Lennox International Inc. (LII) Q2 2019 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by. Welcome to the Lennox International Second Quarter 2019 Earnings Call. [Operator Instructions]. As a reminder, this call is being recorded. I would now like to turn the conference call 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 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. To give everyone time to ask questions during the Q&A, please limit yourself to a couple of questions or follow-ups and requeue for any additional questions. In the earnings release we issued this morning, we have included the necessary reconciliation of the non-GAAP financial measures that will be discussed to GAAP measures. All comparisons mentioned today are against the prior year period. You can find a direct link to the webcast to 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 thank you for joining us. Let me start with an overview on the second quarter which was significantly impacted by the adverse weather conditions. I will cover the key points on each of our businesses, our current view on the tornado impact in insurance proceeds, and our reduced outlook for commercial and refrigeration end markets, and update 2019 guidance. For the second quarter, GAAP and adjusted revenue was $1.1 billion. GAAP revenue was down 6%, including 8% of negative impact from the tornado, divestitures, and foreign exchange. Excluding the impact from divestitures, adjusted revenue was down 1% or flat at constant currency, including a negative 3% impact from the tornado. GAAP operating income was $214 million, up 10%; and GAAP EPS from continuing operations was $2.81, down 17%, including a non-cash pension settlement charge of $1.14. On an adjusted basis, total segment profit was $202 million, down 2%. The total segment margin was relatively flat at 18.4%. Adjusted EPS from continuing operations was up 2% to $3.74. Residential revenue was down 3% at constant currency and down 4% on a reported basis with volume down 6% and down 3% adjusted for the tornado impact. Residential profit was flat and segment margin expanded 80 basis points to 22.3%. Price performance was strong at 3.6% yield. Our Residential business in the second quarter was negatively impacted by the significantly cooler temperatures and higher precipitation across the United States, especially in key Central regions where cooling degree days were down more than 30% and precipitation was up more than 60%, areas that account for approximately 40% of our revenue. We said over the years that a hot summer could add 10% to residential growth and a cold summer could subtract 10%, which was the case in second quarter this year. Adjusted for the tornado, our residential volume was down 3%. If you add 10% to that, you’d get a more normalized number in line with the overall residential market conditions. Our Residential business had negative tornado impact of $28 million to revenue in the second quarter and $16 million to segment profit, offset by $18 million of insurance recovery. Adjusting for the net impact from the tornado and insurance proceeds, residential revenue was flat, profit was down 1%, and margin was down 30 basis points to 21.1%. The adverse weather in the second quarter led to slower moving shipments in the industry, which slowed us in regaining market share following the tornado and extends our recovery timeline to include the fourth quarter. We remain confident we will resume gaining share in 2020. For 2019 overall, we now expect $99 million of negative tornado impact to Residential revenue, up from $70 million previously. We expect a negative $54 million impact to segment profit, up from $40 million previously. We expect insurance recovery for lost profits of $94 million, up from $80 million previously. The resulting $40 million of net benefit to residential segment profit in 2019 is unchanged. Of the remaining negative tornado impact for 2019, we expect to have an impact of approximately $22 million in revenue and $11 million in segment profit in the third quarter. For the fourth quarter, we expect an impact of approximately $14 million to revenue and $9 million to segment profit. For the remaining $36 million of insurance recovery in our core guidance, we expect that to be split evenly between the third and fourth quarters. Taking a step back and looking at the big picture for both core and non-core related to the tornado, we now expect total insurance proceeds of approximately $372 million, up from $358 million previously. We have received $252 million of that as of the end of second quarter and expect the remainder by the end of 2019. The 2019 non-core gain expected for the difference in the book value and replacement value of assets remains approximately $91 million or a benefit of approximately $1.73 per share to GAAP EPS. We’ve posted tornado financial updates via our website summarizing the guidance I just discussed. Turning to Commercial in the second quarter. Revenue was a second quarter record of $261 million, up 4%. Commercial profit was a record $54 million, up 6%; and the segment margin expanded 50 basis points to a record 20.6%. Commercial revenue in the second quarter was led by high single-digit growth in national account equipment business. Regional and local equipment revenue was up low-single digits at constant currency. Breaking out the business another way, commercial new construction revenue was up low-single digits at constant currency, and replacement revenue was up high-single digits. Planned replacement was up low-double digits; and emergency replacement, which also was negatively impacted by cooler weather in the quarter, was down low-single digits at constant currency. Our VRF business saw high-single digits in the second quarter. On the service side, Lennox national account services revenue was up low-single digits. In Refrigeration, for the second quarter, adjusted revenue was up 5% at constant currency. Adjusted revenue profit was down 19% and adjusted segment margin was down 340 basis points to 12.8%. Profit was impacted by unfavorable mix as North America volume was down and Europe volume was up in the second quarter. In addition, profitability was negatively impacted by the timing on the sale of refrigerant allocations in Europe compared to the prior year quarter. Before I turn it over to Joe, I will review the latest of our outlook for 2019 and provide a few early thoughts on 2020. For the industry overall, we still expect North America residential HVAC shipments to be up mid-single digits. We're reducing the outlook for Commercial and Refrigeration end markets in North America. We now expect commercial shipments to be flat for the industry in 2019 and expect refrigeration shipments to be slightly down for the industry. That's for the market. We still expect our revenue to be up for both businesses in the second half of the year. We expect year-over-year Commercial margin expansion to