Q1 2023 Lennox International Inc Earnings Call
Press Star Zero.
Welcome to the analytics first quarter 2023 earnings conference call. All lines are currently in a listen only mode and there will be a question and answer session. At the end of the presentation. You may enter the queue to ask a question by question to start and one on your phone to extract the Q Press star.
Two as a reminder, this call is being recorded I would now like to turn the conference over to you Chelsea Polson.
From Atlantic Investor Relations, Steve Chelsea. Please go ahead.
Thank you Brittany.
Everyone and thank you for joining us for Lennox as first quarter earnings result.
Here today with CEO alone Mascara, CFO , Joe Reitmeier, and VP of Finance Michael Glazer.
Our local discuss highlights for the quarter and Joe will take you through the company's quarterly financial performance and our view on 2023 fiscal guidance.
After that we will have a Q&A session with a local Joe and Michael.
Turning to slide two 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.
Please refer to our SEC filings available on our website for additional details.
All comparisons mentioned today are against the prior year period, unless otherwise noted.
Seekers may also refer to certain non-GAAP adjusted financial measures that management may consider to be relevant indicators of underlying business performance and trends.
A reconciliation of all GAAP to non-GAAP measures is included in today's earnings press release.
T SEC filings and in the appendix of this presentation.
The earnings release, today's presentation slides and the webcast archives link for today's call are available on our website at Www Dot one is international Dot com.
Let me turn the call over to our CEO Hello Mascara.
Thank you Chelsea.
Good morning, and welcome everyone.
Allow me to start by sharing my appreciation for all of our employees, whose hard work has enabled us to deliver exceptional performance this quarter, including record quarterly earnings per share.
We take great pride in our teams effort to gain share expand margin and seamlessly transition our product portfolio to meet the new minimum energy efficiency regulations.
This successful quarter.
Next our company's product leadership strong customer relationships and advanced digital platforms.
These factors will continue to fuel our share gain and margin expansion for the foreseeable future.
I want to also take this opportunity to tank car dealers and customers for their loyalty to Lennox as we improve our service levels, while delivering the best each we see our products and solutions in North America.
Now please turn to slide three where I'll.
I want to highlight four key messages.
Horst Lennox.
<unk> is proud to report another quarter with record financial results.
Fourth quarter 2023 core revenues grew 3% our margin expanded 210 basis points.
I think in our adjusted EPS, increasing 15% to $2.83.
Our free cash usage this quarter was $114 million, which is typical given the seasonality of our business.
Second we are pleased with the pace of margin recovery and our commercial business segment.
Our profits more than doubled compared to last year as a manufacturing operation stabilized and the benefit of price and mix.
Inflationary cost increases.
Third we continue to help our dealers and customers succeed during the transition to the new minimum efficiency regulations.
That went into effect on January 1st 2023.
Our superior design and successful track record of executing during regulatory changes in conjunction with improved service inventory levels has put us in a strong position to gain share.
Food <unk>.
Given the strong quarterly results, we remain comfortable with our previously issued full year financial guidance.
We continue to closely monitor and market sentiment track.
Track movements in commodity pricing and execute counter measures, including additional price increases.
We are also optimizing our inventory levels, given improved lead times and current sales outlook.
Now please turn to slide four for our view on the current end market conditions.
In the residential end market.
We are experiencing destocking and our two step distribution channel.
As we had expected.
We anticipate the Destocking to continue through the beginning of second half of this year.
Volume in our direct to dealer channel was flat in Q1. However, we are expecting softness later in the year driven by fewer new housing starts in 2022.
We are closely monitoring consumer confidence for any changes that may impact the replacement versus repair decisions.
But we are also encouraged by the recent improvement in the new housing starts.
There is no change in our full year outlook for mid single digit decline in residential unit volumes.
In commercial our backlog is strong and our lead times have improved as the factory situation has stabilized.
The industry lead time for commercial equipment remains extended due to just shortage of common components.
We still believe that commercial sales will grow by high single digits. This year.
On the price war <expletive> inflation balance we are price cost positive.
But we are monitoring recent inflation in commodities, such as steel and copper.
To offset the higher material cost we have implemented a targeted residential price increase that will become effective on June 18th of this year.
Overall, we are well positioned to gain share with our success in seamlessly transitioning to the new minimum efficiency standards and given our improved service inventory levels.
In addition, we are strengthening our go to market organization by adding more field resources and offsetting those investments by driving back office SG&A productivity.
Now please turn to slide five.
To accelerate our profitable growth and to expand margins, we are investing in pricing excellence Atlanta Hawks.
Over the past few years, we have managed to offset inflation with price, but there remains a significant opportunity for us to refine our pricing strategy to drive greater benefits from both price and mix.
We are strengthening our pricing infrastructure, while increasing price analytics engaging outside experts and further developing our internal talent.
Recently, we have revised our company wide contract signing authority to ensure appropriate scrutiny or key account pricing and have redirected new business development on higher margin channels and applications.
We also plan to expand our EBIT auditing process and take all the necessary steps to increase price netting.
Another priority of ours is to work with our larger key accounts to optimize our cost to serve so that we can establish win win partnerships.
In summary, we know that pricing excellence is an important step towards Linux regaining our competitive margin advantage and thus we are increasing our focus to meet or exceed our long term margin goals.
Later in the presentation I will provide an update on our long term goals, but for now I'm going to hand, the call over to Joe Reitmeier, who will go through our first quarter financial performance.
Good morning, everyone. Please turn to slide six.
Looking at the quarter for Lennox overall, the company posted strong revenue and profit growth.
