Lennox International Inc. (LII) Q2 2013 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by. Welcome to the Lennox International Second Quarter 2013 Earnings Conference 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 second quarter of 2013. I'm here today with Chairman and CEO, Todd Bluedorn; and CFO, Joe Reitmeier. Todd will review key points on the quarter, and Joe will take you through the company's financial performance and outlook. Financial results in prior periods have been revised to reflect sold businesses and discontinued operations. In the earnings release we issued this morning, we have included the necessary reconciliation of the financial metrics that will be discussed to GAAP measures. You can find a direct link to the webcast of today's conference call on our website at www.lennoxinternational.com. We will archive the webcast on that site and make it available for replay. We 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, and thank you all for joining us. We continue to see strong momentum from our strategic initiatives and operational execution in the second quarter as the company set records for total segment profit and operating margin. In the end market, environment is still 25% to 30% below peak shipment levels for the industry. For the company overall, second quarter revenue was up 9% from the prior year quarter and total segment profit margin expanded 200 basis points to a record 11.6%. Adjusted EPS from continuing operations was a record $1.31, up 34%, and GAAP EPS from continuing operations was a record $1.26, up 31%. The company's growth continue to be led by our Residential business with revenue up 16% in the second quarter, driven by both Replacement business and new construction. Residential profit was up 58%. Despite weather being cooler across the U.S. than in the second quarter last year, Replacement business revenue was up 17%. In addition to our market share gain initiatives, we are seeing strong growth in Replacement business as the market benefits from stabilization in unemployment and a general improvement in consumer confidence, home values and existing home sales. Replacement accounts for more than 75% of our Residential business. We also continued to capitalize on growth in Residential new construction with revenue up 13%. This is a traditional strength for Lennox, and we continue to be well-positioned in this market with more than half of the top 50 builders using Lennox, many on an exclusive basis. In addition to capturing price across our Residential business, we also benefited from an improved product mix as Replacement business grew even faster than the new construction in the second quarter. 14-plus SEER shipments were up 4 points to 36% of cooling product shipments in the quarter, the first increase in this measure for a second quarter since 2010. With minimum efficiency of 13 SEER equipment shipments, our 22 equipment continued to trend down. In our Commercial business, revenue and profit were up 4%. Growth was led by North America commercial equipment and services while Europe remains soft and was down in the quarter. Our Lennox National Accounts service business was especially strong on the growth of national-wide services. In Refrigeration, profit was up 22% in the second quarter. Revenue was flat on the timing of National Account businesses in North America and soft economic conditions in Europe, while growth was strong at South America and Asia Pacific. South America revenue was up more than 20%. In Asia Pacific, Australia revenue was up high single-digits as we continue to expand refrigerant sales in our wholesale business there. And China revenue was up more than 30%. Before I turn it over to Joe, let me update you on a couple of our strategic initiatives. In Residential, we added 12 more Lennox PartsPlus stores to our distribution network in the second quarter and are on track with plans to add a total of 28 of these wholesale stores this year. We now have 127 PartsPlus stores, and they continue to be one of the keys to the success we're seeing in our Residential business. Within these stores, about 3/4 of the sales are HVAC equipment and 1/4 of sales are parts and supplies. In commercial, our new RAIDER product line of rooftops focused on emergency replacement market came out in March. This market is a sizable opportunity for Lennox since it has not been an area of traditional focus for us, compared to our success in planned replacement and commercial new construction. But with RAIDER, we now have the right product to sell in this segment of the market that prioritizes upfront cost, and while it is early, the launch is going well. With 27 commercial regional and local distribution centers at the end of the second quarter, we continue to invest in distribution to provide the high level of same day, next day delivery that customers require for emergency replacement. We're on track with our plans to have at least 32 commercial distribution centers in place by the end of 2013. With a solid balance sheet, we are well positioned to continue to make transformational investments in our businesses. From expanding our residential and commercial distribution networks to introducing new products to attack major market opportunities, to continuing to lead the field in energy efficiency and product innovation like our new 25 SEER air conditioners and heat pumps. Beyond investing in the business to drive growth, we also continued to return cash to shareholders. In the second quarter, we increased our dividend 20% and repurchased $33 million of stock toward our plan of $100 million in buybacks this year. We plan to continue to grow the dividend over time with earnings, as well as continue to repurchase stock. Currently, we have $338 million remaining under our existing repurchase authorization. Now I'll turn it over to Joe.

