Steve Harrison - VP, IR Todd Bluedorn - Chairman and Chief Executive Officer Joseph Reitmeier - EVP & Chief Financial Officer.

Jeff Hammond - KeyBanc Capital Markets Steve Tusa - JP Morgan Jeffery Sprague - Vertical Research Partners Julian Mitchell - Barclays Gautam Khanna - Cowen & Company John Walsh - Credit Suisse Rich Kwas - Wells Fargo Securities Steven Winoker - UBS Ryan Merkel - William Blair Nigel Coe - Wolfe Research Walter Liptak - Seaport Global.

Ladies and gentlemen, thank you for standing by. Welcome to the Lennox International Third Quarter 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 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 third quarter of 2018. I am here today with Chairman and CEO, Todd Bluedorn; CFO, Joe Reitmeier. Todd will review key points for the quarter, 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 to today's conference call on our website at www.lennoxinternational.com. The webcast also will be archived on the site for replay.

I would like to remind everyone that in the course of this call, to give you a better understanding of our operations, we will be making certain forward-looking statements. These statements are subject to numerous risk and uncertainties that could cause actual results to differ materially from such statements.

For information concerning these risk 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.

Before I turn the call over to Todd, I would like to announce the date of our Annual Investment Community Meeting that will be held the morning of Wednesday, December 12th in New York City. Please mark your calendars. Invitations and more details will follow. The meeting will also be webcasted.

Now let me turn the call over to Chairman and CEO, Todd Bluedorn.

Thanks, Steve. Good morning, everyone, and thank you for joining us. There are lot of moving pieces and noise from the tornado impact on the reported results to walk through for the third quarter and as we look ahead.

First let me level set everyone with our estimates on the impact from the tornado that damaged our Marshalltown, Iowa residential manufacturing facility on July 19th.

Then also make the overarching comments keep in mind that the lost profits from 2018 and 2019 from business interruptions due to the tornado will be fully offset by insurance proceeds in 2019 to be a benefit to us in that year.

On our last conference call one month after the tornado hit, we estimated the impact on our core business for 2018 of approximately $100 million of revenue and $55 million of segment profit and about $1.05 of EPS. Our initial view is that about one-third of this impact would hit into third quarter and about two-thirds would hit the fourth quarter.

Further along, with more visibility, our current view is that the impact to our core business in 2018 will be approximately $115 million of revenue, $65 million of segment profit and $1.25 of EPS. We now expect that approximately 40% of this impact was in the third quarter and 60% will be in the fourth quarter.

So in the third quarter, we had $0.52 of tornado impact on our core business which was $0.17, approximately $0.17 more than originally estimated. From an operational viewpoint, the recovery is path or ahead of schedule in all key areas.

The Lennox team and our partners in the recovery have done a tremendous job and the Marshalltown community in Iowa have provided strong support. We still have ways to go but we expect to come out of this better positioned than before.

The change in the 2018 financial estimates come from a clear view on customer dynamics in the near-term relative to our original round number estimates. For example, with the Lennox high efficiency equipment shortages, we are seeing a lower number of visits to our PartsPlus stores during this time and lower sales of accessories to parts and supplies.

We have maintained close relationships and strong lines of communications with our dealers and we remain confident that we will win the short-term borrowed market share back given the many reasons these customers were doing the majority of their business with us in the first place.

Looking ahead to 2019, we are introducing a view on the tornado impact on our core business for next year. We are estimating approximately $85 million of the impact to revenue, a $35 million to segment profit and $0.70 to EPS. To reiterate the lost profits in 2019 are fully covered by insurance and we expect to receive the proceeds in the same year.

Below the line for 2018, non-core special pre-tax charges related to the tornado are still expected to be approximately $80 million, offset by insurance proceeds in 2018. In the third quarter, we had $49 million of these charges offset by $49 million of insurance recovery.

Below the line for 2019, we are estimating non-core special pre-tax charges relating to the tornado impact of US$15 million. We expect these to be more than offset by insurance proceeds in line with the cost to replace. Turning to the business results as reported today.

For the company overall, revenue on a GAAP basis was $1.03 – excuse me was $1.03 billion, down 2%. On an adjusted basis, excluding non-core Refrigeration business in Australia, Asia and South America divested in 2018, revenue was up 2% to a third quarter record of $1.02 billion. Foreign exchange was neutral to revenue.

On a GAAP basis, operating income was $145 million in the third quarter, down 6%. GAAP EPS from continuing operations is a third quarter record $2.65, up 8%. On an adjusted basis, total segment profit declined 3% to $155 million. Total segment margin was down 80 basis points to 15.2%.

Adjusted EPS from continuing operations rose 8% to a third quarter of $2.72. Turning to the key points on our business segment for the third quarter. Our Residential Commercial businesses set new record highs for revenue and Refrigeration set a new all-time high for segment margin.

In Residential, of course, impacted by the tornado, revenue rose 1%, profit was down 1% and segment margin was down 40 basis points to 19%. Residential revenue from replacement business is up low-single-digits and new construction was down low-single-digits. Turning to Commercial, revenue was up 2%.

Segment profit was down 7% and margin was down 170 basis points to 16.9%. Commercial’s performance is impacted by the lumpiness of shipments in our Commercial national accounts equipment business, lower factory productivity in the timing of about $2 million of expenses on a year-over-year basis.

