Lennox International Inc. (LII) Q1 2026 Earnings Report, Transcript and Summary

Good morning, everyone. Welcome to the Lennox 2026 First Quarter Earnings Conference Call. [Operator Instructions] As a reminder, this call is being recorded. I would now like to turn the call over to Ms. Chelsey Pulcheon from Lennox Investor Relations. Chelsey, please go ahead.

Thank you, Bo. Good morning, everyone, and thank you for joining us as we share our 2026 First Quarter results. Joining me today is CEO, Alok Maskara; and CFO, Michael Quenzer. Each will share their prepared remarks before we move to the Q&A session. Turning to Slide 2. A reminder that during today's call, we will be making certain forward-looking statements, which are subject to numerous risks and uncertainties as outlined on this page. We may also refer to certain non-GAAP financial measures that management considers relevant indicators of underlying business performance. Please refer to our SEC filings available on our Investor Relations website for additional details including a reconciliation of GAAP to non-GAAP measures. The earnings release, today's presentation and the webcast archive link for today's call are available on our Investor Relations website at investor.lennox.com. Now please turn to Slide 3 as I turn the call over to our CEO, Alok Maskara.

Thank you, Chelsey. Good morning, everyone. Before turning to our quarterly performance, I want to recognize the exceptional adaptability and dedication of our team as well as the trust and loyalty of our customers. While the macro environment remains uncertain, our core values empower us to respond with discipline, innovation and an unwavering commitment to enhancing the customer experience. Turning to Slide 3. Revenue was $1.1 billion, up 6% year-over-year as growth initiatives gain traction and channel conditions stabilize. Our segment margin was 14.4% in the quarter, down 130 basis points primarily due to the impact of factory under absorption. Operating cash flow was positive $16 million and adjusted earnings per share for the quarter were $3.35. In Home Comfort Solutions, industry conditions began to stabilize as expected. One-step results continue to be impacted by weak new home construction, while sentiment in the 2-step channel improved as distributors began to restock ahead of the summer season. In Building Climate Solutions, emergency replacement momentum and disciplined execution contributed to record quarterly performance. We are reaffirming our full year adjusted earnings per share guidance range of $23.50 to $25. With that context, let's turn to Slide 4 to discuss the current economic outlook. The industry environment continues to gradually improve. Channel destocking has largely concluded as dealers regain confidence and replacement demand strengthens. Consumer sentiment remains cautious, contributing to continued softness in new home construction and remodel activity. At the same time, Lennox-specific growth initiatives are gaining momentum and beginning to offset these pressures. On the cost side, we are experiencing inflationary and tariff-related increases across commodities, components and finished goods. Fuel and transportation costs are also rising. In response, we are sharpening our focus on mitigation activities, including productivity and reductions in material cost. We are also further streamlining our supply chain optimizing manufacturing operation and implementing thoughtful pricing actions. In Home Comfort Solutions, sales volume year-over-year improved sequentially during the quarter, supported by better performance in the 2-step channel. Repair versus replacement stabilized, providing greater visibility into underlying demand trends. New product introductions, including a successful water heater launch and growing traction with new heat pump products contributed positively. In addition, the on-track integration of Supco parts and supplies strengthens our attachment rate growth better. In Building Climate Solutions, our superior execution continues with emergency replacement and national accounts, both driving volume growth. Greater engagement across our full life cycle offerings along with the integration of DuroDyne parts and supply is expanding our commercial portfolio. Now let's turn to Slide 5 to highlight recent product introductions. Innovation continues to be a critical differentiator for Lennox. Our recently launched products further elevate our competitive position to meet the evolving needs of our customers, particularly around efficiency, backwards compatibility and ease of installation. In Commercial, our new Strategos Rooftop with heat pump technology expands replacement options for customers. This product offers greater flexibility in where and how systems can be installed supporting a wide range of electrification as efficiency expectations continue to rise. In residential, we are broadening our heat pump portfolio to serve all climates and installation requirements. Core climate capabilities allow us to better address demand in northern regions while our new compact air handlers make it easier to deploy high-efficiency systems in retrofit and space-constrained applications. We are also extending our presence within the home through high-efficiency Lennox heat pump water heaters via our Ariston joint venture. This new product integration supports the convergence of HVAC and water heating and strengthens the Lennox home control platform. Together, these innovations expand our addressable market, increase share of wallet and reinforce Lennox's long-term competitive position. With that, I will turn it over to Michael to review our financials.

