Ladies and gentlemen, thank you for standing by. Welcome to the Lennox International First Quarter 2019 Earnings Call. [Operator Instructions]. 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 first quarter of 2019. I'm here today with Chairman and CEO, Todd Bluedorn; and CFO, Joe Reitmeier. Todd will review key points for the quarter, and Joe will take you through the company's financial performance and outlook.

[Operator Instructions]. In the earnings release we issued this morning, we have included the necessary reconciliation of the non-GAAP financial measures that will be discussed to GAAP measures. All comparisons mentioned today are against the prior year period.

You can find a direct link to the webcast of today's conference call on our website at www.lennoxinternational.com. The webcast will be archived on the site for replay. I would like to remind everyone that in the course of this call, to give you a better understanding of our operations, we will be making certain forward-looking statements.

These statements are subject to numerous risks and uncertainties that could cause actual results to differ materially from such statements. For information concerning these risks and uncertainties, see Lennox International's publicly available filings with the SEC.

The company disclaims any intention or obligation to update or revise any forward-looking statements whether as a result of new information, future events or otherwise. Now let me turn the call over to Chairman and CEO, Todd Bluedorn..

Thanks, Steve. Good morning, everyone, and thanks for joining us. Let me start with an overview on the first quarter and key points on each of our businesses and then discuss accelerating recovery in our residential business from the tornado impact as well as the insurance proceeds for this year.

On a GAAP basis, company revenue was $790 million down 5% including 10% of negative impact from the tornado and divestitures. Foreign exchange had a negative 1% impact on revenue growth. On an adjusted basis, excluding divestitures, company revenue was a first quarter record $756 million, up 1% including negative tornado impact of 5%.

Foreign exchange had a negative 1% impact on revenue growth. GAAP operating income rose 79% to a first quarter record $95 million. GAAP EPS from continuing operations was up 92% to a first quarter record of $1.73.

On an adjusted basis, total segment profit rose 34% to a first quarter record of $99 million, and total segment margin expanded 330 basis points to a new first quarter high of 13.1%. Adjusted EPS from continuing operations rose 38% to a first quarter record of $1.68.

In our residential business in the first quarter, revenues set a new first quarter high of $466 million, up 3%, including 8% of negative tornado impact. Revenue was up in both replacement and new construction business. Residential segment profit rose 69% to $87 million.

Adjusted for a $22 million net profit resulting from $40 million of insurance proceeds against $18 million of negative tornado impact, residential segment profit was up 26% in the quarter. Residential segment margin expanded 730 basis points to 18.6%.

Adjusted for the tornado impact and insurance recovery, segment margin expanded 160 basis points to 12.9%. Turning to Commercial in the first quarter, revenue is down 3%. Segment profit declined 31% and segment margin was down 360 basis points to 8.7%.

Commercial revenue in the first quarter was driven by a mid-teens decline in new construction, well known for being a lumpy business. Both 2017 and 2018 for example, we had two quarters of strong growth and two quarters of a decline in new construction revenue.

In replacement business, revenue was flat in the quarter with planned replacement down a couple of points, with solid growth in emergency replacement, up mid-single digits.

For both new construction and planned replacement, we saw some national account customers temporarily pause investment in the context of all the government and macroeconomic uncertainty in the market in the first quarter. Currently, however, we are seeing backlog up nicely heading into our seasonally largest quarters.

Operationally, we continue to focus on productivity improvements at our factory in Arkansas. We have been addressing labor shortages and inefficiencies in recent quarters. In the first half, we are continuing to focus on training for all the new employees brought on board full time and ramping up productivity further.

Our VRF business saw strong double-digit growth in first quarter, and on the service side, Lennox national account service revenue was up mid-single digits. We continue expect Commercial segment growth and margin expansion on a full year basis with revenue up the remainder of the year and margin expansion in the second half.

In Refrigeration for the first quarter, revenue was up 2% at constant currency, but we had 4% of negative foreign exchange impact in quarter. Regionally, North America was down mid-single digits due to the same dynamics as I mentioned for Commercial.

We saw some customers temporarily pause investment in the context of all the government and macroeconomic uncertainty in the market. As in Commercial, Refrigeration backlog is building up nicely as we enter our strongest seasonal periods.

In Europe, revenue was up low-double digits at constant currency with Refrigeration down slightly and Commercial HVAC up more than 20%. Both of these businesses can be lumpy on a quarter-to-quarter basis. Refrigeration segment profit was down 20% in the first quarter and segment margin was down 180 basis points to 8%.

Lower mix was a factor with a fast growth in Europe and volume was down for the segment overall. We continue to expect Refrigeration segment growth and margin expansion on a full year basis with revenue up the remainder of the year and margin expansion in the second half. For the company overall, the second quarter is off to a solid start.

We are reiterating our revenue and adjusted EPS guidance as we look ahead to another year of strong growth and profitability. We are raising our guidance for stock repurchases this year from $350 million to $400 million.

Before I turn it over to Joe for more financial details on the quarter and our outlook, let me summarize where things stand on the tornado impact and insurance recovery this year.

Big picture, for core and non-core related to tornado, we now expect total insurance proceeds of approximately $358 million, about the same as the $356 million of previous guidance. We received $124 million of that of 2018 and expect approximately $234 million in 2019.

