Lennox International Q2 2023 Earnings Call Transcript

Quartr
Provided by Quartr
July 27, 2023

There are 18 speakers on the call.

Operator

Welcome to the Lennox Second Quarter 2023 Earnings Conference Call. All lines are currently in a listen only mode As a reminder, this call is being recorded. And I would now like to turn the conference over Chelsea Poulshan from Lenox Investor Relations team. Chelsea, please go ahead.

Speaker 1

Thank you, Ashley. Good morning, everyone. We are excited to have you here with us this morning. Joining me today is CEO, Alok Miskara CFO, Joe Reitmeier and VP, Finance, Michael Kwenzer. Alok will discuss quarter highlights, and Joe will go into depth on the company's quarterly financial results and our updated guidance for fiscal 2023.

Speaker 1

After that, we will have a Q and A session with Alok, Joe and Michael. 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 to be relevant indicators of underlying business Please refer to our SEC filings available on our website for additional details, including a reconciliation of all GAAP and non GAAP measures. The earnings release, today's presentation slides and the webcast archive link for today's call are available on our new Investor Relations website at www.

Speaker 1

Investor. Lennox.com. Now let me turn over the call to our CEO,

Speaker 2

Thank you, Chelsea. Good morning, everyone.

Speaker 3

I am delighted to share our impressive results from the recent quarter Ending on June 30, during which we delivered record revenues, record profit, record EPS, Record margins and record cash flow. These results demonstrate the power of our focused growth strategy And the progress of our commercial turnaround plan. I'm grateful to our dealers and customers For their continued loyalty towards our products and services as we remain committed to further improving our service levels And enhancing their customer experience. I'm also thankful for the dedication and hard work Of my 13,000 Lennox colleagues whose relentless efforts have contributed to our outstanding performance this quarter. This successful quarter demonstrates the power of our laser focused strategy, which builds on our existing Strong direct customer relationships, advanced products platform and our unique distribution network.

Speaker 3

These factors will continue to fuel our share gain and margin expansion for the foreseeable future. Now, I want to discuss some key highlights of the quarter on Slide 3. 1st, core revenues grew 3% and our adjusted segment margin expanded 320 basis points to 20.9%, resulting in our adjusted earnings per share increasing 22% to $6.15 Additionally, our operating cash flow increased nearly 100 percent to $196,000,000 2nd, we are extremely proud of our commercial team's execution of our profitable growth strategy. Both revenue and profits for the commercial segment hit a record this quarter, driven by favorable price mix And improved production output from our Stuttgart manufacturing location. 3rd, Residential end markets were challenging, which resulted in our residential segment delivering lower revenue, margins and profits.

Speaker 3

Margins were also impacted by lower factory output and absorption as we normalize our own inventory levels Post the CO transition, we remain cautiously optimistic about the second half as we believe That the industry's inventory rightsizing is decelerating. In addition, our recent price increase 4th and finally on this page, we are pleased to share the revised fiscal guidance for this year as we anticipate Higher revenues, higher earnings per share and higher operating cash flow for the full year. Joe will review the revised guidance in greater depth Later in the call. Now please turn to Slide 4 for our view on the current business conditions impacting the industry. For the residential end market, we experienced higher than expected distributor destocking And a cooler start to the summer selling season.

Speaker 3

We are now anticipating unit volumes for the full year To decline by high single digits versus prior expectation of a mid single digit decline. Looking at the second half, we expect the impact of distributor destocking to diminish and we have started to see an uptick We now anticipate sales to be up low double digits for the full year versus prior expectations of high single digit to low double digit sales increase. The order backlog remains strong And although delivery lead times remain extended, they are 50% lower than last year and in line with the industry. Regarding price versus inflation, we are pleased to report that the industry pricing remains disciplined And our own media price increase has been broadly successful. Our outlook On both components and commodity cost inflation remains stable and unchanged.

Speaker 3

And we expect the second half of the year And increased commercial production gives us confidence that we are well positioned to gain share in the second half of this year. We continue to invest SG and A dollars towards improving our go to market processes While deploying incremental frontline resources to win over more dealers and more key accounts, We believe that Lenox outperformed the industry in successfully launching the product portfolio To meet the new minimum efficiency standards, gaining further loyalty from customers And our dealers. During future regulatory transitions, including the upcoming low GWP refrigerant requirements On January 1, 2025, Lennox aims to deliver similar outperformance and capture additional share. Please turn to Slide 5 for more details regarding ongoing Lennox activities related to the upcoming refrigerant transition. We are pleased to announce that Lennox will transition to R454B From R-410A refrigerant to meet the EPA's requirement effective January 1, 2025.

Speaker 3

The R454B choice was driven by our commitment to provide the best option for our valued customers And the environment. Compared to the existing 410A refrigerant, R454B reduces greenhouse gas emissions Anne has approximately 80% less global warming potential. Lenox has demonstrated a solid track record We are successfully navigating regulatory changes and this will be no exception. We have completed most product redesign And are now in the testing phase for this transition. The redesign includes updated compressors and other components For refrigerant compatibility and high efficiency performance, to address safety requirements for the new A2L refrigerant, We will have additional safeguards on all our products that use this refrigerant.

Speaker 3

These safeguards may include sensors, Controls and algorithms, which will mitigate any leaks if and when they occur. Safety of all our products remains our highest priority and our redesign will meet or exceed applicable safety standards. As you know, Lennox has a structural advantage of primarily selling direct to dealers. This enables our team to deliver advanced training to delivers and equip them with accurate information To share with the end consumers, this helps us and our dealers to win during the regulatory transition While addressing all the safety requirements for manufacturing, distribution and installation. Throughout this transition, we do not expect a significant inventory pre build as the transition to R454B Would likely happen faster compared to similar refrigerant transitions in the past.