Thank you, Alok. Good morning, everyone. Please turn to Slide 6. After two consecutive quarters of year-over-year sales declines, we were pleased in the first quarter to return to year-over-year revenue growth of 6%. Growth from our DuroDyne and Supco acquisitions completed in Q4 2025 contributed 6%, while growth in BCS was offset by continued sales declines in HCS. As expected, residential end markets remained down year-over-year, but the rate of decline improved sequentially versus the fourth quarter of last year. If inventory levels normalize, the segment profit was negatively impacted by approximately $15 million of manufacturing costs under absorption. Against that backdrop, results progressed as expected. Let me turn to the details of our Home Comfort Solutions segment on Slide 7. In our fourth quarter earnings call, we noted that the first quarter end markets would remain challenging, which should show signs of improvement. Overall, HCS revenue declined 10%, M&A contributed a positive 2%, while organic revenue declined 12%, with one-step down approximately 10% and 2-step down approximately 15%. Organic sales volumes declined 21%, but this represented a meaningful improvement from a 32% decline in the fourth quarter of 2025. Within the one-step channel, lower new construction activity continue to weigh on results. In the 2-step channel, distributor sentiment improved as customers began to restock ahead of the summer season. Mix and price realization contributed positively to results driven primarily by the full conversion to new R-454B products. Product costs were a $23 million headwind driven by materials inflation and under absorption due to lower production levels. Finally, Acquisitions contributed approximately $2 million of profit and SG&A cost [indiscernible] taken last quarter mostly offset SG&A inflation. Please turn to Slide 8 for an overview of the Building Climate Solutions segment. BCS delivered another exceptionally strong quarter with organic sales up 26%, M&A growth up 12% and profit margins expanded 300 basis points. Sales volumes increased 17% as national account demand normalized alongside continued growth in emergency replacement and new customer wins across both equipment and service offerings. Price and mix delivered 9% revenue growth, driven by the full transition of light commercial products to the new 454B refrigerant. Similar to HCS, BCS experienced absorption pressure as we optimize inventory levels, but manufacturing cost efficiencies offset this impact. M&A contributed $7 million of profit growth, offsetting SG&A inflation and distribution investments. Please turn to Slide 9 for cash flow and capital deployment. Free cash flow in Q1 2026 was at $39 million use of cash, an improvement versus a $61 million use of cash in the prior year quarter. Underlying operating performance improved materially. Adjusting for approximately $30 million of higher capital expenditures year-over-year, operating cash flow was $16 million, an improvement of $52 million driven primarily by inventory growth of $60 million this quarter compared to $210 million in the prior year period. Inventory build in the quarter focused on parts and specific SKUs to support customer fulfillment during the upcoming peak season. Given normal seasonality, we expect inventories to moderate from current levels in the second half of the year. We continue to maintain a strong balance sheet with healthy leverage while supporting the $550 million acquisition completed in Q4 2025 and continued share repurchases. We also see a healthy pipeline of bolt-on M&A opportunities and remain disciplined, prioritizing deals that enhance our portfolio and meet our return thresholds. For 2026, we continue to expect approximately $250 million of capital expenditures, focused on innovation and training centers, digital capabilities, distribution network optimization, ERP modernization and targeted AI capabilities. With that, let me move to Slide 10 to review our updated 2026 financial guidance. Our updated full year 2026 guidance reflects Q1 results and trends, including higher cost inflation and tariffs. The tariff environment continues to evolve with little notice. Earlier this month, new Section 232 tariffs were announced. As Alok noted earlier, we have a proven track record of using multiple levers, including price and productivity to offset tariff-related cost pressure. As a result of our move to FIFO accounting, we do not expect any income statement impact from these new tariff rules until the third quarter. With that context, I will walk through the specific guidance items that have changed since we introduced our initial 2026 outlook in January. All other guidance items remain unchanged. Revenue is now expected to grow approximately 8% compared to prior guidance of 6% to 7%. The increase is driven by modestly higher mix and price, reflecting the Lennox price actions announced earlier this week, the annual price increase implemented earlier this year and the carryover benefit of the 2025 regulatory mix. Looking at the segment revenue guidance, HCS is now expected to grow 4% compared to the previous guidance of 2% and BCS is now expected to grow approximately 16%. Organic volumes are still expected to decline low single digits, net of approximately 1 point of growth from parts and accessories, commercial emergency replacement, inducted heat pumps and Samsung Ductless products. Cost inflation is now expected to be up approximately 5% from up 2% driven by recent increases in tariffs and input costs for aluminum, steel, copper and fuel. Based on these updated assumptions, adjusted EPS is still expected to be in the $23.50 to $25 range. Free cash flow remains expected to be $750 million to $850 million, driven by inventory normalization and higher profitability. Overall, we feel good about the underlying momentum in the business while recognizing that the external environment remains dynamic and will require continuous focus and execution. With that, please turn to Slide 11, and I'll hand it back to Alok.

Thanks, Michael. As we close, I want to take the opportunity to share why 4 years in, I'm still genuinely excited about Lennox. We operate in an attractive growth industry with an enduring place in the market. However, what really sets Lennox apart is how we deliver differentiated growth through our execution on enhancing the customer experience, disciplined capital allocation and effective acquisition integration, all of which reinforce our resilient margin profile. What excites me most is that innovation is always at the forefront. Our product and advanced technology portfolios continues to expand, enabling us to capture a greater share of wallet. Of course, not all this would be possible without the strong foundation that is our culture. Guided by core values and guiding behaviors, the Lennox team shows up every day committed to creating long-term value for our customers, employees and shareholders. For all of these reasons and many more, I truly believe that our best days are still ahead. Thank you. We'll be happy to answer your questions now. So let's go to Q&A.

[Operator Instructions] We'll go first this morning to Noah Kaye with Oppenheimer.