Core revenue, which excludes our European operations was a record $990 million up 3% compared to prior year.
Both our residential and commercial segments experienced sales volume declines, but price execution and favorable product mix more than offset the volume headwinds.
Total adjusted segment profit increased $24 million or 20% versus prior year.
Price and mix exceeded product cost inflation by $63 million with partial offsets of $17 million from lower volume and $22 million for inflationary effects and investments in distribution and SG&A expenses.
Total adjusted margin was 14, 4% up 210 basis points with most of the margin expansion driven by performance in our commercial segment.
In the first quarter corporate expenses increased $6 million to $19 million due to the timing of incentive compensation expenses.
Moving on to net income and cash flow performance starting on slide seven.
The first quarter not only achieved record levels of revenue and segment profit, but also marked record earnings per share with GAAP earnings per share rising 20% to $2.75.
And adjusted EPS growing by 15% to $2.83.
Our first quarter adjusted net income included a 21, 4% tax rate and.
Diluted shares outstanding were $35 6 million compared to $36 4 million in the prior year quarter.
The company used $79 million of cash in operations.
Care to a use of $98 million in the prior year.
Working capital optimization as a priority and we remain on track to achieve our 2023 cash flow target.
Capital expenditures were approximately $35 million for the quarter, an increase of $10 million compared to prior year.
Capital investments will be higher this year, as we fund growth and increase capacity, including a new factory for our commercial business.
We used $114 million of free cash flow compared to a use of $123 million in the prior year quarter.
In the quarter the company paid approximately $38 million in dividends.
Total debt was $1 67 billion at the end of the quarter and our debt to EBITDA ratio was 2.1.
Cash cash equivalents and short term investments were $48 million at the end of the quarter.
Moving to the business segments, starting on slide eight where our residential segment delivered record fourth quarter revenue.
Residential revenue was flat to prior year sales volume declines of 8% were offset with 4% favorable price.
5% favorable mix and 1% unfavorable foreign exchange.
Total sales, which go direct to dealer represent about 70% of our segment revenue and were up mid single digits.
Remaining 30% of our revenue goes through distributors, where total revenues were down low teens. The result of expected industry Destocking.
Residential segment profit rose, 3% to $111 million, a first quarter record.
Segment margin expanded 50 basis points to 16, 3% as continued pricing gains more than offset product cost inflation of our new minimum efficiency standard products drove favorable mix.
Partially offsetting these gains were $12 million of lower volumes and 16 million from inflationary headwinds on distribution and selling and administrative expenses, where we've made investments to fuel growth.
Turning to slide nine and our commercial business.
As announced in our last earnings call beginning in the first quarter of 2023. The commercial segment results will include our North American refrigeration operations.
Our European operations will be reported in our corporate and other segment until we complete the divestiture of the European businesses.
Revenue was $309 million in the quarter up 10%.
Combined price and mix were up 16% and volume was down 6%.
Commercial segment profit was up 110% and segment margin expanded 770 basis points to 16, 2%.
We are pleased with the profit recovery in our commercial segment, where price and favorable mix were the main contributors to profit growth early in the year.
In the first quarter, we successfully transitioned our HVAC products to the new minimum efficiency standard, but industry wide supply chain challenges constrained production output. It can't continue to limit sales volumes.
Demand from commercial customers remains remains robust with a solid order backlog, while supply chain challenges persist lead times to our commercial customers are shortening and are competitive with the industry.
Turning to slide 10, let's review, our 2023 full year guidance.
Our outlook provided on our last conference call remains unchanged as a reminder, I will reiterate a few guidance points.
We expect core revenue to be flat to up 4% for the full year and earnings per share of.
Between a range of $14.25 per share to $15.25 per share.
Free cash flow was targeted within a range of 250 million to $350 million.
We are planning capital expenditures of $250 million that includes investment in our second commercial factory and investments related to refrigerant transition to take effect in 2025.
Price benefit including price associated with the 2023 share transition is now expected to be $175 million.
And we now expect net material cost to be at $45 million headwind in 2023.
Material cost headwind is driven by component cost inflation of $100 million net.
Net of $30 million in savings from cost reduction initiatives, along with $25 million from commodity cost benefits.
Corporate expenses are still targeted at $80 million.
We will manage SG&A tightly while continuing to manage necessary investments in the businesses to support growth initiatives and drive productivity.
And finally, we still expect weighted average diluted share count for the full year to be between 35 to 36 million shares which incorporates our plans to repurchase $100 million to $200 million of stock this year.
With that let's turn to slide 11, and I'll turn it back to <unk>.
Thanks, Joe.
Please turn to page 11 for an update on the key initiatives reviewed during last years Investor day to deliver on our long term targets.
As a recap our 2026 target is to deliver an R. O S of 18% to 20% with revenues over $5 billion.
We believe that our laser like focus on North America, HV ECR market.
Our direct to dealer business model and our superior technology portfolio will ensure long term success.
We are executing six sales type strategic imperatives outlined on the right hand side of this page to meet or exceed our 2026 cohorts.
First.
Growth acceleration to drive share gain will be achieved by optimizing our go to market effectiveness by.
By improving our brand customer experience and by increasing growth capacity.
Second we will increase resilient margins through commercial recovery.
Activity and pricing excellence, which was highlighted earlier in the call today.
Third to maintain execution consistency, we have introduced a balanced scorecard operating system we.
We are transitioning to a dual source supply chain and we are implementing lean digital processes like sales and inventory planning.
Fourth we are reconfirming, our commitment to 90% to 100% cash conversion and a healthy balance sheet, while building a bolt on M&A pipeline focused on North American HVAC CR.