Breaking up commercial revenue for the third quarter, national accounts equipment revenue was down low-single-digits, compared to 20% growth in the prior year quarter. Year-to-date, national accounts revenue was up low-single-digits, which includes being at low-double-digits in the second quarter and flat in first quarter.

As is typical, not straight-line growth here. As we look at the first three weeks of October, the backlog is strong, up double-digits and we are tracking having a strong growth in the fourth quarter. For our local and regional commercial businesses in the third quarter, revenue was up mid-single-digits.

Overall for North America equipment, revenue was up low-single-digits in constant currency. Replacement revenue was up high-single-digits and new construction was down high-single-digits at constant currency. On the commercial service side, Lennox account services revenue was up high-teens.

In Europe commercial HVAC revenue was down low-double-digits as market softness continues. Turning to our core refrigeration business, revenue was up 4%. In North America, constant currency revenue was up mid-single-digits.

In Europe, the constant currency revenue was also up mid-single-digits led by double-digit growth at our non-food refrigeration business. Refrigeration profit rose 19% in the third quarter and segment margin expanded 190 basis points to 15.4%.

We completed the last of the divestitures planned for this year closing on the sale of our South America business in the third quarter. In the second quarter, we closed on the sale of our Asia and Australia businesses, as well as the sale of real estate in Sydney area. Total net proceeds in these transactions were $116 million.

Overall for the company, price to cost was favorable in the third quarter. We had $27 million of price benefit, more than 2.5% of revenue, which more than offset commodity, freight and tariff headwinds in the quarter. We have even more confidence on price in 2018 and are raising our guidance for a price from $75 million to $80 million for the year.

We plan to repurchase $100 million of stock in fourth quarter for a total of $450 million this year as we look forward to a strong close to 2018 and ahead to 2019. We remain focused on normalizing residential production and continuing to execute on our corporate initiatives to drive company performance and shareholder value.

Now let me turn it over to Joe to talk more in detail about third quarter performance and the full year outlook. .

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 third quarter, revenue from Residential Heating and Cooling was a third quarter record $595 million, up 1%.

Volume was down 2%, price was up 3% and mix was relatively flat. Foreign exchange was neutral to revenue. Residential profit was $113 million, down 1%. Segment margin was down 40 basis points to 19%.

Segment profit was impacted by the tornado and the business had lower volumes, higher commodity freight, distribution and other product costs and other favorable foreign exchange in the quarter. Partial offsets included higher price, sourcing and engineering-led cost reductions, factory productivity and lower SG&A expenses.

Turning to our Commercial Heating and Cooling business, commercial revenue was a third quarter record $276 million, up 2%. Volume was up 1%, price was up 1% and mix was flat. Foreign exchange was neutral to revenue. Commercial segment profit was $47 million, down 7%. Segment margin was 16.9%, down 170 basis points.

Segment profit was impacted by higher commodity, freight, distribution and other product costs, higher SG&A expenses and unfavorable foreign exchange. Partial offsets include higher volume, favorable price and sourcing and engineering-led cost reductions.

In our Refrigeration segment which excludes the non-core businesses in Australia, Asia and South America that we divested this year, revenue in the third quarter was $153 million, up 4%. Volume was up 4%, price was up 2% and mix was down 2%. Foreign exchange was neutral to revenue.

By region, on a reported basis at actual currency, North America and Europe were both up mid-single-digits. Refrigeration segment profit was $24 million, up 19%. Segment margin was 15.4%, up 190 basis points. Segment profit was impacted by higher volume, higher price, sourcing and engineering-led cost reductions and lower SG&A expenses.

Partial offsets include higher commodity, and freight costs. Overall for the company on an adjusted basis, the third quarter had a net after-tax charges of $2.4 million.

This included $2.4 million for the net loss on the sale of business and related property, a total of $3.1 million for various other items, and a $1.7 million benefit for excess tax benefits from share-based compensation, and a $1.4 million net benefit for other tax items.

Corporate expenses were $28 million in the third quarter, up from $24 million in the prior year quarter. Overall, SG&A on a GAAP basis was $149 million in the third quarter or 14.5% of revenue, down from 15.1% in the prior year quarter.

On an adjusted basis, SG&A as a percent of revenue was $14.4% in the third quarter, down from 14.5% in the prior year quarter. Net cash from operations in the third quarter was $266 million, including $45 million in cash from insurance proceeds, compared to $177 million in the third quarter a year ago.

Capital expenditures were $18 million, compared to $17 million in the prior year quarter and free cash flow was approximately $248 million, compared to $160 million in the third quarter a year ago. Total debt was $1.13 billion at the end of the quarter and we ended September with a debt-to-EBITDA ratio of 1.9.

Cash and cash equivalents were $46 million at the end of September. The company paid $26 million in dividends in the third quarter. Before I turn it over Q&A, I'll review our current outlook for 2018. Our underlying market assumptions for 2018 are unchanged.

For the industry overall we still 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 America Refrigeration shipments to be up low-single-digits.

We are reiterating our 2018 guidance for GAAP revenue growth of 2% to 4% and for an adjusted revenue growth of 4% to 6%. We are updating our 2018 guidance for GAAP EPS from continuing operations from $8.38 to $8.78 to a new range of $8.11 to $8.51.

We are updating 2018 guidance for adjusted EPS from continuing operations from $8.90 to $9.30 to a new range of $8.70 to $9.10. The updated GAAP and adjusted EPS ranges include the additional $0.20 of tornado impacts expected this year, $0.17 of which were in the third quarter.