Michael, the [indiscernible] conversion continues to give us talking points. And I want to ask, following up on your comments, just how to think now about the timing difference in cost increases versus price realization. You mentioned the incremental costs, many of them won't really layer in until 3Q. How do we think about pricing? And should we still think about kind of the previous guidance for first half, second half EPS split still applying or is anything shifting given these moving pieces of the outlook?

Yes. First, is write down the guidance. Most of the cost impact and the price impact would fall within the second half. We've announced a price increase earlier this week, it will take some time before we start to see the full impact, maybe you'll start to see a little bit later in the second quarter. But predominantly, both of these should come into the second half of the year. When you look at the revenue split, it'll put a little bit more revenue, obviously, now in the second half than the first half. But overall, profitability should still be about the same as we reflected last year by the quarters.

Okay. And as a follow-up, you called out the $15 million under-absorption impacting this quarter. Any lingering under-absorption headwinds to think about here for 2Q or are we kind of mostly caught up now that restocking is underway and you haven't increased your inventories too much?

I think as you saw within our results in the first quarter, we continue to not grow inventory as much as we did in previous years. So we had some absorption headwinds. We reduced our productions about 30% in the first quarter. So there will be a little bit of absorption that will go into the second quarter. But by the end of the second quarter, the inventory normalization will have occurred.

We'll go next now to Ryan Merkel with William Blair.

I wanted to ask first on HCS, the revenue outlook for 2Q. I think previously you saw it down low single digits year-over-year but it sounds like you're seeing a bit of stabilization. And I'm just curious if April has been a little bit better.

It's pretty hard to call quarter, especially given some of the impact of whether that is still very unknown. So I don't think at this point, we would give you any further clarification compared to what we said in the past and would go with the same assumptions. The change we made in the guidance simply reflects a stronger Q1 overall. And more importantly, the impact of additional price increases that we announced earlier this week that are going to mostly fall in the second half.

Okay. Got it. And then as my follow-up, BCS was really strong. You mentioned good execution. Anything else you'd call out there? And why not raise the guidance a little bit more there?

You should have asked [indiscernible] CFO as I have, Ryan. So listen, on the guidance piece, it's such a seasonal business, weather makes an impact. And I think we have based on everything we know, Q1 is not a quarter to raise guidance anyway. I mean there's just so much more to go given the -- there's just a shorter season. So I wouldn't read too much into Q1. On BCS, first of all, congratulations to the team. I mean, the execution out there is just super. The new factory is paying strong dividends. We are getting the right amount of productivity that we expected, maybe a little more than we expected. The emergency replacement initiative now that we have inventory position all over the U.S. is paying off meaningfully. And more importantly, the fact that now Stuttgart is more stabilized, is also helping us win back national account and gain additional volume from that. And don't forget our other two businesses, the Service business is benefiting from the full life cycle value proposition, and the refrigeration business also continues to set records both in growth and profitability. So just a good success story and something that we think we are going to start seeing in HCS as well as our markets stabilize and the end markets are not such a big drag on us. So congratulations to the BCS team. Nothing unusual just strong execution on a very, very defined strategy.

We go next now to Julian Mitchell with Barclays.

Maybe just wanted to start on the overall operating margin guide for the company. Is it fair to say that you've sort of got a flattish operating margin dialed in total company for the year? And then within that, you've got HCS down, BCS up and just trying to understand sort of HCS margins, I understand we had a tough time in Q1 for many reasons. How quickly do those margins kind of climb up out of that hole?

Sure. So I'll speak to the overall margin guide. When we talked in January, we expected a slight increase in the enterprise margin expansion now with the increase to revenue and costs, we expect a slight decline in the margin. But you're correct, within BCS, organically, we expect margins to be up there within HCS organically, we expect them to be down. M&A will have a slight drag overall in the enterprise. But we should expect to see as volumes recover in the second half of the year, the incrementals within HCS approved. We just need to go through the first half of the [ Q for HCS ], we'll see that challenge behind us.

Yes. And I think one thing, as we dug into the results in Q1, it became abundantly clear to us that the decline in margin, which we don't love it all is 100% driven by the factory under absorption, we were able to offset inflation with a volume with pricing and efficiency, but it is the under absorption. So as that and absorption kind of continues to become less of an issue as we go into Q2 and second half, we are very confident in the margin going back to normal.

And then my follow-up, I suppose, was around -- so the cost inflation numbers moved from 2.5% to 5%. So is that right that that's roughly kind of $100 million or so extra gross cost headwind? And then I suppose, do you see any competitive implications from that cost base movement? And sort of tied to that, how is the price elasticity of volume playing out in HCS at present, please?

Yes. So I guess on the first piece, your numbers are roughly right, as usual, Julian, so no surprise there. I don't see any competitive dynamic or drawback to us [indiscernible] inflation in oil, commodities, components [ are adapted ] in all of us. The Section 232 derivative tariff impact, that hits deeper differently, but it does hit every manufacturer. Some will bring metal components from overseas, some bring finished products from overseas. So that was -- there may be some slight variation depending on which company, but we don't think it puts us at a competitive disadvantage overall. We remain very sensitive to those competitive dynamics, and we'll continue adjusting those as we go along. Sorry, Michael?