The non-core gain expected for the difference in book value and replacement value of assets is now approximately $91 million down from the previous guidance of $109 million for 2019 due to lower estimated construction costs, approximately a $1.79 benefit the GAAP EPS versus a benefit of about $2.30 in previous guidance.

From a core perspective, our residential business continues to make significant progress and we're seeing acceleration in the recovery from the tornado.

As I mentioned previously, we are back -- we were back to full production across all three of our residential factories for cooling product by the end of fourth quarter of 2018 and are there as well for heating products as the end of the first quarter of 2019.

We are taking back business as the market as we resupply dealers and are focused on fully refilling our company-owned regional and local distribution network. The expected negative impact from the tornado is down from our prior guidance as the team continues to perform operationally and take back business for Lennox in the market.

From a core perspective in the first quarter, the negative tornado impact on revenue was $35 million versus guidance of around $42 million. The negative tornado impact on segment profit was $18 million in first quarter versus guidance of around $21 million.

For revenue in 2019, we now expect $70 million of negative tornado impact down from the prior guidance of $85 million.

We estimate $40 million of negative segment profit impact down from a prior estimate of $43 million, and the business interruption insurance recovery for lost profits is expected to be about $80 million in 2019 compared to $83 million in prior guidance.

This results in a net segment profit impact of positive $40 million in 2019, the same as in prior guidance. Of the remaining negative tornado impact for 2019, we expect to hit of approximately $21 million in revenue and $13 million in profit for the second quarter.

For the third quarter, we expect a hit of approximately $40 million to revenue and $9 million to profit. For the remaining $40 million in insurance recovering in our core guidance, we expect that to flow evenly across the three remaining quarters. A lot there.

We have posted a tornado financial updates chart on our website with the details reflecting prior guidance and the current view. Now I'll turn it over to Joe..

Thank you, Todd, and good morning, everyone. I'll provide some additional comments and financial details on the business segments for the quarter, starting with Residential Heating & Cooling. In the first quarter, revenue from Residential Heating & Cooling was a first quarter record $466 million, which was up 3%.

Volume was flat, price was up 2% and mix was up 1% and foreign exchange was neutral to revenue. Residential profit of $87 million was up 69%. Segment margin was 18.6%, up 730 basis points.

Segment profit was favorably impacted by a net $22 million of benefit from insurance proceeds relative to negative $20 [ph] impact in the quarter, as well as higher volume, favorable pricing mix, and sourcing and engineering led cost reductions.

Partial offsets included higher commodity, freight, tariffs and warranty costs, lower factory productivity, distribution, investments and higher SG&A expenses. Turning to our Commercial Heating & Cooling business. Commercial revenue was $173 million in the first quarter, down 3%. Volume was up 6%, price was up 2% and mix was up 1%.

Foreign exchange was neutral to revenue. Commercial segment profit was $15 million down 31%. Segment margin was 8.7% down 360 basis points. Segment profit was impacted by lower volume and factory productivity, higher commodity, freight, tariffs, warranty and other product costs, distribution investments, and higher SG&A expenses.

Partial offsets included favorable pricing mix and sourcing and engineering led cost reductions. In the Refrigeration segment, revenue was down 2% in the first quarter. Volume and mix were flat and price was up 2%. Foreign exchange had a negative 4% impact on revenue. Refrigeration segment profit was $9 million down 20%.

Segment margin was 8% down 180 basis points. Segment profit was impacted both by lower volume and factory productivity, unfavorable mix, higher commodity, tariffs and freight costs, distribution investments, and higher SG&A expenses. Partial offsets include favorable price and sourcing and engineering led cost reductions.

Regarding special items in the first quarter, the company had a net after tax benefit totaling $2.2 million.

That include a gain of $5.2 million from insurance recoveries, net of losses incurred, a benefit of $4.4 million for access tax benefits from share based compensation, a loss on the sale of business of $5 million, $1 million for non-core business results, and a net charge of $1.4 million for various other items.

Corporate expenses were $12 million in the first quarter. On a GAAP basis, overall SG&A was $146 million or 18.4% of revenue, down from $155 million or 18.6% in the prior quarter. Net cash used in operations in the first quarter was $141 million compared to a use of $84 million in the prior quarter.

Capital expenditures were $37 million compared to $23 million dollars in the first quarter a year ago. We also had proceeds for tornado damage to property plant equipment that totaled $7 million. In the first quarter we used $171 million of free cash flow, compared to a use of $106 million in the prior quarter.

The increase and use of cash for the quarter was the result of timing of payments tied to the reconstruction of Marshalltown and was in line with our expectations. Given our business seasonality, we used cash in the early part of the year and generate cash in the latter part of the year.

The company paid $26 million in dividends in the first quarter, and repurchased $100 million of stock. Total debt was $1.3 billion at the end of March, and we ended the quarter with the debt-to-even our ratio of $2.0. Cash and cash equivalents were $32 million ending the quarter. Before I turn over to Q&A, I'll review our outlook for 2019.

Our underlying market assumptions for the year are unchanged. For the industry overall, we expect North America and 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 relatively flat.

For the company in 2019, we are reiterating revenue growth of 3% to 7% with neutral foreign exchange. We are updating GAAP EPS from continuing operations from a range of $14.30 to $14.90 to a new range of $12.65 to $13.25.

