Q4 2024 Lennox International Inc Earnings Call
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Speaker Change: Welcome to the Linux fourth quarter and full year 2024 earnings conference call.
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Chelsey Pulcheon: I would now like to turn the conference over to Chelsey Pulcheon from the Linux Investor Relations team.
Chelsey Pulcheon: Thank you, Angela. Good morning, everyone. Thank you for joining us today as we share our 2024 fourth quarter and full year results.
Speaker Change: Joining me is CEO Alok Maskara and CFO Michael Quenzer. Each will share their prepared remarks before we move to the Q&A session.
Speaker Change: 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.
Speaker Change: We may also refer to certain non-GAAP financial measures that management considers relevant indicators of underlying business performance.
Speaker Change: Please refer to our SEC filings available on our Investor Relations website for additional details, including a reconciliation of all GAAP to non-GAAP measures.
Speaker Change: The earnings release, today's presentation, and the webcast archive link for today's call are available on our Investor Relations website at Investor.Lenox.com.
Speaker Change: Now, please turn to slide three as I turn the call over to our CEO, Alok Maskara.
Thank you, Chelsey. Good morning, everyone.
Speaker Change: I want to start by expressing my gratitude to our 14,000 employees, our 10,000 plus dealers, and all of our customers for their loyalty and innovation that enabled us to deliver an exceptionally strong finish to 2024.
Speaker Change: One of the highlights for 2024 is that for the first time ever, Lenox delivered over $5 billion in revenue and over $1 billion in adjusted segment profit.
Speaker Change: Another achievement in 2024 is that both our segments delivered double-digit revenue growth.
Speaker Change: In addition to delivering record results, we also made thoughtful investments, such as starting a new commercial factory to create growth capacity.
Speaker Change: Let us turn to slide three for the fourth quarter and full year 2024 overview.
Speaker Change: Adjusted earnings per share was a record $5.60 for the quarter and $22.58 for the full year.
Speaker Change: Core revenue grew 22% in the quarter and 13% for the full year.
Speaker Change: The team also delivered a record $332 million in operating cash flow in the quarter and $946 million in the full year.
Speaker Change: Michael will provide more details later in the presentation, but I want to highlight how proud we are of the work the team did this year to deliver significant year-over-year improvement in our cash conversion.
Speaker Change: Now, please turn to slide four as I review some of the drivers of our 2024 success.
Speaker Change: In 2024, we successfully completed the initial phase of our Self-Help Transformation Plan.
Speaker Change: The team's effort in 23, including pricing initiatives, portfolio simplification, and strategic acquisitions, not only restored margins, but also established a strong foundation for an exceptional 2024.
Speaker Change: Our strategic initiative enabled us to successfully navigate the construction of a new commercial factory and overcome challenges associated with the refrigerant transition, showcasing resilience and outstanding execution.
Speaker Change: In 2024, we continue making strategic investments while delivering impactful results, positioning us to continue our momentum into 2025 and beyond.
Speaker Change: We successfully navigated the manufacturing transition from our 410A refrigerant, effectively meeting customer needs as investments in sales and distribution channels elevated the customer experience.
Speaker Change: Our ongoing focus on pricing excellence programs partially offset the investments for improving customer experience.
Speaker Change: Our new commercial factory is now online and will be key to enhancing output and productivity.
Speaker Change: We maintained our strategic M&A pipeline and our disciplined M&A approach.
Speaker Change: The best deals for Lenox in 2024 were the deals that we decided not to pursue, thus safeguarding long-term shareholder value.
Speaker Change: Finally, by driving accountability through the Lenox Unified Management System, we ensure consistent performance.
Speaker Change: Before I hand the call to Michael, I want to extend my heartfelt gratitude to Gary Bedard, President of our HCA segment since 2023, who has announced his decision to retire from Lenox.
Speaker Change: Gary's 26-year tenure at Lenox will leave a legacy that will continue to shape our future.
Speaker Change: We have initiated a search process to identify our next HCS president.
Speaker Change: I'll now hand it over to Michael, who will walk you through how we successfully invested in the business, while also delivering strong results.
Michael Quenzer: Thank you, Alok. Good morning, everyone. Please turn to slide five.