Fifth we will enhance our technology leadership through the frequent regulatory transitions by winning in cold climate heap pump and investing in digital AI ml adoption across all our business functions.
Sixth and finally, we are reinforcing our high performance talent and culture by rolling out guiding behaviors to support our core values.
In addition, we are undertaking sufficient planning and ensuring that our compensation scheme remains aligned with value creation.
Once again I would like to thank our employees, who are working hard to successfully implement this self help transformation plan.
To close our prepared remarks, I would like to summarize on page 12. The reasons why I believe NII is an attractive investment opportunity.
Linux is a narrowly focused north American leader in the attractive industry energy efficient environmentally friendly HV ECR solutions.
We operate in high growth end markets with strong replacement demand that provides us with the resiliency even during periods of economic uncertainty.
The company has a unique direct to dealer network, which creates a sustainable competitive advantage.
And we have a history of robust execution with disciplined capital allocation.
Okay.
As I complete my first year, Atlanta Hawks, I'm, even more excited about Linux as future 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 Britney, let's go to Q&A.
At this time, if he would like to ask a question. Please press the star and one of your Touchtone phone.
Remove yourself from the queue at any time by pressing star and two well once again that is star one if he would like to ask a question. We will take our first question from Joe O'dea with Wells Fargo. Your line is now open.
Hi, good morning, everyone.
Thanks, Joe.
Just to start on the commercial margins certainly some encouraging progress there are anything that you can talk about that you would consider sort of non repeat and in the quarter versus just some of the progress that you were expecting maybe coming through a little bit faster.
Kind of weave that into how you're thinking about sort of the go forward from here is it supply chain continuing to improve in those margins continuing to improve sequentially.
Yeah. So Joe on the commercial we are pleased with the progress we had talked about earlier that we think there's a reset coming in the first quarter of this year.
Given that many of our key accounts.
I had to be repriced with the CEO change and the new product addition, and you saw that largely reflected in our P&L. So that's consistent with what we expected.
We had also talked about almost a nickel in Nevada under a year ago $100 million in EBIT improvement I know in the past.
Few quarters, you have already delivered 60 of the $100 million.
So yeah, we are a little ahead of where we expected and that's a good thing we remain on that journey I think we are going to get to that 100 million faster than what we had originally talked about just given we are more than halfway through with that.
And with supply chain, improving demand remaining strong we still expect high single digit growth. This year and we still expect margins to hold and no. There was nothing unusual in Q1, we would expect that performance trajectory to continue going forward.
Great. Thank you and then.
On the resi side can you talk a little bit about your sort of expectations for the year on the sort of direct to dealer versus to distributor.
Kind of outline.
You gave some color on the first quarter, but but curious sort of how you think about that you know if youre able to talk at all about through your framework for the second quarter thinking about that and then just generally for.
For the full year, you know, how we should think about those varying trends.
Sure. So I think let me start with the end consumer right because that's how we look at it I mean, the end consumer demand seems to be holding pretty well from our perspective.
As you know this was not a great season from a hedging perspective.
Unseasonably warm it quite a few parts of the country.
Despite that we talk about that in a direct to dealer business you there'll be at flat driven unit.
So coming through and on a two step model we had declines.
And that was largely destocking driven so from our perspective, the end consumer demand remains healthy.
Obviously slowdown in growth.
We don't see any declines coming up because of the replacement business is holding pretty steady.
For the rest of the year Joel I will expect a decline in direct mostly because of residential new construction, that's slowed last year and thats going to impact our demand now.
Two step I think the declines get better starting in Q2, we'll see less destocking that we saw in Q1, and Q3 will probably see little to no destocking that gets behind us.
We only in April May June our bigger month for US then in April but overall, we remain confident in our full year outlook calls.
Single digit.
Unit decline, but generated 4% revenue growth for us as we look at all of these factors combined together.
I appreciate it thanks.
Thanks, Joe.
We will take our next question from Nicole to place with Deutsche Bank. Your line is open.
Thanks, Good morning, guys.
I think Nicole.
Maybe just going back to the commercial margins, obviously really strong this quarter and with respect to Joe's question. I mean, I think you usually see a step up in margins seasonally in commercial from <unk> and then a smaller step up in the third quarter would you say that it's possible that we could see a seasonal increase.
It's just kind of hard to gauge since <unk> was that a strong. Thank you.
Yeah, I mean commercial listen overall, the long term, we expect that business to be at 20% Rois business.
In Q1 was good but we're only at 16%. So I think there's still room for improvement for us.
I don't want accurately try and predict Q3 Q4.
Our Q2, and maybe you don't have that level of precision, but I would see no reason why our typical seasonality trend wont hold this quarter because remember this quarter. We also had some inefficiencies related to the CEO transition has been completed.
So stay tuned, but I think we are starting at a good spot.
We expect.
And then a few years that closer to 20%.
Thanks, that's really really clear and then second question just on price cost, obviously, a benefit to margins in the quarter, how does that phase through the year, especially given the new price actions that you talked about today. Thanks.
Yes, so the new price actions that we talked about that on the residential side and commercial we had a reset going into it.
This year, so I think the price cost benefit that you saw.
We will see the levels remain the same but obviously if you start going to more difficult comps because we had done significant price increases so the year over year comps get difficult, but I think the levels.
Yes.
This basis remains.
Where we have to do more pricing effort is on the residential side and that's where we're putting a lot of our emphasis and focus and that's where the new price increase.
We talked about goes into effect in June 18th.
Thanks, I'll pass it on.