continue in the second half and Refrigeration margin expansion to resume in the fourth quarter. Looking ahead and thinking about 2020, we're still six months away, but the residential market continues to look robust setting aside the second quarter weather. Commodity costs continue to trail down and that is setting us up nicely for more positive price/cost benefit in 2020 than we’ve had in 2019. And the investments we made in equipment, controls, and distribution set us up well in 2020 as do the easier comps post the tornado impact to get us back on the share gain path. Now let me 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 second quarter, revenue from Residential Heating & Cooling was $689 million, down 4%. Foreign exchange had a negative 1% impact on revenue. Volume was down 6% or down 3% adjusted for the tornado impact. Price was up 4% and mix was down 1%. Residential profit was flat at $153 million. Segment margin expanded 80 basis points to 22.3%. Segment profit was favorably impacted by a net $2 million of benefit from insurance proceeds relative to the tornado impact in the quarter as well as favorable price, sourcing, and engineering-led cost reductions and favorable warranty. Offsets included cooler and wetter weather, tornado impact, factory productivity, unfavorable mix, higher commodity, freight, tariff, and other product costs as well as distribution and SG&A investments and unfavorable foreign exchange. Turning to our Commercial Heating & Cooling business. Commercial revenue was a second quarter record of $261 million, up 4%. Foreign exchange was neutral to revenue. Volume was up 2%, price was up 2% and mix was up 4% on the strength of national account growth. Commercial segment profit was a record $54 million, up 6%. Segment margin was a record 20.6%, up 50 basis points. Segment profit was impacted by favorable price, favorable mix and sourcing and engineering led cost reductions. Partial offsets included lower volume, higher commodity and other product costs, tariffs, freight and distribution and SG&A investments. In the Refrigeration segment, adjusted revenue was $149 million, up 2% in the second quarter. Foreign exchange had a negative 3% impact on revenue. Volume was up 1%, price was up 2%, and mix was up 2%. Adjusted segment profit was $19 million, down 19%. Adjusted segment margin was 12.8%, down 340 basis points. Profit was impacted by lower mix from the timing on the sale of refrigerant allocations in Europe compared to the prior quarter higher commodity, freight, distribution and tariffs and other product costs and unfavorable foreign exchange. Partial offsets included higher volume, favorable price, sourcing and engineering led cost reductions and lower SG&A expenses. Regarding special items in the second quarter -- excuse me, the company had net after-tax charges totaling $36.6 million. This included a charge of $45.5 million for pension settlement, a net charge of $1.5 million for various other items and again -- excuse me, of $10.4 million from insurance recoveries, net of losses incurred. Corporate expenses were $24 million in the second quarter compared to $23 million in the prior year quarter. Overall, SG&A on an adjusted basis of $152 million compared to $151 million in the prior year quarter. Net cash from operations in the second quarter was $30 million compared to $49 million in the prior year quarter. Capital expenditures and purchases of short-term investments were $18 million compared to $21 million in the second quarter a year-ago. We had proceeds for tornado damage to property and proceeds from the disposal of property, plant and equipment of $6 million in the second quarter this year. Free cash flow was $20 million compared to $28 million in the prior year quarter. The company repurchased $150 million stock and paid $25 million in dividends in the quarter. Total debt was $1.47 billion at the end of June and we ended the quarter with a debt to EBITDA ratio of 2.3. Cash and cash equivalents were $36 million ending the quarter. Now turning to our guidance for the company overall in 2019. We're updating guidance for adjusted revenue from -- for adjusted revenue growth from a range of 3% to 7% to a new range of 2% to 5%. We're updating GAAP EPS from continuing operations from a range of $12.65 to $13.25 to a new range of $11.91 to $12.51. This incorporates special items in the first half of the year, including the $1.14 non-cash pension settlement charge in the second quarter. As previously discussed, the pension settlement charge relates to an agreement that 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 a remeasurement of the pension plan and results in a non-cash $45.5 million after-tax settlement charge in the second quarter to write-off the related accumulated actuarial losses. And as Todd mentioned, we continue to expect a total 2019 pre-tax gain of $91 million related to factory construction costs and the associated gain from replacement value above book value. For adjusted EPS from continuing operations in 2019, we're updating guidance for a range of $12 to $12.60 to a new range of $11.30 to $11.90. Let me now run through the other key points for our guidance assumptions and the puts and takes for 2019. First the guidance elements we are updating. We're lowering the headwind expected from commodities for the full-year from $30 million to $20 million. We're lowering the guidance for factory residential factory productivity from a benefit of $8 million to be flat year-over-year due to the weather impacts on production in the corresponding lower fixed cost absorption. We're updating guidance for 2019 capital expenditures from approximately $195 million to $155 million, as $40 million of capital to fully reconstruct the Iowa manufacturing facility damaged by the tornado has moved from 2019 to 2020. We're updating 2019 guidance for free cash flow from approximately $420 million to $390 million for the full-year. There are three moving pieces to the guidance. The two headwinds are lower earnings guidance and higher working capital and the benefit is a reduction in capital expenditures due to the project timing in the Iowa factory reconstruction between 2019 and 2020. For the guidance elements that remain the same, we still expect to capture $80 million of price for the full-year. We still expect a $25 million benefit from sourcing and engineering led cost reductions. We still expect $15 million of a headwind from freight and $10 million from tariffs, and we continue to expect headwinds of $15 million for distribution investments and $15 million for SG&A. Corporate expenses are still targeted at $90 million for 2019. Net interest expense is still expected to be approximately $45 million and we still expect an effective tax rate in the range of 22% to 23% on an adjusted basis for the full-year. 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 from the line of Julian Mitchell with Barclays. Please go ahead.