Yes. I'll just add. I mean, if you look at the spot market, since our last guidance, aluminum is up 25%, [ steel 20% to 25% ], Diesel is up 50%. Copper is up 10% to 15%. We have hedging programs that delay some of that. We have fixed contracts. But overall, these input costs are up significantly since our last guidance.

We'll go next now to Chris Snyder of Morgan Stanley.

I also wanted to follow up on the price cost drivers into the back half. I guess there might be some rounding involved, but you guys are still calling for mid-single digit price, but it does sound like more is coming. So just maybe if you could kind of provide a little bit more nuance around that? And then also, why is the incremental on the price action getting better? I think now it's expected to be 90% versus prior 75%?

I'll take the first part of the question. So yes, there is a bit of rounding. I mean mid-single digit is still a broad range. And overall, as you know, we are very transparent with what we do, but it's within the mid-single-digit range. Michael can address the realization point. But essentially, given all the inflation that we just talked about and the additional pricing actions we have taken this week, that just gives us better drop-through because it's just going to stick better going back to each of the inflation piece that Michael just talked about. Michael?

Yes. Specific to the 90%, within that, there's really two guide points. First, we have price that has an incremental of 100% because we have costs on the other side of our guidance. And the mix normally, what happens there is there's an incremental somewhere in the 50-ish percent range that we have within that. So when you blend the two together, you start to get a higher drop-through because there's now more price than mix because the mix is generally behind us now from the carryover the regulatory change last year.

I appreciate that. And then if I could just follow up on the HCS revenue trajectory from here. It seems like on my math to kind of get to that full year guide, the build into Q2 and Q3 off the Q1 level seems steeper than typical on my math. Correct me if you guys disagree with that. And I guess, is that a function of the channels restocking demand is getting better? You guys are taking share, more price? Any color there would be helpful.

So let me start with the second half. I mean the comps get much easier in the second half. I mean that's where we see massive declines last year. Michael did talk earlier about pricing will have more of an impact in the second half. I think in Q2, remember, mix will still benefit us because we hadn't completed the 454B conversion all the way by the time we hit Q2. So I think you put it all together, Q1 last year, the mix was very tough because a lot of people were stocking up in preparation for the transition and buying a lot of 410a inventory. So large part of the answer is just comps, what happened last year. and then the pricing impact. Michael, what would you add to that?

Remember, Q2 had the canister issue last year that was significantly within that quarter with the canister shortage issue.

We'll go next now to Jeff Sprague with Vertical Research.

Just back to the inflation, Yes, Michael, in view of that, let me -- you went through aluminum, steel, copper, et cetera. We've been watching that ourselves, obviously. How would you parse kind of the inflation headwind between the tariff changes and just kind of the general inflation going on? And then obviously, there's an annualized impact on what you laid out here given sort of the half year dynamics. The price that you're putting in place would fully cover you for sort of those carryover headwind impacts into 2027.

So I'll speak to the input costs. We do have hedging programs and fixed contracts for a lot of that, as I mentioned. So we're about on average, 70-ish percent hedged on that, but there is a piece of our overall inflation guide for the remaining 30% and then the balance is mostly tariffs. And then on the annualized impact, we're going to continue to look to find ways to mitigate. As we talked about, this is still not fully mitigated. We still have a lot of levers that take time on the supply chain and the manufacturing processes to be able to continue to mitigate that cost. That's our goal is keep focusing on cost mitigation, just some of these efforts take a little longer.

Yes. And I'm pretty optimistic on our ability, just like we have done before, is to reduce the mitigated impact of tariff. But as Michael says, supply chain moves, manufacturing moves, product SKU moves, buying U.S. Steel in Mexico moves, they just take a lot of time. So we are working through all of that to continue mitigating the impact.

And then just on the channel behavior, right? It's kind of always interesting how we can quickly move from destock to restock. Do you sense in the channel that there was sort of pre-buy in front of inflation or there's been some early heat in some places, maybe a realization that things got a little bit too lean. Just kind of that behave your animal spirits in the channel right now, a little more color on what you're seeing?

No. We have no indication of any prebuy ahead of price increase or inflation. I mean the April tariff announcement took most of us by surprise. So there's just absolutely no opportunity or knowledge within a channel to do any pre-buy around it. We think the restock is pretty normal. I mean, we do like the word re versus de when it comes to stock, so restock is good. And folks are just looking at the upcoming summer season and nobody wants to be sharp. So we think inventory levels are pretty normal. I'm not concerned. But remember, we haven't had normal year in years, and this will be the first time that we won't ever be with a refringent transmission, canister sorted, SEER transition and all of those things. So we think the inventory levels are reaching normal for the channel and for us.

I'll just add, we continue to look at our warranty registration data that suggests that inventory in the channel continues to be normal, especially on the one-step side.

We'll go next now to Amit Mehrotra at UBS.