This incorporates the benefit from special items in the first quarter, lower estimated factory workers reconstruction costs and the associated gain of approximately $91 million, which was the $109 million in the previous guidance for 2019, that results from the placement of a value above book value, and a non-cash pension settlement charge of approximately $61 million pre-tax in the second quarter of 2019.

The pension settlement charge relates to an agreement we entered into with Pacific Life Insurance Company in April to annuitize $106 million of our defined benefit pension obligation. As part of this transaction, we also transferred $100 million in pension assets to Pacific Life.

This event required lead measurement of the pension plan and it will result in a $61 million non-cash, pre-tax settlement charge in the second quarter of 2019 to write-off the related, accumulated, actuarial losses. For adjusted EPS from continuing operations in 2019, we are reiterating guidance for a range of $12 to $12.60.

And now let me run through our key points in our guidance assumptions and the puts and takes for 2019. We still expect to capture $80 million of additional price for the year. We are planning for a $25 million benefit from sourcing, and engineering led costs reductions and an $8 million benefit from residential factory productivity.

We still expect $30 dollar headwind from commodities, and that's $15 million from freight, and $10 million from tariffs. We continue to expect headwinds of $15 million for distribution investments, and $15 million from SG&A. Net interest expense is still expected to be approximately $45 million.

Corporate expenses are still targeted at $90 million for 2019 and we still expect an effective tax rate in the range of 22% to 23% on an adjusted basis for the full year. Now a couple of updates. Capital expenditures are now expected to be $195 million down from the $215 million in the previous guidance.

The change is due to lower reconstruction cost to complete the Iowa manufacturing facility. We now expect this to be $95 million versus the prior guidance of $115 million and will be funded by insurance proceeds.

And finally, we continue to expect the weighted average diluted share count for the full year to be between 39 million to 40 million shares, which incorporates our plans to repurchase $400 million of stock this year. And with that, let's go to Q&A..

[Operator Instructions]. First on the line, we have Julian Mitchell with Barclays. Please go ahead..

Hi, good morning..

Good morning..

Hey, maybe just the first question around the Commercial margins. I know you talked on the last call about headwinds in Q1 from labor inefficiencies and factory productivity. I just wondered if the margin decline in Q1 that you saw was worse than you thought.

And how you think about the timetable of getting through those productivity issues over the balance of the year?.

It's quite frankly a little worse than what we thought. And we now think it's going to be second half of the year before we see the margin expansion. I mean there were a couple of things though in the quarter for commercial above and beyond the factory.

We had lower volume as well as the lower factory productivity as we discussed, and the lower volume hurt us on absorption.

And as I talked about in the script, operationally we continue to focus on productivity improvements at our factory in Arkansas where we've been addressing these labor shortages and we continue to focus on training and ramping everybody up.

Also in the second half of 2019, we expect to have a larger positive gap between price and commodities, freight and tariffs.

So, on a full year basis, we're ahead as a Corporation and Commercial on a full year basis we're ahead, but in the first quarter in Commercial, we were negative price/cost, the elements I just said, because it takes a little longer for Commercial to get priced in the marketplace from -- the price increases they announced at the end of the year.

So, second half of the year, we’ll have a positive gap between those two. As I mentioned on the script, margins are up nicely, which is up mid-single digits as we entered the quarter, and we -- as we enter a quarter on Commercial, about 50% of our revenue is already in backlog and 50% we have to book and ship..

Thanks. And then my second question on the residential business, any update on sort of broad end market conditions, how you are feeling about Q2. And also if the market share progress you're making is in line with what you'd hoped coming out of the tornado impact..

The short answer is -- short and long answer is, we're actually slightly ahead of where we thought coming out or when we guided last time of winning back share and you saw that in a lower tornado impact to core earnings, so in other words, we sort of overdelivered on the revenue and EBIT side for residential ex the tornado.

I'd look at our results, our first quarter revenue was up 3% at actual and residential, and then we said we had 8% of tornado impact which implies we would have been up 11%. Residential is going -- still going very strong and we're getting ready for the summer selling season.

We continue to gain back the share that was borrowed from us and we're confident as we go through the year we'll do that..

And market conditions are as you thought as well?.

Yes. I mean it's always a little hard to tell as you go – when you’re this early in the second quarter, but we have events. We call them Lennox LIVE, but they are really dealer meetings where we meet with thousands of our largest dealers in four or five locations around the country. The mood was extremely positive.

People are excited, both loyal to us atleast that's what they tell us in the room when we bring them in, but they're showing that with their spending. But more importantly, people are confident going into the spending season. I think you saw.

Well, I don't think you saw, you saw in our Commercial and Refrigeration numbers, which I think are more tied to sort of concerns that you'd get by watching cable news.

And I think there is some softness that was attributable to our softness in Commercial and Refrigeration that was tied to sort of this macroeconomic overhang in North America or certainly in the U.S. I think that's now behind us. And all three of our businesses as we go into summer selling season feels pretty good..

Thank you very much..

Thanks..

Next, we'll go to our Jeff Hammond with KeyBanc Capital Markets. Please go ahead..

Hey, good morning Tom.

How are you?.

Good.

How are you?.

Good. So just, just going back to the kind of share recapture. Are you finding just what are your experiences as you talk to dealers and are you expecting some dealer attrition because it just seems like some of your competitors were suggesting that they’d be able to hold some of this share shift..