Thank you, Todd. Good morning, everyone. I'll provide some additional financial details and comments on the business segments for the quarter starting with Residential Heating & Cooling. In the second quarter, revenue from Residential Heating & Cooling was $476 million, up 16%. Currency was neutral, volume was up 13% and combined price and mix was up 3%, with both price up and mix up. Residential profit in the second quarter was $66 million, up 58%. Segment profit margin was a second quarter record, 13.9%, up 370 basis points from the prior year quarter. Residential results were positively impacted by higher volume, favorable price and mix and lower material costs with partial offsets from higher SG&A and investments in our distribution expansion. Commercial Heating & Cooling segment revenue in the second quarter was $230 million, up 4%. Currency was neutral, volume was up 3% and combined price and mix was up 1%. North America commercial equipment and service revenue was up high single-digits in the quarter, led by growth in the emergency replacement market and in Lennox National Account Services. Europe Commercial HVAC revenue was down high single-digits at constant currency. Commercial segment profit in the second quarter was a second quarter record, $35 million, up 4%. Segment profit margin was 15.1%, up 10 basis points from the prior year quarter, and commercial results were positively impacted by higher volume, favorable price and mix and lower material costs with partial offsets from higher SG&A and investments in distribution expansion. In our Refrigeration segment, revenue in the second quarter was $207 million, flat with the prior year quarter. Currency was neutral, volume was down 2% and combined price and mix was up 2%. From a regional perspective in constant currency, South America was up more than 20%, Asia Pacific was up high single-digits and North America and Europe were down mid single-digits. Segment profit was a record $26 million, up 22% from the prior year quarter. Segment profit margin was a second quarter record, 12.4%, up 220 basis points. Refrigeration results were positively impacted by favorable price and mix and lower material costs with a partial offset from lower volume and higher SG&A. Looking at the special items after-tax in the second quarter. The company had a $1.6 million charge for restructuring activities, $500,000 for the net change in unrealized losses on open futures contracts and $100,000 for other items. SG&A was $151 million in the second quarter, up from the $131 million in the prior year quarter on higher selling expenses and higher incentive compensation expense. Corporate expense was $21 million in the second quarter, up from $15 million in the prior year quarter. Cash from operations was $49 million in the second quarter compared to $24 million in the prior year quarter. Capital spending was $11 million in the second quarter compared to $10 million in the prior year quarter. And free cash flow in the quarter was $38 million compared to $14 million in the second quarter a year ago. Total debt was $537 million and our debt-to-EBITDA ratio was 1.7 ending the quarter, within our targeted range of 1 to 2x. Cash and cash equivalents were $45 million at the end of June. Before I turn over to Q&A, I'll review our updated outlook for 2013. We now expect North American Residential HVAC shipments to be up high single-digits for the industry for the full year, up from our prior assumption of low single-digit growth. We still anticipate North America commercial unitary shipments to be up low single-digits for the industry in 2013, and we continue to expect our Europe HVAC and Refrigeration market shipments to be down low single-digits for the full year. Based on the company's first half performance and outlook on the second half, our guidance for 2013 revenue growth is now 6% to 8%, up from the prior year range of 3% to 6%. Foreign exchange is still expected to be neutral for the full year. With Residential product mix up slightly in the first half, we no longer expect the $10 million of negative mix for the full year. We are now assuming $5 million of negative Residential mix for 2013 with the rest of the summer still to go and in the transition into heating season. We continue to be on track for approximately $30 million in material cost savings through a combination of sourcing initiatives and engineering-led cost reductions. We expect about 2/3 of this benefit in the second half of the year. We now expect a $30 million benefit from price and lower commodity cost this year versus our prior assumption of $20 million. We expect about 45% of this benefit to be in the second half of the year. For corporate expenses, we are increasing our guidance from $70 million to approximately $85 million for the full year on higher incentive compensation for both our annual and long-term incentive programs to reflect the company's financial performance for these periods. We are raising our 2013 guidance for adjusted EPS from continuing operations from a range of $3.25 to $3.55 to a new range of $3.45 to $3.75. GAAP EPS from continuing operations guidance incorporates the $0.07 difference in the first half and moves to a range of $3.38 to $3.68. And to wrap up with a few other guidance points for 2013, we currently expect net interest expense of about $15 million for the full year, our tax rate is still expected to be between 34% and 35% on a full year basis, and our fully diluted share count for 2013 overall is now expected to be approximately 51 million shares. And finally for capital spending, we continue to expect approximately $60 million in 2013. And with that, let's go to Q&A.