This will be a benefit to 2019 upon receipt of insurance proceeds next year. Now let me walk you through the various puts and takes in our 2018 guidance, starting with the ones that are changing. As Todd mentioned, we are raising our guidance from a price from $75 million to $80 million, and even more confidence on capturing yields this year.

And as we look ahead to 2019, our commercial business has already announced a price increase of up to 4% to be effective January 1. For commodities, we now expect $45 million of headwind for the full year, down from our prior guidance of $50 million.

Freight expenses are now expected to be $25 million for this year, up from the prior guidance of $20 million and we now expect $30 million of savings from our sourcing and engineering-led cost reduction programs, down from prior year guidance of $35 million.

For the 2018 guidance points that remain the same, foreign exchange is expected to be neutral for the year. Tariffs are still a $5 million headwind for 2018. We still see $7 million of savings from our residential factories as we focus on automation at our U.S. plants and other productivity initiatives.

Our distribution investments are a $10 million headwind. SG&A is still expected to be about $10 million over last year and the corporate expense target for this year remains approximately $85 million. Now just a few other guidance points. Net interest expense is expected to be a bit over $35 million for the full year.

Tax rate guidance remains 22% to 24% on an adjusted basis for the full year. Capital expenditures are still planned to be approximately $100 million excluding the impact of the tornado repairs.

We are planning a total of $450 million of stock repurchases for the full year and are reiterating guidance for an average diluted share count of approximately 41 million shares on a full year basis and we are still targeting approximately $395 million of free cash flow for the full year. And with that, let’s go to Q&A..

[Operator Instructions] Our first question is from the line of Jeff Hammond with KeyBanc Capital Markets. Please go ahead..

Hey, good morning guys. .

Hey, Jeff. .

Hey, just – so, on the impact, one, what’s informing the higher amount for 2018? And then, what does that - the $85 million? What does that imply that you will be back to normal production by? And then just, also, it looks like you are using the lower incremental margins or margins on the 2019 impact, if you could just kind of touch on why that is? Thanks.

.

Let me see if get all parts of the question if not jump back in and correct me. First on, I think the first part of the question is, why that we sort of raised the 2018 guide for the tornado impact and I think, I’d answer in a couple ways.

One is, the first guide we gave was about three weeks after the tornado and we did a high-level estimate of round numbers and I’d sort of made the point the $100 million was a big round number. $100 million of revenue and $55 million of segment profit or $1.05 of EPS actually in 2018.

We’ve refined those estimates now that we’re several two, three months into this thing and we got further long enough of a clear view quite frankly on the customer dynamics in the near-term.

And as I said on the call or on the script operationally, we were ahead of or at where we thought we’d be on sort of building a product, ramping up, it just reflects how customers are buying, specifically as I mentioned in the – on the script about the attachment rate of parts and supplies and accessories to when we sell major pieces of equipment.

I think the other part of the question was just operationally, where do we stand and where we being ramped up. When we look at full production capability for Lennox Residential and this includes all three residential factories, Marshalltown, Orangeburg and Saltillo and that’s how I’ll talk about it sort of full production capability.

In Marshalltown, the heating products section of the factory had the most damage and the cooling product section had relatively less damage. So for cooling products, we expect Lennox to be back up the full pre-tornado production capability early in fourth quarter in 2018, so here in the next month or so.

For heating products, we expect Lennox to be back up to full production capability in first quarter of 2019.

We will have a bit of lag from the perspective of fully meeting market demand due to having to catch-up on rebuilding our inventory in the channel and so sort of the tornado impact if you will, will sort of lead into second quarter even though we are up to full production as we’ll have to sort of ramp up that to build even more inventory.

And then I think the other question is, why was the drop through different in 2019 versus 2018. This is a function of the mix of products and the product tiers impacted and really sort of shorthand, I’d point to furnaces are more profitable than air-conditioners and we are more impacted by furnaces in 2018 than we will be in 2019. .

Okay. .

I think that’s everything you asked.

You okay?.

Yes, you covered it great. And then just, just can you just talk about how you are thinking? You mentioned the price increase in commercial, how you are thinking about price cost as you move into 2019? And then, you lowered the material cost savings bucket for this year. How should we think about that bucket into 2019? I’ll get back in queue. .

So, we lowered the price – or excuse me, the material cost reduction bucket, just reflecting sort of more inflation, because again, this is always in that number. I also mentioned on the call that, third quarter – yes, third quarter we turned the corner. We have a quarter and corner mixed up.

In the third quarter we turned the corner and had a $27 million of price more than offset commodities, freights and.

Tariffs. .

Tariffs, excuse me. And as we go into 2019, that’s clearly going to be the case as we are setting up now less commodities move on us very quickly. We have announced the commercial price increase. We thought it was quite frankly bad form to announce a residential price increase right now with all the moving pieces.

But we are clearly going to announce a residential and refrigeration price increase as we go into 2019. I’ll get more specific math at the December Analyst Day. But price, commodities, tariffs and freight will be a net, net positive to us in 2019. .

Thanks a lot. .

Thanks, Jeff..

Next we go to the line of Steve Tusa with JP Morgan. Please go ahead. .

Hey guys.

How is it going?.

Hey, Steve. .

