our next question comes from the line of Ryan Merkel with William Blair. Please go ahead. Hey, thanks. So first off, Todd, you mentioned the resi replacement cycle spinning faster and you gave us some nice data points. Can you just speak to how much this will increase HVAC demand annually? And what I'm trying to do is just trying to judge how impactful these changes are? Well, I think the most important metric that I gave is if you think the unit life goes from on average 15 to 12. So in other words, the curve I always show shifts to the left by 3 years. What that does is it all doesn't come into the market in 1 year, but in essence what doing is creating all this demand that spreads out, I think, over a multiyear period. And I haven't specifically called it out, Because the what I was trying to introduce is just a very explicit point that the traditional way You guys and us, not you personally, Ryan, but the analysts have viewed it and the industry has viewed it as a very traditional boom echo analysis. When were the units put in place during the housing boom? How old are they and how long do they last? And we're introducing some new variables that are real and we've measured them. And so when it spins and you take 3 years off the life or 30% off the life or 20% off the life, Then all of a sudden you're creating much more demand over a 5 or 6 year period. It is sort of our best guess of how it will play out. So that's why we're real confident of what we've been publicly saying that this is a mid single digit growth market for years, and that we're not afraid of a cliff. Got it. Okay. Makes sense. And then second question, you raised revenues all year, but EBIT margins for the second half have come down. Just what explains this if you were to rank order them? I think price cost maybe first, but just clarify that if you would. I think it's inflationary pressures from Components and Commodities. I think it is a tightness of the supply chain that leads Self productivity issues in the factories were running over time and sort of mixing up shifts to be able to juggle things. And then I think the third thing is it doesn't incorporate the 3rd price increase yet. So I don't think we get all the way back 30% incrementals, but I think it's the price increase bites and timing of some SG and A. I think it will look better than what's out there now. Got it. All right. Thanks. I'll pass it on. Thank you. Our next question comes from the line of We've got Tom Kearney with Cowen. Please go ahead. Yes. Hey, thank you and congrats, Todd. I know you're here for another year, but Thanks. It's always been a pleasure to work with you. We're going to miss you. I feel like I'm Tom Sawyer at his funeral. I said, I thought I'm Tom Sawyer at his funeral if you've ever read Tom Sawyer, but go ahead. Yes. No, I totally get it. Hey, I was just going to ask on the national account business was up quite a bit. I was wondering if you had any updates to your thoughts on how quickly Commercial deferred replacement picks up catches up. Yes. I stand by my current view. It's a year and a half to 2 years. That's what I saw after 9eleven when I was a carrier. So I saw after the financial crisis that commercial companies or commercial buyers, National Accounts better stated deferred planned replacement and for a year, 15 months and they've now turned it back on and They don't do it all immediately and they don't even do it all in a year, it's 18 months to 2 years. So I think we have nice tailwind in commercial. Okay. Thank you. And then just another one on resi. Last quarter, we asked about competitors and their ability to supply and If that's benefiting Lennox in terms of share pickup, do you have an update on that, an updated view on whether Some of your competitors you're hearing in the channel that some of the competitors are just not able to get product and that's conferring an outsized benefit to I think the answer is all the major competitors have one issue or another because we're all The same supply chain, Trane had an issue with her tire factory, goodments had issues in Houston. So I think it's all the challenge. What unfortunately happens in this type of environment is some of the sort of lower end brands, people like Nordyne, maybe people like Green Have a little bit of advantage because they're able to pick up share they hadn't before. We're gaining share. We're quite frankly not getting as much share as we could if we had more product, But we're gaining share, and I don't think it's one competitor. I think it depends on the marketplace. And I think what competitors are doing, are protecting Certain marketplaces and certain distributors. So I assume carriers protecting Watsco as best as they can where some of their other Distributors aren't being protected as much. Great. Thank you. And Todd, one last one. Just What are your current views on consolidation in the HVAC industry? The likelihood of it and the What might actually drive it if there's a catalyst? Because we've been talking about it for a long time, but not a whole lot's happened. Just curious, I'll answer the question more broadly, but I'll directly narrow the question. I think there was well, I read all the things You guys are right. In some of the notes we're talking about whether my announcement had any impact on consolidation or some who suggested it might. I don't think it mattered one way or What I'm doing on industry consolidation. In