[Operator Instructions] We'll go to the line of Sanjay Shrestha with Lazard Capital.

It's Aditya Satghare from Lazard Capital Markets. I have 2 questions here. Could you elaborate on your PartsPlus strategy and how we should think about the total contribution of the expanded distribution channel to both overall growth and market share gain?

When we initially launched this initiative 3 or 4 years ago, we talked about sort of half the benefit of a $25 million 2013 savings from logistics costs and the balance, $12.5 million, $13 million from share gains that we got from the distribution network. I think on the way I calibrate it, it's on the logistics side, so the cost savings, I think we are tracking about where we thought we would be given -- adjusting for the volume that we have. And I think on market share gains, we're probably actually doing even a little bit better. When I think about the momentum of our Residential business and sort of the implied market share gains, I think a big driver of that is the PartsPlus business -- or the PartsPlus investments.

Got it. My second question was on mix. Could you help us understand what kind of feedback you're getting from the distribution channel in terms of this mix towards, as you said, 14-plus SEER going north of 35%? What are the feedback you're getting in terms of driving this mix shift here?

Well, I think -- I'll even broaden the question a little bit and just talk about mix for the quarter in our Resi business, I mean, one driver of the positive mix was add-on and replacement was stronger than new construction. And it wasn't that new construction was down, it was AOR was so strong for us, up 17%. So that helped. And then the mix up within AOR, add-on and replacement where we mixed up in the SEER levels, I think that reflects sort of the strengthening of the American consumer, the consumer confidence and existing home values, some of the other metrics that we've talked about that, talking in business jargon, if people are managing for NPV, they'll make the investment in the higher-SEER product in many locations in the country and that would people who are managing for cash flow, they resisted it. I also think quite frankly, it's after 2 or 3 years of mix-down, we were due for a quarter where the markets started to change, comps just got a little easier, too, I think.

And our next question comes from Rich Kwas with Wells Fargo Securities.

Todd, could you just detail, as the quarter played out, what you saw, particularly in the replacement side? I know back in April, you said that Q2 got off to a pretty good start. But it sounds like you got some incremental momentum as the quarter went on.

It was pretty solid the entire time, Rich, to be honest with you. I mean, it was -- in the quarter, it started at -- overall for the quarter, while it was warm historically, it was down 10% in cooling degree days. And so it was cooler than it was a year ago. I think maybe the only way that sort of helped us at the end in June was the last week or two of June was warm even on a year-over-year basis. April, May was cooler, but we still had good momentum. And so I think during the full quarter, we saw it.

And then Q3, you mentioned some pretty warm weather here, it seemed it's gotten off to a pretty good start, but any comments there would be helpful.

Again just to sort of calibrate a little bit on the weather because it's all relative on a year-over-year basis, we had a really hot summer last year. So through mid-July, cooling degree days are actually down 15% in the U.S. and Canada, so actually cooler than a year ago, which is hard to imagine but it's true. All that being said, we're off to a solid start in July in Residential and the momentum that we saw in the second quarter has, broadly speaking, has continued. In our Commercial business, we've seen some choppiness in shipment timing with grocery customers, we had pretty good -- pretty solid backlog and order rates in our Commercial businesses, both our Refrigeration and Commercial, going into third quarter.

Okay. And then, just when you look at M&A in the balance sheet right now, anything changed in the last few months, whether it's properties that are out there or just the attractiveness of it at this point?

I don't think anything has changed. And it's just sort of the constant thing that we've said for several years now, which is we'll invest in Kysor/Warren-like acquisitions to build out our refrigeration business and our commercial service business, and those are sort of $100 million, $150 million deals like Kysor/Warren would sort of the way I think about it. And then if a property opened up in North America HVAC in the unitary business, either Residential or light commercial, we think we could create value by consolidating the industry, and if something opened up and the valuations are right and we can create some value by doing it, we would want to do that.