We will take our next question from Tommy Moll with Stephens, Inc. Your line is now open.
Good morning, and thanks for taking my questions.
Got it.
We appreciate it.
The insight you provided on the pricing excellence strategy and I wanted to drill down on a couple of the items in there specifically around the optima.
Optimizing local versus central decision, making can you bring us in on what that involved and to what extent was that related to the midyear price increase that you just announced an <unk> tooth today or was there some other factor driving that decision.
You know what I think as we went through the.
Tornado or many years ago as he went through Covid and significant inflation.
He went into a more of a command and control more because we have to those low prices is going to be managing historically, we have really good territory managers. We have really good branch leaders, we have really good folks who have good field intelligence and we need to act accordingly, just like a distributor does because although we had a manufacturer that can work.
<unk> hundred 50.
Outlets Act more a distributor so as we're looking at is we want to give for.
More input more say to local pricing decisions or looking at things doing more centrally.
And so obviously you want to set our strategy centrally.
Local field force a lot more market intelligence and you'll get a V teach and behaving a little differently. So that was a comment was.
Going to optimize it and that's a pretty typical thing for us to do pricing.
Pricing in South, Florida may be very different in pricing in North Dakota, and we need to make sure that we appropriately account for those differences.
Thanks, a lot I appreciate the context, there as a follow up I wanted to.
Look at the residential.
Profit contribution versus the commercial side, which was quite robust this quarter.
But if we think about the full year trajectory there. Your your guidance does imply some some growth in profitability year over year.
Given the residential volume headwinds that you've articulated should should we assume that all or substantially all of the profit growth. This year should come on the commercial side or is that not the right way to think about it.
No I think it'll be a balance between residential and commercial listen commercial had a good start I think residential has lots of room for improvement.
With the price with the mixing with the inventory level coming down so I'm optimistic on residential and we are driving that hard.
It did have a easy comps to compare to where we started in Q1 last year. Obviously, we look at that but no I think the overall profit increase for this year will be balanced between those two as residential the benefit of Seer change also is going to happen a little slower than commercial because commercial we didn't have as much finished good.
The inventory sitting around.
And in residential we saw quite.
Quite a bit at the lower tier products in Q1, as you were finishing that inventory so I think putting it all together.
Equally optimistic about residential improving while the rest of the year.
I appreciate it and look I will turn it back.
Thanks.
We will take our next question from Jeff Hammond with Keybanc. Your line is open.
Hey, good morning, guys.
Hey, Jeff I guess, just just wanted to come back on price I guess first you know what's informing you know another price increase kind of run. This June 18th and then just yet.
As you talk to the contractors and get feedback any any start youre starting to see are you starting to see any pushback.
Oh from contractors or fatigue from the consumer on Kennedy's these multiple increases.
Yeah, I mean listen costs keep going up I mean, you saw Steve it's been up significantly accomplish starting to go back up and what we also did is they kind of just like you would expect good companies to it we did a pricing benchmark on where we stand. So I think the price increase in June as a targeted price increase we targeted areas, where we think we have greater opportunities.
And that's because of the past couple of years that'll be good for price increases versus what I would call sophisticated price increases.
So a lot of that is working with our own analytics and our teams to go through that and fully offset the inflation and make sure we remain competitive in the market.
Capture the adequate balance.
So there's a lot of BD as an analytics behind it to Jeff, but we remain confident that the right thing to do and supports the industry pricing level.
On the second part of your question no I mean remember the equipment right. There's only a small portion less than half of what the consumer pays are seasoned.
And we have seen no.
Back because the repair versus replacement dynamics.
In fact still favors replacement given that repairs are more expensive.
<unk> units are very hard to repair our crosswalk when he has gone up and cost of spare parts and <unk>.
Labor has gone up more than the cost of equipment.
We haven't seen any changes and I think that's consistent with the industry, but obviously we.
We remain closely aligned with 10000 dealers that we keep getting their feedback and we'll adjust if anything changes.
Okay.
Okay great.
And then just just as we look at it seems like you still have a lot of confidence in the resiliency right. It seems like commercial is running ahead, what what kind of precluded you from kind of move and they move in the guide at this point.
Yes, Jeff I think once again first and fourth quarters are seasonally our lightest yeah, we've got a lot of.
Europe is still in front of us and just didn't really want to once again, we approach it with conservative.
Cautious optimism I think is the right way to characterize it we remain confident in our gauging the underlying markets, but just wanted to get into the peak season before we made a call on the full year.
Okay. Thanks, guys.
Thanks, Jeff.
We'll take our next question from Julian Mitchell with Barclays. Your line is now open.
Hi, good morning.
Oh.
Good morning, maybe I'll leave commercial margins are in piece for the time being maybe just on the commercial kind of.
Topline.
Fully understand the excitement around the the good margin performance, but on the topline maybe remind us of some of those main sort of end.
End market exposures.
For the commercial piece in terms of kind of end market verticals.
A lot of concern from people out there on things like office and retail and so forth in recent months.
So have you seen any kind of shift in customer behavior is any color you could provide on sort of bookings or does it all on the commercial side and again any any sort of flavor you could give on how the end market.
<unk> for the business.
Hey, Julien this is Michael.
The commercial side the backlog still is healthy we're seeing.
Good demand across most of our verticals new construction is kind of 15, 20% of that business.
We're not seeing any credit issues, yet, but backlog is definitely still healthy going in reaching into Q3. So we're really not seeing a pullback on the demand yet.
Backlogs are extended a little bit because of some of the lead times in the factory, but from a demand perspective still looks healthy.