I guess I just wanted to come back on the Section 232 changes. From my seat, it's a little bit like the blind leading the blind in terms of what the actual impact is. And I'd love to get -- you've got -- done a good job giving us kind of a very high-level view, but there's a lot of moving parts in terms of how much you have in Mexico, how much that's crossing borders, it's actually in the scope of the new Section 232, what the net effect is in terms of the steel content versus the total value, you buy compressors, you move them down to the south and bring it back up north. So just a lot of moving parts. Maybe you can just kind of pull back the curtain a little bit and just explain to us kind of how -- what the scope is and just so we get a little bit of a flavor of what's going on.

Sure. The scope is pretty wide. I'm not a tariff expert, but I can tell you, we have a lot of tariff experts in our company. I think there's a 7 a.m. crisis, war crisis type call every day. I wish I could invite you to that because then you will get answers to all of your questions there, Amit.

I'm happy to join.

The scope is pretty wide. And also, as time progresses, the secondary impacts are coming out to be also quite challenging or new. So the primary impact is often well understood. Once you understand all the different products and the classification codes. But from our perspective, this is not new. This entire thing took us by a little surprised last year when we had [indiscernible] the country. This year, we're getting some reforms. We are paying some more. What we have done is get ourselves and our team used to working through these uncertainties remaining very adaptable, very flexible, moving products, raw material out of media and working with our vendors to share the pain. So I think we are working through all of that. Net-net, when it comes down to is, I think every manufacturer who deals with metal is impacted. So clearly, the only one. And I think overall, we seem to be leading it with appropriate resiliency and appropriate determination. We also have to continue to wait and see, right? Things change dramatically, too. There could be another tweet sometime in the next week or two that could just flip this on its head. So I can't really tell the details on that, Amit, I'm happy to have an offline conversation. But the teams are very qualified, very [indiscernible] and we're working through it.

Okay. I appreciate that, Alok. And then maybe just a follow-up on your comment about replace versus repair sort of stabilizing. And I'm just curious if you're seeing actual evidence of consumers moving back into replacement? Or is it just kind of repair activity that simply is not getting worse? And the context of the question is really, it's natural for inventory to restock at this particular point in the year. I'm just wondering if maybe it's a leading indicator of potential destock unless you're actually seeing real consumer activity moving back towards the replacement paradigm?

Yes. So remember, first of all, one-step channel, we are very close to thousands of dealers, right? and we have 10,000 direct customers, and we have multiple conversations with them every hour, every day. The sentiment, what we get back from them is that it is not getting worse. And if anything, a lot of the deferred replacement that happened last year or so is now coming back up for a replacement so I don't think this is an exact science. But last year, we were hitting a lot more hesitancy even within our contractors to recommend replacement versus repair. They were short on canister. They were not fully trained on 454B and now the contractors are more confident and consumers are back to making the economic decision, which is that let's not repair that [indiscernible] system versus look for replacement, which gives you better efficiency, better warranty, better financing. So definitely not getting worse, definitely [indiscernible] and some green shoots in terms of confidence among dealers and consumers returning back to more economic decisions.

We'll go next now to Tommy Moll with Stephens.

Alok, to continue with that same theme there where you said for the one-step channel, there are at least some green shoots, can you give us any sense of how the volumes have progressed year-to-date, just observing other data points across the industry. Yes. It seems like the year started really slow, but then March and April, things have started to pick up. Some of that may just be a comparison issue, I don't know, but any context you can share would be helpful.

Yes. I think -- so things have improved sequentially month-over-month since the beginning of the year. So yes, both the statement that you made are accurate. Some of it is driven by comparison as last year, people were holding [indiscernible] at this point, and this is now turning out to be more normal. But some of it is also just confidence back in the channel where folks are taking more advantage of our stock-up promotions. We are seeing 2-step getting a lot more eager to make sure they're not left behind in case we have a really hot start to the summer. So yes, sequentially, things have improved.

And then on the BCS side, Alok, specifically emergency replacement, I think you used the word momentum earlier. What additional details can you share there? And what inning are we in? I know you're starting from a pretty low base of revenue. So you have to be strategic about how you attack that market going forward.

I'm still in the second inning or something out of a 9-inning game. Last year, we're not even fully covered in U.S. We are still not fully covered in the U.S., but we're now covered most of the metro areas. Each region gets launched one at a time. What we have positively surprised by and pleased with is the ability of our own Lennox dealers to get back in the game, support us and then some and start using and getting back into the rooftop business with us. So that's been positive. Honestly, I'd tell you what the other good news lurking in there is the fact that we took most of the emergency replacement volume away from Stuttgart makes Stuttgart more of a configured to order factory dedicated to national account. That's been probably better dividend than we had expected in terms of restoring confidence in national accounts with shorter lead times, more custom products, basically going back to basics and there where we used to be very good at and lost our way. So early innings in emergency replacement, but also pleased with the momentum in National Account. The two words we were trying to use, so I'm really pleased you said that is momentum in BCS and stabilization in HCS those are our buzzwords for the quarter as we were practicing.

And I'll just add to that, the bundling of the service offering with the national accounts continues to perform very well.

We'll go next now to Jeff Hammond with KeyBanc Capital Markets.

Just going -- I mean it seems like the lean is more your inflation impact is 232. And you mentioned a couple of times, like you think everyone has the same issues. But I'm just wondering it seems like there's one OEM that does not make product in Mexico. And just what do you think happens if most people move on price, but not everybody moves on price?