And our next question comes from Jeff Hammond with KeyBanc Capital Markets.

Just, I mean, great, great margin improvement in Residential and Refrigeration. I just wanted to get a better sense of how much of that you think is execution and mix and how much was maybe just a favorable variance on price cost and some of the deflation we're seeing.

We spiked out on a full year basis that we're now calling for $30 million tailwind from pricing commodities and about half of that is commodities, so sort of order of magnitude $15 million on a full year basis on lower commodities, up from order of magnitude to $10 million that we were calling out before. So there's some benefit from lower commodities. But I would tell you that really the driver of the quarter in the margin expansion across all our businesses was what we're doing on material cost reduction, both the design out, which we sort of called out as increasingly important, as well as continue to move to -- within China and within Asia to lower-cost sources. Positive mix up and price up, and so you can define that, whether that's sustainable, how you want to. But I would argue the mix is up. In Residential, we launched the 25 SEER product along with icomfort/harmony which is a new control system, and we're calling it the ultimate home comfort system. And I think sort of having that pinnacle premium product helps with the mix up. And in our Refrigeration business, lots of good work on the cost side, sort of flat revenue globally, really good work on the cost side. So I think the margin expansion, and then the final piece, obviously, is volume leverage that we've said all along that if we could get some volume flow across all our businesses, including Residential, that we would grow SG&A at half the rates and sort of get some volume leverage, and I think we saw a good volume leverage in the quarter also.

Okay. And then just on mix, I think you called out 36% for this quarter and maybe that was versus 32% a year ago. Can you give us a sense of what that was at peak and what you think normal should be?

We're going to the archives to see it.

And just maybe while you're looking for that, did you say $85 million for corporate expense?

Yes. And second quarter of 2010, as I quickly look back, and I think that was the peak of sort of the mix up. Second quarter of 2010, we were 45%. And I think what we've called out back in 2011 when mix went down that we said 2012 would be worse, and then we called it, mix -- we're calling mix will be a little worse this year, but then I think it starts to go back up to the more historic levels, up 40%, 45%.

Okay. And then just a final question. So you mentioned Refrigeration and commercial backlog pretty good. I mean, should we see an acceleration in some of those growth rates into the second half?

Not the Parts stores, too much. I think I meant to use the word solid, I don't know if I used the word good. I meant to say they're solid going into the third quarter. I think short answer is yes. I mean I think what we've talked about was some National Accounts pushing out to the second half of the year, and that's still our sort of view on things.

And your next question comes from Keith Hughes with SunTrust.

Question on commercial in Europe, it was up in the first quarter, down in the second. Is there any sort of trend you can read there or is this kind of all of the results you expect to see moving forward?

I think no and unfair characterization. So I don't think there is any major trend. I think sort of our sense is what others are sensing that Europe's hit bottom and sort of bubbling back up, albeit at a slow pace. I think we have some large project business, especially in Eastern Europe and some of that, the timing sort of got pushed out to second half of the year. We're not concerned about the European business now that the markets have solidified a bit. So I just think it's timing, and we'll see better growth rates, we hope, second half of the year.

And the U.S. business, commercial did -- or North America did fantastic in the quarter. Were there some timing of shipments there or is that just strong demand as you continue in the second half?

I think it's solid demand. I also think we gained share. I think the investments that we're making an emergency replacement, both on now up to 27 distribution points on our way to 32, along with the new RAIDER product, I think paid dividends during the first half of the year. And I think that's where we saw the growth was in the emergency replacement business.

And we'll go to Rob Wertheimer with Vertical Research.

So great results, and if I got it right, you gained share and price and cost all at once. Are you seeing the industry getting any more disciplined to the extent you're able to comment or do you think it's more that you're, as you mentioned on the cost out, et cetera, outpacing and able to keep sort of all 3 things going?