terms of the precondition for industry consolidation, I think it's either someone's willing to pay the Lennox premium to buy us, which I don't think they will or need to or whatever. I think the other way would be, if someone who's in the business decides to get out And it's hard to imagine that happens when resi is going as well as it is. So I've been very adamant over the years that Someone like JCI is a commercial player and isn't getting full value out of their residential business, but They feel differently and they and so it's up to them to make a decision or anyone else. Thank you very much. Thank you. Our next question comes from the line of Julian Mitchell with Barclays. Please go ahead. Thanks a lot. Good morning. Maybe one question around the margin outlook. So I just wanted to double check, are you sort of dialing in a Sort of mid-20s incremental margin for the year as a whole and so margins are down sort of 100 bps plus Year on year in the back half, is that roughly the right way to think about it? I was trying to be a little cuter than that. I think if you take our guide, it's a hair lower than that. And then I was signaling that we had some additional upside versus the guide because of the price increase that it was south of 30, But north of low 20s. So I think you're probably in the right zip code. Perfect. Thank you. And then just on the commercial business Specifically, you had the margin headwind year on year in the second quarter. Just wondered maybe some more background on what's behind that. And what do you think happens to those commercial margins in the back half? There was a couple of things that well, 3 things that impacted commercial. 2 of them impacted all the businesses. One was sort of unique. One was just the timing of expenses, incentive comp and some SG and A expenses of when they happened this year versus The prior year and in a business that size, you have a couple of those happen, it can sort of hurt the margins. But the other sort of maybe More important points are the things I've spoken about, which is inflationary pressures And their inability to get price during the quarter because they have a larger backlog where it was already priced out and they'll start to get price second half The year in a better way. And then the inefficiencies due to in their factories due to Shortage of supply and labor shortages at our Stuttgart facility. So those are sort of all the things that led to lower margins. I expect that they'll have a better performance for the or we expect to have a better performance for the balance of the year. Great. Thank you. Thank you. Our next question comes from Tommy Moll with Stephens. Please go ahead. Good morning and thanks for taking my questions. Of course, Tony. Todd, I wanted to start by following up on your commentary on the replacement cycle, Potentially bringing the asset life in 3 years give or take. You referenced some runtime data that you combed through, But I just was curious if there's any more detail you could offer there in terms of the method or any surprises You came across it seems pretty straightforward, but anything else you could offer would be helpful. Yes. I think we did it the way, Tommy, you might have thought we did, but I'll say Others, I mean, we have eye comfort on a lot of our units and tens of thousands of units and we have access to the run times. So We were able to go in region by region, not quite zip code by zip code, but region by region, adjust for the weather, Make sort of other adjustments we thought were appropriate and then we're able to come up with the average run time of the units on a year over year basis. And that was sort of around it, say 30%, it's plus or minus 30%, but right around 30%. And then I did some Kentucky windage by just saying, it's probably not going to be that on an ongoing basis Because we won't have as many people working from home as we did last year. So that I just said, say it's 20% instead of 30%. And that sort of felt right at least from the world that I'm living in because we still have a lot of people working at home and we will continue to have people working at home even when we get to the other side of this. And that's where the 20% came from and then 20% times, 15% gets you 3%, 3%, 15% minus 3% gets you 12%. And then I just sort of rolled into it to say, the weather is 5% warmer the last 3 or 4 years Than it was when we originally came up with a 15 year data point. And that 5% weather has a higher impact than just saying you reduced the life cycle by 5 And so I didn't even try and quantify it, but it's sort of exponential in nature. So it's sort of somewhere between 5% 10%, maybe closer to 10% from having 5 That's sort of in the mix also. So I wanted as I repeating myself, just introduce the concept of Very traditional way of saying, okay, how many units were installed in 2,006 and we're 15 years forward, so that means it goes to 0. That's not the way to look at I think we all knew that there were other variables in play because it doesn't explain what's been happening in the market for the last The bears have been predicting resi turning for a while now and they've been wrong. And the reason they're wrong, we think, are these new variables. Thank you, Todd. That's helpful. Wanted to follow-up on price. So you've pushed 2 increases through. You got another one announced for the fall. Just interested to hear you confirm, I think that