Thanks. Good morning.

Hi, Julian.

Good morning. Maybe just the first question around Commercial and Refrigeration demand. You had talked about a temporary pause back in Q1, entered Q2 with good backlog growth in both pieces. So just wondered kind of what changed as you went through the second quarter and may be how you're seeing -- get a start to Q3 across the three segments in terms of demand?

Yes, as you can see, we had a nice second quarter revenue wise in both segments, especially in Commercial, and we entered the third quarter with solid backlog. Our Commercial backlog is flattish from a year-ago and our Refrigeration backlog is up mid-single digits. And again, we expect the revenue to grow in both those segments. But in some ways, we are just truing up what we're seeing. I mean, when you look at ARI data for Commercial through May, market is up 0.5%, 1%, we think it was down in June in part because of weather. And so, we think calling it flat is just sort of a more realistic assumption. What we’re seeing in Refrigeration is some of our larger customers sort of deferring given some of the macroeconomic uncertainty, but again it's on the margins. We are going from being up low-single digits market, call it sort of slightly down -- it should be flattish to slightly down, so it is sort of a toggle of a couple points, if you will. But again, we still expect revenue in both of those segments to be up in the second half of the year.

Thanks. And then sort of tied to that maybe just any thoughts on Residential, how that's trended the last couple of months if you’ve seen any improvement in sell-through conditions recently?

It's certainly warmed up in July from where it was in June, so that's helped, so we're off to a solid start. I’d like to remind everybody third quarter last year was warm. If you could recall, it was up, from memory 25% above normal and 15% above the prior year, so last third quarter was pretty warm. So, the comps aren't so easy, but Residential is sort of chugging along and we’re off to a nice start.

Thanks. And then my last question on that point would just be in terms of the market share efforts at Residential. Maybe just walk through where you are thinking you’re falling short or if it's really the external conditions of weather that has sort of held you back on that market share retake?

I -- again, we are gaining share back, we are just -- we didn’t gain it back as fast as we had hoped in second quarter, and I think it was largely driven by the weather. I think it's just an old business truism, which I’ve always found to be true. It's harder to get share in a down market than in a up market in some of our markets. The area that we're talking about is sort of region in the center of the country. Our revenue was down there even greater than it was overall in the business, and it's tough there to gain back share when things are down. We think that’s the majority, vast majority of the impact. I think to be honest and straightforward about it, full transparency, there are some sort of smaller dealers who quite frankly were probably not going to get back that we protected our most valuable customers, and those we did protect when we get to the other side of it if they had a good experience with their new vendor, some of them aren’t coming back, but we’ve gotten back the majority of the share where we think by and we’ve guided that as we go into 2020, we are confident we will back on the share gain track again.

Great. Thank you.

Thanks.

Next we will go to Steve Tusa with J.P. Morgan. Please go ahead.

Hey, guys. Good morning.

Hey, Steve.

Good morning, Steve.

Just on the Commercial side, I mean, you had talked I think a bit about at a conference in early June about how you were seeing the order rates come back there at that stage. Did something kind of happen later in the quarter on this front to kind of tweak that lower for the year?

Again, I think I’m reflecting a guide on the industry rather than our share. So, what I’ve is, we had a nice second quarter in revenue, and we expect revenue to up the second half of the year, our backlog chart is flattish because we sort of delivered a lot in the second quarter. So, we’re still optimistic on segment overall, but we’re halfway through the year and the industry is flat. And I think -- I don't think it's going -- I think the second half will sort of -- closer we get to election, the more these macroeconomic uncertainties hang, the less likely we are going to see growth in the end market in the second half of the year.

Right. Okay. On the resi side, you guys started to disclose in your Qs, the difference between externally sold sales and sell-through your own distribution, I think that number was up. The external sales were up pretty nicely in the first quarter. Your sell-through was, through your own stuff , was kind of down moderately. I think the Q’s going to come out today, can you just talk about was that the similar trend here in the second quarter? And then how should we read into that? Is that just you guys kind of restocking the channel from tornado impacts or what's kind of the framework with which to kind of look at that around?

It's even more pronounced in the second quarter maybe than it was in first quarter. So, our direct business, our Lennox business, which is 80% of what we do, revenue wise, down 6%. And our Allied and ADP businesses, which are direct was up 3%. I think it's a couple of things. I think it's weather exposure. Our Lennox historic -- well, our Lennox branded business is more on the center of the country than our allied business, so I think that's part of it. I also think it's this issue that the independent distributors were able to hang onto their dealers because they had multiple brands and so we're able to juggle brands and sort of keep dealers happy. And then as we are able to reload our independent distributors with our product and are able to sort of seamlessly move back the dealers with that product line. And so no one sort of was turned off by the -- had a relationship turn them off they were able to sort of seamlessly move it back in. so I think that’s part of it.

Okay.

So it's a bit of weather end, so the other issue I talked about, we are gaining share.

Okay. And then one last one. Are you at all considering monetizing some of your distribution or is it still a very core part of who Lennox is having this much capital distribution?

Did I ask you to ask that of me?

Well, he was very -- probably he is very quick to compliment you guys on the conference call because it is warranted. I mean, you guys have done a great job, but just curious …

Very nice compliment. Thanks for that compliment and I thought it was a left. Again, I kept my head off for the right. We absolutely notice -- [indiscernible] distribution. As you’ve heard me say multiple times, I think it's a differentiator today. It will increasingly be a differentiator, all the investments we made in digitization has gone from a business where you needed local knowledge and sort of moving boxes to this business where you won't be able to leverage investments. And then again, if I learned anything at business school I want have thousands -- tens of thousands of small customers rather than one large customer, so we’ve no desire to get out of it independently.