Yes. I mean, the short answer is yes. There's some dealers we lost, that that won't come back. But at the same time every year, we have met hundreds of dealers that we bring on. We lose some, we bring new ones on. So sort of when it's all said and done, they can't hold all their dealers. They can't hold all their dealers plus the ones they took from us.

So we're attacking on a broad front, both winning back our dealers, who they borrowed share from, but also going after their existing dealers. And so we're attacking on all fronts. We're real confident at the end of the year we're going to be in a good share position and we're seeing it in the numbers..

Okay. And then just on Refrigeration, just confident that you know that steps up given some of the you know I guess pause or concern as we move into the latter part of the year..

Yes. I mean, its confidence you can be when you have 50% of backlog for the quarter and you still have to book and ship, but we're up double digits in Refrigeration backlog entering the quarter and like Commercial 50% of that we start to book and ship, with 50% of it's in backlog.

Like Commercial, it can be lumpy where we saw the softness was in North America which was down mid-single digits our European business was actually up. And I think that ties to the theory of the case that I said earlier and so again, we're confident going into the balance of the year.

Like Commercial there'll be a lag on price cost and so margin expansion will be second half the year, but we expect revenue to be up second quarter..

Okay, thanks a lot..

Thanks, Jeff..

Our next question is from Ryan Merkel with William Blair. Please go ahead..

Hey thanks. So first question is on second quarter. You said it's off to the sound start.

I just want to confirm, is this true across all segments?.

Yes. So. So, I'll give you the math again. Commercial backlog up mid-single digits. Refrigeration backlog up double digits and residential where backlog doesn't much matter. You know we're off to a solid/strong start, but again, the reminder obviously that you know right now I'll say to others is April is about 20% of what we do.

May is about a third, and June's half. So, bottom of the first, we're doing well, but we still have a [Indiscernible]..

Got it. Okay. And secondly, Commercial margin expansion in the second half of 2019, maybe just give us some context on the second quarter though.

Should we be lowering our expectations, is that what we're sort of hearing?.

Yes. What I'm trying to tell you is -- is I think margins -- I would guide that margins will be flat to down in second quarter and they'll be up second half of the year. And it's a combination of still ironing out some of the factory productivity issues we have.

Roadmaps in place we're executing it’s just a matter of when you have 1500 people in a factory and a lot of them are new. Getting everyone trained up and then second is, price cost. It was negative and Commercial first quarter will be relatively flat, and second quarter and then second half of the year we have positive price cost..

Got it. And then maybe just quickly lastly, it's good to hear you’re taking back share in the resi business.

But are you having to do less discounting than you expected?.

I think, I'd answer it this way. We got 2% price in the quarter. We see it in the numbers and we're real confident we're going to get 2% price. So I won’t necessarily get into what we expected, but we’re holding – we’re getting the price increases that we had hoped for and what we guided to and we’re sticking with the price..

Okay, great. Thanks very much..

Thanks..

Next, we’ll to Nicole DeBlase with Deutsche Bank. Please go ahead..

Yes. Thanks. Good morning..

Hi, Nicole..

Hi.

So, with respect to the margin improvement that you guys expect to for Commercial and Refrigeration for full year; is it possible to get a sense of the magnitude? Are we talking about 10, 20, 30 bps? Just give us some conviction around what’s embedded in the second half?.

Yes. I’m not -- this early in the year I’m not going to guide the margins. I think I’ve given more than I normally do on segment guide. So we’re guiding that both will be up year-over-year, for the full year will be up second half for the year and will be down first half..

Okay, understood..

The way I frame it, I mean, I’m not breathless about margins that we’re confident that they’re going to be up..

Okay, got it. And then on capital allocations I know you guys raised the buyback guidance, makes a lot of sense, it seems like its deployment of Kysor proceeds.

But does that – what’s that indicate with respect to the M&A pipeline if you could talk about that a little bit?.

I think it’s a – there is no read-through to the M&A pipeline.

Our M&A pipeline as we’ve talked about will sort of most likely be -- we think we’ll be interested in with the HVAC North America that would be large and lumpy and when that time comes – if that comes and then we’ll figure out how to finance and then take care of it in a shareholder friendly way.

But in lieu of that we’re not to let the balance sheet grow and we’ll get money back to shareholders..

Got it. Thanks..

Next question is from Robert McCarthy with Stephens. Please go ahead..

Good morning everyone..

Hey, Rob, how are you?.

Good. I guess may be just to augment some of your comments around the homebuilding channel. I think you said positive growth there? And what you're seeing there? And then not to beat a dead horse, but it sounds like you’re really typifying this as a pause as opposed to something worse particularly in the Commercial channel in North America.

Obviously, you have a limited visibility, but maybe you could just reiterate what the strength of your argument is there?.

Construction -- new construction and Residential is up low single digits for the quarter. And again that's on -- that's with the tornado impact. We didn't break out the 8% tornado impact between new construction and replacement, although I would tell you, the vast majority of that was replacements.

So, new construction is up sort of low to mid single digits roughly in line with what we expected for full year. And again, when we talk to the builders going into the summer building season they remain confident.

In terms of Commercial and also I’d extend it to Refrigeration, within industry phenomenon there are three or four months where the industry was down. We were part of that. We saw industry data for February that’s started to recover. And as I said, we can see it on our order book and our backlog where our Commercial business is up mid single digits.

And we talked to the customers, they are confident. So, we’ve seen last year in 2018 we had a couple of quarters where we were down. In a couple of quarters that we were really strong, and so it’s not unusual for that to be the case with this business..