you've yet to see any kind of gamesmanship Across the industry, it seems pretty consistent across the group. There's no one trying to steal share with a little bit of price in this environment. And then you think downstream, just in terms of customers, has there been any pushback at all? Or does it feel like, at least for your Lennox brands, that Your customers can pretty easily pass it along through ultimately to the homeowner? Well, I think short answer is They can absolutely pass it on right now. In fact, if we had more units, I think we could price it whatever we wanted and many people would pay. On the competitor side, Carrier announced up to 8% effective September 1 Aon, 5% effective September 1 Trane, 7% effective August 7 Daikin, 4% to 5% effective August 1 JCI, 6% to 13% effective July So we're all in the pool together. And then I think the other point I would make, and we're not talking about 2022 yet or 2023 yet, I'd remind everyone, and you know this, Tommy, but the way this industry works is you have this inflationary shock with commodities. And granted this is different I think we've seen before, but you have inflationary shock with commodities. And then when the inflationary pressure abates, You never passed a price back. And so we're sort of roughly keeping up this year, although a little bit of lag in 2nd The full year will be roughly in line. But then in the out years, if you think cold rolled steel, which was $600 A ton 18 months ago and it's now over $1800 a ton. You think it's going to pull back at some point. When that happens, we won't give the price back. Or if you think copper is closer to $3,000,000 than $4.50,000,000 we don't give the price back. So there's going to be an out year, whether it's 'twenty two or 'twenty three, where all that's going to come back to us and we'll still hang on to the price. And so again, that's why I feel good about the trajectory of the business and the business model. Thanks, Todd. I'll turn it back. Thanks, Tommy. Thank you. Our next question comes from the line of Steven Volkmann with Jefferies. Please go ahead. Next, we'll go to the line of Nicole DeBlase with Deutsche Bank. Please go ahead. Thanks guys. Good morning and congrats to Todd. Hi, Paul. Thanks. So I think you guys you mentioned in the press release There was some unfavorable mix dynamics in resi. Can you just talk about that a little bit and the expectation for mix over the next few The biggest mix issue on resi is just that We've been able to produce more product out of Sotillo factory, which is more entry level product. And so as we've been production constrained, We've been able to get more out of SITIO. And that's quite frankly due to the supply base in Mexico being able to stay with us longer than the supply base in U. S. Has done. So that's the major reason. And then the other reason is sort of the mix of the customers and just some of the customers that we were selling to Had a slightly lower mix, but overall good quarter for resi. And so I wouldn't be concerned about the mix going. Got it. Thanks, Todd. That's really helpful. And then I don't think you commented this in the prepared remarks, but typically do like order activity in commercial and refrigeration. And I'd be curious like how long the backlog goes out now, like are you booking into 2022? Yes, we're not quite booking into 2022. I mean, we because if we did, we'd be in big, big trouble. I mean, typically what you do or typically what we see in this business In our commercial businesses, entering a quarter, we're about half the quarter in backlog And half we book and ship. And so if we were quoting into next year, we'd be like the integrated circuit guys. We'd have long lead times that no one would buy from. So we don't have that yet. I didn't get into the order rates and the backlog just because They're sort of silly high numbers because of where we were last year at this time. But the answer is the momentum in commercial and refrigeration Remain strong. And what I said about commercial having another year and a half to 2 years of strength is absolutely true And to a lesser degree, but still the same directional point as true in Refrigeration. So order rates and backlog is extremely strong in both businesses. Got it. Thank you. I'll pass it on. Thank you. Our next question comes from the line of Joe Ritchie with Goldman Sachs. Please go ahead. Thank you. Good morning, guys, and then congratulations Todd. Thanks, John. So, Tom, maybe, I want to focus just maybe one question on the announcement. I know that from my vantage point, I was Surprise and a lot of folks that I spoke to were also surprised a little bit by the timing because there wasn't necessarily a successor in place. So I guess anything that you can kind of tell us around what influenced your decision, whatever you're comfortable disclosing, just any thoughts around the timing would be helpful. Well, in some ways, it's and I don't want to offend anyone who has elderly grandparents, but it's sort of like I had a 93 year old grandfather who died and I was shocked that he died. And what I mean by that is I've been at OAI for 15 years. That's a long time. And I'm ready for a change. And I think the company in fact, I know the company the Board wanted me to stay. But in some ways, think there's a shelf life on a CEO in 15 years, maybe it. My hands are firmly on the wheel, and I'm going to keep Running the business like I do every