Thanks for all the detail on the unfortunate situation there. Just on the market, you guys were down in resi and in new housing-related business. Can you maybe just discuss what you think kind of the markets? I have done this quarter.

So, just so we can kind of figure out where the impact for you guys is kind of most pertinent or maybe it’s split between the two, new housing versus replacement in resi?.

I think it’s split between the two and I – when we really started seeing the tornado impact in September, so the vast majority, I don’t want to say all, but the vast majority of the tornado impact was in September. In July and August, we were off to a strong start in residential both in new construction and in add-on replacement.

And I – to give a read through the other guys, I think the market was pretty strong in the third quarter. August – July and August, we are up mid-to-high single-digits in residential, both segments of the marketplace and then August we saw as we start to run out of equipment. We saw the impact in September.

And I think the weather was reasonably good in September. So I think overall the market is very strong for the quarter. .

Got it.

And then, with regards to tariffs, what are you, this new round that’s come out or at least the new couple rounds, I can’t even keep track anymore, but - what – how are you kind of thinking about that specifically for now for 2019? And how much of that impact, I don’t know if you gave it yet, but what is the specific impact that you think from that on 2018?.

For 2018, we think the overall impact is $5 million and that’s the guide and again it’s – that’s included what’s been implemented, what’s been announced with detail, but doesn’t include any tweets that sort of even add more to it than that.

So, it’s sort of – it’s what you can do the math on, we think that 2018 order of magnitude it’s going to be $5 million and then I’ve publicly said, that’s in essence sort of less than half a year and so, 2019 is going to be something probably little over twice that. And then, the other point I’d like to make is, we are proactively taking action.

I am not sure that Chinese tariffs are going to be short-term and so we are taking action to sort of avoid the tariffs by moving to Southeast Asia and other low-cost countries that can meet our requirement. .

And that’s the gross number that just basically you are taking what you buy and kind of marking it up by the amount of the tariffs or is that kind of the net number?.

It’s sort of our – it’s the net number. So the $5 million is what – order of magnitude $5 million is what we expect to see on the P&L. .

Okay. .

And then we haven’t guided yet on 2019. But I would sort of take over twice that amount and sort of if was building a model I’ll assume that for 2019. .

Okay. And then again just to be clear on this, because there is a lot of – everybody is kind of approaching their communications around this in different ways that that would reflect the new round of stuff that’s coming through at kind of a higher rate, correct. So, that’s the – that would reflect the incremental, okay, got it. All right.

And then, just one more. You talked about doing something in resi, but obviously, not exactly the right time to go through with something additional. There have been others that have gone through with other price increases.

Is there a sense that, if you did go out with something in resi here in the near-term excluding the tornado impact that customers have yet to kind of pushback on that price or everybody is generally understanding of the, i.e.

price discipline in the industry and the acceptance of that price is still pretty strong in the channel?.

I think it impacted a couple ways. To that question I’d say, which is a direct question. Customers expect price increases and several of our competitors announced some things, we announced in commercial mix they are not surprised they are accepting at point one.

Point two is, we raised our price guide in 2018 from $75 million to $80 million in that $5 millions, I think I am comfortable saying it’s exclusively residential. So quite frankly, we didn’t have to announce the price increase. It’s always about the yield and high hang on to it.

And so, we are getting better price yield in residential just like we speculated we might getting the shortage of inventory. But we didn’t want to announce something new just sort of continuing to toe the line and getting a better yield than what we thought we were.

And then as we go into 2019, we are confident again that we will announce another price increase and get more price in 2019 both in res and in our other businesses. .

Okay. Sorry, one more quick one. Sorry to dominate the early innings here.

You made some comments at a recent conference – or a competitor conference that you kind of opined on consolidation in the industry and you said that you believe that there could be consolidation among the top four resi guys out there despite what looks like a reasonably consolidated situation.

Can you maybe just clarify that or maybe I read that in the transcript the wrong way? Can you maybe clarify what you said there on industry consolidation of potentially one of the top four resi guys?.

I was asked the question. I think you got it what I said pretty close. I always get in trouble when I opine. So maybe strike the opine. I had asked the question and answered the question. But, I don’t know York’s residential market share.

But I think it has one digit in it and so I think they could combine with other players in the industry, certainly could combine with us. I think their commercial unitary share starts with one digit and then their applied is there is a larger part of the business.

But, so they – sort of the York business can certainly combine with us and when I look at the other residential businesses, it’s other players, again, I think they could combine with York or maybe even us. So I think those are the – that was sort of the broad question of that I think anything was prohibited.

Are there things that couldn’t happen? Certainly. But are there combinations it could happen, certainly. .

Right. I guess, you commented on York very specifically.

Can you comment on Carrier very specifically?.

I am not – their share starts at two digits. I know that. And then, beyond that, I am not exactly sure where they are at. So I’d – my guess is that, they could combine with us. I think they could – well, certainly, they could combine with York and I think they could combine with us. But I don’t know that for certain. And it also depends….

Okay..

It also depends what’s being enforced at time, but I think it’d be – I don’t know the exact number because I don’t know Carrier’s share. .

Okay, I’ll leave at that. Thanks a lot. .

Next we go to the line of Jeffery Sprague of Vertical Research Partners. Please go ahead. .

Well I can’t help but to pick up on that, it’s a good try. .

You guys are a feeding frenzy on this. .

I know, well..

It’s a consolidation..

At least we're not talking about tornadoes, right. .