Speaker 3

We intend to deliver a safe, Seamless transition supported by appropriate inventory levels. By maintaining strong relationships And timely communications with our suppliers, we will avoid supply chain disruptions. While we are still reviewing this transition's financial impact, we expect it to be neutral or accretive to our margins. We are confident that the increase in the product cost will be offset by price. Overall, We anticipate that once again we will outperform the industry and garner additional loyalty from our dealers and customers during this refrigerant transition.

Speaker 3

Now let me hand the call over to Joe, who will take us through the details of our Q2 financial performance.

Speaker 4

Thank you, Alok. Good morning, everyone. Please turn to Slide 6. As Alok mentioned earlier, the company posted strong revenue and earnings growth. Core revenue, which excludes our European operations, was a record $1,340,000,000 up 3% compared to prior year's price and mix benefits More than offset residential sales volume declines.

Speaker 4

Total adjusted segment profit increased $50,000,000 $43,000,000 from lower volume and $13,000,000 from inflationary effects and investments in distribution and SG and A. Total adjusted segment margin was 20.9%, up 3 20 basis points versus prior year. For the quarter, corporate expenses were $25,000,000 a decline of $2,000,000 as we continue to tightly control corporate spending. The 2nd quarter not only achieved record levels of revenue and segment profit, but also marked record earnings per share with GAAP earnings per share rising 23 percent to $6.10 and adjusted earnings per share growing by 22% to $6.15 Our record our 2nd quarter tax rate was 17.6 percent and diluted shares outstanding were 35,600,000 compared to $35,700,000 in the prior year quarter. Now turn to Slide 7.

Speaker 4

As we saw in the Q1, industry wide distributor destocking continued in the 2nd quarter and the summer season began with cooler temperatures, Resulting in a 12% volume decline. The volume decline was partially offset with 2% favorable price And 6% favorable mix. Our direct to dealer sales, which are around 75% of our segment revenues, Experienced a revenue increase in the low single digits. The remaining 25% of our revenue, which goes through distributors, was down approximately 20 Residential segment profit fell 6% to $203,000,000 and segment margin dipped 50 basis points to 21.6%, driven primarily by lower volume, inflation effects and selling and distribution investments. The headwinds were partially offset with price increases and favorable mix, partially driven by the new minimum efficiency standards.

Speaker 4

Turning to Slide 8 in our commercial business that delivered another quarter of exceptional results. Revenue was $408,000,000 In the quarter, up 24%. Combined price and mix were up 22% and volume was up 4%. Commercial segment profit was $103,000,000 up 150% and segment margin more than doubled to 25.3%. Price and mix had an outsized impact in the quarter delivering $66,000,000 And the total $62,000,000 of the total $62,000,000 of the profit increase.

Speaker 4

Last year, we provide guidance on a multi year profit opportunity of $100,000,000 and I'm delighted to share That our trailing 12 month segment profit has already surged by $120,000,000 compared to the same period last year. Our rooftop production output continues to increase and we are maintaining a robust commercial backlog while steadily improving delivery lead times, which now align Moving to cash flow performance and our debt to EBITDA starting on Slide 9. Operating cash flow for the quarter was $196,000,000 compared to $97,000,000 in the prior quarter. Capital expenditures were $49,000,000 for the quarter, an increase of $28,000,000 compared to the prior year. Our capital deployment priorities remain consistent, supporting organic growth investments like our new commercial factory in Mexico, Driving industry leading innovation and exploring potential bolt on acquisitions.

Speaker 4

In the quarter, the company paid $38,000,000 in dividends. Total debt was approximately $1,600,000,000 at the end of the quarter and our debt to EBITDA ratio was 1.9. Cash, cash equivalents and short term investments were $58,600,000 at the end of the quarter. Turning to Slide 10, let's review our 2023 full year guidance. As a result of our strong first half performance, We are increasing our full year outlook.

Speaker 4

We expect core revenue to be up between 2% 4% for the year And earnings per share of $15.50 per share to $16 per share. We're increasing our free cash flow target To a range of $300,000,000 to $350,000,000 Our guidance for capital expenditures remains consistent with our prior guide at 2 $50,000,000 As a reminder, that includes investment in a second commercial factory and investments related to the refrigerant transition to take effect Price benefit is now expected to be $250,000,000 and we now expect net material cost to be a $25,000,000 headwind in 2023. The material cost headwind is driven by component cost inflation of $90,000,000 Net of $30,000,000 in savings from cost reduction initiatives along with the $35,000,000 commodity cost benefit. Our new target for corporate expenses is $95,000,000 attributable to higher incentive compensation expenses. We will continue to manage SG and A expenses tightly while simultaneously making essential investments in the business to support growth initiatives, Advance our innovative products and solutions and enhance productivity.

Speaker 4

And finally, we still expect the weighted average share Diluted share count for the full year to be between 35,000,000 and 36,000,000 shares. With that, let's turn to Slide 11 and I'll turn it back over to Alok.

Speaker 3

Thanks, Joe. In addition to solid short term results, we are also making significant progress towards transforming the company For longer term shareholder value expansion, last quarter, we shared the key initiatives That pave a clear path towards our 2026 financial targets. Today, we would like to share 3 transformation phases That will clarify the execution timeframe of those initiatives. Collectively, these initiatives We'll deliver on the 2026 targets and set up lineups for even longer term value creation. We are currently in the self help phase of the plan, which delivers execution consistency to our customers and shareholders.

Speaker 3

We have already demonstrated success in our commercial recovery and portfolio simplification initiatives. Our pricing excellence initiative will drive favorable margins through improved price setting, getting and netting. We are strengthening our core foundation by enhancing talent and reinforcing culture with an emphasis on accountability. This stronger foundation will serve as a springboard for accelerated growth in 2025 and beyond. Looking into 2025, Lenox is prepared for growth acceleration in several areas.