I think the industry on price has always been reasonably disciplined. I mean, I think it's a consolidated competitor base, with similar profit motives to ourselves. And we -- I think after sort of some shocks up and down and sideways around commodities that everyone understands that even if commodities may be trending down over the last 5 or 6 months, where one sort of mill shutting down or copper spiked up, from it going back up. And so when you announced price increases, you have to realize it, almost irregardless of what happens with commodities. And I think that's how we're behaving and my sense is that's how others are behaving.

I don't think you mentioned, within the Resi business, are you able to have a sense of planned replacement versus emergency replacement? You mentioned the mix was good. I assume that correlates. I'm just curious if that's been strong, and the cooling degree day is down, it sounds like people are doing more planned but what's your insight on that?

I'd use slightly different words. I think there's very little planned replacement in Residential. I mean, there are some when people are selling homes, that they are told that they have to replace them, but we think 85%, 90% of units that are sold happen when the unit breaks, that's just the only way people are going to do it. I think some of the things that when I look at the quarter, one quarter isn't a trend. But we are encouraged by what we saw in the sense that whether degree cooling days on a year-over-year basis is down 10%, but our replacement revenue was up 17%. And some of that were share gains but some of that, a large part of that was market growth. And the preconditions that we've talked about for pent-up demand over the years, about stabilization and unemployment and consumer confidence and housing values and existing home values, I think a lot of those sort of are heading in the right direction. The other metric that we've talked about is 6 quarters in a row with second quarter, the growth rate of Residential equipment as a percentage has been greater than replacement parts as a percentage. And that was after a couple of years of being just the opposite. So while one quarter is not a trend, in the second quarter, I think we saw some things move in the right direction in the add-on Replacement market in North America vis-à-vis pent-up demand.

Our next question comes from Glenn Wortman with Sidoti. Glenn Wortman - Sidoti & Company, LLC: Just one question, you just had quite a strong margin performance in Residential in the quarter. I mean, did this change at all your long-term view for the margin potential of that business?

I think you take it and then you move on, Glenn. So I mean, I think we said 12 to 14 for Residential for our, I guess, 2015 targets. And someone just pointed to me 11 to 14 instead of 12 to 14 but 11 to 14. Again, we play it out and see what happens, but I think I'd underline what you said, we are very encouraged by the strong margin performance of our resi business in the second quarter.

We'll go to Steve Tusa with JPMorgan. Charles Stephen Tusa - JP Morgan Chase & Co, Research Division: How much, just to clarify, how much of the $30 million in favorable price cost was realized in the first half and what's versus the second half? And then, how are you positioned, assuming kind of a stable environment, for the carryover into '14?

We're saying -- we think about -- we saw about 55% of the $30 million first half and we'll see the balance, 45%, second half. I think on the commodity side, we all know coppers trended down during the second half of the year. So I think that helps us, if it stays there, as we go into 2014. I think steel is more complicated. Steel prices have spiked up over the last month or so, not for any demand reasons but on the supply side. So I think as we get closer to 2014, when we give our guidance in December, we will have a better view, but I think the big variable is going to be what steel does, at least on the commodity side. Charles Stephen Tusa - JP Morgan Chase & Co, Research Division: Got you. On the new systems, can you maybe comment on the related revenue pull through from 410A? I mean, now I would assume that, that's already kind of in the run rate, but was there anything interesting there from indoor versus outdoor units, that kind of thing?

Are you talking about R-22? Charles Stephen Tusa - JP Morgan Chase & Co, Research Division: Well, just the 410A, I mean any benefits, the new systems, obviously, I assume that's in the run rate. But is there anything -- was there any kind of benefit to revenues from that, with kind of the new systems now that replacement is up?

You mean, attachment rate? Yes. Short answer is yes. I mean the things that some of our competitors talk about, same thing we're seeing that when R-22 -- I'll sort of say the negative then get to the positive. I mean, R-22 was down to about 10% of our second quarter sales where it was about 15% last year. So R-22 trended down in the quarter, which is good news. And then when that happens, obviously, you're not just selling a condensing unit, you're selling an indoor unit and an outdoor unit at the same time. And I think, obviously, part of that -- that was part of our 17% revenue up on the add on and replacement also. Charles Stephen Tusa - JP Morgan Chase & Co, Research Division: Got you. And then just one last question, I guess you guys talked about being interested in the resi, perhaps, resi acquisition if it's out there and it's reasonable. I mean, is the scenery basically that look, you guys have all this footprint now set up and you can just kind of take the brand and whatever comes with that and run the volume through distribution channel there, manufacturing, consolidation, obviously, that's probably out there? I mean, maybe just talk about a couple of the positive things that could come, that would make you guys better equipped than maybe some others out there?