Got it. One last one for resi. What was the actual -- was there any major differencing kind of parts versus equipment, or parts up in the quarter, like what or any difference there?

No, I mean, sort of the part of the business that was up the most was residential new construction …

Okay.

… less impacted by the weather, but parts and the add-on or replacement trended the same direction that the cool weather impacted both, and parts and supplies maybe even little bit more than equipment.

Okay. Awesome. Thanks, guys.

Thanks.

Next question from Jeff Hammond with KeyBanc. Please go ahead.

Hey. Good morning, guys.

Hey, Jeff.

Good morning, Jeff.

Already knew the answer to that distribution question.

I was just going to joke, which I would be shocked if I will ask you to ask a question, but go ahead.

All right. Just going through the 70% cut, I mean, I know you made adjustments to the commercial piece, but can you maybe break out how much of the -- how you break out that 70% cut? How much is it kind of soft 2Q residential versus how much is it is the Commercial piece being softer and then it looks like the Refrigeration margins seem to be coming in lighter as well?

I think order of magnitude, what I think about it, Jeff, is we passed on the second quarter miss to the full-year guide. And then we had sort of lowered the second half of the year because of the push out of the share gain, but that's offset by insurance. And then the third piece would be sort of a lowering at the end markets and corresponding revenue of the Commercial and Refrigeration businesses.

Okay. That’s helpful. And then can you just explain this Refrigeration allocation dynamic and how big it was. And I think you said Refrigeration, the margins will get expansion in the fourth quarter, which would suggest that maybe margins are down in the third quarter and so what's going on there?

So the issue in third quarter is the mix, and I refer to it is as mix. It's just this dynamic that our business in Europe is growing quicker than our business in North America. I think part of that's market, part of it is we are sort of flattish share in North America refrigeration organic share in Europe and that hurts it. The refrigerant issue is -- was second quarter a year-ago, we had about a $3 million gain on refrigerant, I will come back to that in a second and second quarter the issue we had about $1 million. So net-net a $2 million difference year-over-year. And as you may recall, it's a simplified, it's a cap in trade program in Europe for F gases, fluorine base gases and we had an allocation, we were able to resell the allocate -- parts of the allocation you don't use and we're able to sell those again to a $3 million gain last year second quarter and a $1 million gain this year. So year-over-year $2 million.

Okay. So that the third quarter margin comment on Refrigeration is that this mix dynamic continues and then it normalizes in 4Q?

Correct.

Okay. And there is …

I would broaden the answer. Also self-help will kick in, in fourth quarter.

Okay. And then last one on this distribution growth versus direct, declined in the first half of the year. How should we think about that impacting the second half of the year just with kind of the pre-buy dynamic?

Which pre-buy dynamic you’re talking about? The furnaces?

Yes.

I paused is because I haven't quantified it yet in my own mind, so I’m going to real-time to think. I think obviously the way you asked the question, you're right. It will -- and on in the direct side we will have more of a sell. We will be selling furnaces where it indirectly sort of stocked it already. Although I will tell you because of the tornado impact we didn’t do as much pre-stocking of our distributors as our competitors have done. I also think there will be normalization as we get away from the weather impacts, especially in second quarter.

Okay. Thanks a lot.

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

Hey, thanks. So first question from me, I’m guessing you don’t want to give numbers by geography, but I just like to get a better sense of how weak the Midwest was in the quarter?

I won't give the exact numbers as you suggested, but it was about 40% of our revenue. And it was a -- maybe 2 or 3 points down in revenue in the add-on or replacement versus the overall market. I would contrast that, I will give you the exact numbers for something I want to say, which is in a market like Florida where we had warm weather, our Lennox replacement revenue was up 12%. And so a market we had good weather we did well, and large parts of the country where we didn't have good weather we didn’t do well.

Okay. That’s helpful. And then just a follow-up to a prior question. So it sounds like you didn't assume that you would make up some of the 2Q resi shortfall in the second half, am I hearing that right?

I think that's what the guide says, yes.

Okay.

So the short answer is yes, and that’s what’s in the guide. Now again, we -- I often don't like to talk about weather, but I almost have to now given everything we said so far, but sort of the conventional wisdom that I also believe is true is sort of the weather that you want now is hot/cool, hot/cool. So they sort of sellout and then cools down they can -- better say that it gets hot. Our dealers get really busy sometimes a week or two weeks planned out, and then you want to cool so they can catch their breath to caught up and ready to take on new business. And then it gets hot again, they get the business they order from you. And then as we get into September, we want to whether to break and sort of stay cool, so we will start loading up our furnaces. So it's not just record heat now for the balance of the quarter. We are going to have to sort of have some things move, but it's hard to make up the miss we had in second quarter due to weather.

Got it. Okay. Just lastly, Residential price yield up 3.6%, that’s a little better than I was thinking. Is this just a function of a double price increase still helping and maybe you didn’t discount equipment to try sell-through, just given the shipments this quarter?

It's primarily the first point. It's just the double price increase. And so second quarter was the sweet spot where we're sort of getting peak -- a carryover at both of them, if you will. And the year, we [technical difficulty] we're going to get 2 points might be slightly better than that given the performance in second quarter, but second quarter is sort of at the high water mark of year-over-year price increases. And look we were competitive in the marketplace, and so it's not like we said, look, we are not going to do any pricing to protect to regain share just, at some point you realize that’s not the lever to pull, so we try to pull a lot of other levers instead.