Yes. I know for a fact Greg knows the Carrier share. So you should ask him..

We think you know it too, but we won’t press you. Okay.

Does consolidation makes sense? What would be gained in your view given kind of this great pricing discipline that we are observing especially in the resi business?.

Well, I mean, industry consolidation will obviously with the caveat of at the right price, but I think of the traditional horizontal integration of an industry, so, then I would view it as distribution forward.

So, consolidating factories, consolidating supplier spend, taking out SG&A, taking out corporate expenses, we are making significant investments. We, as a company and digitization of the business, significant investments, control systems. Again that could all be leveraged over a larger volume business. We have a great Mexico campus.

Most of our competitors on residential don’t and so the ability to leverage that Mexican campus to lower cost. And so, I just sort of think traditional cost take outs and then a assembled product business like we have, I think you could create lots of synergies. And then, again it have to at the right price.

But I think it’s clear industrial logic of how we take out cost. .

And how about on the distribution side, Todd? Some companies had chosen to kind of third-party to distributions, others like you own it.

Putting that type of footprint together, do you see any particular challenges there?.

My experience haven’t seen this done in other places open that is, I think the challenge is to make sure in these market share when you rip all the cost out of the back-end. And so, my perspective on it would be in an industry like this, when we consolidate that there will be some period of time you need distribution alone.

And so, whatever it was you optimize it and manage it as it was. I don’t think you’d want to sort of go from one model to another model quickly.

But the investments that a company was making in digitization and support of your contractors, whether it was a company-owned distribution or JV or independent distribution, you could leverage those investments with those distributors.

So, I don’t think you have to physically make a change in distribution to leverage some of the investments that a company was making. .

And then, just one on the quarter from me. Just to kind of make sure I’ve gotten my head around really what’s going on in your margins, right. So, the resi margins we are seeing today, obviously you have a revenue impact on the top-line, but you have little or no or over profit impact on insurance recoveries.

Right, so, we can kind of calculate an underlying margin that’s lower than your headline margin.

Is that – is that difference primarily this the negative – I’ll call it ripple effects to lack of a better term in the PartsPlus and other parts of your business? Or how would you characterize that?.

I am not sure I understand the question. You had me right to the end when you start talking about the PartsPlus. .

Well, I am just saying, your underlying margins arguably were down, right. And I am just trying to understand the composition of that in resi. .

I’ll ramble and see if I answer the questions. I mean, margins were down because of the tornado impacts on revenue and the corresponding impact on EBIT was why they were down.

And even from the guide that we’ve given earlier, which was 120 and 55 of EBIT, a third of it in fourth quarter, we are now saying it’s 40% in third quarter and the overall number is going up to $65 million of EBIT and $120 million of revenue.

And we perform extremely well in residential and so, if I understand the question, right, it’s all because of the tornado..

Okay. Got it. Thank you. .

Thanks..

Next we go to the line of Julian Mitchell with Barclays. Please go ahead. .

Thanks a lot. So maybe just trying to stick to two questions. The first one on the commercial business. If there was any extra color you could give on U.S. trends as where you stand today? And also on the margin front, margins were down a bunch in the third quarter.

How quickly do you think that comes back? And any extra detail you can give on the factory productivity you cited?.

First talking about commercial and I talked about it in the call, I think at some detail. It’s just a lumpiness in national accounts. And so, we feel confident I think in the fourth quarter.

We have still lot of work in front of us but through the first three weeks of the quarter backlog is strong, up double-digits and we are tracking to have another strong revenue quarter for commercial in the fourth quarter. And so, second quarter – first quarter we were flattish in commercial.

Second quarter we were up 18%, third quarter we were flattish and fourth quarter we would have strong revenue growth. In terms of the margin, as I mentioned in the call, it was impacted by a couple things.

One was the timing of some expenses, just sort of year-over-year differences of when you make adjustments for expenses like warranty and LIFO, we are getting to0 accounting on - county on you.

And then the other one, I think more operational was, we had some factory productivity issues in the third quarter and really what’s driving the factory productivity issues is we are seeing labor shortages in our Stuttgart facility.

And we’ve been addressing it with overtime and extra shifts to be able to meet customer demands and we are in the process of staffing up with full-time workers. We’ve historically used quite a bit of temporary workers. Now we are moving to full-time workers and converting the temp workers to full-time workers.

And this will have – the issue around labor productivity and not having enough folks will have impact in Q3 and we’ll also see a bleed off into Q4. So, on the fourth quarter call, I’ll also be talking about this because it takes a lot of getting in place. But we expect to have it fully resolved by first quarter 2019. .

Thank you for the detail. My second question would be on refrigeration. One of your peers have talked about the retail refrigeration market, maybe bottoming out. Your own revenue growth number suggests, you are taking some share and so maybe just any commentary on how you see the market in the U.S. retail refrigeration..

I still think it’s tough. I mean, Dover refers to it as retail refrigeration, we just refer to this grocery I assume that’s what you are talking about and that has the biggest impact to us in our Kysor/Warren segment. We still saw revenue down in KW even though we were up in North America.

Where we are seeing the growth in our North America business is driven - the year-over-year growth is large part driven in cold storage and so it’s not the retail segment or the grocery segment. It’s sort of other parts of the cold storage channel – or cold chain, it’s cold storage market where we’ve seen the growth. .

Great. Thank you..

Thanks. .

Next is to the line of Gautam Khanna with Cowen. Please go ahead..