Speaker 3

Our up to date go to market sales strategy will increase our growth capacity and grow our core dealer base With a renewed focus on premium margin products, as we highlighted earlier, We anticipate accelerated share gain during the upcoming refrigerant change. Our technology advantage In cold climate heat pump will enable additional share gain during ongoing industry electrification. While we remain committed to delivering our 2026 financial targets, we also recognize the opportunities To continue expanding shareholder value even beyond 2026, we will build upon our structural competitive advantage To expand our share of wallet through higher commercial service penetration, higher attachment rates for parts, supplies and adjacent products used by HVAC dealers. In summary, we are committed to our 2026 fiscal targets And also have a clear line of sight to strategic imperatives that will continue creating differentiated shareholder value. Now please turn to Slide 12, where I would like to recap why I believe That Lennox's structural competitive advantage is poised to deliver long term differentiated shareholder value.

Speaker 3

Let me highlight the 5 pillars of our structural advantage. 1st, our direct to dealer model Uniquely positions us to deliver accelerated growth. To capture this, we will enhance our sales go to market effectiveness, Consistently elevate the customer experience and make necessary investments in growth capacity to meet market demand. 2nd, because we own our own primary distribution channel, we can deliver Sustainable and resilient higher margins by leveraging scale and technology to reduce cost And increase the efficiency of our distribution network. 3rd, our balanced scorecard based operating system, Dual source supply chain and lean digital processes deliver execution consistency throughout our operations.

Speaker 3

The 4th pillar is our advanced technology portfolio that is perfectly suited Finally, we have high performance talent and culture that is nurtured by our core values And recently launched Guiding Behaviors. We are continuously engaged in talent development and succession planning, While diligently ensuring that our compensation structure is closely aligned to shareholder value creation, I would like to close by reaffirming my gratitude to our employees and our customers. We are proud of our accomplishments in the first half of this year and continue to believe that our best days are ahead of us. Thank you. Joe, Michael and I will be happy to take your questions now.

Speaker 3

Ashley, let's go to Q and A.

Operator

We will take our first question from Jeff Hammond with KeyBanc. Please go ahead.

Speaker 5

Hey, good morning, everyone. Dave, just on commercial, I mean, the margins were just exceptional. So just wanted to understand Margin sustainability, any aberrations in the quarter? And then maybe just speak to the backlog and How much lead times are improving versus peak and just the level of reduction that kind of contributed to the quarter?

Speaker 6

Yes. From a sustainability perspective, 1st, the backlog remains resilient. It's down a little bit mostly because the lead times are improving, margins within the backlog remain Reflective of the margins we saw in Q2. So pricing mix is solid in that business. And We continue to see output coming out of the factory, which is a good sign for volume growth to continue.

Speaker 4

Yes, I think the one thing you'll see, Jeff, for the quarter price and mix propped up quarter back half of the year, you should see volume even more from the commercial segment. So we're excited about the future there. Once again, I think we've achieved Getting this business back to the trajectory that it was once on and are excited about our ability to now demonstrate our getting into our target margins by 2026.

Speaker 5

Okay, great. And then Just in resi, anything more than really weather that's informing kind of the lower trajectory there? And just Maybe speak to how your destocking is going for your company owned stores are? Thanks.

Speaker 3

Sure. This is Alok. Yes, listen, on resi, I don't want to talk just about weather, but we all know Q2 was softer. I think the distributor destocking was also more pronounced than we had expected. When at the end, we took our volume guide down and talking about high single digits.

Speaker 3

That's also to just reflect our learning in 6 months of the year. But as you see notice, we kept our revenue the same. From my perspective, our own inventory destocking is going fine. I think it will take us another 6 to 9 months to bring it down to more normal levels. And that's because internally we are just more cautious I don't want to lay off a lot of people just to turn around and try and hire them, which we know was a struggle in the past.

Speaker 3

From what we hear from the distributors, most of them expect destocking to be over by Q3. If there's a little bit that bleeds into Q4, that's likely to be seasonal products like furnaces and things that don't sell well in Q3. So that view hasn't changed for us. So overall in RESI, it's slightly worse than we had talked about last time. But within the overall guide range, we think it's similar outlook to what we previously disclosed.

Speaker 7

Okay. Appreciate the color.

Operator

Thank you. We'll take our next question from Tommy Moll with Stephens Inc. Please go ahead.

Speaker 8

Good morning and thanks for taking my questions. I wanted to follow-up with one more on the resi Volume trends and outlook, are you able to share the volume trends in the quarter for direct to dealer versus Allied. And then you've talked on several occasions about the distributor destocking, which I would think is more an Allied driven comment. But is there anything on a sell through basis other than like you said, Alok, the cooler weather in the second quarter That's changed in terms of your outlook. Thank you.

Speaker 3

Yes. So clearly Allied and ADP, which makes up our indirect channel. They had significant decline. Our core Lennox business was kind of Flattish, maybe slightly down in terms of units. So I mean that gives us a lot of confidence that the industry is holding quite well.

Speaker 3

And all the current softness is mostly driven by just the distributor destocking. Now you got to ignore things like weather because June was a little colder, July is going to be a little bit harder, but that just get washes out for the full year, Tommy. But net net, I think overall industry is holding up well and the current impact is almost all driven by channel destocking.

Speaker 8

Thank you. That's helpful. I also wanted to follow-up on a theme you highlighted earlier, Alok, just on the accountability And growth culture that you really want to drive. Can you just bring us in a little bit more on what that means and what some of the initiatives

Speaker 3

Sure. So I mean, Lennox has a great culture, has always had a great culture. For past 5 years, we're just trained for Lennox. Starting with the Marshalltown tornado, which as you saw, we finally finished the rebuilding and we never want to use the T word again in any of our conversation. To COVID and many other pieces where supply chain, we got disproportionately negative impacted The industry because the supply chain was more reliant on China.