I think the synergies would be less on distribution consolidation, at least, my sense and certainly my experience in the industry is you have to tread very lightly. And so you can imagine who we might -- who the combination might be with. But all our competitors have very good distribution channels. So I think we will respect that and leverage that and work with the channels as they are. I think the more traditional synergies that you would see would be on the factory side, on material purchase side. I think investments in R&D and not only in R&D, but when we think about launching a new product, it's really sort of the expenses in the engineering that's in tooling up your factories, and ability to sort of tool up factories and our product -- different brands through the same factory and run 3 shifts and sort of leverage all that investment, I think you could get cost out that way. And then I think there would be some SG&A. But I think on the distribution side, I view it as we run our Lennox products for our Lennox distribution channel and our Allied through our Allied channels and if we got additional brands, we can run them through their channels. Charles Stephen Tusa - JP Morgan Chase & Co, Research Division: Right. And the PartsPlus investment, that's leveling off now, right? I mean, are there new investment there, or that's pretty much where you want it to be?

No. I think we're going to continue to go, right? We've said that -- I'm doing this now from memory, I don't have all the -- someone is pointing something to me. We ended the quarter at 127, and we're going to be at 136 by the end of the year. And then we were targeting to be at -- excuse me, by 2016, 215, I think, is what we talked about in December. So we think this continues to grow.

And we'll go to Josh Pokrzywinski with MKM Partners.

Just to follow up quickly on Steve's question. Thinking about your cost base and how you've tuned it over the past couple of years, I think a little cost sourcing alone is probably something around $100 million. How would you handicap Lennox's starting point on that? If you were to come across another property in the space, do you view that as kind of a good run rate for what you could do elsewhere? I'm presuming you guys would characterize yourself as pretty close to best-in-class now. But were you just so far behind the curve that there was more to do or is that probably a good way to think about other properties in the space as well?

I think to answer it, as much as I'd like to try and say it the other way around, I think we lagged our competitors. I mean our larger international competitors, Carrier, Trane, even York, when you're doing business in China like they are, in Asia like they are, you just had a better sense of what the supply base looked like. So I think a lot of that was catching up. And by the way, that's good because I think otherwise, if everybody is going down the cost curve together, you tend to give it to your customers, and I think we've got to keep a lot of that. But I think there are some opportunities around the things that we've done on sourcing new compression in China or -- excuse me, in Asia. Some of the things we've done in sourcing new motors in China that, depending on who you bought, depending on who the suppliers were, either getting volume leverage with those suppliers or introducing them to those suppliers. So I think, I don't know if we're best in class, but I think we're pretty good at supply chain. And I think depending on who we -- but so are some of our competitors, depends who the combination was with.

Got you, fair enough. And then I guess, on the sourcing, do you feel like you guys have kind of tapped out or reached critical mass at that point or is there a potential to continue making progress in 2014?

I think the momentum continues. I mean, I think what we find is that as we've talked about, we've evolved from sort of the obvious things, to move to China sourcing to designing our product costs. And we're increasingly now sort of doing a little bit of both, which is moving within China or Asia to different suppliers or moving west within China to lower-cost sources. But continue to drive out, design out cost, really focusing on platform redesigns. So I think the momentum continues into 2014 and 2015. I think it's now become a way of life here and we'll continue to do it.

Got you. And then just one final follow up, if I could, help unpackage guidance a little bit. It does seem like historically you guys have gotten 55%, 60% of your earnings in the second half, and that still seems to be the case here even at the high end. But I hear you talking about a lot of these tailwinds being much more back-end-loaded. I mean, are there anything -- is there anything out there in the way of incentive comp or investment spending that you would look to accelerate at the high end of demand that would buffer some of that, or how should we think about it?

Yes, I think that's true. I think there is variable expenses that if revenue's strong or earnings is strong in the second half of the year relative to what we forecast that there'll be some buffer. I also think the guidance -- and I don't think I've ever raised guidance $0.20 since I've been here, so I'm not going to be bashful about raising it $0.20, but that being said...