Any comments you can make up around the segments in terms of how we – is there any change that we could see in terms of underlying incremental margin lift at Refrigeration and Commercial, obviously given the fact that you change margin targets of Refrigeration that should be the case.

But any kind of color how we should be thinking about incremental margins at the sub-segment level for those two? And then just in the context of resi?.

I'm not going to give you – at least I don’t have guide points that I’m going to share right now for 2019, the three-year targets and I would -- the three-year targets for Resi are 19 to 21 and for Commercial, 19 to 21 and for Refrigeration, 15 to 17 and I think about roughly is a straight line between 17 and 21 to get there, excuse me 18 and 21 to get there.

But I think I've been pretty clear about, I said it three and four times that Commercial and Refrigeration will be back half for the year..

Congrats for this sold start..

Okay. Thanks..

Next we’ll go to Jeffrey Sprague with Vertical Research Partners. Please go ahead..

Thanks. Good morning everyone..

Hi, Jeff..

Hi, Jeff..

Just back to the share recovery pie, if we could. Could you still elaborate a little bit actually how you’re calculating that at this point, right? I would imagine it's somewhat imprecise, but we’re talking relatively precise numbers.

I mean, the 8% unfilled orders or is it some other kind of mathematical construct?.

I mean, it’s a couple ways, and we sort of triangulate than its quite frankly how we’re talking to the insurance company also. I mean, we understand what the market does. And we understand what our share was going into the tornado. And so then we understand the delta between what “our revenue would have been to what it was”. So that’s top-down.

The other way we do it is we know literally by customer. Who took -- who left us, who we allowed to leave, how much business they took and then we can tell how much we’re winning back as we get it back. So we have a pretty clear line of sight of what was lost, who was lost with, how much was lost. Quite frankly who took it, borrowed it from us.

And so when it comes time as it is now to get it back we know exactly whose door to knock on and how to get it back..

And to the extent that pushed, this is maybe a struggle for dealers as opposed to a struggle for volume within a dealer.

Are there non-price things going on in your business kind of pledges the dealers, some givebacks, rebate, things like that showed some point in the future? Or do the numbers fully reflect the competitive dynamic that's going on?.

Yes. Its fully reflect the dynamic that’s going on. In other words just from the accounting, I mean, if we make a promise on some kind step or kickback then that sort of reflected in the economics as we accrue the revenue against it. So that's all in there. I mean, we’re doing the basic things.

Quite frankly, we always do when we convert dealers, and in this case it's getting back share, but somebody switched over a competitor X and they have a handful of furnaces or air-conditioners, we’ll buy them out. We’ll take over the units from them. But if they need some marketing support we’ll do that.

There's lots of created things we’ll do and we reflected in the P&L. But as I said earlier, we did better on revenue and getting back to share in first quarter than we initially guided and we stuck with the 2% price. And so I would be nervous if we weren’t sticking price, but we’re sticking price..

Great. Thank you..

Thanks..

Our next question is from Robert Barry with Buckingham Research. Please go ahead..

Hey, guys. Good morning..

Robert, how are you?.

Good. Thanks.

Maybe just to start with the weather, anything notable call out there, as either a headwind or a tailwind in the quarter?.

No. I mean, it was a little bit cooler than it had been last year, but sort of on around the same number. So weather really didn’t impact much..

Got it. And then, if I pull out that $22 million net benefit from the tornado and resi, which I think that you highlighted with kind of more than you expected. Kind of the underlying contribution margin there looks kind of -- I don’t know, kind of mid-teens ish maybe.

I don’t know if that just seasonality or if there's anything mix going on in the quarter that you want to call out?.

Here’s what I think about it.

Just talking resi overall, right? You’re talking resi?.

Yes..

Yes. I mean, I would subtract $40 million of the insurance proceeds. Add back $80 million of tornado impact. And then add $35 million in revenue. And I think if you do that if it shows incremental sort of 28%, 29%. So, I'm not sure where you get 13%. I think it's 28%, 29% and I think it shows margins up 150, 160 basis points..

Got it. Got it. Yes. No. I’ll definitely revisit the math there. On the Commercial….

I think you're just testing my conviction, Robert, I don’t….

Okay. I was also doing the math on the fly. So, I’ll check it.

On the Commercial just anything from a vertical perspective in terms of pressure, any particular verticals under pressure?.

No. I mean, it was across the board. I mean, we’re half national accounts. So predominately the story as you would expect would be national accounts. But I wouldn't believe that over to the broader concern that we all have longer-term about what's going to happen to retail. This is more people just sort of pulling back in and deferring.

As you know in replacement there’s -- for national accounts the majority of the time that’s planned replacement, so they have discretion that they can make decisions on with just a matter of sort of pulling back a bit and the new construction, same thing..

Got it, got it. Just lastly and I apologize in advance for kind of more esoteric accounting question, but just looking though the K for last year.

I think there was a fairly significant headwind in this kind of other product cost category, which I think a lot of that was LIFO adjustments? Curious, if there's any visibility there on – like is that expected to be neutral this year or first or just any thought on how that might play in the P&L?.

I mean, I’ll give the layman’s answer and then I go to Joe, he’s here in front of me. I mean, LIFO just an accounting attempt to trueup at the end of the year what should or could have flown to the P&L during the year. And it has to do the timing of when the cost of inventory flows through the P&L.