Thanks, good morning. .

Hey, Gautam.

How are you?.

Doing well.

I was wondering, Todd, could you just talk a little bit about your confidence level in recapturing the share that you are sort of giving up in the interim, while you were recovering from the tornado, what specifically can you do to kind of – what gives you that confidence? Or what are you doing to make sure on the other side of it we are not going to see an impact at PartsPlus or elsewhere?.

Yes, I mean, we are working hard to do that. And I mean, as I’ve spoken about before, and you’ve heard me saying I am not saying for anybody else is, we are communicating very clearly with our dealer partners who are out there daily talking to them about what we have and when we are going to have it back and allowing them to make the transition.

I’ve used the phrase a week early rather than a week late. So we don’t want to run out of equipment and then have them feel the pain. So we want – we’ll feel the pain and allow them to move over. I think that honest open communication helps a lot.

And then, the second thing is going to be on the flip side, that as we reach full production capability and if I spoke about, we expect air-conditioners in fourth and furnaces in first quarter will be up full production capability that as we start to make new commitments to people and turn them back on, that we execute against those new commitments.

So, we don’t let them down on the way down and then we don’t let them down on the way back up and we are very focused on doing that.

Overall, we have a loyal Lennox dealer base and as I’ve mentioned also on prior calls, almost all dealers carry multiple brands and we think the majority of this borrowed share will be someone who did business with us and with some – and with competitor B and go move some volume of competitor B while we are not able to provide supply and then when we come back online, they will move the share back to us.

So, we are very focused on this and we’ll put incentives in place for our sales guys and sort of do all the right things to make sure we have laser-like focus in 2019 and we are committed to doing that. .

Okay. Just a quick follow-up on just the national account equipment and service pipeline as you look out to 2019.

Can you make any comments on how rich an environment it is?.

2019, little early to sort of speculate or even give guide, because the order book tends to fill up three, four, five months ahead of itself, so, 2019 is still very early. And then the other caveat I’d make is, we always know much more about national accounts once we get through the Christmas selling season.

That retail while we reduced our exposure to that is still about half of our national account business and so getting a better take on the Christmas selling season will help us. All that being said, retail is strong right now. Consumers are spending money. Consumer feel good.

Retailers are spending money on things they weren’t a year or two ago in our industry. So we feel pretty good as we go into 2019, but we will give more of a guide at December Analyst Day. .

Thank you..

Thanks..

Next we go to the line of John Walsh with Credit Suisse. Please go ahead..

Hi, good morning. .

Hi, good morning. .

So, I apologize if I missed it, but, as we think about the moving parts for the free cash flow, can you help us think about maybe a finer point on this year and then next year as you are looking to rebuild inventory and how that kind of impacts the conversion ratio?.

I don’t think we’ve gone into that kind of detail quite yet about sort of how it’s going to impact. I mean, I would point out we had a very strong quarter in cash generation in the third quarter and so, we continue to generate cash. But we sort of haven’t put a fine tuned answer about the inventory bleed out and the inventory rebuild.

The only point we made on cash is that, the below the line impact of $80 million, I am looking at Joe make sure I have that number right that we’ll expect to have cash proceeds to offset that. So we’ll be neutral on cash on below the line charges, if you will and in the third quarter we saw that 47, 47, on the offsets.

And then, for the above the line impact, sort of the core impact, we expect to have cash proceeds in 2019 to offset the EBIT miss or the EBIT that will shift or that we are not going to get in 2018 because of the lost revenue. We’ll get that back in EBIT payout from the insurance companies in cash in 2019. .

And we are compensating with the lost profits which are a proxy for cash flow. We are going to obviously offset that or compensate with lower investments in working capital and inventory which will keep us well on target for the 395 for the full year. .

Okay. Thank you.

And then, can you just remind us your comfortability or where you are comfortable taking the balance sheet in terms of leverage?.

We’ve said our guide has been one and a half to two times debt-to-EBITDA and that allows us to remain investment-grade and we think that’s an important place to be in an uncertain world.

And then we always put the caveat around that through the right opportunity to create shareholder value we would look to go higher with the path to come back down that it’s an industry that others like a Goodman have gone private over the years couple times and have had debt-to-EBITDA maybe twice that amount and they have been fine with it and I think we would be too.

But I don’t think I’d want to do that just as the natural course of events. So I think we had something that could create real shareholder value like an industry consolidating acquisition we would think about it. But in a more normal course of business, I think the right balance approaches 1.5 to 2. .

Great. Thank you. .

Thanks..

Next we go to the line of Rich Kwas with Wells Fargo. Please go ahead..

Hi, good morning everyone. .

Hello..

On price, so, I think the guide implies $22 million for the fourth quarter.

You did $27 million in Q3, what drives it down in terms of contribution given the number of price increases this year?.

I think it’s just the volume that the third quarter is seasonally higher volume..

Okay. And then the lap over benefit into 2019 should be meaningful, right. I mean, you’ll be comping against some contribution, but it should be the decent contributor, right. That’s the way we should be thinking about it..

Yes, I mean, I think you could sort of shorthand, I would say, the $50 million that we initially gave and sort of assume how much of that was in first half of the year versus second half of the year and then, we’ve now raised it to $80 million and that incremental $30 million is all second half of the year and you might even expect even sort of more back-end loaded to that.