Got it. Okay. Thanks, I will pass it on.

And we will go to Jeffrey Sprague with Vertical Research Partners. Please go ahead.

Thank you. Good morning, guys.

Hey, Jeff. How are you?

Doing well. Thank you. Just coming around to the kind of cash flow and absorption, so -- of kind of those three pieces Joe mentioned, clearly working capital is got to be a chunk. Inventory looks high. I guess, I really have kind of two questions. Was there some kind of absorption benefit in the quarter actually from building inventory?

There was -- Jeff, there was some inventory build, but there's also some raw material that are at higher levels given the increased production between Marshalltown and Saltillo.

And then, conversely, I guess your guide would assume some under absorption in the back half as you’re burning inventory down. Can you give me any context on the margin impact there, if there's any?

I think the margin impact is de minimis and we’re going to continue the level of production to optimize the impact on absorption.

And then just back to price, Todd or Joe, I mean did you see any indication anywhere that there is some push back, we heard that in some industrial channels, Watsco kind of mentioned it around some parts pricing. Obviously, raw mats are coming down, volumes maybe not as good as people thought.

No. we are -- we’ve seen price stick in marketplace obviously from the results we’ve had. And we -- as always plan on passing on an annual price increase and commodities have trailed down a bit. But labor is extremely tight in North America and we’ve had to raise wages in our factories, our suppliers have to raise wages in their factories, the tariff situation still not settled. Freight and transportation is still -- well, down a little bit from last year, still high versus last couple of years. So there is still inflation in the system and the need for us to pass on price and our competitors are doing the same thing.

So would it be fair to assume the double dip was obviously a bit unusual, but kind of normal year-end? Beginning a year, list price increases should kind of where were they again into 2020?

Yes, I mean, while we [indiscernible] into 2020 is just we -- I will repeat what you just said. We will be announcing a price increase at the end of 2019, that set us up for realizing into 2020. And that's historically how the industry did it. Not to bash Watsco, but when Watsco is talking about price, they may be talking to their supplier and letting them know what they want them to hear. But from our perspective, we are still getting price in the marketplace.

Great. Thank you.

Our next question is from Robert McCarthy with Stephens. Please go ahead.

Good morning, everyone. How are you today?

[Indiscernible]. How are you?

Good morning.

Good. Maybe since you broke hearts a little bit on 2023 outlook, Todd, I mean, could you talk a little bit about just maybe current environment. Are you seeing any chinks in the armor of the cycle and how do you think about '20 and how do you think about your long-term targets from where you sit now, just so we get some comfort because obviously some investors think that this could precede something worse than just bad weather?

I think it's bad weather. I think its two things. It's bad weather in terms of cool and wet weather and bad weather in terms of the tornado. But those are the dynamics. I mean, from a residential viewpoint, the market is still robust. U.S consumer is still strong. U.S consumer is still spending, I think you sort of see that in all the surveys and macroeconomic data. And as we go into 2020, we expect that continue. We sort of toggled down just a bit the Commercial and Refrigeration end markets and I think that just reflects reality. But we continue to gain share and expect our revenue to be up in those end markets. So we think 2020s end markets are going to be good. 2021, my crystal ball is a little less clear, but our 3-year targets still stand up even with this second quarter drop because of weather.

And then in terms of the residential -- excuse me, in terms of the refrigeration and commercial lowering, I mean you do answer the fact that you do expect to grow and that there should be share increase. I mean, do you think this is some conservatism that you're baking into the guide or do you think you’re just calling the market as you see it?

Yes, I mean the guide is the guide the way I sort of think about it and I hope we’re wrong and I hope it does better, but that's sort of our best call right now.

I'll spare you a question on your distribution and whether you want to sell it?

No matter what happens, you’re going to write that down as we do not want to sell distribution. Thanks.

Next we will go to Gautam Khanna with Cowen and Company. Please go ahead.

Yes, thanks. Good morning, guys.

Hey, Gautam. How are you?

Doing well, thanks. Couple of questions. First, I was wondering any change that you would expect in the competitive environment, given the CCS spin or anything else the climate, the Ingersoll break up. It doesn’t sound like you’ve seen anything, but what might you expect in an environment that's going to be unfolding over the next year?

I don’t think I would expect any change in Trane Co. or whatever the new business is going to be called. I mean, the management as I understand that Lamach and the management team at the parent company are going to go with Trane Co., right? And so I assume they’re going to compete the same way they’ve competed now. If Carrier Co., -- it's unclear exactly -- I think one way -- one thing I think about is sort of the distractions are going to stop, because Carrier Co. in of itself is a multi-industrial conglomerate that probably needs to be broken up. And so I think there will be continued internal discussions about what they do with refrigeration, what they do with some of their lower profit international businesses, what they do with security business. And so I think all that will continue to be a distraction and I think that's good for us.

Okay. That’s helpful. And also just what are your latest thoughts on North American HVAC consolidation? You think it happens, do you think there's -- if it happens, when it will happen?

Yes, my answer, Gautam, you’ve heard me say a thousand times, I will say it for people who are listening and new. We don't need to do anything worth scale, but I think value could be created. And if something would happen, we'd love to participate. We think we'd be a good player to help drive the value. I think over the long-term if there's value to be created, markets find -- the financial markets find a way to have assets to be combined. But right now it's only a handful of assets and someone who is in the business would have to decide if they want to get out of the business and I can't really control that, that's -- that question is better asked to somebody else rather than me.