day until the day I leave. As we mentioned in the press release, I'm stepping down to create a better balance between my personal and professional life, but I'm not done with my career. I like to think of myself as youngish, if not young and have lots of energy and I plan to do something more entrepreneurial, maybe private equity, maybe venture capital, but something. Now there's never a perfect time to make this kind of transition, I get that. But this is a good time to begin the transition with the strong market conditions And the company well positioned for growth and higher profitability. And now that I've announced that the Board can conduct an open search for the right person The year transition that I've committed to ensures that the process is not rushed and that there'll be a smooth transition. Got it. No, that's super helpful. Thanks for that detail. And I guess maybe my follow on question and just focused on how you guys Now characterize what the prezi replacement cycle looks like. The commentary around R-twenty two was interesting. I'm curious when you guys did your in-depth analysis, Yes. How much is left from an installed base perspective on R-twenty 2? I'm just trying to understand that opportunity as The potential upgrade cycle over the next few years. That's a very good question, Joe. I don't have it at my fingertips. We'll get it out publicly. I think it's in the AHRI data, but we'll pull it out. And again, those who've sort of been ingrained in the story for years may remember in 2011, There was a huge dry run excuse me, dry charge phenomenon that had a huge impact on the year. Those are all our 22 condensing units were put in place. And so even past 2010, there were units being placed into the market that were R-twenty 2. And again, the bell shaped curve of those units that were being put in place, were 15 ignoring the heat comments and the runtime comments I gave at the old 15 midpoint, The right side of that bell shaped curve is going to get cut off because you're not even going to be able to do sort of traditional repairs because if you lose It's prohibitively expensive. But I understand the question, Joe. We'll get that data and put it out to you guys. Got it. That's helpful. Thanks again. Thanks. Thank you. Next, we go to the line of Steven Volkmann with Jefferies. Please go ahead. Great. We'll try this again. Can you hear me? Yes, sure can. Sorry, I don't know what happened last time. Just a couple of quick follow ups, if You talked about that replacement sort of spinning faster, Todd. Any similar thoughts or analysis you've done on the commercial side? No, we haven't. In part because emergency replacement in commercial is 30 Percent, 40% of the market, as important is the planned replacement, which really isn't broadly impacted By that, and then the new construction. And again, sort of the major driver of resi is people being at home. I don't think there's a negative, if I maybe not, I understand your question better. I don't think there's a negative reciprocal of that, if that's the right way of phrasing it commercial, at least unitary commercial, maybe for high rise office space, but we don't play there. But retail has been running, Restaurants have been running, and whether you have one person shopping or a 1,000 people shopping, you're still running the unit. So I don't think there's a negative implication to commercial. Okay, great. And then on I'm curious about your commentary around heat and more degree days, etcetera. It seems like a lot of that's been focused on the northern part of the U. S. Recently, Where there may actually be still some penetration opportunity. Do you have any view on that? I think that's true. I mean that's not worked into our point of view, but That's quite frankly throwing another log on fire, right? I didn't know this number, so I'll quote it from an article I read that said in the It's about 40% penetration of installed HVAC. They have many more 100 degree Summer days, I think that's going to be head higher than 40%. So that's clearly an opportunity for us moving forward also. Okay. Appreciate it. Thanks. Thanks. Thank you. Next, we go to the line of John Walsh with Credit Suisse. Please go ahead. Hi, good morning, everyone. Hey, John. Maybe just A quick one on the unitary, right? I mean, if you look at PK through 12, unitary makes up a good amount of that installed base. We talked a lot about kind of the corporate accounts, but what are you seeing there on the education verticals? And is this stimulus we've all been Reading about is that actually flowing through and are you seeing it? No, we're seeing some flow through, but it's a long In a normal case, it's a long gestation period for schools. I mean, the decision making is Slower and it's obviously more of a Board decision than an individual decision. And then lay on top of that the overlay of this money coming and What's the money going to be spent on? Who has decision rights on the money? It's a little slower than we would like it to be, but I remain real confident that Slightly less than 10% of our unitary business is K through 12, and that's going to be a growth market going forward. Great. And then a lot of discussion around the margins, and I appreciate you guys obviously Don't give quarterly guidance, but Q4 on the residential business, the margin the last couple of years, you haven't kind of Seeing that normal step down sequentially from Q3 to Q4. I