Speaker 3

In the past 5 years, we just got beaten down and started using all of those As excuses, and I think going forward, we have launched, relaunched our core values. We have 9 guiding behaviors. You may have seen some of those posters when you were here. Each and every employee is going through a training that's going to be over the next 12 months complete. And we really want to emphasize things such as customer experience, accountability, innovation, sustainability And of course, that depends on where you are in the organization.

Speaker 3

But we're very pleased. We're very pleased with the results. Employees are generally Excited about the path forward and everybody is ready to put the past 5 years behind us and truly embrace the next 5, 10 years.

Speaker 8

Thanks, Alok. I appreciate it. I'll turn it back.

Operator

Thank you. We'll take our next question from Gautam Khanna with TD Cowen. Please go ahead.

Speaker 7

Hey, thanks and great numbers guys. I wanted to ask about that refrigerant change next year. And when you expect The mix to transition to that new refrigerant, and then what are the pricing implications of that change. When do you start to see the product transition into the channel? And is it Do we get another lift like we did this year with this year transition in terms of average selling price and the like?

Speaker 6

Hey, Gautam, this is Michael. Yes, so the transition really won't happen until pretty much January, but you will start to see in January 2025 Some of that price mix dynamic where we'll lift up the price to more than offset the cost, but really that'll be more of a 2025 impact than 2024. We'll be preparing for that through inventory preparations and transitioning and preparing the dealer network, but really no financial impact in 2025 or 2024.

Speaker 7

Okay. And just a quick follow-up on the commercial side, where are you with respect to the emergency replacement market? Have you Kind of reentered it. Do you have the capacity

Speaker 3

to do that yet? No, I think we're When do you expect to?

Speaker 4

Yes, Gautam, the way I would characterize that, right now, we're still focused on the plan replacement and national account segment of the business. We're early innings in reengaging in emergency replacement as our factory continues to increase output. By the end of the year, we'll be more fully engaged in that, but it's early innings right now and that remains a significant upside opportunity for us going forward.

Speaker 7

Thank you very much. I'll turn it back to you guys.

Speaker 3

Thanks, Gautam.

Operator

Thank you. We'll take our next question from Nicole DeBlase With Deutsche Bank, please go ahead.

Speaker 9

Yes, thanks. Good morning, guys.

Speaker 10

Good morning.

Speaker 9

So just maybe on the revised full year guidance. So I think you're kind of implying that sub-fifty percent of earnings going to come in the second half now and typically that's more like 55% in the second half. So just trying to understand like the dynamics between potential conservatism in the guidance or something that we should be

Speaker 4

Yes. I think once again, Nicole, we've been accused of being conservative in And I think even though we've had a strong first half, there still remains some uncertainty around the economy and certain residential end markets. Whether It's certainly cooperating now. It tempered second quarter results a little bit. You saw that in our commentary about our residential segment.

Speaker 4

But going forward, once again, I think we probably have upside in the number. But once again, we're going to be cautiously optimistic as we move forward.

Speaker 9

Got it. That's clear. Thanks, Joe. And then, with respect to the resi margins, so I guess, normally margins are kind of flattish sequentially between 2Q and 3Q from a seasonal perspective, do you guys see opportunity to improve resi margins as we move into the Q3 because of some of those Specific headwinds that you caught out on the call related to 2Q.

Speaker 3

Yes, Nicole, this is Alok. On the resi margins, I was disappointed on Where the margins turned out to be. So while we understand the seasonal trend and I don't want to bake up like a lot of upside in the model. From my perspective, resi margins have a lot more room for the upside. If you think about just the things we talked about, we need to get both manufacturers margin And distributor margin to have margin performance that's much, much higher than where we are today.

Speaker 3

So I think there's a lot of room, a pricing excellence initiative, Which only starts in Q3 from delivering results perspective is going to have benefit. Right now the factories are building less than we are selling, There's a clear negative absorption impact, which is going to last through the year. So we think margins are going up in the second half and then I think Same will continue in 2024 as well.

Speaker 1

Thanks, Alok. I'll pass it on.

Speaker 5

And we will take

Operator

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

Speaker 11

Hey, good morning. Thanks for taking the question. I wanted to follow-up on the commercial margin. Joe, you said it was price mix, I think that boosted the quarter. It seems like the second half of the guidance is more like EBIT margins in the 15%, 16% range.

Speaker 11

So can you just help us bridge kind of 2Q to the second half and what's changing?

Speaker 6

So obviously, we don't give really second half guidance, but implied in that is still some conservativeness. But what you really saw in the first half was a lot Carryover price benefit that we started to get in the second half last year. So you will see some more price benefit in commercial in the first half than the second half. With that said, our backlog still has solid margins and they should reflect that way through the balance of the year.

Speaker 11

Okay. Makes sense. And then I had a question on resi, just the second half sales. It seems to imply maybe down 1. And it seems like what are the big drivers?

Speaker 11

Is it destock decelerating in a bit more price? Is there anything else?

Speaker 3

I think those are the 2 right ones, Ryan, is destocking that caused most of the decline. And obviously, July weather has been a Tailwind for us as we move forward. So I think those would be the 2 things I would call out.

Speaker 11

Got it. All right. Thanks. Appreciate it.

Operator

And we will take our next question from Josh Pokrzywinski with Morgan Stanley. Please go ahead.

Speaker 12

Hi, good morning guys.