Yes. Listen, there are a bunch of game theory scenarios, Jeff, which is hard to get into this, right? But remember, 232 derivative tariffs are not about products made in Mexico. They're about products made anywhere coming from outside as long as the steel content, the [ metal ] content is over x percent depending on weight. That does impact a broader group of folks beyond just what we're making in Mexico. At the same time, remember, the secondary impact of this is a lot of the cost of steel and aluminum, like Michael mentioned, has gone up. So nobody is immune to it. I think like you won't see where everybody lands up on this. We are very confident, and we have done price increases quite thoughtfully to make sure that we are not disadvantageous on share. So we'll work through the dynamics. But at this stage, based on what I'm looking at, I look at us doing the appropriate action and sharing the pain with our vendors and our customers.

Okay. Great. And then just another one on BCS. I mean it sounds like -- I mean the 1Q numbers were pretty eye-popping, and I understand easy comp. And just all the comments you made in the previous question were pretty positive. So -- but it seems like the raise is pretty small. So maybe are there -- were there any aberrations in 1Q? Or is there any reason to temper maybe the enthusiasm on emergency replacement, national account momentum?

No, besides what you already said, like last year, we got beat down because they were bad. So we had easier comps in Q1, the comps get tougher and [ be going up ]. But there's nothing beyond that, that is going to temper the performance going forward. just the comps get tougher as you move along the year.

We go next now to Nicole DeBlase with Deutsche Bank.

Maybe just on the BCS business. You guys obviously have a lot going on with respect to various drivers of market share gain. It's hard to see what's happening with the underlying commercial unitary market. So look, I'd be curious how you'd frame the performance of the overall market? And is it still down overall and Lennox is just outperforming that much? Or have you seen any improvement at the same time?

The overall market remains challenged. The last data that we saw in AHRI the declines have become less. So I mean the second order derivative is kind of turning favorable. But the overall market remains challenging and did decline. So we are clearly outperforming the market in there. But it's not just on unitary equipment, I mean, our services offering, our ability to do a full life cycle. So I think that's all put together doing that. Yet our market remains challenging, but our market share remains very small, Nicole, I mean from our perspective, we continue to have significant opportunity to regain national account and enter emergency replacement in a meaningful way. But at this stage, based on all the data we look at is we are pleased with the fact that we're outperforming the market.

Okay. Got it. And then just a quick follow-up maybe for Michael. I think you mentioned, Michael, that you expect under-absorption to continue but maybe at a lesser rate in the second quarter. Can we just put a finer point on that relative to the $50 million, I think you spoke to in 1Q, what are you expecting for 2Q?

Yes. It's $15 million in Q1. It's not going to be 0, somewhere between that. But there will be a little bit of a headwind in the second quarter. But by the end of the second quarter, that should all be behind us and we should start to see actually some year-over-year absorption benefit as we get to the second half.

Yes. Nicole, and also $15 million makes a big difference. When you make only $160 million, right? I mean Q1 is one of our softest quarter. In Q2, which is a more profitable quarters, it doesn't move the needle at all.

We'll go next now to Stephen Volkmann with Jefferies.

Great. Just a couple sort of bigger picture follow-ups. I think, Michael, you mentioned some spending on ERP and AI targeted. Just any details? Those sound like interesting potential projects.

Yes. So ERP, first, let me take away any fear. We're not doing any massive big ERP changes. We love [indiscernible] as we go into integrating new acquisitions that we have done, we're just moving them to our own platform, and that work is underway. So we are very good at this. We do it diligently, we do it one at a time, so I just want to make sure we take away any risk concerns about that because none and it's limited to the acquisitions we have done recently. On AI piece, yes, we continue to make investments. We are getting really good results when it comes to 2 or 3 specific areas within AI. As we look at where we are making a difference is, clearly, pricing, we are seeing some good benefits on using AI which increases our win ratio and also increases our overall profitability, which is typically hard to do, but AI enables us to do that. Second piece, which we are seeing good traction is truly around looking at demand planning, sales inventory, ops planning. I know right now the headline news on inventory is not great, but we are getting better. As that initiative move forward, we are very optimistic on what AI can do there. Third big bucket is just general productivity with agentic AI and how we have looked at everything from staffing our call centers to our own HR impetus to really looking at robotic process automation. I mean all of those things are helping productivity on the SG&A side. And you saw we did really good on the cost control on SG&A. All of that requires investment, and we are making investments in data lakes. We are making investments in partnerships with LLMs. But we are also very focused on reducing some of that cost by cutting down on useless subscriptions, subscriptions that are no longer needed, sunsetting old IT systems, as we upgrade our tech stack, and we sunset legacy ones. There's just a little bit of bump along the curve, right, because at one point, we are paying for both. But in the long term, I think it's going to be productivity and pricing will outweigh the benefits and outweigh the cost of all the investments we are making. So very pleased with the progress there.

Great. Okay. And then, Alok, I'm interested both Samsung and Ariston kind of your growth programs, I suppose, around distribution. I'm guessing those started before all this tariff noise kind of came to bear. And I'm just curious if you've changed the way you're thinking about those opportunities given the realities of sort of the world today?