mean, 1 year you had the insurance recoveries last year was really strong. I mean, I'm just curious, what are you how are you thinking about it in your guidance that you gave us today? I mean, are you expecting a normal step down or How do we think about that, the seasonality in the back half? Just what's in your guide? Well, I don't know if I'll directly answer The question, but I think the one thing to sort of weigh into any thinking is going to be, we have 6% fewer days in the quarter. And so that creates headwind, not only on revenue, but you have you can't absorb all the costs. You have more factory Cost fall to the bottom line. And so having 6% less days in the 4th quarter, everything else being equal, will have a negative impact on margins. Yes. No, okay, makes sense. Thank you for taking the questions. Thanks. Thank you. Next, we go to the line of Jeff Sprague with Vertical Research. Please go ahead. Hey, thanks. Good morning, everyone. Good morning, Justin. Hey, Todd. Just a couple for me. First on price, Understand with things so fluid, you don't really want to dial this into your guide. But maybe just give us a little bit more color on how the market responded To the first two price increases, obviously, we've got the number for the year now you gave us. But Are you worried about it being accepted? There's some mix down that might result. Just want to understand why you actually don't want To include it in the guide, because I assume you're including the inflationary pressures in the guide. I think in part we didn't I'll be very transparent is we made we came out early with the earnings because of my announcement and we came out with a guide. And then between that time and we were finalizing the price increase, the 3rd price increase, but we hadn't made a decision yet. We made a decision shortly after the announcement. We announced it, and we're going to implement it September 1. And then I just thought it was a little cute to Have a guide 2 weeks ago and then changed it today. And so I just thought we'll just leave it where it's at, being very transparent That it's out there and that we'll touch it up at the end of Q3. The first part of your question is, just on the first two price increases, We had been guiding that we're going to get 90, now we're guiding we're going to get 110. So I think that answers the question how it's being accepted, it's being accepted And we're able to pass it on and it's sticking. And again, the fact that our competitors have announced 3rd price increases across the board, and quite frankly, I actually struggled in econ, which I should admit as a CEO, but the one thing I remembered in econ is, if demand is high and Flies down, I think price should go up and that's what the industry is doing. Absolutely. On the replacement thing, Yes, we all know we can make this seem much more realistic in an Excel spreadsheet than it is in real life for sure. But Just wondering how much of this pull forward do you think might have already happened, right? Because again, if we do go back to the Excel spreadsheet, one Complication we have, right, is 12 years ago was actually the 2009, 2010, 2011 trough when there weren't many units being shipped. So Just wonder if you could tell from that data, has this pull forward already happened? Is it in progress? Or do you think it's still in front of us? Well, I think it's I don't think it's already happened. I think it's probably already started Because last summer already started and the units running more has already started. But I think it's a large part in front of us. And again, I'm not validating all these numbers. I'm just I'm validating the 30% and I'm validating the 5% warmer. But sort of guessing a 20% reduction on an ongoing basis, that's just a swag, use your own number. But if it goes from 15% to 12%, A 20% reduction means a 20% of a full year's production sort of gets moved. And that's not happening in 1 year. I mean, that's not what this year is about. This year is about scarcity of demand and Distributors buying a lot of units to protect themselves. I think that's what this year is about. And so I'm a broken record on this, Jeff, as you know. But now I'm putting some math around my opinion that I think we got multiple years of mid single digit growth in resi. Great. Understood. Thanks a lot. Thanks. Thank you. Our next question comes from the line of Josh Pachwitzki with Morgan Stanley. Please go ahead. Josh, that wasn't even the same zip code as your name. Are you there, Josh? Operator, he was so offended on how you pronounced his name, he hung up. Can you bring someone else in, please? He's here. Thank you. Casey here. Can you hear me? Are you there, Josh? I can, Josh. Why don't you go ahead? Excellent. Yes, I think we were a few Eastern block countries off on the pronunciation there, but That's probably for George. So, Todd, I guess, on this whole kind of replacement cycle stuff, I have As much excel time in that as anyone knew I have had opinions on that over the years. But the I just want to make sure I'm understanding this right. This is assuming like 20% kind of higher home usage for us, is the die already passed? No, I think it will be, to sort of get the full benefit of going from 15% to 12 Forever, then it's 20%. There was a year where they ran 30% more. I know that is a fact. So that die is already cast. There have been 4 years that the weather is 5% hotter than what we build in