Speaker 10

Good morning, Patrick. Good morning. So

Speaker 12

I guess one thing I want to follow-up We talked about commercial margins a little bit, obviously, big turn versus where we were a year ago. Alok, how much of what you're seeing Today or what you're seeing this year is sort of a pull forward of maybe kind of this 3 year discussion that you originally laid out last year. Are you just had a plan by 12, 18 months? Is it more of the price cost stuff which maybe normalizes, maybe walk us through that journey and how we should think about linear progression from here?

Speaker 3

Sure. Last year, about this time, we were at, I think at Ryan's conference in Chicago and we talked about 100,000,000 As Joe said, we have got $220,000,000 What happened is the price cost turned out to be better and rest was as we expected. And that's because the team did a really good job kind of getting the cost benefits, getting the right kind of negotiations and repricing some of the backlog. The upside continues from a lot of other factors such as manufacturing. We are still below historical levels, which we talked about in terms of output.

Speaker 3

I think our factory still has a lot more room for productivity. I still feel there's a lot more opportunity for us, as Joe mentioned earlier, on getting into things like emergency replacement, but we are barely scratching the surface of. And remember, we have a second factory that We're spending money on right now with no output. So net net, it's not necessarily kind of pull forward, I would say. It's kind of things that just went better than we had communicated.

Speaker 3

Now clearly when we promised 3 years for $100,000,000 on external basis, Our internal plan called for half of that and now we are 6 months ahead of it. But glad to put that $100,000,000 behind us. We would not be making a new commitment, but we'll talk about a long term margin range of we've always said we want both segments to be in the 18% to 20% range on a sustainable basis and that's what we're going to be focused on.

Speaker 12

Okay, that's helpful. And then just transitioning to this refrigerant transitions you talked about Kind of the new equipment coming out in 2025. I know next year there's a big step down in allocation for R-410A. Any for what you think that does to refrigerant prices or the replacement market if folks are like, hey, this Refrigerant is getting much more expensive. Do I really want to replace something where availability is going to get tough?

Speaker 12

How do you think about that Equipment transition being a couple of years away, but refrigerant gap up maybe being a little more near term. Just open ended question, anything on your mind?

Speaker 3

Sure. A lot in there and I'll tell you we don't have a crystal ball looking into 2024 yet. Each of things that you mentioned is true, but we don't have final price on the R-410A for next year. There's always going to be inventory Drawdown that we'll have to do to make sure we're not stuck with legacy 410A beyond what we need. And from a consumer perspective, I think this is going to be a small change.

Speaker 3

We have gone through changes before. Consumers really don't think about refrigerants. It's more going to be educating our dealers and a few consumers who are probably more well versed in this than others. So still a lot of moving pieces. Net net, I think there's a danger of over analyzing this because the industry is used to these changes.

Speaker 3

We are very used to this change. Our dealers are now getting used to this change. I think this is going to happen more seamlessly than we all expect With some pluses and minuses, but as Michael said earlier, we think this helps our mix upwards in 2025. But some of it might start happening in 2024 if the 410A pricing is higher and we are forced to increase our price in conjunction. So stay tuned, lots of moving pieces.

Speaker 3

But for product design, dealer training and truly having confidence in the Transition,

Speaker 10

I think we are way ahead. Understood. Thanks for the color.

Operator

We'll take our next question from Nigel Coe with Wolfe Research. Please go ahead.

Speaker 13

Thanks. Good morning, everyone. Thanks for the question. So I guess beating a dead horse here, but this R454 Transition, investment spending, how does that sort of shake out through the next couple of years? I mean, you talked about investment spend this year.

Speaker 13

How does that look into next year? Clearly, you don't know the mix impact that's going to be positive. But from your understanding, is this an installation deadline Was it a production deadline? And do you think there's going to be any sort of channel impact as we transition to this new refrigerant?

Speaker 4

Yes, I think this will be a situation where maybe a little bit different than the larger Transitions we've had in the past, going back to the 10 to 13 SEER transition, which was traumatic for the industry. I don't think that's going to be anywhere near this, as Luke mentioned, probably a little bit more seamless. So we'll just play it out the way that Veer is seeing, once again, we're in great shape. We typically do very well during these transitions because we're On the leading edge of innovation, this requires a significant investment, dollars 50,000,000 this year, probably $50,000,000 next year To prepare the factoring and processes, etcetera, to make the appropriate investments. And we've made some of those investments already.

Speaker 4

And as Alok mentioned, our Head of Things. This usually creates opportunities for us. There's typically 1 or 2 competitors that stumble and they lease some share on the street. So once again, we're well positioned for this transition. We're excited about what lies ahead in front of us and we typically win when these things come to fruition.

Speaker 4

So we're excited about what This brings forward to us.

Speaker 3

And Nigel, just to add to that, it's a manufacturing date transition. As Joe said, we don't expect significant inventory build because the 4.10 is more expensive next year. The delta between a 2024 price and a 2025 Price might be just like a normal price difference year over year. And I just don't think that's going to make a meaningful difference to dealers' Economic calculations.

Speaker 13

I'm just wondering, are contractors as excited as you are about using this It seems like there is definitely some contract out there that might be pushing the 410A next year To customers just on that basis alone.

Speaker 3

There might be and we have 10,000 dealers Plus more in U. S. And we can't control. But I think overall, I think the flammability concerns are a little overblown. I mean if you take a Candle and blow the refrigerant on it, the candle extinguishes versus catch on fire.

Speaker 3

So this is not as flammable as Some people might fear. We have done lots of internal testing and the safety mechanisms are solid. So I think from that perspective, I believe majority of the contractors will come along with us to say, hey, this is a safe product, This is a good product and we'll follow the rules and make the transition seamless.

Speaker 10

Okay. I appreciate that, Saluk.

Speaker 13

And just a quick one, just to Clarify the distribution network expansion, is that primarily Lennox store expansions or are you looking at do you think it's mean more on the independent channels?