Michael Quenzer: We are pleased to report our eighth consecutive quarter of double-digit year-over-year adjusted earnings per share growth. This quarter, we increased our adjusted segment margin by 250 basis points.
Michael Quenzer: and achieved an impressive 22% revenue growth, resulting in 54% adjusted EPS growth.
Michael Quenzer: Our success is driven by volume growth in both segments as we continue to effectively manage the transition to low GWP refrigerants.
Michael Quenzer: As expected, customers pre-purchased R410A equipment, which is estimated to have positively impacted revenue by $125 million and increased earnings per share by $1.
Michael Quenzer: Now, let's proceed to slide six to review the fourth quarter financial performance of our Home Comfort Solutions segment.
Michael Quenzer: The Home Comfort Solutions segment had an exceptional quarter, delivering 25% revenue growth, 67% segment profit growth, and an impressive 550 basis point expansion in segment profit margin.
Michael Quenzer: Our one-step contractor channel also saw volume increase low double digits. This was supported by better R410A product availability compared to the broader market as well as some pre-buy.
Michael Quenzer: After adjusting for the pre-buy, segment sales volume still grew by mid-single digits.
Michael Quenzer: Pricing initiatives continue to progress well. Although the impact to the corridor was limited, we have implemented price increases on our new R454B products, and these initiatives are progressing as expected.
Moving on to slide 7.
Michael Quenzer: The Building Climate Solutions segment delivered a very strong fourth quarter with revenue growing 17%.
Michael Quenzer: Of this growth, 3% was driven by inorganic contributions from our AES acquisition.
Michael Quenzer: From an organic perspective, sales volume increased 14% during the quarter. This reflects early revenue benefits from our new Saltillo, Mexico, manufacturing facility as well as some R410A equipment pre-buy activity.
Michael Quenzer: Segment profit increased by $8 million, however, profit margin declined due to $20 million in higher product costs related to new factory ramp-up activities and inefficiencies at our existing manufacturing facility.
Michael Quenzer: Production output continues to grow and is well positioned to support our 2025 Emergency Replacement Growth Initiative.
Michael Quenzer: Turning to slide 8, Linux delivered an impressive performance for 2024.
Michael Quenzer: We successfully navigated the low GWP refrigerant transition, achieving notable volume gains.
Michael Quenzer: Our disciplined pricing strategy drove consistent quarterly price yields contributing to margin expansion of 150 basis points.
Michael Quenzer: While strategic investments for future growth tempered this margin improvement, these investments are expected to deliver significant benefits in the coming years, including sustained revenue growth and further margin expansion.
Michael Quenzer: Turning to slide 9, let's review our cash flow and capital deployment.
Michael Quenzer: While revenue and earnings growth were impressive, our cash flow performance stood out even more.
Michael Quenzer: As highlighted in the Q3 earnings call, enhanced working capital efficiency has been a key focus.
Michael Quenzer: We've made significant progress, particularly in accounts payable initiatives, resulting in a free cash flow conversion rate of 97%. This strong cash flow conversion comes despite capital expenditures exceeding depreciation by approximately $65 million.
Michael Quenzer: Capital expenditure investments in high ROI projects remain a core component of our cash deployment strategy.
Michael Quenzer: Over the past two years, capital expenditures have consistently outpaced depreciation.
Michael Quenzer: This trend is expected to continue 2025 with estimated capital expenditures of $150 million.
Michael Quenzer: We maintain a robust balance sheet with net debt to adjusted EBITDA at 0.6 times down from 1.3 times in the prior year quarter.
Michael Quenzer: Our free cash flow deployment strategy continues to prioritize inorganic growth opportunities that deliver ROIC exceeding WACC within three years of acquisition. Additionally, we will continue leveraging share repurchases to efficiently return excess cash to shareholders.
Michael Quenzer: If you will now turn to slide 10, I will review our 2025 full year guidance.
Michael Quenzer: Anticipating another year of profitable growth, let's begin with the table on the left, which summarizes our full-year revenue growth drivers.
Michael Quenzer: Total company core revenue is projected to increase by approximately 2%. However, the 2024 pre-buy will result in year-over-year revenue headwinds in both Q1 and Q4.