Thanks, very much Michael any color you could give them sort of vertical splits I don't know education versus more commercial applications anything like that.
Yeah.
Seeing some good demand on the education side. This is predominantly a summer season, though when the schools are our out of season, and we can get in and do the replacement works at some schools are more of a Q2 kind of Q3 dynamic more than Q1 right.
Right now it's still just executing our backlog that we've had for quite a while and we're seeing a good.
Good demand across most of the channels yes.
You know a few more things Julien you know where are we.
Put a concerted effort was preserving our national account customers. Once again that strategy I think is paying off for us.
You know whats getting the order rates and backlog remains strong there and then as we continue to re engage in the emergency replacement segment of the market that should provide us additional upside more in the second half than first half, but regardless of how the underlying vertical is performing we still think given where our business is positioned today, we still have tremendous runway, particularly in the second half of the year.
Yeah.
That's helpful. Thank you and then just my quick follow up.
Going back to sort of residential volumes.
Volumes.
So I understand that maybe Q1's, a bit noisy with the CEO transition just sort of happening and so forth and you had that.
And so maybe some some weather constraints so you've got the down eight volumes in resi in the quarter just behind you.
As we think about how that plays out through the year and what you've seen in April , albeit it's a very small months for the quarter, but do we assume sort of a second quarters down about the same amount of sort of volumes down high single digit in the second quarter and then by the fourth quarter, you probably growing volumes again is that in.
The way to think about the year for resi volume.
No.
I mean, it's hard to say in April or in April it doesn't really give a trend I mean, if you think about the key drivers of the volume decline in Q1.
Almost all of it was destocking right. So I mean, if I take that Destocking part and I would say.
Q2 will see somebody some more destocking I don't know if it would be as extensive as Q1, probably not because Q1 was the most pullback as people competed CEO transitions and knew that they were comfortable stock and that's what we expected I think Q2, they'll be less destocking Q3 will be minimal to zero and then Q4, we should be done with Destocking. So I think thats.
The way to think about it and user demand seems to be holding just fine I mean, there is no growth that we saw rapid growth that we saw during COVID-19 and other places, but that demand seems to be holding just fine and RNC residential new construction. We can predict very about housing starts is what drive it.
So I think the volume declines moderates it won't be 8%.
Q2 Q3.
But in Q4 do you have specific portion I'm not sure if it return to growth because that will depend on residential new construction, it's looking better than we started the year thinking it'll be down 20% right now it looks like its closer to 10% from housing start perspective, we do need to watch and monitor that Julien.
That's helpful. Thanks, a lot.
Thanks.
Well take our next question from Jeff Sprague with vertical research partners. Your line is open.
Thank you and good morning, everyone.
Hey, I wanted to come back to kind of the and maybe it's on slide five kind of the pricing.
Slide <unk>.
Hello can you dig a little deeper into maybe the opportunities.
Yes, I'll call them non price price actions right.
Rebates leakage things like that.
Is there a scenario where you know the firm once had discipline and lost it or this is a new area of focus and.
Maybe you could give us some.
Some color insight on like how significant.
Driving some of these quote unquote netting actions might be.
Yeah, I guess, having done pricing back in my consulting days I strongly believe that all three levers that important setting getting in netting so I think its important in some of these cases, yes, we had strong discipline and during Covid and other cases, we as we pulled back on noncritical activities. Thank you.
Some of these just had to guess that we had to focus on other things such as.
Recovery on Covid looking at supporting the volume constrained. So I think we have that muscle we got to kind of make sure. We retrain it would make sure we find it and deploy it.
A lot of this is also around we have structural advantages when it comes to serving some of the larger cars, whether it's a.
We call it national accounts or key accounts, and it's gonna be for us to work jointly with our customers.
To find the lowest cost.
Way to serve them and create win win situations that.
Because we are direct right, we can optimize a lot of freight distribution.
And make it win win for Us and these large growing.
And like you have a sponsor owned dealer network. So we think that's a big opportunity.
Where it's less about what the list price is but it's more about what margin on both sides and we have an opportunity to optimize that.
So we used to do it very well.
<unk> lost some ground just because we have to focus on other areas, we're bringing that back and we are excited about the structural advantage we have.
And going after larger accounts, where the cost to serve would be lower on both sides.
And then just on <unk>.
Inventories you know you spoke to the channel Destocking and the like I was just wondering if you could address your own inventories.
And I guess, we're up 30% year over year, and 20% sequentially, it's not crazy given the inflation that's out there, but maybe just address where your inventories are.
This would be where you think they should be.
Any particular absorption or other issues embedded in the guide.
As you work through that or anything else to be aware of there.
No I think what you saw was our inventories definitely grew in Q1, but that's normal with our seasonal nature of our business. We always got inventory in the first quarter and then we'll burn that off in Q2 and Q3 built into the guide that burn off of the inventory, we're going to look to potentially do a little bit more we think there may be some upside to exceed the free cash guide, but it's normal to be.
Inventory as we did in Q1.
And if I can just jump on that you know I mean, if you go back again.
Few years ago, when we were turning inventory at five to six times a year.
We still have room for improvement there I mean right now we are turning at a three to four times. So I think over the treaty Youre planning periods, you can expect us to go back to turning inventory.
The historical levels.
We win by finished goods optimization that Michael mentioned, but also raw material supply chains became extended we bulked up on raw material.
And we don't want to do anything crazy here, but over the next two to three years in a very disciplined by not working.
Working with our suppliers and our customers.
We are going to drive our inventory turns to be better.
Alright, Thanks, a lot appreciate it.
Yeah.