Speaker 3

It's both. I think the way we look at it as we are under penetrated in both. On our stores, our recent focus is more around increasing output through the current stores and putting more products through that. We are still geographically penetrated in North America. And on independent distributors, of course, we have a very low share.

Speaker 3

So both of those, I think we have significant expansion opportunities. Once we get through our self help, once we get through our Growth acceleration and put the right amount of feet on the street and the process behind it. We are super excited about the expansion phase.

Speaker 10

Great. Thanks a lot.

Operator

Thank you. We'll take our next question from Steve Tusa with JPMorgan. Please go ahead.

Speaker 12

Hi, good morning.

Speaker 6

Good morning, Steve. Good morning.

Speaker 14

So just on the commercial side, So the I know there's like differences in comps and things like that, but Carrier reported very, very strong volume. You I think we're up like 3%. You mentioned you still have yet to reenter emergency replacement. But where do you think The differences between your growth rate and theirs and anything vertical specific to talk about?

Speaker 6

Hey Steve, this is Michael. Yes, so we saw total volumes up 4%, but if you look at the rooftop production out of our stuck our factory that was up significantly So we're pleased to see that, that side of it. We had some obviously offset some different products, but definitely some growth more than the 4% coming out of our Stuttgart factory. A lot of that growth that we saw on the rooftops was on the national accounts and it was really broad based across retail And restaurants and distribution, so really saw that broad based growth. From an emergency replacement, although small, we did see a little bit of growth in the quarter, but still Very small, so it's a good start to that journey as we move back into that space.

Speaker 3

And I think I would start also say that, hey, congratulations to the to the Carrier team. I haven't digested the earnings, but great growth for them and we are excited that the industry growth trend continues And the industry overall is in good shape. I think that bodes well for us and for them. We still remain production constrained where We are producing less than we can sell. So excited about continued output increase in Stuttgart and our new factory in Mexico.

Speaker 14

And then just on this, since you're kind of delving into the technology here, you talked about it not being that big of a change, I In December, you said you now have I mean, you just chose your refrigerant, I guess, is what you're saying. What's the source of confidence that your technology is so much better than the other guys? And also, Why do you think you're entitled to share gains? In the last couple of years, it's been very choppy, obviously, with what's happened. A little bit of a different approach on initiatives relative to what the former CEO did over a 10 year period, a little bit different of a market.

Speaker 14

Like what where do you think your product is so differentiated versus the other guys?

Speaker 3

Sure. Couple of things, right. First of all, For the past 5 years, as I said, Lennox was in a very difficult spot because our supply chain was more constrained versus others We are more reliant on China than others. The tornado severely crimped our manufacturing ability, especially for the premium products. And I think the transition on leadership and CEO that obviously while it doesn't have a direct impact had lots of indirect impacts.

Speaker 3

But that's not important right now. And what's more important is your question of why are we confident. I think our direct to dealer network is something that we have under leveraged, I've done a great job building up. So I think that's the investment that still needs to continue delivering results for a while. Technology wise, I mean, even in the current state of transition, there was a lot of noise about compatibility of indoor units versus the outdoor units.

Speaker 3

Lot of new homebuilders, they put indoor units first and then they put outdoor units. During the SEER transition, they had to go rip out indoor units. If the indoor units were the older SEER compatible and outdoor units were newer SEER, ours didn't have to make that difference Because our indoor units were compatible both with the new SEER and the old SEER. So the connection to the dealer we have, That helps us make those kind of choices and decisions. At the end, I can't tell you that our compressor is better than our competitive compressor because you buy it from the same place usually.

Speaker 3

But what we can tell you is our product design, our actual package and the choices we make for our dealers. That's what helps us gain share. The results would be Probably more convincing than any of my answers. So let's wait a year or 2 and then we'll answer this question with numbers.

Speaker 14

All right. Well, talk to you in a

Operator

All right. We'll take our next question from Jeff Sprague with Vertical Research Partners. Please go ahead.

Speaker 15

Hey, thank you. Good morning, everyone. Hey, look, you probably accused us of over analyzing stuff, but That is what we do. So I appreciate Joe's comments and reiterating kind of the investment for the transition. It sounds like you clearly know what you need to do.

Speaker 15

So I think Mike kind of left Gautam's question somewhat unanswered in terms of What's your best guess on the increase in cost or selling price To customers in 2025 on the transition.

Speaker 3

I think the Well, fair enough. I'll try and give more detail. Part of it is we don't know exact numbers. I can give you ranges. So there's 2 things to think about.

Speaker 3

The price increase from current prices like 2023 to 2025 and then price increase from potential 2024 price to 25. The reason we are hesitant to answer that question is not that we're trying to be evasive, but we don't know the 2024 pricing, Which could get significantly impacted by our 410 production curtailment that's going on. I don't think it's going to be 20%. I'll just give you some ranges. I don't think it's 0% either.

Speaker 3

It's likely to be between 0% 10% Putting everything together and that's just going to help us all preserve our margins and pass on the cost through. Going back to the over analyzing, it was actually one of the Sunlight Research report, which says, HPAT Industries become like analyzing storms in a teacup. So I'm not confusing. I actually enjoy reading all of this and I think I've learned a lot in my 1 year. And I think what we have learned is that Lenox is going to win because of our direct to dealer network, because we need to leverage that better, Because we are really focused on one thing and only one thing.

Speaker 3

And because we are able to design our products. Just recently we got the design awards and we won more awards than others. So I think that's what I've learned more is that Everything else matters, but we all do it about the same. What differentiates Lennox is what was in the last page of my presentation.

Speaker 15

Yes. That 0 to 10 is from 23 to 25 though, just to put that finer point on it

Speaker 3

Or is it a If you're not going to hold me to it, yes.