So, I think, if you sort of do some of that and then you’ll add on top of top of that some new price that we would announce going into 2019, I think you can start to back into a number that’s going to be meaningful and as I said will offset the inflationary pressures we are feeling from commodities, freights and tariffs. .

Cost base should start coming down to as 2019 plays out, right even with the hedging..

Say it again..

The cost base should start getting incrementally improved with – even with the hedges as we start rolling through 2019, right?.

If commodities continue on the trend they are on, yes. .

Yes, okay. And then, just on the – as you think about affordability, I mean, everybody, some have put through three, you put in a couple, you are going to put in another one. There is going to be another price increase on the residential side across the board. One would think at the start of the year. Any impact on mix.

As we think about mix, that’s started to get better for everyone? How do you see this playing out over the course of 2019 on the resi side?.

I am not sure I understand the question per say. I mean....

Well, let’s just say 13, see I mean, is there, does the incremental buyer come in on the remodel side and say I am not going to do 17, SEER, I’ll do 14 SEER, because mortgage rates are up and I am not going to – I bought a house, I am not going to up to any with regards to the efficiency because the cost. .

No, I think it’s – I think, maybe on the margins that I think people sit down and do the economics on most markets. In the northern markets, they are going to be in a house three to five years.

It make sense to get a premium furnace and it’s here in the south, and they are going to be in a house three to five years it makes sense to get a premium air-conditioner and that’s just a math of it and I don’t think that changes incremental interest rates.

The other point around our pricing power is, as you know, half the cost of a unit’s labor and they buy one every 15 years. So, our ability to continue to raise price in the marketplace is driven more about at the dealer level and what competitors do rather than the homeowner, homeowners willing to accept it. .

Okay.

All right, and then just last one real quick on commercial was, do you see new construction was down high-single-digits in the North America? Did I catch that right?.

Yes, correct. And that was certainly in large part by national accounts. .

Okay. Okay, okay, great. Thanks guys. .

Thanks. .

Next we go to the line of Steven Winoker with UBS. Please go ahead..

Thanks. Good morning guys. .

Good morning. .

Hey, Todd, I just want to come back to the consolidation comments again. So, we’ve been talking about consolidation on and off for twenty years, industrial logics, generally always has been there. If you sort of think about what dynamics have changed now to make that increasingly likely despite some of the moves that have already taken place.

What do you think of the biggest factor that would actually make that more realistic in the industry today than saying it’s been in the past decade?.

Just pausing to make sure I answer the question in a way that when the transcript comes back to me, I am happy to what I said. So, I think I would….

Always wise..

I think I’d answer it this way. We’ve always talked about focus wins and that the best place to be as a corporation is to be large enough to be at scale and then we focused on industries.

And then I think, at least in my business lifetime, there has never been a time where the investment community feels the same way and I think corporate leaders feel the same way. And so, that’s another way of saying industrial conglomerates are under pressure.

And at least two players in our industry are owned by industrial conglomerates who – from everything I read or reviewing their portfolio of businesses. And so I think there is sort of more optimism that maybe one of them or both of them will decide to be something with our portfolio that could make assets available. .

Okay. So, willingness to sell in that front. So, secondly, just going to the replacement demand in a little more detail, I know it’s got to be a little hard to tell with working through all of the mitigation actions and recovery on the tornado front.

But just from a market level, I guess, as you – and you talked about a little bit earlier I think on new construction, what are you seeing in terms of replacement demand on the resi front, resi light commercial two?.

It still remains strong, Steven.

So, July and August, our replacement business is up mid to high-single-digits and then obviously it slowed down in September and that’s what you see in the reported numbers and I think September was warm enough and sort of a good enough month that my guess is our competitors will talk about a market that was up mid to high-single-digits. .

And where are you thinking we are in terms of the overall cycle, again exclusive of what you guys have been personally experiencing with the tornado.

But as you sort of look out on the timing, how would you characterize it?.

We publicly said it was –and it continue to be the case in my mind is that, we think there is another three to five years of mid-single-digit growth in residential and this reflects the echo of all those homes that were put in, in the new housing bubble in the early, mid-2000s and that continues to sort of bleed into the replacement market and that analysis that we did has bell-shaped curve around this number, but on average units lasts about 15 years before this catastrophic failure that has to be replaced.

And so we do all that math. We think it’s three or five years of mid-single-digit growth and again, that assumes sort of a neutral economy. It doesn’t have to be 3.8% unemployment. Just a solid economy and then again any given year it can be swung by the weather, but we are still optimistic that this market still has legs. .

All right. Thanks, Todd. I’ll pass it on. .

Thanks, Steven..

Next we go to the line of Ryan Merkel with William Blair. Please go ahead..

Yes, thanks. Two quick questions from me. So, first, Todd, you said, as the Iowa factory recovers, you will come out of it stronger than before.

Can you just expand on this?.

I think a couple ways, one, maybe where you are leading me is, as we are building capability in our other factories to manufacture and fabricate parts for premium products and I think that transfer of knowledge and capability is important for longer-term capability of the company.

I also just think that, as we are sort of testing and challenging team members and the rising to the occasion, and I just think the talent in our Iowa factory has been challenged and pushed and my experience is the way you sharpen a blade is that way and I think the blade of the Marshalltown factory is being sharpened and our capabilities are just being improved.

.

Got it. Okay.

And then, secondly, just to clarify, if the tornado impact is pretty solid estimate now in your mind?.