Michael Quenzer: We also expect a low single-digit increase in sales volume driven by growth in our BCS segment.
Michael Quenzer: The phase-up of legacy 410A products is expected to conclude by the second quarter.
Michael Quenzer: Turning to the right side of the slide, we've outlined key cost assumptions for 2025.
Michael Quenzer: Inflation is anticipated to increase costs by approximately 3%. At the same time, we plan to make strategic investments in areas such as information system advancements, distribution growth initiatives, and projects designed to improve customer service.
Michael Quenzer: These investments will also include enhanced sales and marketing efforts, with total investments estimated at approximately $25 million for the year.
Michael Quenzer: In terms of cost productivity, we expect to generate savings of $50 million as the ramp-up costs of our new BCS factories subside and material cost efficiencies are realized.
Michael Quenzer: In summary, even with the headwinds from the 2024 pre-buy, we anticipate revenue and profit growth with profit margins relatively flat.
Michael Quenzer: We expect adjusted earnings per share to fall within the range of $22 to $23.50, and free cash flow is projected to fall within the range of $650 million to $800 million.
Michael Quenzer: With that, please turn to slide 11, and I'll turn it back over to Alok for an overview of our 2025 priorities.
Thanks, Michael.
Alok Maskara: Let us revisit our self-help transformation plan, which has been a cornerstone of our success since 2022.
Alok Maskara: We transition from the recover and invest phase to the growth acceleration phase at the end of 2024.
Alok Maskara: As we move through 2025 and into 26, we will maintain a disciplined approach to investing in the business while prioritizing growth.
Alok Maskara: This year will lay the groundwork for the next phase of expansion supported by the momentum from share gains and new product introductions.
Alok Maskara: Investments in digital customer experience are making it easier for customers to engage with us, strengthening loyalty and satisfaction across all touch points.
Alok Maskara: Our expanded heat pump offering, supported by the Samsung JV, not only broadened our product portfolio, but also positioned us to capitalize on growing demand for energy efficient solutions.
Alok Maskara: Additionally, our focus on improving attachment rates for parts and accessories ensures that we provide a more comprehensive customer experience while driving incremental growth.
Alok Maskara: An additional growth driver is a commercial emergency replacement program, enabling us to better serve a significant segment of the market that we have been unable to fully supply in recent years.
Second, we are committed to resilient profit margins.
Alok Maskara: Benefits expected from the low GWP product transition, increased productivity from BCS volume improvements, and material cost reductions strengthen our ability to deliver consistent and reliable financial performance.
Alok Maskara: Lastly, we will continue to utilize our Linux Unified Management System to deliver superior execution with clear priorities.
Alok Maskara: Defined M&A strategies, a robust distribution network, and ongoing investment in customer satisfaction underscore our commitment to operational excellence.
Alok Maskara: As we look ahead, the investments made over the past two years set the foundation for growth in 2025.
Alok Maskara: with a strong trajectory into 2026 and beyond as we move towards the expansion phase.
Alok Maskara: With our collective commitment and strategic focus, I am confident that we are not merely executing a plan, we are creating a path for ongoing success.
Alok Maskara: We remain confident in our long-term vision, and given progress so far,
Alok Maskara: We believe we will be within the 2026 revenue target range of 5.4 to 6 billion dollars and at the high end of our ROS target range of 19 to 21 percent.
Alok Maskara: Hence, we anticipate a stronger 2026 as our strategic investments continue to drive momentum.
Now, let us turn to slide 12.
Alok Maskara: Let me wrap up by summarizing the five reasons that make Lenox an attractive opportunity for all our stakeholders.
Alok Maskara: First, we are 100% focused on North America growth and markets of HVACR and our accelerating growth through share gains.
Alok Maskara: Second, we are expanding our resilient profit margins through pricing, productivity, and mix optimization.
Alok Maskara: Third, we deliver superior execution through the Linux Unified Management System.
Alok Maskara: Fourth, we are an advanced technology industry leader with high efficiency products and services supported by a digital customer ecosystem.
Alok Maskara: Fifth, we win because our exceptional talent and culture is defined by our core values and guiding behaviors. Our pay for performance philosophy ensures that our internal goals are closely aligned with those of our shareholders.