the model. That's already cast. And then other than Morgan Stanley and JPMorgan, I think most companies Let people stay at home as we get through the pandemic. And so decide whether people are going to work 50% flex time at home or 60% flex time at home. At Lennox, it's going to be 40% flex time at home for most of our employees. So it's somewhere South of 30 greater than 0 that the units are going to run more. And I think that's here to stay. Got it. Yes, and they need you to write me a doctor's note On that work from home policy. And then on the parts side of the equation, I'm sure you saw Watsco had pretty healthy growth on the equipment side as well as parts. You guys clearly have a window into that as well with parts plus stores. Did you see kind of proportionate growth, any observations on repair versus replace? I would imagine there's probably a bit more replace than usual, but I don't want to make it Like it's overloaded to one side. No, I mean equipment grew faster And parts did for us in the quarter, but we had strong growth rates in both. Got it. And then just last one, if you wouldn't mind. On the price cost equation, I mean, we can all sort of look at Steel costs in copper and aluminum and sort of play the hedging game, which never really ever works, so I gave up on that. But there's a lot of inflation out there that kind of falls outside of commodities, whether it's labor or logistics. How does that visibility look like? Is that getting worse or better? And then how do you think your ability to kind of price that into the marketplace Versus other kind of material inflation trends over time? Yes. I mean, I would think about it this way. We typically get $25,000,000 $30,000,000 of engineering sourcing led cost reductions a year. And that's always a net number. That's after all the price increases we get. Initially, we're calling it out of $5,000,000 So what you should take from that is that we're having $20,000,000 or so more price increases on components that we buy from others Along with the $80,000,000 of steel, along with the $15,000,000 of LIFO and all that's being offset by the 110,000,000 Price we've already gotten, plus the 3rd price increase that we're going to have in 4th quarter. So I think we're offsetting it this year. We're not Setting it and still getting the margin percentage. But then as I said earlier, those things will turn. And when they turn, we won't get the price back, But all of a sudden, we'll have our engineering led cost reduction instead of being the normal 25, 30, because all the commodity price increases that we took For motors and compressors and everything else we have, we'll get those reduced. And so we'll have a year where we'll have a blowout cost reduction year, Plus commodities will decline, plus we'll hang on the price. And so we're sort of having lower margins than normal this year, but then there'll be a year or 2 Where margin percentage will be higher than the 30% because of the things I just said. Personal clear. Appreciate it. Thanks. Thank you. And our next question comes from the line of Steve Tusa with JPMorgan. Please go ahead. Hey, good morning. Hey, Steve. Congrats on like really an epic run. Great Grassroots turnaround, fantastic market outgrowth and deserve all the credit in the world to enjoy whatever you do next. So congrats. Thanks. Appreciate it. And you're a good guy. I think you're a really good guy. But I think I kind of disagree on a lot of the numbers. I just kind of want to dig in a little bit. I was a Poly Sci major, so Mark Twain and Fancy macro econ stuff wasn't my suit. But how do you how did you validate the 30% again? You said on a few 1,000 Lennox units that you have visibility into? Yes, exactly. We can track the units. So we have in our dealer portal, When the homeowner signs up for it, we can track the run hours on units. So we're able to go in on our installed base and do it region by region so then we can adjust So it wasn't just sort of okay, we have 20,000 units, how much did they run? We would go region by region, not quite zip code by zip code and understand how long the units were running. I got detailed analysis, detailed spreadsheets, we And how long the units were running. I got detailed analysis, detailed spreadsheets, we went through it and looked at it. And then we're able to say What we expected, which is people are at home more, they're running the units more. And then we calibrated it and it came out a lower number, but we looked at how much Energy usage went up at homes, and that's just a high level macro number. And for the full year, it was up about 10%, 15%. And so that sort of said, okay, we're in the right zip code. We would expect air conditioners in the summer to run longer because people are at home. The furnaces, You're going to still sort of have it, it's roughly the set point in the wintertime because you don't want it to go down. So again, my commentary is about air conditioners Running 30% more and we feel pretty good about it. What was the sample size of that again? I don't know off top of my head. It's about $150,000, Todd. Yes. So small number, only $150,000. And are those what do you think the installed base is for the industry? I think you could figure that out on your right. So look at an annual number, multiply times 15, that's probably the installed base. And then you would I thought you guys had said it was 16 years, but obviously there was a kind of