So strategically, we remain very committed to both of those ductless and water heater remains core part of our portfolio, and we are gaining momentum in both. I mean we had really solid momentum in Q1 and what did we do, we just launched in March, but in Q1 and March [indiscernible]. The fact that these are joint venture versus buy and supply agreements, that makes us very comfortable sitting where we are because we can have very intelligent discussions about supply chain moves, tariff cost sharing and other future district changes that we can make to mitigate any long-term impact of tariff. So we appreciate the partnership spirit with both those companies, but no change in current dynamics. Almost all ductless today are imported from outside especially when it comes to interior, indoor component and some of the core outdoor components. So no, we are moving with the industry and have no concerns around the structure.

We'll go next to now to Nigel Coe with Wolfe Research.

By the way, Alok, I'm down for the 7:00 a.m. Crisis call. So I'll ask Chelsey to send me the details of that. Could be [indiscernible].

Maybe we start charging you guys, and that could be part of our tariff mitigation effort.

Could be. I'm sure people would pay for that. By the way, I'm not disappointed with the baseball analogy. I thought you're more a cricket guy, Alok, but I'll let you get away with that.

If you will ask me the question, but I don't know how you break down two innings. I would have like to say, like we are 0.2 in the first inning or something...

Yes. The first innings or the first [indiscernible], some of that. That's right. So sorry, I do want to go back to tariffs. Roughly, where are we today in terms of U.S. production of residential like commercial units? And are you planning to redomesticate production? I'm not saying next week or next month, but over time, or does it still make sense to keep your production in [indiscernible] and pay the tariff from a unit cost perspective? And I'm just wondering what sort of non-price mitigations you're [ competing ] right now?

So if you're paying a [ T20 ] cricket game, we are in the third over of the full [indiscernible] so we are early in that [indiscernible]. So first of all, we need things to stabilize before we make any big decisions or changes. I mean, things seem to be moving around quite a bit. Obviously, the USMCA agreement is coming up for renewal, and we'll see where that moves but currently, we are continuing to fine tune, change things, change the source of metal, changed a bunch of like a smaller division but before we make any large decisions, we do want to see some stabilization in policy and more of a consistent approach versus seem like the approach is [indiscernible] so no major changes in the pipeline in terms of massive reshoring. Now remember, we do have 3 residential factories today in the U.S., and we do pretty well going through that. That's in Granada, Orangeburg and Marshalltown, and we have one large one for our residential in Mexico. So we have plenty of flexibility in our network, and we will continue making changes for some big massive transformation, we just need stability in our policies from the government before we look at it. Today, it still makes sense to continue doing what we're doing and just mitigate the impact. One product at a time, one screw at a time and one sheet metal part at a time.

Okay. It doesn't sound like you won't give me the number on the percentages of production and domestic. But in case you do, I just thought I remind you that. Going back to the sell-through, the minus 10% on the single channel sales. You did mention that you were rationalizing your residential new construction exposure last quarter. I'm just wondering if that was an impact during the quarter and whether that process is now complete?

Yes. What we said in the past, it's about 25% of the HCS segment, the residential new construction. We definitely saw the volumes down there more than others is above 30% [indiscernible] in the channel. Not necessarily all just customers move into other competitors. It's a combination of just weak new construction and that, but we definitely saw that channel weigh on the overall one-step volume growth.

Yes. And that share loss which is what we'll show in print is going to negatively impact us all through the year, and that's built into Michael's overall guidance, as we said, 2-step is going to do better than one step. From a profitability perspective, that's going to work in our favor because the margins were like negative [ 20 ] of those businesses that we have lost.

We'll go next now to Joe O'Dea with Wells Fargo.

In terms of the pricing announcements over the course of the past week, can you just give any color on that? We see the HCS guide go from [ 2 to 4 ] but presumably, where your pricing is on a narrower scope of products. And so just looking for any quantification of the recent price increases. And in addition to that perspective on the dollar effect. And so when we think about this, if consumers today are paying $10,000 for a unit, presumably the dollar effect of what you're flowing through is a pretty small number as long as the channel doesn't try to price on top of that?

Yes. So the first one, the price increases for us just went into our customers' announcements on Monday. So I think we need to work through that over the next multiple weeks and you probably know some competitors have announced that the week before. From our perspective, we need to work through that. I would take Michael's guide as the changes in our overall revenue is what we're expecting in price. So there's going to be announcement number. There's going to be a stick rate number out there as normal. But what we are confident is we'll offset the increased cost inflation through those actions is the way ever look at it.

Then on the impact to the homeowner, we still think the equipment is maybe 40% of the total installation costs but we'll have to see how that cost evolves, but we don't see this as a big driver of that input cost. It's most is the contractor labor and margin still.

Yes. I think 40% includes equipment, parts, supplies. And in some cases, it's less than 30% is better, depending on the installed and time. So I don't think it changes the consumer price elasticity in any meaningful way. But we are sensitive to the market demand supply agreement, but remain convinced that equipment pricing is the least of the variable in that equation.