Alok Maskara: As I look forward, I remain confident that our best days are ahead.
Alok Maskara: Thank you. We will be happy to answer your questions now. Angela, let's go to Q&A.
Alok Maskara: At this time, if you would like to ask a question, please press star one on your telephone keypad.
Alok Maskara: You may remove yourself from the queue at any time by pressing star 2.
Once again, that is star one to ask a question.
Operator: We'll go first to Ryan Merkle with William Blair. Your line is open. Please go ahead.
I'm
Operator: Hey, thanks. Good morning and congrats on that nice quarter. I wanted to start with the three buys. It looks like it was a little bigger than maybe you were expecting. Just comment on what you saw and why that was and then what does it mean for 1Q? I think it's really a question I have.
Operator: Hey Ryan, good morning. I don't think I heard the second part of the question properly, but the first part on the pre-buy. Listen, we are calling out $125 million in pre-buy.
Operator: As you can imagine, it's an estimate. We don't have 100% visibility into the number. And we know there was some cloudiness because we had temporary share gains that happened in Q4 as some of our competitors were out of products.
Operator: So it's a little higher than we expected, but I would say it's within the range of where our expectations are.
Speaker Change: And then Ryan, on the second part of your question, the impact to Q1, yeah, really the $125 million was a pull forward into Q4 from Q1, so we'll see a headwind there. And then also you'll see that in Q4 in 2025 is the year-over-year comps won't have that as well.
Speaker Change: Got it. Okay, so $125 million revenue hit, 1Q is sort of the math. Yes, that's correct.
Speaker Change: Okay then the second question is that the flat volume outlook for the HDS segment I mean I think it makes sense to be conservative but talk about some of the assumptions behind that.
Speaker Change: Sure. I mean, there's a lot of uncertainty in the market, right? I mean, you saw existing home sales are at a very low level, interest rates, mortgage rates, they continue to be high.
Yeah, that's fair. Okay. Thank you.
Thanks Brian.
Operator: We'll go next to Joe Ritchie with Goldman Sachs. Please go ahead.
Hey, good morning, guys. Great year.
Joe Ritchie: Historically, you guys have tended to guide very conservatively. As I look at the components of this bridge in slide number 10,
Joe Ritchie: It seems like, you know, what you're baking in for incremental margins, if I just take into account price mix.
Joe Ritchie: and Insulation is very low, like I'm calculating something that's like low double digits. So just help me kind of understand number one, just like where you think there might be some potential cushion in the guide and how to think about that equation between price mix and inflation. Thank you very much.
Joe Ritchie: Yeah, Joe, I think there's some opportunity, potentially the Lotus mentioned there on the volume. If interest rates go down, maybe the HCS volume could give us a little bit more. That's obviously would come through at 30% incrementals.
Joe Ritchie: But if you look at the overall guide, it does imply...
Overall margins are approximately flat at 19.4%.
Joe Ritchie: And I think the bigger issue here is the amount of uncertainty that's present. You know, I mean, if you look at noise around tariffs, if you look at noise around migrant labor and labor shortages for our dealers, and if you just look at mortgage rates, interest rates, I mean, there's just a lot of uncertainty. So we went with a fairly wide range.
Joe Ritchie: I wouldn't call it very conservative, but I think it's consistent with what we have done in the past.
Speaker Change: Okay, that's helpful. And then as I kind of think through...
Joe Ritchie: Just the one key number I think in answering Ryan's question. So the right way to think about things sequentially in HCS
Joe Ritchie: is you've got to call it $125 million that goes away, 4Q to 1Q. And then there's typically like a, I don't know, mid-single-digit sequential step-down. So is the, you're still assuming then organic growth in HCS in the first quarter? Am I thinking about it correctly?
Joe Ritchie: Well, first of all, the Q1 is an estimate, right? We are only in January. Some of it could extend to Q2, depending on how dealers convert, because you're now already selling the full 54B equipment and it just...
drawing like you know a line in the sand somewhere.
Joe Ritchie: But on your sequential question, maybe Michael can give you some. Yeah, I think that's generally close, but not all 125 million was in the ATS segment, though some of it was in the BCS segment. But I think if Alok said it right, we did have a little bit of R410A inventory going into the quarter. So some of this might kind of move into Q2. But...