Fair. And then you mentioned, you're not going to retain 100% of the customers that you lost and related to the tornado. Can you quantify that? What sort of the net -- of the dealers you -- the customers you had previously what percentage do you think don’t come back? Is there any way to quantify, so we can understand the hurdle you’re overcoming as you do recover?

Again, with some degree of uncertainty, sort of the order of magnitude is we keep 90%, we get back 90%, we lose 10%. And if you do some of the backward math on that, that implies a 1.5, 2 points of resi revenue, maybe one away at the end of the tornado versus closer to 10 points of resi revenue that was totally impacted by it. And I think that kind of revenue changes a quarter of a point or so of share, maybe three -- yes, .3 points of market share. And that’s why I’m comfortable to go in the 2020 its now we will sort of pivot away from just flitting out this piece that we still haven't gotten to more broadly talking about our market share gains. So we gained half a point or more of market share in resi up to the tornado during the prior five or six years and as we go into 2020 we will do the same thing and this will be behind us.

And last one, sorry. Marshalltown, is it fully operational, fully up to speed, there's no lingering production interruption there?

No lingering production interruption, we are up to speed. I mean the pushout of the capital, no one has asked the question, but I will anticipate it pushout of the capital has nothing to do with sort of being up to speed on production. It's building sort of the admin wing of the factory, adding in parking lots. And sort of lesser priority things of what we needed to do to make it an up -- a full time factory again. But production wise, we’re where we need to be.

Thanks a lot guys. I appreciate it.

Thanks.

Next we will go to Deepa Raghavan with Wells Fargo Securities. Please go ahead.

Good morning. Can you talk about what's embedded in the high-end and low-end of your revenue or EPS guide? Is that now all just resi weather playing out new few months, because it looks like you’ve already factored in some weakness in Commercial and Refrigeration?

It's that, it's also just sort of there's always a range around commodities, there's a range around freight and transportation, there's a range around some of our execution in the factories. And so, I think it's sort of a stacking of the operational bell shaped curve, The range of outcomes around lots of initiatives that we have in place. I think the most important thing is maybe the weather impact and -- or more broadly state the overall residential market. But there's other things in that guide.

Okay, got it. Can you comment on a few puts and takes to Q3? I mean, how should we think about your EPS contribution versus prior years? Anything you'd think it's worthy of being called out, just given all the noise this quarter and last year?

No. I mean, as you know we don't give quarterly guidance. I know -- I don't want to give you a number and you know that. I think as I said earlier, we're off to a solid start. I gave the backlog outlook sort of flat in Commercial, up mid-single digits in Refrigeration. I’ve talked about Residential. You can read a weather map, but you also got to read a weather map from last year to sort of understand, it was hot last year, it's hot this year and operationally we're executing. So I think that's sort of the color commentary I would make.

Okay. Lastly from me, can you give us some color on what you’re seeing in non-res. I mean, some recent data points not very favorable. You gave us pretty good color on market -- I mean, you talked about markets, you’ve obviously talked about your growth, but generally is there anything else on a broad basis that you'd like to talk about in terms of office versus retail versus institutional? And is that concerning to you? Just any viewpoints there, I appreciate it. Thank you.

No macro use that I would share that you couldn’t get elsewhere. I mean, again it's sort of overall call and the inventory market's flat, so no additional color. Thanks.

All right. Thanks.

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

Hey, good morning guys.

Hi, Joe.

Good morning.

Can we just kind of dive a little bit deeper into this market share dynamic. So I just want to make sure I understand that your production was back and running in 4Q. It seems like the recovery was getting better-than-expected last quarter. I mean is the way to think about your resi growth rate right now just talking up to weather and where you guys are based regionally or is there more to it than that?

I think it's -- the more to it is what we called out for the revenue tornado impact or the tornado revenue impact in quarter, which was $28 million. So there's $28 million revenue impact in second quarter associated with the tornado. And part of that was being at full production early in the quarter and then part of it was, as I said earlier that there's portion of the share that left us that we haven't regained all back yet, and so that's tied to the $28 million. The larger number in the quarter is weather and that's by definition its weather. It's a 100% weather.

Got it. Okay. And then so, I guess, as I’m kind of thinking about the portion, you’ve discussed that with the smaller dealers is a portion that you're not going to get back. I’m trying to understand, I guess, just so the increase in the expenses related to the tornado is related to the portion that you're not going to recapture in terms of your share, is that fair?

I’m not sure, I understand the question. You mean the additional gain of insurance proceeds?

Yes, the gain on the insurance proceeds, any impact to the insurance proceed this quarter, so it's expected to go up by $14 million for the year. I guess, what is that related to?

That's lost revenue associated with the tornado.

Okay. And then, I guess, as we think through 2020 and just this concept that the whole business interruption insurance and how that’s calculated, is there an expectation that there is going to be additional recovery in 2020 or should we get a clean slate in 2020 and we can just look at the core business and how the core business is doing in 2020?

That’s a fair question. We are in the process of negotiating with all the insurance companies and they’re worked very closely with us and have been fair and we continue to sort of get back with the money we expect to get back. Our current expectation now would be that that we would wrap things up by the end of the year with some forward look maybe into 2020, but that will be a negotiation. But at some point, we are just going to collect the money and move on. And right now the guide expects that to be in -- all happen in 2019, but it may lead over into 2020, but I understand the need to have clean numbers or the desire to have clean numbers in 2020.

Got it. That makes sense. Okay. Thanks, guys.

Thanks.

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

Yes, thanks. Good morning, guys.

Hi, Nicole.

Good morning.