Right. That's what I was getting at. And then just in terms of seasonality in HCS and margins, I think the past couple of years, we've seen margins step up from 16%, 17% in Q1 up to kind of 23% to 25% in Q2. Obviously, absorption headwinds that make it a little bit lower starting point in Q1 of this year. But just looking for weather, you think the past couple of years are a reasonable benchmark for what you think you can achieve as you get that seasonal step up in Q2 of this year.

Yes. I think the main driver is going to be the volume recovery within ACS. Obviously, we had some weird comps last year. But we're building within the guidance that we expect sequential year-over-year improvement Q2 versus Q1, Q3 versus Q2 and Q4 versus Q3. So if you look at the year-over-year declines, sequentially that should continue to improve. That will obviously help our margins. And then when you get on the second half of the year, you'll start to have even better absorption within those margins. That's what we're expecting right now, but we'll watch the summer play out. Q2 is a big quarter for us that we need to get through. And once we see that play out, I think we'll have a really good line of sight for the year.

We'll go next now to Deane Dray with RBC Capital Markets.

I appreciate the update on the new products on Slide 5. Can you just remind us, do you track a new product vitality index or the contribution from the new products? And then just kind of related, I believe you gave an indirect update in Steve's question on ductless, but anything on the Samsung JV would be helpful, too.

Sure. So yes, we track vitality pretty closely. And we track vitality where we do not consider refringent changes as a new product. So excluding that, our vitality remains in the 45% to 50% range. If we didn't exclude that, clearly, 80%, 90% vitality. But excluding the refrigerant change and [indiscernible] changes, we do remain quite pleased with the Vitality number. And I think the exact number is like 48 or something right now, but it's always in the 45 to 50 range. And we see are very pleased with heat pump introductions, indoor air quality introductions, [indiscernible] the control changes. You probably saw a lot more of that during [ Prakash's ] presentation at the Investor Day. So we remain quite pleased on where we're coming down. On the Samsung joint venture, we talked last year but the meaningful impact is going to be this year because it takes almost a year for us to kind of get it through the channel, get dealer conversion, work through phase out of the inventory, and we are pleased with the current momentum and feel like there's a lot more upside as we take this forward, especially as we look at kind of everybody's impact in the same different tariff. The feedback from the channel and the consumer has been very good. These are high-quality products with much better controls, much quieter than some of the competitive products. And the contractors like the fact that the same truck that's going to deliver [indiscernible] product also delivers this. The same rebate program can be added. So we are pleased with the direction it's going, and feel this continue to be a lot of upside as we go through the rest of the year.

That's really helpful. And then just a second question. And I'm really not sure the extent whether you can comment, if at all, but regarding the recent litigation against the resi HVAC manufacturers. And if it helps, we had an expert call and published on this where the expert declared the case very weak as it stands today. But just are you able to comment on it?

Well, thanks to you and others who have experts call on their own analysis. I really want to say a lot about this, Deane, and maybe we'll have to wait for some other occasion. Because at this point, I have to read a prepared statement given to me by my lawyers, but I'm glad you asked. Our response is the matter is pending legal complaint. The lawsuit contains only plaintiff allegation and there has been no funding of wrongdoing. We dispute the accuracy of the allegation and will actively and vigorously defend our position through proper legal channels. Again, there's a lot more, I want to say, but I'm currently constrained because the lawsuit saying only the prepared legal portion of this.

That's great. I'm glad I asked. I'm glad you were able to read that statement and we certainly agree. So we'll leave it there...

You've made my general counsel's day that I read the statement.

We'll go next now to Patrick Baumann with JPMorgan.

A lot has been covered. I maybe just wanted to tie the inventory being normal comment with like the growth that we're seeing on the balance sheet year-over-year. I know some of that's acquisitions. Just wondering if you could give any color on like residential units within that bucket, either looking year-over-year or kind of versus current sales levels relative to history. Any context around where you are on that front?

Yes. Sure, Patrick. So typically, when we go from Q4 to Q1, like just last year, we built about $210 million worth of inventory. This year, we built $60 million. So think of that as $150 million reduction compared to what we normally build because we have to build a lot of inventory as we get into the peak summer selling season. When we ended the year last year, we talked about being $100 million and $150 million more inventory than we needed. So think of it as we are essentially back to a normal seasonal thing. Now I feel like we still have opportunities and Michael referenced through that as we get better in demand planning, better in [indiscernible] to work some of this down. And we'll continue to invest in inventory when appropriate especially when it comes to parts and supplies, which Michael referenced, emergency replacement, which we have been talking about in the past to make sure that our fulfillment rate remains at a very high level. But we are pleased with the progress of our inventory drawdown and feel like we are on track to meet our commitments to get to a stage where we are back to normal inventory.

And then maybe just a cleanup on price mix. Can you give any context on the 9% in the first quarter, how much came from price versus mix? And then for the year, the mid-single digit, it sounds like you added a little bit of price to that. How much is coming from price and mix within the full year guide?

Within the first quarter, the majority of it was mix. Alok mentioned that mix should really taper off here in the second quarter. Then for the balance of the year, it's all price.

Thank you. And ladies and gentlemen, thank you for joining us today. Since there are no further questions, this will conclude Lennox's 2026 First Quarter Earnings Conference Call. You may disconnect your lines at this time, and have a great day.