You haven't gotten a very good tailwind either.

Fair enough. But it all feels a bit fragile out there, to be honest with you. I mean, we like what we see in second quarter, we like the momentum we are getting, we like all that and we forecasted that and rolled that into our guidance. But when you think about the U.S. economy and you think about the global economy, there's still a lot of risks out there and there's still a fiscal situation in our country and in Europe that needs to be sorted out. It's uncertain what's going to happen with China and the impact that it will have in North America markets. So there's still uncertainties. There's interest rates going up. So while we're confident, it's cautious confidence about the end markets, and I think that's reflected in the guidance.

Next question comes from Nigel Coe with Morgan Stanley.

It's actually Mike Zhang [ph], in for Nigel. I guess related to the last question on the uncertainty, could you maybe comment on where you saw channel inventories kind of trend throughout the quarter and where it stands now?

Yes, I mean, as you probably know, I mean 80% of our product we sell through our own distribution network and so they're fine. And on the independent or Allied brands, we sell through independent, I think distributors I would characterize as cautiously optimistic. We had a strong quarter in our Allied business. And so I think a lot of that inventory is probably sold through. So I think I'd sort of characterize it, at least from our side, inventory is not an issue.

Okay. And then on just capacity, vis-à-vis the strong growth from resi, are you seeing any bottlenecks at this point? Or what's your sense on capacity underneath the hire going forward?

Yes, I don't think we -- we certainly haven't missed any deliveries because of capacity. Again, in our business, given the huge seasonality of the resi business, you have to place your bets in many ways a couple of months earlier as you build up inventory for the season. And so we sent strong signals to our supply base, that's the other constraint. Then you got to make sure you have all the right components, and I think we planned right, and our supply base supported us and we ramped up when we needed to. So I think we're sort of from -- the manufacturing guys are almost ready to start thinking about furnaces, that's sort of how it works as you get into July and August, just start to transition, even though we are still selling a lot of air conditioners, from a production viewpoint, they're thinking about furnaces. And so I think we've done a good job managing supply chain in an up market.

And we'll go to the line Walt Liptak with GBL Hunter.

With Global Hunter. Good quarter, and I have just 2 follow-up questions. One, on the SEER 14-plus, what was the number in the first quarter, if you're 36% this quarter?

Yes, our guys here, again going through the glasses to pull up the number. It was 42% in the first quarter. But again, that's a little -- it's a bit -- not misleading but the first quarter 13 -- or 14-plus SEER number matters less than summertime. I mean, summertime is where the big volumes are at.

Okay, okay. And wanted to ask just kind of see if I can drill down on the pricing, too, with the price cost being more favorable. At what point -- these are all price increases, that I presume. But at one point does the industry started looking at commodities prices and maybe start to think about bringing prices down or even lower at this price level and will just go up from here?

What experience the industry has been is when the commodities spiked up, you can never raise prices fast enough to capture it. And so there is 1 year or 2, which we bled pretty hard and I assume our competitors did on negative commodity price relationship. And then as commodities start to trend down, you sort of keep the prices where they're at and sort of inch along a couple of points a year and then you gain it back. But over the full commodity cycle, you start to haul or maybe up 1% or 2% the price versus commodities. And I think that's what we're seeing now. And so I -- we have no expectations that we're going to sort of lower price because copper is down today, because we're cognizant that copper could spike up tomorrow, and then it would take us 18 months to sort of drive the price again through the system in a way that we could hang onto customers. So I think you just sort of inch price along commodities go up or down and sometimes you are doing well, sometimes you are not doing well. But over the full cycle, you break about even, and I think that's what we've done and what the industry has done.

And we have no further questions.

Okay, great, thanks. A few points to leave you all with. As you saw, we raised our revenue and EPS guidance for the full year following the company's strong performance in the second quarter and July is off to a solid start. Looking ahead, there's a long way to go for full HVAC recovery with industry shipments still 25% to 30% below peak levels. As markets continue to recover, the company's strategically well positioned to drive our financial performance, to continuing new heights as we continue to execute on our key initiatives. I want to thank everyone for joining us.

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