Speaker 15

Yes. And then just a separate question. I Joe likes to kind of wink and nod and yes, we're conservative. But I mean realistically guys, like you're going to be at your 2026 guide This year, right? You're going to be at the midpoint of it roughly.

Speaker 15

So Clearly, you're signaling you think there's upside to that, but also are you in fact signaling that maybe there's heavier investment to drive growth and therefore we shouldn't kind of extrapolate too aggressively on Well, we shouldn't kind of extrapolate too aggressively on margins from here. Maybe just give us a little bit more context on how you're thinking about that? Sure.

Speaker 3

I think the reason I talked about the 3rd phase of the transformation, which is beyond 26 Yes, there's a high chance that we will get to the 26 target sooner. I won't commit to this year or next year Because I mean our actions remain the same. So I think that's what. On the conservatism side, listen, there are so many things that could go wrong. Historically, it has gone wrong for us in the past.

Speaker 3

So we just want to make sure that if we are wrong, we are going to be wrong on the conservative side versus being wrong on the aggressive On the investment questions, no, I think I mean our current investment rate is kind of what we expect going forward. I mean CapEx will go down going Forward for sure. The second factory is the heavy lift this year and a lot of those refrigerant change investment It's happening this year and some will happen next year. So no, and some of this is also we are lapping ourselves on incentives Much lower incentive payouts last year, like last year incentives were below target. This year at least current match shows it will be above target.

Speaker 3

So that's where the corporate cost delta But net net, we are optimistic and we hope to get to the 2026 target sooner, but We know we'll get there to 2026 by sure.

Speaker 15

Okay. Thank you.

Speaker 3

Thanks.

Operator

Thank you. We'll take our next question from Noah Kaye with Oppenheimer. Please go ahead.

Speaker 10

Hey, good morning, Alok, Joe, Michael. Thanks for taking the questions. Great. Maybe just to better understand the revised price mix EBIT Outlook of $250,000,000 benefit, you've already done $182,000,000 right year to date. So Maybe

Speaker 2

if you can

Speaker 10

help us understand the dynamics for the rest of the year. It seems like Maybe a little bit less benefit in commercial because the carryover is easing, but I mean resi is clipping along at kind of this 40,000,000 Per quarter run rate, you just implemented PIs. So just help us understand that revised guide.

Speaker 6

It's Michael. Yes, one of the big drivers is, as you mentioned, the carryover benefit of commercial. That's an outsized difference between first half and second half. But with that said, we do have a little bit of conservatism. As Luke said, some of that would be in the price mix category.

Speaker 6

But really what we're focused on is the pricing excellence in residential This new price increase that we've just announced, that will start to happen in the second half. And again, margins look good in the commercial backlog. So everything looks positive for the second half of pricemix But guide may be a little conservative.

Speaker 10

Yes. Just to double click on that, I mean, how do we think about the incremental benefit of that price increase than resi side?

Speaker 6

Yes. So in the last quarter, we raised our price mix guide from $150,000,000 to $175,000,000 that $25,000,000 reflected that additional residential price increase. So we already had that in the previous $175,000,000 guide.

Speaker 10

Okay.

Speaker 6

That's progressing well.

Speaker 10

And then on the Saltillo expansion, just Can you give us an update on how the timetable there looks? And then just sort of remind us or dimension for us How much that increases commercial's revenue capacity?

Speaker 3

Sure. Yes, just before this, 15 minutes before the call, I was with the commercial team congratulating them on an excellent quarter. And I saw Latest video feed and pictures of the Saltillo factory construction. The ground is all prepared. We have roof going up in portion of the business, we are hiring talent, some are being redeployed from our residential factory in Saltillo.

Speaker 3

Clearly, we are well on the way of ordering equipment given some of the extended lead time. So All indications are green and solid that we will be starting production end of next year. Nameplate capacity wise, Over years, it could more than double our capacity. But at the same time, like we're not going to put all the equipment immediately, right? We're going to Get enough land and roof space to put more, but we're going to put equipment on a judicious basis.

Speaker 3

And the last thing we want is the industry to have overcapacity on So we've got to watch out. And as Joe mentioned earlier, this would be focused around standard products Shipped by the truckload, getting into the emergency replacement, where our revenue is below what it used to be and our share is just decimally low. And we have a huge opportunity to use our distribution network to increase that number. So we're pretty excited and all systems go there.

Speaker 10

Great. Thanks so much for the color guys. Take care.

Speaker 5

And we'll go next

Operator

to Joe Ritchie with Goldman Sachs. Please go ahead.

Speaker 2

Hey, thanks. Good morning, guys.

Speaker 7

Hi, Jeff. Good morning, Jeff.

Speaker 3

So just Maybe just along the

Speaker 2

lines of Jeff's question earlier, and just trying to think about these commercial margins. I know that it It was only just a few months ago that you gave us that 19% to 21% long term target, but first half of the year, you guys are already there And actually slightly above it. I'm just curious like how do you kind of think about the trajectory of the margins from here for that business, maybe even beyond 2023.

Speaker 3

I think our next Investor Day is going to be 2024 And we love to update you on long term targets. There's a lot going well, but I keep in mind that a lot could

Speaker 15

go wrong as well.

Speaker 3

I think 1 quarter doesn't make a trend. I mean it's a great sign of our progress. I think the team has done an excellent job, but we need to leave some room for Things could slide different ways. Net net, listen, we are not doubting anything you're saying. I think just we need to be cautious and not get ahead of ourselves And where we are in the journey.

Speaker 2

Yes. No, that's fair. And look, it's a good position to be in to be able already be ready to update those targets. So congrats on the progress there. I guess maybe my quick follow on question.