Predominantly will be in Q1.
Okay, great. Very helpful. Thanks, guys.
Thank you.
Moderator: We'll go next to Julian Mitchell with Barclays. Please go ahead.
Julian Mitchell: Hi, good morning. Maybe just wanted to switch tack for a second to the BCS segment and sort of the guidance there.
Julian Mitchell: You know, I think people have been concerned about the revenue outlook there because you don't have AI exposure or what have you in BCS and there's some question marks around the ESRA funding unwinding into 2020.
Speaker Change: Sure. I would say from our perspective, the markets that we serve remain healthy. And at least this week on Monday, seek
Speaker Change: Chinese told us that it was good not to have data center exposure in our stocks. So I think from that perspective...
Speaker Change: We are not terribly concerned since exposure there was low or slash zero to start with if I look at our
Speaker Change: And we see the replacement volume, which is primarily our sales, actually picking up now since we have made the conversion to 454. And some of these companies had been waiting to go to the new refrigerant before they put more sales.
Speaker Change: Second thing underlying our confidence is that, you know, clearly we have a new factory.
Speaker Change: So from a nature of the replacement program and the non-discretionary nature that we look at, we don't see that as a much impact.
And that gives us sufficient confidence on our guide.
Right now, um...
Speaker Change: because of the refrigerants change. But, you know, if we had to put a finer point on it, is the right interpretation, maybe it's a couple of points less of the full year's earnings in Q1 than one would normally expect. And then we get the full sort of catch up in the rest of the year, particularly Q2 with a big mix tailwind coming in.
Julian Mitchell: Yeah, Julian, I think I'd bucketed a little different, maybe look more at the first half just because the dynamic of things kind of shifting key one to key two with the
The Selling Out of the Fort in Esau.
Julian Mitchell: From a revenue perspective, we think kind of the first half will be about 45% of the year, second half being 55%. This is a little bit different than the normal kind of 50-50. Second half of the year, you'll really start to see the mixed benefit of the 454B product coming up, as well as
Julian Mitchell: Some more of the gains from the new commercial factory in the second half.
That's great. Thank you.
Yes, thank you.
Julian Mitchell: We'll go next to Noah Kay with Oppenheimer. Your line is open, please go ahead.
Noah Kay: Thanks very much. So Alok, we've had a couple of years now of regulatory transitions where the company is executed well and really claimed the opportunity around pricing and share gains.
Speaker Change: You mentioned in, you know, some of the factors that went into your thinking did include potential tariffs.
and labor and.
Speaker Change: other considerations brought about by the administration change. So, you know, how would you think about your opportunities related to that? And for example, if we do have, you know, Tara Sun, USMCA partners and others.
Speaker Change: Perhaps that could be a missing opportunity, perhaps with your investments there's some share gain opportunities there. The essential question is how are you thinking about contingency planning and responding to any potential changes?
Speaker Change: Sure, no, that's a great question. And things remain very dynamic, as you know. But if we take each of these, if tariffs come into more in China, and less in Mexico, Canada, we would be net beneficiary, as we have done a really good job of reducing our supply chain reliance on China.
Speaker Change: And the fact that we did the Samsung JV also means that things like our mini splits are now coming from Korea, not from China. So I think that in hindsight, not just the benefit of a Samsung better quality product, but avoiding any tariffs coming from China would be a big win for us.
Speaker Change: So, if they're tariffs coming in from Mexico, 40% of the industry capacity is in Mexico, roughly. Which means we'll all have to work through offsetting with productivity, seeing the impact of any peso devaluation, but then offset with price.
Speaker Change: So we look at that price going to be incremental to what we have positioned here. But clearly, there could be a delay in timing, given I'm not sure how much time we would have to react to any tariffs and tariffs announcement.
On the labor piece.
Speaker Change: Listen, there'll be no impact to our factories. And so obviously, we had a different type of employer versus people who might be doing construction or HVAC installs in the field. I think what does happen with that is since replacements require less skill and less labor versus massive repair.