a curve around that. But I feel like in the last couple of years of the housing echo boom discussion that you guys, it was more of a Your number you threw out there. I think I was rounding because there's a sometimes we talk mean, sometimes we talk mode, but say it's So it goes from 16 to 13. Okay, got it. And just on I think the last thing you talked about was this has been you try to figure out what's been happening in the Couple of years? I mean, when I look at your data, you guys were down kind of coming into COVID. You guys really weren't growing very much. I know that there was 18 year that was kind of like messed up. But the industry was, I mean, I think down kind of heading into COVID. It was At least weak, kind of in the low single digit range. So I mean, isn't the strength just really the last 12 months? Like how are you Confident that like what happened during COVID is really something that we kind of like Need to dig into and figure out like how this has changed kind of a decade plus long type of discussion we've been having for the last few years. I'm not a Poly Sci major. I'm a Electrical Engineer. I look at the data. And everything I know about the data tells me 2 things: How long you run the unit impacts how long it lasts and how hot the weather is because in a spike up in temperature, it's an exponential impact on how long the unit lasts. So the question that we have been asking ourselves is there has to be an impact of people staying at home. We've been talking about that for a year and a half. And I think it's I think you have to take the new facts into consideration. We all are and as things are changing. And so we looked at the data The data said 150,000 units are being run longer and that fits with all my anecdotal evidence. We talk to dealers, talk to my family members, My own freaking home. So to make sense, they're running longer. And if they're running longer, they're going to break sooner. And then I step back, I know JPMorgan is coming back to work, but Lennox ain't 100% Neither is Apple and neither is Dell and neither is a lot of other companies. And so it's pretty clear to me, it's a phenomenon that's going to change. Now it may change back in 5 years, But it's there and it's going to have an impact. But I guess my point is sorry, last point on this because I think it's a really interesting discussion obviously. It's really been only the last 12 months. So like I just struggle to kind of read into something that's happened in Pretty abnormal time period over the last 12 months. And you said, look, it's 20% or whatever it is. I mean, your average sales have been up 20% for the last 12 months. So like why haven't we just kind of experienced that? And why are we making this out to be something that's been a trend for 2 or 3 years that we have to figure out. I mean, again, I haven't really been as bearish on the market in the last 3 to 4 years, but the math. I think you're misstating what I'm saying. I'm saying 2 things. I think the weather has been warmer over the last 3 or 4 years. I think the units over the last 18 months Because the pandemic started in March of 2021 excuse me, 2020, units for the last 18 months have been running, Pick your number, 20%, 30% longer. And that's going to have an impact on the lifecycle of the product. And then you ask yourself, Is that going to continue? And the answer is yes. So I mean, I sort of extrapolated. If we were talking about Buicks and we said the entire country moved 20% further from their workplace, we're going to put 20% more miles on the Buick, would the units break faster? We'd say, of course, they would. And that's what we're seeing in HVAC. I mean, and again, we can it's been 18 months. I'm trying to give answers to what's going on. The world's changing quickly, Steve. And so we can wait another 3 years to come out with numbers, I'm telling you what's happening now. Right, right. Very, very helpful. Just one last one. Any color on You gave us kind of the day's impact in 4Q. Any color on just high level, what you expect the industry to grow in 3Q, maybe What you're seeing so far in the 1st few days of July? We continue to do well, demand is strong. I'm not calling the industry call, we call this full year, which is up low double digits. Let's see how it plays out. Again, I think the variable that's unaccounted for in my mind is those who are selling exclusively to independent distribution I've said, are going to hit a cliff before we do. And so I don't know what they see. That will impact the industry more than what we do because we're A little less than 20% of it. Question is what's the other 80% are selling independent distribution to because they're going to hit a cliff before we do. Great. Thanks for all the color. I appreciate it, Todd. Congrats again. Thanks. Thanks. Thank you. There are no further questions in Q, I'll turn it back to the speaker for closing comments. Thanks, operator. To wrap up, we raised guidance for revenue, profit, free cash flow and stock repurchases for this year. Demand remains extremely strong and the company is doing as well or better than anyone in the market. We look forward to the second half and continued strong market conditions in 2022 and beyond. Thanks everyone for joining us. Thank you. Ladies and gentlemen, that does conclude our conference for today. We thank you for your participation and for using AT and T conferencing service. You may now disconnect.