You had perfect information obviously, is sort of set up, so there was no LIFO adjustment. The negative LIFO that you saw -- we saw last year was really more of – we had really good or significantly good news in 2017. We have less good news in 2018. So it showed the change. The change was negative.

When we think about LIFO during the year, we never guide to it, so we just sort of expected its going to be neutral during the year and that’s how I encourage you to think about it?.

Yes. What we expected to be and quite frankly the way that we planned it and we’re guiding is no impact in 2019 at this point. If that changes in future periods we’ll give you some heads up..

Got it. All right. Thanks..

Our next question is from John Walsh with Credit Suisse. Please go ahead..

Hi. Good morning..

Hey, John..

So, talking with some dealers we heard that there is some new fan efficiency rating requirements that are going to be coming online this summer. I believe it's more related to the heating side instead of the AC side.

But just wanted to maybe understand that dynamic a little bit? And if you're seeing anything outside of kind of the normal share recapture that would distort the way to think about this cooling season?.

Why don’t I talk about that that the regulatory change and talk about how it impact us and then I’ll make sure I capture the share impact at the end, because the answer to that is, yes, there’s some things that will take place with those of independent distribution.

So, on July 3rd this year there's a furnace fan efficiency rating FER, furnace – excuse me, Fan Efficiency Rating, FER regulation is scheduled to go in effect.

This requires some move from the standard efficiency what it called PSC motors to higher efficiency what it called constant torque of variable speed motors, its probably more technology than anyone that called once but waited -- from a business point of view, the regulatory change is going to add about 25 to 50 bucks to the cost of a furnace.

This regulation is based on manufacturing stop date for the standard efficiency units and companies continue to sell them after that date, i.e., you can build up inventory of independent distribution, company distribution to sell later.

And like we’ve done on other regulatory transitions, we’re going to have to prebuild of the standard units as well, as our competitors and we’ll continue to sell the past July 3.

And the goal and we’re pretty confident that we’re going to do it, will be the same thing that happened on the 13 to 14 share transition that you sell -- you further in the new units that are higher cost over time and so there is a step function change in pricing, better stated, there isn’t this erosion of pricing on order units and so you sort of feathered in over time.

And so we’re confident we’re going to be able to protect margin and price when we go through this transition. I think the impact that you’ll see in share will be – and you’ll be able to pick it up on the AHRI data, that the April, May, June aren’t big furnace seasons compared to wintertime.

But some of our competitors or some independent distributors will see a big spike in furnace share, furnace volume for them during that time period that's them stocking independent distributors with these standard units that they can't build after July 3.

You don’t see that in our numbers because we’ll carry the inventory ourselves and we’ll sell through the dealers during the furnace selling season that will come later in 2019.

Was that clear enough, John?.

Yes. No, that was a great detailed answer. Appreciate that.

And then maybe just a quick follow-up here, I mean given the move in copper, wouldn’t necessarily expect any impact to 2019 giving your hedges, but how do you think about that move and maybe further or around pricing potential?.

We continue to remain confident. We can get price to offset commodities and so I prefer that all the commodities go down rather than up, but if they go up we’ll price in the out years to do it. As of April we’re 73% hedged on copper for 2019, so we’re pretty locked in. And again as copper moves we’ll adjust..

Okay. Thank you..

Thanks..

Next, we’ll go to Steve Tusa with JPMorgan. Please go ahead..

Hey, guys. Good morning..

Hi, Steve..

So what was price in the first quarter for a residential, price realized?.

[Indiscernible] to make sure we got the right number..

It was a little more than 2% for the quarter..

Yes, so its 2% for the quarter. I know that, but I don’t know the exact number, but 2% for the quarter..

Okay.

And then just kind of like better understand that how you calculate the tornado impact? I mean, your revenue was…?.

I heard [ph] from somebody, its $11 million..

Okay. Your revenue was up 3% or whatever, but you’re just kind of like looking at just stripping out the impact of the insurance proceeds, which you could consider to be like totally non-operational if you will, your profits were down.

So, I guess if we’re not adjusting -- I guess the point is like you have extra cost that just running through from all the things that kind of skews that that kind of profit performance if not just kind of an incremental margin on the lost volume? Is that the correct way to kind of think about it?.

No. I mean, I’ll tell you what I think about it. I mean, we’ve been clear from the beginning that the drop-through on the lost revenues was going to be a rich drop-through.

So the guide for the quarter or the actual for the quarter which is better than our guide was $35 million tornado impact, $35 million someone in the back ground is yelling and agreeing with me. It was $35 million of revenue impact and $80 million of the EBIT impact from the tornado.

And that's because it's our highest margin product that’s really rich mix coming out of Marshalltown.

So, if you take what our reported results were and subtract $40 million from the insurance proceeds and add back $35 million of revenue and $80 million of EBIT what you'll see is that our earnings were up 25% in resi and that our margins expanded 150, 160 basis points. We had a 28%, 29% incremental.

So that's how I do the math and the story just what I thought it would be. I think your math doesn’t take into consideration $35 million in revenue yield at $80 million of EBIT and that’s because it's such a rich mix of product..

Okay. Got it.

So, but I guess, if we just look at it in kind of on a real-world basis that would suggest that your profits would have been down on kind of these lower mix units -- on growth of those lower mix units?.