Speaker Change: I think the repair versus replacement trend will probably continue shifting more towards replacement. As the units are harder to repair, that requires much more skilled labor and not more labor versus picking a higher ticket item just such as
Speaker Change: full replacement. But from our contingency planning, you know, we're staying close to our customers, close to our dealers.
Speaker Change: making sure that we can address any of those concerns and also continue to monitor tariffs and work on supply chain redundancies because we are now have a much heavier dual source focus than we had two to three years ago giving us flexibility in supply chain movements.
Speaker Change: Finally, the last thing on the consumer side, which is probably going to have the biggest impact.
Speaker Change: You know, we just need to watch consumer confidence, interest rates, mortgage rates, and help our dealer offset any weaknesses that come in, either through financing programs, either through, like, you know, really more education to the consumer.
Speaker Change: and keep working with new homebuilders and others, which are more guaranteed volume for us.
Speaker Change: So I hope that answered your question, I know it was a little winded.
Speaker Change: No, it was comprehensive and I realized I asked, in some respects, a multi-part question. So, out of respect to colleagues, I'll take myself offline and follow up then. So, thank you very much.
Thanks to all.
Speaker Change: We'll go next to Tommy Moult with Stevens. Please go ahead.
Good morning and thank you for taking my questions.
Morning, Tommy.
Speaker Change: I want to start on the topic of your 454B pricing. Are we still thinking 10 or maybe 10 plus percent? There's at least one OEM in the market that's less disciplined than that. And if we just look at the mix.
Guide for Home Comfort, anyway, in the mid-singles range.
Speaker Change: Maybe you could bridge us from whatever the 454 contribution is to how you get to that mid-single.
Speaker Change: Sure, Tom. Yeah, I'll give you some more clarity on that.
Speaker Change: Yes, our plan still is a 10% price increase on average on the 454B product, and that equates to about 70% of the revenue in the HCS segment.
Speaker Change: And as we've been talking about, we're going to continue to sell through some 410A equipment in the first half of this year. So it will take a little bit of time to bleed into the 454B product. So we think about 65% of the full year will be sales of that 454B product. So you kind of do all that math.
Speaker Change: It dilutes down to that mid-single-digit mixed benefit for home comfort solutions.
Speaker Change: Yeah, and on the competitive question, Tommy, I mean, we have heard that too. But I also think people are talking about 2024 pricing, because some of the OEMs released 454 in 2024. And we released 2025% pricing.
Speaker Change: So, we are optimistic that as we take this forward, all the OEMs will be adjusting price in 2025. That typically happens in the first quarter anyway.
Speaker Change: the separate volume call out you have there is flat. I just want to make sure I'm interpreting this correctly that for the volumes that you would report and your financials.
Yep.
Speaker Change: You just add those two together. So it'd be a mid singles headwind Maybe you could just clarify how we should think about that
That's exactly right. That's exactly how to look at it.
Speaker Change: Okay and then if we take that mid singles headwind for the segment level can you give us any sense of the sell-in versus the sell-through assumptions you're making there?
Speaker Change: I think you can see in the results in the fourth quarter we were more impacted in that channel for the sell-in, the two-step channel, but we did see a little bit of pre-buy on the sell-through as well.
Okay, thank you. I'll turn it back.
Speaker Change: We'll go next to Chris Snyder with Morgan Stanley. Please go ahead.
Speaker Change: But, you know, if I kind of look at that next year, it's about a 2% headwind on a.
Speaker Change: Unknown Speaker 5 billion plus revenue base pieces that imply that there's maybe like a similar amount of pre buy in the Q3 numbers as well. Or am I missing something in that math?
Speaker Change: Yeah, Chris, this is a great question. So what happens is if we take that 125, first we will get the destocking impact of that. And let's say that's in the Q1, Q2, and then in the Q4 timeframe, Q4, 2025, we will fix difficult comps.
Speaker Change: So that kind of impacts you twice, right? So from that perspective, that's why the number seems twice.
Speaker Change: One is a detoxing effect and one is a calm impact, right?