Speaker 2

The piece of your business, the quarter of your business that independent distribution, I think you guys said it was down 20%. How much were volumes down versus the pricing that came through in that business?

Speaker 3

Well, volume on that one is a little messy because remember we sell a lot of coils in that business. So I think that kind of often skews the volume number for us In a negative way. But in general, I would say they were more they were slightly better than what you would look at on the AHRI data. I mean, you guys all look at the AHRI data. So I think we did better than what you saw in the HRI data, but slightly better.

Speaker 2

Okay, great. Thank you, guys.

Operator

And we will take our next question from Joe O'Dea with Wells Fargo. Please go ahead.

Speaker 16

Hi, good morning.

Speaker 10

I wanted to just start on high.

Speaker 16

The commercial manufacturing, you've sort of noted that there are Still further manufacturing improvements to make in the back half of the year. Any details around that that you could outline for us? Any major sort of goalposts there? And what's the timeline for when you expect factory output to hit targeted levels?

Speaker 3

Sure. Very good question on that. Listen, when we started the year, we hardly had any production in January because we were taking some Drastic improvement actions. We rationalized 65 percent of our SKUs. We looked at different lines and reconfigured the line to make the products That give us the best way to serve our customers.

Speaker 3

So starting from almost 0 in January until the end of the first half, We have reached progressively higher numbers and are starting to hit daily rates that Consistent with what the factory used to do in the past, I think of first half as kind of linear progression from 0 to getting to the rate And second half, I think that we got to obviously maintain rate and continue driving the improvements going forward. The team is doing well there. I mean, our labor challenges are behind us. We are no longer struggling to attract labor. I would say supplier challenges are kind of 75%, 80% behind us.

Speaker 3

We still feel like we are playing whack a mole sometime, But we have done a good job at getting dual source supplier or working with our suppliers to better communicate and build the appropriate buffer and transportation. So things are going well. It could go better is the way I look at it.

Speaker 16

Got it. That's helpful. And then just circling back to the 25.3 percent commercial margin, how does that compare to kind of internal expectations for the quarter. And then when we think about seasonality going forward, I mean any sort of variances to be mindful of versus typical seasonality in the back half?

Speaker 3

Yes, I could tell you my answer, but I'll hand it over to Michael to answer the rest. Yes, listen, my expectations are always higher than the team delivers. So Put that aside, like I think Michael can give you more better answer on this.

Speaker 6

Obviously, the speed of the recovery is a little faster than a lot of this on the price mix benefits, so we're pleased to see that side of it. But it was a little better than what we had expected mostly just because of the price mix The speed of recovery that we saw.

Speaker 4

And then on the seasonality that you inquired about, there's always a natural in the commercial business because of a lot of its project nature, it doesn't really have the perfect seasonality that we sometimes see in our residential demand pattern. So I I'll just leave that out there. Sometimes the 2nd quarter can be a little bit more of a leading quarter for us than the 3rd quarter, but it all depends on projects.

Speaker 16

Nothing non repeat really in the quarter to be mindful of in terms

Speaker 10

of sort of comp for the back half. Thank you.

Operator

And we'll take our next question from Julian Mitchell with Barclays. Please go ahead.

Speaker 17

Thanks very much. Thanks for squeezing it in. And just for anyone overly sensitive, definitely the teacup comments were not meant to denigrate

Speaker 3

Julian, I sort of enjoyed that comment and I use that often. So I thought it was a great way to look at We got picture. Why continue to analyze the store mini teacups?

Speaker 17

Yes. So we'll see how the resi cliff plays out, I suppose. But the In the very, very short term, we sort of kind of move away from 2025, but are we trying to think about resi HVAC volumes in your guide, you're assuming sort of down low double digit third quarter and then down sort of Low singles in 4th quarter. Is that the way to think about it year on year?

Speaker 3

On the indirect side, maybe, but no, not on the overall basis. Our volumes are not down that much. And I know if you look at the Current bridge and we showed 12% on the resi side, Julien. Yes. And you got to keep in mind that's probably the worst that you would see during the year.

Speaker 3

As we go toward Q3, we think the number just gets better from there on.

Speaker 17

Okay. So even with the destocking in Q3, it's still a narrower year on year decline

Speaker 3

Exactly, exactly. I think some destocking started happening in Q3 very little and we do think destocking is decelerating as we mentioned in the comment. So I would look at that number being much lower in Q3 and then Q4.

Speaker 17

That's perfect. Thank you. And then I just wanted to put a finer point on the core sales guide of sort of up 3% total company for the year. Did you clarify the pricemix tailwind within that? I see the pricemix EBIT Guided benefit, but just wondered if you clarified any revenue benefit from price mix in that sales guide?

Speaker 3

We did not I think a lot of that is there are so many different types of mix in there. I mean we look at channel mix, we look at Products like equipment versus parts versus coil, we look at obviously mix based on the SEER. We did say that About half of the mix benefit in residential was because of CRM and the other half was all the other factors in there. So still a lot of uncertainty out there, but we are pleased with where we are in July.

Speaker 17

That's helpful. And one last quick one, commercial backlog, How do you see that moving from here? Understand that lead times should normalize. Does that put much Pressure on the backlog or the end market is sort of strong enough it should stay stable?

Speaker 6

Hey, Julien. This is Michael. Yes, so we saw our lead times improved 50%. Backlog didn't decline that much. So order rates continue to remain strong.

Speaker 6

Everything we see on plan replacement for national accounts still remains strong. So really no indication yet of a backlog decline except for just because of lead times are shortening.

Speaker 17

That's great. Thank you.

Speaker 10

Yes.

Operator

And thank you for joining us today. Since there are no

Powered by Quartr
Earnings Conference Call
Lennox International Q2 2023
00:00 / 00:00