So I just want to start on Europe. I think during the first quarter you talked about low double-digit growth ex FX. And a lot of that was driven by commercial HVAC and it sounded like you’re up with kind of strong again this quarter. So if you could just give us a little bit of update on what you’re seeing in the region?

In Europe we were up mid-single digits. Our HVAC was sort of low-end of that and our Commercial, Refrigeration was the high-end, but sort of on average mid-single digits in Europe. And we are primarily in France and Spain and in Germany, those are our major end markets and that's where we've seen our strength.

Okay, got it. And then commercial HVAC margins, I think when we got the last update in the first quarter you have guided for flat to down in the second quarter, but we saw some improvement there. What was better? Was at the top line was a little bit better than you expected or was it that the operational improvement was the driver of the upside?

It was both. I would say it's equally split between the two. We did better in the factory and then we did a little bit better on revenue and mix than we had hoped [indiscernible].

Understood. Okay. And then last one from me just price cost. The impact on margins in the second quarter and then if you still expect to see improvement there in the second half?

Turning to folks to see if we have than in front of us. I got too many numbers in my head right now. Well, [indiscernible] I mean, the answer is we were positive. See if I’m turning that right in front of me. For the quarter, we had $32 million in price and $15 million headwind of commodities, freight and tariffs, so we're positive $17 million for the quarter and that’s obviously the high water mark for the year.

Got it. Thank you. I will pass it on.

Thank you.

And we will go to Robert Barry with Buckingham Research. Please go ahead.

Hey, guys. Good morning.

Hey, Robert.

Good morning.

Lots of ground covered, I guess just a few things to follow-up on. So Todd, I think earlier in the quarter or late in the quarter in June, you had alluded to at a conference, potentially price and also material costs tracking better, but, so that you kind of kept the guide for those two components, the same any kind of reason for that?

I think we -- I think we lowered commodities. So, it went from a $30 million headwind to a $20 million headwind.

Sorry, the material costs. It was price commodity and material costs.

I think maybe I tried to lump all those together just by saying that the total of the three would be better. I didn't mean to say each element would be better. And so that all three of them, I think used to be $55 million and are now $45 million, if I have the math right.

Got it. Got it. And then that number you gave for the replacement volume in Florida that up 12. Is that like how same store is that? Is that a same-store number or are you adding stores in Florida contributing to that growth?

I don't know, if we had -- I don't think we had any parts plus stores if that's the question because I don't think we added in Florida, but I know, I don't really think about it for our business quite that way Robert. I mean it's -- I think we had more dealers than we did last year because that's how we gain market share and so I just. I don't view to sort of same-store sales. I view it is did we gain share or not, we did.

Got it. Got it.

And the market was up.

Right. I guess, just lastly, following up, I think, with Joe's question about the way the share recapture is included in the numbers. So that $28 million of revenue in this quarter. It's not just volume lost its net of what you've estimated is recaptured share. Is that right?

Correct.

And I guess two same thing with the -- at the EBIT line?

Correct.

So the fact that the EBIT track a little bit better on insurance recoveries, even though the revenue was, or the share recapture was lower is just kind of out-of-period?

Correct. And some way and we gave rough guide last time. But the $18 million of insurance proceeds in Q2, I would tie to the $18 million lost profits we had in Q1. So it's sort of lag -- not sort of it lagged by a quarter.

All right. Thanks for clarifying all that.

Thanks.

Next, we go to Josh Pokrzywinski with Morgan Stanley. Please go ahead.

Hi. Good morning, guys.

Hey, Josh.

Todd, wonder if you could calibrate something for me. We've kind of touched around a few of these elements with the pre-buy around the furnace standard and some of the growth differential between the independents and the company-owned. I guess how should we think about that into the second half to then the independents go the other direction like can you size up the magnitude of what you thought was maybe pre-bought there versus underlying?

I don't have the map in front of me, Josh. We will put it together, I -- the pre-buy versus our competitors was dramatically less just because we didn't have the factory capacity to be building the pre-regulatory furnaces like others may have done. And so I think that's part of it, but I think, how I doing better, are independent distribution doing better during the second quarter and was that thing more driven by the ability not to be impacted by the tornado to the same degree that the independent distributors were able to hang on to dealers with other brands, which are Lennox distribution by definition wasn't able to.

Got it. So that's kind of where I was going with this is, obviously, your competitors who don't have substantial company distribution are able to fill the channel, a little bit more I think Carrier was still taking pre-buy orders through May. So does that mean then, it's not just a timing flip where they've already made the sale in the first half, they came in the second half through the company-owned you can make that in the second half. I guess in the absence of a big pre-buy or the notion of that maybe not as big of a flip into the second half is how I should read that?

I'm not sure, I followed the question. I think, if you are …

Yes, so the …

If you're a company like Carrier who is selling to independent distribution, the revenue, first half of the year, we'll be over inflated in a revenue second half of the year will be deflated by that fact. If you're a company-owned distribution like we are in Lennox, our revenue would have been -- versus competitors would have been understated during the first half for the year and overstated during the second half of the year. Reason I haven't spent a lot of time talking about that is -- that's like a third order equation after the tornado after the weather that I think that's sort of a rounding issue of a couple of points here there and I think on Allied again there was a -- we got some tailwind from selling furnaces first half of the year and that will be a headwind second half of the year, but I think the amplitude of that was less than our competitors, because we didn't build as -- pre-build as much and that the greater the driver of the disparity between our Lennox brands and our Allied brands during the second quarter was driven more by this issue of regaining with the loss share more seamlessly through independent distribution the company on distribution because independent distributors were able to avoid losing dealers by using alternative brands.