Speaker Change: Okay, thank you. I really appreciate that. So I guess the assumption is that there wasn't, I guess, a material pre-buy impact in Q3. And then maybe just following up on that, you know, I know it's kind of hard, I imagine, to kind of triangulate it and kind of pinpoint what the pre-buy is. So I'd just be interested in how you guys went about doing it because
Speaker Change: because obviously a lot of focus on that as a 25. Thank you. Thank you.
Speaker Change: But first of all, thank you for acknowledging and we admit that it is not easy, nor is it precisely accurate, right? We think we are directionally correct, not precisely accurate on 125. So, but we just want to give a clean number. We did not encourage any pre-buys.
Speaker Change: We did have last call on 410A, so that may have forced some distributors and others to order pre-buy.
Speaker Change: I believe that led to better availability for Lenox products in the marketplace when it comes to 410A products.
Speaker Change: And that gave us share gain in addition to the pre-buy impact that we are talking about.
Speaker Change: Our goal is of course to keep as much of that share gain as we can, but realistically speaking, we have baked in that we are unlikely to keep all the share gain that we had had. And that's one reason we are being more muted in the volume outlook for 2025.
Thank you. I appreciate that.
Brett Lindsey: We'll go next to Brett Lindsey with Mizzouho. Please go ahead.
Hey, good morning, everyone.
Brett Lindsey: Yeah, first question on the new commercial Mexico facility. So you're moving from the piloting to the production. You said it's online. Are you able to quantify what you're embedding in 2025 in terms of the volume contribution and better throughput there?
Brett Lindsey: Yeah, if you look at the Volume Guide and BCFS, we're up above mid-single digits. There's a few points in there for share gain, which would be predominantly related to the new factory supply improvement.
Brett Lindsey: A little more back-end loaded. I mean, the season for emergency replacement is predominantly Q2 to Q3, so kind of starting more in late Q2 into Q3 is when it'll start to ramp up.
Brett Lindsey: Sure. Yeah, I think the existing facility inefficiencies were related to the startup as we got a lot of components from Stuttgart during ramp up to send to Mexico and do trial runs and otherwise. But yeah, that was late in the year. And it was on the higher end of what we were expecting. So those inefficiencies.
Brett Lindsey: which obviously we will capture back in 2025 as we are through the ramp-up phase. But yes, it was Third Guard and then the ramp-up patient in Stahl TO. But Third Guard was the bigger impact.
Brett Lindsey: The factory in Stuttgart is doing much better and frankly having the new
Brett Lindsey: factory in Saltier means we are going to reduce the number of SKUs we manufacture and
Brett Lindsey: So we are more optimistic on recovering. But as you know, that's been a difficult factory for many years. So fingers crossed, we are optimistic for this year.
All right. Appreciate the insight.
Thank you.
Joe O'Day: We'll go next to Joe O'Day with Wells Fargo. Please go ahead.
Hi, good morning.
Speaker Change: I think, Michael, you touched on maybe the inflation has a bit of conservatism in there, but can you unpack that a little bit? And that's...
3% inflation, presumably a cost.
Speaker Change: across all costs. And so you're talking sort of labor, materials, freight, kind of all in bundled and in anything in particular where you're seeing more of the sort of inflationary headwinds coming through.
Speaker Change: Yeah, it's on average on all of our costs. We have about $4 billion of cost. We're seeing higher inflation at SG&A around healthcare and some of the wages there, more than the three. A little bit lower on the commodity side, but in general it kind of blends the three.
Speaker Change: I think we'll continue to watch it. And like I said, it could be some conservatism, but inflation definitely continues to exist, and especially on some of the SG&A side.
Speaker Change: And keep in mind that some of the tariff uncertainty impacts that as well. If there are tariffs on things like steel, then we clearly want to like, you know, acknowledge that and be prepared for that.
Speaker Change: Right, but I guess so the idea is that that price in the revenue bridge of up one compares to inflation up three. So you're not going out to the market and saying, we got, you know, we have a right to get more because the costs were getting burdened with.
Speaker Change: Correct. I mean, we have some of that through the mix as well, that we're getting a little bit better incrementals to cover for some of that, but we're also looking to drive more productivity as well. And keep in mind the 454B, we could have put in mix and price, you put that in mix. So you got to think of a lot of that is covering inflation as well.
Yep.