Yes, exactly, so for instance, the tornado impact we lost the cream [Indiscernible] right? So yes, we had lower margins..

Okay, great. That’s really helpful. Thanks..

Thanks..

Our next question is from Joe Ritchie with Goldman Sachs. Please go ahead..

Thanks. Good morning, guys..

Hey, Joe..

Hey.

So, Todd, your comments earlier on resupplying your dealers, I’m just curious when you think about selling versus sell-through in the resi channel, how far along are you on the sell-in process?.

We’re 75% to 80% owned distribution. So, we only have – we don't sell-in, sell-out, we just sell out. So we don’t recognize it until we sell the product. On our allied business there some inventory loading with selling in. But the sell-in, sell-out is really for people who are dominated or have large independent distribution, that's not us.

Our numbers are 80% sell-through. That's all we report..

And maybe asking that a little bit differently; in terms of getting your inventory levels back to where they need to be do you feel like you’re there at this point? Or is there still some room to go?.

There’s still some room to go. I mean, we turned on full production at the end of first quarter. It’s now April and so we’re still sort of running our residential factories hard to get ready for the summer selling season..

Okay. And then maybe one follow-on, as I kind of think about some of the cost headwinds that you guys outlined for the year whether that’s commodity, freight, tariffs.

I guess how should we be thinking about the cadence? Was there any – like was there potentially disproportionate impact in 1Q? Or how are you guys thinking about it as the year progresses?.

We’re thinking about it as that about a third of the benefit – we said that price would be $80 million and commodities, freights and tariffs will be 55, so we’re going to be 20 plus, $25 million. And we think order of magnitude, a third of that would be first half of the year and two-thirds of it will be second half of the year.

And so it’s going to be backend loaded..

Okay.

And do you guys have a number for 1Q at your fingertips for that cost impact?.

1Q we were slightly negative..

Slightly negative. Okay. Thanks guys..

Thanks..

And next, we’ll go to Deepa Raghavan with Wells Fargo Securities. Please go ahead..

Good morning. Can you comment on your Residential momentum in the quarter? I know backlogs don’t matter. You spoke pretty extensively about Residential. But just curious how was the progression from March to April, March was a big month.

And also like some other distributors call that, was Easter, a benefit in the quarter and therefore probably a pull forward from Q2? Or just curious any other puts and takes from a year-on-year perspective or a seasonality perspective as we think about Q2?.

Yes. I don’t think Easter much matters. I mean, I understand Good Friday is a selling day, but – so I don’t think Easter. It's not like Christmas where it’s a week of activity gets delayed or deferred. It's like a day of activity and not for lapsed Christians.

I think in terms of the timing and the momentum of the business I think the end market remain strong and solid, but it's more about our performance, I mean the factories are roaring. We’re producing all the product lines. We’re sort of out there gaining back share. And so the momentum in the Residential business is strong as we go into second quarter..

Got it. Can you – this is probably just a forward looking question. Can you comment on if you would be impacted by any Mexico border closure if that happens at all? And what could some of the steps be that you should taking to look around such an event? Thank you..

Yes. We would be impacted by a Mexico border shut down, parenthetically so with most of corporate America. And so obviously we produce a lot of production in Saltillo and as a percentage of our business even more than it was a year ago and we source components for Mexico for our North America factory. So shutdown would impact us.

And so we’re doing the things you might expect to do looking at different options about buffering inventory and different ways to get across the border, but short answer is if the border get shutdown we’re all going to be impacted and we'll all scramble..

Okay. Thank you. That’s all I had..

And next, we’ll go to Tim Wojs with Baird. Please go ahead..

Hey, gentlemen. Good morning. Just two quick ones from me.

So, first just on the CapEx reduction, is there any reason why that $20 million shouldn’t flow down into free cash flow for the year? And then secondly just what’s the right quarterly D&A number once Iowa was kind of fully in the -- the reconstruction Iowa plant fully in the P&L?.

Tim, I’ll take the capital spend comment. That’s really tied to the reconstruction of Marshalltown. So there’ll be direct reduction in insurance proceeds as well for the capital expenditures there..

Okay..

And then D&A comment..

Yes. Depreciation and amortization, we have $80 million for the full year. That will impact us more as we get into 2020, but not so much in 2019..

Okay, great..

The next question is from Gautam Khanna with Cowen & Company. Please go ahead..

Thanks. Good morning guys..

Hey, Gautam, how are you?.

Doing well, thanks. Follow-up question on the Commercial productivity comment you made in the warranty expense. Just -- is there any amplifying color you can give on what's at the root of the problem there? Is it behind us or….

I don’t remember anything about warranty, but I mean, the issue has to do with productivity and it has to do with – we’re a seasonal business we’ll bring in and a significant amount of temp workers every year into the factory and when unemployment are at record, not record lows, but lows that none of us have seen in our business life time.

It's much harder to get workers. And so it has to do with attrition and absenteeism and training the workers we’ve had. We made some adjustments. Quite frankly we’ve raised the wage rates. We’ve change the way we’re operating with direct labor in the factory. And I’ll be frank I thought at the end of the first quarter it would be behind us.

Its lingered longer than what we had hoped, but I’m confident we’re doing the right things and we’ll get it better..

Okay.

Now the warranty reference was in the release, higher warranty year-over-year and other product cost, but okay?.

That’s really for the absence of good news versus bad news in the year and that's what it's about..