Well take our next question from Josh <unk> from Morgan Stanley . Your line is open.
Hi, good morning, guys.
Hey, Josh Hi, Josh.
Well look I want to follow up on.
I guess adjacent to price, but really about share gain.
If you think about where you see the biggest opportunity today.
Is it more on Kennedy the larger dealers.
Bigger national accounts like homebuilders is it in the smaller guys maybe talk about where this kind of newer field autonomy is really designed to try to meet the market.
Between your different customer types.
Sure Josh I think the simple answer is all of them I mean, we have an opportunity with smaller dealers because we are self down post the tornado.
We're known for our Dave Lennox signature series products, we were at really good partnerships and.
And because we didn't have enough inventory of service levels. Many of them were forced to look somewhere else. So we need to win them back and I think that's where a lot of the local autonomy to improve service levels and all of that goes into right second part of that is just geographic based.
Based on legacy and driven I mean, our market share in South Florida is much lower than our market share in Marshalltown, Iowa, and that's been for years.
A lot of the efforts, we have done including <unk>.
Increasing our reach and investing in our distribution footprint getting more heat pump coverage all of that Alex I think second factory geographic.
Third to come back to the National dealers are the larger dealers you know that's why we have a structural advantage and it's a different more sophisticated approach of working with them on trying to make sure that we create a win win partnership so Josh we have opportunities in all three areas and don't forget at the same time, our indirect business.
Which is also doing very well so when I talked about a drag on.
On the indirect side is where we are targeting through allied our independent.
Independent distribution network, and giving them a stronger better value proposition that works for them. So I think all four are important right smaller dealers that we lost unfortunately during and after the tornado.
The truly looking at regional expansion.
Going into key accounts and getting to make sure we have a win win value proposition and finally, continuing to expand our two step model as well because we believe we have a unique value proposition. So those are kind of a full deliveries though.
Leavers for market share gain.
Understood and then just shifting over to the product side in the 2025 transition coming up.
I know you raised the guide.
Guidance today, but it does look like you have.
Little bit of pattern to start the year.
So good performance in commercial anything that you are able to pull forward on R&D capex anything else on your getting set for 25.
Yes.
Situation, where I think we're doing all we can once again, our priorities are elevating our service levels with our customers, making sure. We've got the right mix of product to meet end market demand and then continuing to pull forward and we've done that to some extent Joshua Neurostar capital expenditures are $250 million $50 million of that is associated with staying ahead of the 2000.
25 transition so we're making those investments.
Those activities.
Activities that we can to deliver that value to our customers and once again much like we did with the minimum efficiency transition. This year seamlessly attack what's ahead of us in 2025.
Got it thanks for the color best of luck guys.
Thanks.
And we will take our next question from Noah Kaye with Oppenheimer. Your line is now open.
Good morning, good to be with you. Thanks.
I guess to start with and interested in the commentary around the sheer benefit to mix. A look I think you said actually it was a fairly small amount of fear product throat sold through the resi channel.
<unk> is it possible to quantify the sphere benefit to mix in the quarter. How you would think about that into the seasonal uptick and what's embedded for seres specifically in.
In the full year guide.
Sure Michael will answer that question, but let me just clarify.
Maybe what I was saying is that not all our sales in Q1, while the new <unk> product. So about one third of our sales in Q1, we're still the older seer products, that's occurring but no majority of sale in Q1 did shift to news here with Michael get accurate breakdown that mixed benefits for you correct, Yeah and resident.
We did see favorable mix, it's predominantly for the seer transition as we've talked about previously it acts more volume than price drop through at about a 30% drop through that we saw in residential we should start to see that for the rest of the year at a similar 30% drop through on the benefit for the mix shift and little bit higher margins on the drop through on the commercial.
So as we were able to get some additional pricing on top of that but should be about a 30% drop through that we see in residential.
Okay, Great and then what did you see from the E Commerce channel this quarter.
To the question around share gains overall, just how did that channel factor in.
Yeah, we don't break out e-commerce sales by quarter, but needless to say you know as we've talked in the Investor day, It's a very important channel for us.
Look at.
Well, we're toward off our sales as we mentioned in Investor Day go through E. Commerce, we find that all of those are very sticky customers and that continues to grow. So I think the numbers we disclosed in December still hold I'll go all are better, but we don't break that out quarterly nor do we think it's relevant to break it out quarterly but at St.
And part of our growth strategy and what we're even more excited about is to be able to leverage those data and the relationship and using artificial intelligence and machine learning to make critical decisions everything from inventory planning to pricing.
Also looking at making it easier for our dealers from predictive maintenance perspective and others.
Huge investment for us very important for us for the quarterly breakdown of that is not something we think is relevant.
Yeah I appreciate the color. Thank you.
We will take our next question from Ryan Merkel with William Blair. Your line is open.
Hey, everyone. Just a couple of cleanups for me just going back to commercial alone can you put a finer point on why you're so far ahead on the margin recovery because I think before you thought it was a good three year sort of linear progression and now it looks like it might be there at the end of this year.
Well first of all I'd say, it really pays to have a conservative CFO . So I think that will be the first stock point on that Ryan.
Listen to.
It definitely helps and when we said three years, we really looked at that being like in all our external commitment internally, obviously, we're driving it to a faster pace I think the seer transition worked well for us I mean, as we looked at the factory converting over the labor stabilizing getting the new products, which I give full credit to the.
Team as we were also able to rationalize our SKU. So we make 40% less SKU in the factories working through and simplify so a lot of just a core discipline was restored we make a step forward with a.
SKU rationalization, we were able to work with our key accounts.