Got it. And then just one more point on this. I don't mean to belabor it, but thinking about the -- I'm trying to get the port out, you know, I will follow-up on it. It's little more complicated. I'll leave there. Thanks for the color.

Thanks.

And we will go to John Walsh with Credit Suisse. Please go ahead.

Hi, good morning.

Hey, John.

Just a question around the strong price realization. I mean, obviously, a lot of different things are going into price, right now, whether it's general inflation, tariffs right. But you mentioned earlier about consumer confidence wanting to kind of understand how much of that price is driven by maybe people mixing up to a higher, or going kind of beyond that opening price point anyway you kind of want to articulate it would be helpful.

I think most of it's a straight price. I mean, there's a little bit of mix in the quarter, but given the tornado impact, given the weather, the mix sort of wasn't on its normal trajectory. I mean that's just two price increases being passed on.

Got you. And then, I guess, I think in refrigeration you made this comment you're seeing the customers defer some spending just kind of given the macro. I need color around that? Is it which kind of vertical, you're seeing that in and if it's kind of, we're pushing it, one to two quarters or if it's kind of, they're actually waiting to see if the capital project moves forward?

I think, it's just on the margins and I think it -- we're primary exposed to grocery in cold storage and the question is do you build new, not so much on stores but on cold storage facilities, do you build new cold storage facilities to invest the capital. I think it's sort of the macro investment decisions we're seeing across sort of corporate or industrial America?

All right. Well, thank you.

Thanks.

Our next question Nigel Coe with Wolfe Research. Please go ahead.

Thanks guys, good morning.

Hi, Nigel. How are you?

Good, thanks. Obviously, you cover a lot of ground here. Can we just, I mean, I hate to maybe betray my [indiscernible] here, but just wanted to stand the market share dynamics into Q3. You didn't actually lose any share in 2Q '18. So therefore to be talking about regaining share, it seems illogical. So I'm just wondering, are we talking here about dealers that went away in the second half of the year. That hasn't come back, is that how you're measuring the market share loss in 2Q?

Thanks, Nigel. So the 28th in that number and so dealers who we lost in fourth quarter if we hadn't gain them back the impact in second quarter would have been significantly greater than 28 million.

Okay. That's great. And then, that I think you got a 40% exposure to the Central States, Midwest states. Would that include the Central Southwest as well, so we're talking here about Texas, Oklahoma, both is, on not just the classic Midwest?

Yes, I mean, the swing regions, I will call it out, is to traditional Midwest, which is, be it football fans out there, the big 10 such, Illinois, Indiana, Michigan, Ohio, Wisconsin, the Central Plains, which is really Missouri, Iowa, Minnesota, Nebraska and obviously too much lesser degree the Dakotas and then South Central to your direct question, Texas, Louisiana, Arkansas, Oklahoma.

Okay. That makes little sense. And then just two more quick ones to tick off here. Just, you talked about the insurance negotiation for FY '20. I mean, just, I mean I understand this is somewhat sensitive topic, but conceptually, do you get compensated for one full year of lost profits. So is it not that simple.

It's not that simple. So we're in detailed negotiations where we're justifying everything. Both sort of impact of the factory plus lost revenue. I mean in some ways, I would call speculative lost revenue and it all gets done up in a mix sort of end of the day, we'll work out a number. And we've guided sort of the best of our ability, publicly of what that number is and how much we said -- how much we gained so far and what we expect that number to be looking around. So I got so many numbers. I think, its 472, right?

372.

372. Not, a 372 [Speech Overlap] and we've received 252 to dates. We still have 122 to negotiate that and that's our best estimate.

Okay, great. And then just a quick one on pricing. The cover pricing, this time in detail. There's been a little bit of chatter about dealer incentives picking up during 2Q, to within 2Q. Have you seen that and is that a risk in any dimension for the back half of the year?

It's not a risk for the back half of the year. It's when the weather is that cool and the volumes had soft and people start spiffing to try a new volume. And quite frankly, we did the same thing.

Okay. Thanks, guys. Good luck.

Thank you.

Our final question will be from Damian Karas with UBS. Please go ahead.

Hey. Good morning, guys.

Hi, Damian.

Appreciate your fitness in here. Just a clarification on client capacity. So you had shifted some additional production down to Mexico, as a result of the tornado. Where exactly do things stand now, with respect to the production split across your three facilities comparing to that before the tornado Marshalltown? And is there still some shifting that you'll be looking to do in the future?

Yes, we are always looking to shift in the future. So that's still out there and that continues to be out there and we'll continue to look at our footprint to try and drive, the lowest cost. In terms of the shifted volume for the tornado, we move capability both to South Carolina and to Mexico that capability still remains there, but we're up and running all the products in Marshalltown that we were producing prior to the tornado also.

Got it. And just curious, have you felt any push back from customers on having some of that they've one signature branded product coming out of Mexico now?

Zero pushed back, I mean, we've been building in the Mexican facility for almost a decade now and many of our largest dealership visited facility, they know the quality is and they don't care where whether it's made in Mexico or whether it's made in the US, it's exact same quality.

Very helpful. Thanks.

Thanks.

And with that, I'll turn it back to the company for any closing comments.

Thanks a lot, operator. To wrap up, we've reset guidance after significantly adverse weather in the second quarter and have reduced the outlook on Commercial and Refrigeration end markets in North America for the year. Looking ahead, weather side, the residential market continues to look robust, commodity costs are trending down for more price cost benefit moving forward and the investments we have made in products and distribution set us up well for 2020 and for the second half of 2019. Thank you all for joining us today.

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