Okay..

Yes. Good catch..

Okay. No, no, that’s helpful. I appreciate it. And then just -- if you could just comment on the competitive environment across the three segments, if there's been any change more. Obviously, we understand the resi dynamic of temporarily donating some share.

But if you could just talk about have you seen any incremental price pressure? Is the industry still quite disciplined in terms of kind of raising price to offset commodity and holding it.

Anything you've seen that would signal any sort of change relative to a quarter or two ago?.

Yes. I mean price realization is always as a test of an industry dynamic and we continue to get price in the marketplace across all three of our segments. And we're confident that we'll do it. I mean, residential is sort of now fine again.

I mean, I think about the analogy it's two or three metaphors here, but you think about a fighter with an arm tied behind his back and that's what our sales force felt like, and now their arms released and you know they're wild dogs chasing after raw meat in the marketplace after being held back, and so we're excited going in the second quarter..

And last one from me, just now that you know Marshalltown is back online. Any change to how you got the production system if you will and how you know you're going to source more or less from Marshalltown relative to South Carolina and in Mexico.

Anything you can comment about how that might change relative to pre tornado?.

No. I think, it's what I said earlier about this that we've built capability at our other two factories, a new premium product and we're glad we now have that capability there, and we don't plan on sort of eliminating that capability. But man, we're really glad we had the Marshalltown team.

They've done a heroic job and having all of that experience allowed us to come back and so we're excited about the Marshalltown team, but obviously we're excited about continuing to grow our Mexico facility in our South Carolina facility also..

Thank you guys..

Thanks..

Next from the line of Josh Pokrzywinski with Morgan Stanley. Please go ahead..

Hi, good morning guys..

Hey Josh..

Todd, can you just talk a little bit about the two 2Q, 3Q. I guess you know both changes and just how you're thinking about the loss profits there. It seems like with heating and cooling now being both at full strength.

I get that there's some temporary share shift that comes back and forth, but just any reason why those numbers couldn't be lower still. I think you know just case in point in the in your table you had it actually going up in 2Q in terms of loss profits. So, anything you want to kind of monologue about there would be helpful..

I mean the guide is the guide. So I mean it could be better, it could be worse. That's the nature of guide. I mean, we're attacking or winning it back, but I mean it takes time and it also takes time and I think you understand this is you know our competitors have smart when they went in and did this.

They have rebates tied to sort of buying so much product or they tried to get dealers to buy cooling product early in first quarter before we had the full capacity to meet people's needs.

And so, so it’s going to take us some time to win back, but if we do better like in second or third quarter then like we did in first quarter that's obviously very good news..

Got it. And then I guess just related to that, I think Joe said that mix was up and resi in the first quarter. I guess a little surprising just given that you know some of the higher mix product was what was most impacted.

Is that something that was more of an anomaly or how should we think about mix over the balance of the year? Because I think both pricing and mix if you if you didn't know that the high margin stuff were the one that was off line, it would read like any other quarter the past few years?.

Yes. Mix was up just slightly. The majority of it was price. But we did have slight favorable mix within the quarter..

And we would expect and again it was not negatively impacted from the lost revenue of $35 million because that was skewed to the highest profitable setting. The point is we've had significantly better mix if we had, had the tornado impact..

The mix should accelerate over the balance of the year.

I guess is one other way to interpret that?.

I think, I'd interpret it. We'll have a strong mix here in 2020..

Got it. Thanks a lot Todd..

Thanks..

The final question will be from the line of Nigel Coe with Wolfe Research. Please go ahead..

Thanks guys. Good morning. Hi, Todd..

Hey, Nigel, how are you?.

Yes. Good thanks. So just wanted to go back to inventories you know quite a build up year-over-year and obviously these were unusual backdrop with the rebuild model time, but maybe just speak to that Todd, how you see inventories playing out especially given this switchover that's happening in July..

Well I think part of what's in that. I think our inventory was up 7% or an order of magnitude at last first quarter versus the prior year quarter, we were up 18%. So when your revenues is growing, you tend to build inventory.

You also lay and the cost impacts that we've had on commodities, you know that's also part of what's building into our inventory number and in the prebuilt of the furnaces. So we're still ramping up our factories, still driving production and inventory will continue to build until we get to the other side of the summer selling season..

Okay. Okay, that’s great. And then just quickly on new construction. You know we've seen housing starts down double digits through the first quarter. March was in February, February was in January. Does that suggest that your new builder channel will get worse will get better.

And finally you said low to middle digit growth for the full year, but does it get worse before it gets better?.

You know we were up low to mid-single digits. I think it was low single digits in first quarter for us. So we had a solid first quarter and we think it's going to be up low single digits for the balance of the year. Again, we'll see what happens..

And where is that mix right now tugged between new build and replacement for resi?.

We're probably 15%, 20% new construction to balance out on replacement..

Right. Okay thanks a lot..

Thanks..

I'll turn it back to the company for any closing comments..

Thanks Operator. To wrap up, our recovery from tornado impact continues to accelerate as we enter our largest seasonal quarters. Overall for the company, the second quarter is off to a slow start. We're reiterating our 2019 revenue and adjusted EPS guidance. We look forward to another year of strong growth and profitability.

I want to thank you all for joining us today..

Ladies and gentlemen that does conclude your conference for today. Thank you for your participation. You may now disconnect..