I think where I am most solid on is our production ramp up, but that still has variables in it also. I mean, I’ll be honest with you there is still some pieces of equipment that are under wrap that we haven’t broken out, started back up again after they’ve sort of been rained on and the tornado hit them and so we still have some risk there.

And then, it’s sort of our best guess on how the customer will play out, but, I’d like to say we got all this nailed down, but this is virgin territory for us as we are getting information as we know it. .

Understood. Okay. Thanks a lot. .

Thanks. .

The next is from the line of Nigel Coe with Wolfe Research. Please go ahead..

Thanks, good morning. .

Hey, Nigel. .

We covered a lot of ground here. Appreciate the detail guys. Want to go back to price. I'd imagine that the problems we are having with the heating production makes this month very, very tight as we go into the heating season. So I'm curious whether pricing actually improves short-term, i.e. in 4Q from the 3% you showed this quarter.

And then I see then come back online in 2019, does that then puts a little bit deflationary pressure on industry pricing. I am just curious if we just dig into pricing and maybe focus more on the near-term pricing impacts. .

I think our guide of raising price from full year from $75 million to $80 million for the corporation, the $5 million increase was really tied to residential and our ability to yield the price that we've already passed on. I don’t think we will give price back in 2019. I think it will be the opposite.

I think there will another price increase and we'll get even more in 2019 and so, I think, the short answer is we’ve recognized some benefit of price – increased price in '2018. Maybe we do better, maybe we do a little bit worse, but we’ll see that that’s our guide for today and then in 2019, we think we'll get even more price. .

But does that tightness in 4Q on the heating side mean that rebating and discounting activity might be more moderate and therefore realized price goes higher in 4Q?.

I think our attempt on raising the price guide by $5 million was our attempt to capture that. .

Okay. And then just quick on tariffs, you have obviously minimal impact based on what you know right now. Are all of your China imports wrapped into the current List 1 to List 3 right now.

So if we do get further actions in List 4, List 5, are you pretty much done at this point?.

Ask the question one more time please..

Yes, I am just wondering, your China imports, are they all covered by List 1 to 3 or are there some other potential impacts if we do get a broadening of the tariff lifts?.

I think the vast majority of what we did import from China is impacted from List 1, 2 and 3. But there may be some that aren’t impacted. So, if we move to sort of – if the administration moves the tariff on everything imported from China, there is probably some more risk..

Okay. And then just a quick one. Going back to the European weakness in commercial HVAC. Is that a broad impact that you are seeing across the whole market there? Or was it just lumpiness? And any comments on that European weakness would be helpful..

I think it’s more broad in the European market. Early in 2018, there was a regulatory change in Europe regarding minimum efficiency and refrigerant policy – refrigerant that you can use.

These changes combined added about specifically on our rooftop business there, which is our largest business, these changes combined, added about 15% or so to the cost of the rooftop. And in the near-term, leading customer slowed down their replacement cycle.

In 2018, there was some sticker shocks as we and all our competitors had to make these changes and had cost to the system. As we started to sort of go through the year the market is absorbing the new reality and quite frankly they have to replace the units they have and build new stores.

And so, year-on-year comparisons will start become more favorable at fourth quarter as we go into 2019. But I think a large part of it’s an industry phenomenon..

Got it. Thanks, Todd and good luck with recovery. .

Thanks. .

Next is the line of Walter Liptak with Seaport Global. Please go ahead..

Hi, thanks. Good morning and thanks for taking my question. .

Of course..

I was hoping to go back to the balance sheet and just get some detail about – the receivables were up pretty nicely and I think typically this time a year there is some seasonality to it as they look better.

I wonder what that was relating to inventories presumably were down as you worked off any inventory that you were building for the heating season.

But I wonder, can you talk about the inventory for the fourth and first quarter as well related to heating? And then with production ramping for heating next year in the first quarter, is it early in the year or early in the quarter or this was late in the quarter? How does - do you miss the heating season, because you are – as you are ramping production?.

I’ll answer the last part first. We are clearly missing some of the heating season and that's reflected in the lost revenue guide that we’ve given. And so the short answer is we are missing some.

Second point is, as we expect by the end of first quarter to be up and running in our heating production or have the capability to do heating production and I would also say that, we sell furnaces all year round.

It’s seasonal, but it’s not a seasonal as air-conditioners typically when someone is going to replace an air-conditioning system if it’s a 10 or 15 year old system, they’ll buy a new furnace also. And so there is an attachment rate of furnaces that go with that.

In terms of the working capital flow, it’s going to be off from where it’s been in prior years, because of the tornado impact. But I think inventory being down because we are selling out of our products. Receivable is a seasonal effect where we typically have big third quarters and we did relatively not as well as we have traditionally done.

But still up year-over-year revenue-wise and that drove the receivable increases. .

And I’d say the impacts that you see on working capital are directly related to the impacts of the tornado.

All right. Great. Thank you, guys. .

Thanks, Walter..

And we have no further questions. You may continue. .

Okay, great. Thanks operator. To wrap up, we look forward to a strong close to 2018 as we remain focused on executing on all our corporate initiatives to drive company performance and shareholder value. We hope to see everyone on December 12th at our Annual Investment Community Meeting in New York as we look ahead to 2019 and our long-term plans.

Thanks everyone for joining us today..

Ladies and gentlemen, that does conclude your conference for today. Thank you for using AT&T Teleconference Service. You may now disconnect..