These new Skus are not covered by some of the legacy contracts.
So all of that so I think we.
If there was a.
Like an optimistic scenario in a conservative scenario, we were probably guiding you guys to the midpoint of that and right now we're fighting on cylinders to hit closer to be optimistic, but it's within the range of what we talked right.
That's helpful. Thanks for that and then just on <unk> any differences in the quarter by geography, we obviously had some weather out west just curious there.
Yeah.
Not substantially I mean, there is weather related right because the <unk>.
Winter was mild in certain cases northeast did not do well, but I think that the industry wide factor or not.
Southern States did well, but I think it could also be because some of our competitors stumble during the CEO transition and we had inventory. So I think some other southern states, we saw particular strength, but nothing that I could call out I'll give you a and.
<unk> answer on Ryan.
Got it thank you.
And so we will take our next question from Nigel Coe with Wolfe Research. Your line is open.
Thanks, Good morning, guys.
Hey, nice to see because a lot of ground already hi, guys.
Just on that last point. So obviously, we saw a pretty significant share shift during the during the fourth quarter with the transition.
Sounds like that continued perhaps not as extreme but that did continue in the first quarter.
Hello.
Yeah, that's fair and I think these things typically.
Given the abrupt nature of the regulation, but the difference between north and south.
We all have got maybe in all industry players have got sophisticated on starting to make them in Q4 and continue selling them through end of kind of Q2 to make sure the inventory doesn't become.
Thank you Ian or divert excess and obsolete. So I think we have done all better could you help with that and I think you know I think our direct to dealer strategy benefits us due to the Destocking and the two step channel. So once again I think we were probably unjustly criticized for losing share as the two step channel stocked up.
Once again as a destock, we'll see some of that benefit in the form of additional share.
Yes, that's very fair.
Going back to commercial margins I know that this has been well about it but if you think about the Arkansas facility.
Whereas labor and material productivity.
Today relative to normal I know I'll leave you to define normal, but where are you sort of a target on that on that curve.
I'm glad you're going to leave us or defied normal I'm going to leave it to somebody else, but it's hard to define normal but here's the thing regimen wages are not going back so let's put that perspective, but our factories are still fairly inefficient lot after inefficiencies that captain including expedited freight including overtime.
Clothing line rates dropping below normal, though still persist.
Q1 was actually a little bit worse on that because we had to go through CR changed so imagine retooling all your lines and getting to new products, which were completely new design for us.
Three new models that we introduced at beginning of the year.
So I think there's still room for productivity improvements for us going forward.
Our priority is still output that right I mean, I think the more we can produce the more we can stop you are still limited by output, but getting the output up getting manufacturing productivity and working on the second factory remember all of this is still based on the existing factories. Once we have two factories.
And can truly look at one being focused on mid to stock going after emergency replacement.
Standard products at very high velocity very high efficiency and the other being on made to order for key account specific I mean, that's sort of our.
We shouldn't that hasn't changed we've just got to the one factory improvements sooner.
Okay. Thanks, a lot.
Yeah.
We'll take our next question from Joe Ritchie with Goldman Sachs. Your line is open.
Hey, guys good morning.
Hi, Joe.
Hey can you.
Can you touch on just your visibility into the independent distribution channels. It looks like your Allied business was probably down I am guessing volumes were down like high teens this quarter.
Just what kind of what kind of visibility do you actually have to destocking being being pretty much behind you in <unk>.
Sure. So when we say two step you mean ADP at Allied so combined together and Youre right I mean, the volume was down in the range you mentioned.
We have very good relationship with this China, we have good visibility.
That's the reason we are kind of <unk>.
Hinting at we would expect Destocking to continue in Q2, and then beginning of Q3 year beginning of second half, we think that'll be behind us.
It's hard to quantify because every distributor is different I mean nobody has.
Sticking to the same exact operating were done by somebody else in a different state but.
But the amount of excess inventory that the distributors are holding.
It should be.
Feed with Destocking by beginning of Q3.
Got it that's Super Super helpful and I guess, maybe just to follow on on commercial I know, we've talked about it and congrats on being way ahead of plan.
I'm getting that $100 million back, it's probably unfair for me to even ask this question, but but how are you thinking about what.
Where the where the margin improvement is going to come.
Post achieving the $100 million it seems like it's going to come a lot faster than you originally anticipated.
So, yes, I mean, I would point out to a few different things right first of all remember the 100 million. We had said does not include the second factory benefit. So I think we are still holding to that so the second factory.
We have started construction things are moving along well we expect to be under roof by the end of the year. We would expect production sometime next year. So that will give us significant benefit as we have two factories very focused.
Operating Oh can serve our customers really well so that's gonna be one box second on that is I think there is significant opportunity for us to continue looking at our service growth.
This is a very attractive business for us and we were not.
Not fully focused on that given all the disruptions happening here, so getting service and increasing our service focus which is good margin, it's repeatable and that's predictable and gives us great insight Kookmin stance I think the service will really help us and finally going back to the manufacturing inefficiencies I don't want to rule that out.
In the early stages of working through manufacturing inefficiencies and <unk>.
Getting all of those out of the system. So you know long term, we are committed to 20 plus percent.
R O S across both the segments.
We are excited about all the steps and those are sort of.
Things I mentioned on the last page, but I talked about the six key self help initiatives we're working on.
The kind of equally apply to both residential and commercial.
That makes sense great. Thanks, guys.
Well take our next question from Brett Linzey with Mizuho. Your line is open.
Hi, good morning, all.
Alright.
Yes, just wanted to come back to commercial briefly so you noted the backlog remains strong and order rates are solid and what degree of visibility on those orders converting do you have for this year and is there anything specific of mix, whether its national account versus other verticals that we should be aware of over the next two three quarters.
I'll take the second question first so on the mix side no. I mean, we don't have large projects that funnel through the pipeline or anything right. I mean these are.
All projects in diesel.
The products that we price accordingly, so no the margin in our backlog, it's no different than the margin. We are expecting in Q1. If that's your question right. We have good visibility into that margin and it's all good.
No nothing to worry about there.
Overall demand visibility.
It's everything from some key accounts, who want to plan 2025 volume right now post the law DWP.
People on emergency replacement, who wants product tomorrow.
Cloud is healthy I mean, the industry lead times remain stretched.
Instead of getting a product this year is low.
When you get into Q4 next year.
So I think there is some flexibility here or there, but that's kind of the demand visibility we have.
Pretty solid going forward both from.
Actual revenue sales and also margin perspective.
Can you maybe just speak to your appetite to compete internationally be it organically Inorganically and then maybe just how much investment do you think's required maybe reinvigorate that part of your portfolio.
Hi.
As you know we made a decision last year too.
Mick a portfolio move which includes divestment of our European operation.
I think our focus is going to help us win. So I think we are currently 100% committed to remaining in North America HV ACI plan, we still have lots of bolt on opportunities here, whether it's about service on expanding our line card. So our stores can be more efficient and looking at other opportunities. So I think for us.
Never say never but.
Currently we like our laser focus and I think that'll help us win share that will help us through the transition.
Landmark's gets up every morning, and it's focused on winning in North America IH VCR.
We are confident that's the winning formula for us.
Alright, Thanks, a lot best of luck.
Thanks.
We will take our next question from Steve Tusa with Jpmorgan. Your line is open.
Good morning, Steve.
We didn't comment specifically on April , but I'll tell you, it's consistent with what we expected in April as a hard month given that most of the summer sales starts and kind of May and June .
Nothing in April that would have caused us to change our full year outlook.
Okay, and then I think you mentioned there were some production inefficiencies in the fourth quarter on new products coming up to speed I. It was my understanding that you guys did.
It didn't really do like a major clean sheet kind of redesign for this for this year go around I thought you were maybe taking a legacy product and you know you were talking about I got the outdoor unit.
How your product strategy kind of progressed through that okay. Sure. So let's start with the.
The two segments separately right. So on the commercial we did redesign our product and that's what we were referring to earlier. So we launched three new models.
And replace multiple legacy that included significant SKU rationalization more modular design and when more Martin So commercial we did redesign our product line.
On residential we had to redesign our outdoor units just because those air conditioning and heat pump, but that's what regulation does.
Just a year or so ago, and they already very high efficiency and capacity.
That's the piece I think of the product strategy of you had mentioned earlier.
How much in total is the price increase and then can you just remind us that how that works with your distribution channel. I mean are you selling does that price increase go.
Independent versus your captive like is there a difference between what the contractor is seeing and what your independent distributors, saying.
Yeah, we call it a targeted price increase and I think a lot of the discussions with the customers that are starting now so I would rather not go into tons of details and backbone, but the answer is they can always.
Believe that this is the right step for us to be more competitively priced in the marketplace from a consumer perspective. This is a small portion of the overall cost and all we're doing is making sure we can offset inflation, you'll notice in our full year guide.
Now talk about $175 million and pricing benefits earlier, we had given a range with the high end at 175, and we took our commodity inflation up by offsetting 10 million or so.
So that's kind of where we are on the numbers got it so its embedded its embedded in that 175 now that that your realization whatever you expect to get in June .
Yes, we just to remove the range and stuck with the high number.
Yeah, Okay, great. Thank you.
Thanks, Dave.
And we will take our next question from <unk> Patel with Jefferies. Your line is open.
Thanks, I just wanted to cover the allied piece.
And one more kind of a blush here.
One I was just kind of looking at what the opportunity kind of it seems like for you guys over time I know in the past we've talked about the idea of <unk>.
Share gains of 300 million or so to get to that 2026th target how much of that is allied what are you kind of see the growth acceleration opportunity in that.
Is there opportunity to partner with additional distribution.
Channels to kind of expand that product just trying to get a little bit more sense for what you see is that particular piece of the business growing versus the <unk>.
Sure.
Thanks, Brad.
Yeah. So first of all we're very proud of Allied I mean, they have done great over the past.
Many years I mean that business has grown up for X I mean, the margins have expanded beautifully.
And I think join us and the team have done a fabulous job of taking that.
At the same time, we don't think we're anywhere close to being done we have significant room for improvement I can easily see that business doubling again over the next five years as we continue to add distributors have a very focused product portfolio that wins a lot of awards and we truly focus on best serving these independent distributors. So excited about Allied we think there's a lot.
Growth potential ahead at the same time, I don't want to break down $300 million in opportunity between business ENB ideally both of them will get it right I mean, ideally with the board to get to 10 billion dollar targets and.
Deliver more to the shareholders. The Super excited about Allied I think their share gain opportunities on direct and indirect.
We will keep driving both of them.
I appreciate that would there be a mix shift if that were to grow a little bit faster or slower on the margin side I just mean.
No and we don't break out margins I, just we remain committed to a 20% margin on residential over at all and it's hard to kind of break down margin artificially because remember we share the same infrastructure for manufacturing product development and all of that so that just becomes allocation game right. Okay.
Thank you.
Thank you for joining us today since there are no further questions. This will conclude my next first quarter Conference call. You may disconnect your lines at this time.
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