Speaker Change: Right. Okay. And then just as it relates to that 454B price and the 10% you talked about, which I think is the HCS side, not the BCS side.
But that that 10%
Speaker Change: At what point in the year do you think you'll have confidence in visibility to kind of realization, just when we think about the seasonality?
Speaker Change: of the business, you know, trying to understand kind of when, when you'd really get a good sense of that 10% sticking.
I think the
Speaker Change: mid to late Q2 when we'll get a good sense because we also, some of the OEMs have not announced their 2025 pricing. So that's when we'll get a good sense of it. But so far, the early signs are positive. I mean, there's no reason for us to be concerned about it.
Speaker Change: The reason the impact is what we called out is 70% of 70% of that 10%. So that's why you kind of see the numbers what they are, which means progressively as we go towards the second half, we have a greater portion of that getting captured.
Speaker Change: but like you know right now there's no reason to waver or be concerned with that number.
Got it. Thank you.
Thank you.
Speaker Change: We'll go next to Jeff Hammett with KeyBank. Please go ahead.
Hey, good morning, everyone.
Jeff Hammett: Just a few cleanups. So just on the Mexican production, you said industry capacity 40%. Can you just level set us on what your mix is? And if there's, you know, any particular OEMs you're aware have, you know, particularly lower mix versus the industry?
Jeff Hammett: And we haven't previously talked about it. Their tariffs, we believe about a billion dollars of our 20% of our output would be impacted through that.
Jeff Hammett: Since we make our premium products in US and we also have three residential factories. Commercially so far, all our production was in US and none in Mexico. So we're just starting on that together. But we do know many of our competitors, often sometime in the same geographical area within Mexico.
that they manufactured in Mexico as well.
Jeff Hammett: So, we think the 40% number is about right, obviously more skewed towards residential versus commercial.
Speaker Change: So you're, you'd say today you're probably below that industry average.
Speaker Change: Slightly below, but it depends on which OEM, right? For some OEMs, we are significantly below. With some OEMs, we're actually a little bit higher. So it just goes OEM by OEM, Jeff.
Speaker Change: Okay, great. And then just on this, you know, distribution margin focus, can you just level set us on kind of progress over the past year?
Speaker Change: What are some of the big opportunities this year and do you think you start to move those margins up or is that a longer time frame?
Speaker Change: It is over a long time frame, but some of the results that you see today are based on that initiative as well. So if you think about it, CS, we did have a record ROS and you followed us for a long period of time.
and that is consistent with us getting more distributor margins.
happened at the end of Q2 in 2024.
Speaker Change: So I think some of those results are just coming through, but that's a long journey, right? We've talked about manufacturers plus distributor margin is higher than our 2026 targets. So I think that continues beyond 2026.
Speaker Change: But progress so far gives us the confidence to say that we would be on the high end of our previously published targets for 2026.
Speaker Change: And what's your parts and accessories mix today and and what do you think entitlement is?
Speaker Change: Hasn't changed much over the past year. I mean, we remain at about 20-ish percent in parts and accessories. I'm confident my entitlement is twice that much.
Speaker Change: But we've been talking about that for many years, and I think it's finally time to show some results over the next few months and years.
Entitlement remains high and our current volume remains low.
Speaker Change: We'll go next to Nicole DeBlase with Deutsche Bank. Please go ahead.
Yeah, thanks. Good morning, guys.
Speaker Change: A lot of a lot of ground has been covered here, but I guess maybe just some cleanups for me. How are you guys thinking about new construction versus replacement demand within HCS for 2025?
Speaker Change: New construction is about 20% of that segment. We think it's going to be kind of flat-ish, but the big driver there is going to be if interest rates continue to go down. If it goes down, we think that there's pent-up demand in that space for new home construction that could happen, but there's obviously some labor challenges as well on that side of the industry too, making sure they can keep up with.
Speaker Change: with the demand. So it's mostly interest rate driven, but kind of flattish within the guide.
Speaker Change: Yes, that's correct. Overall, the margin guides about flat up in BCS, down in HCS. A larger portion of the $50 million of productivity will be BCS, which is a big driver of that margin expansion. That'll kind of happen throughout the year, but the volume gains, the share gains will mostly be kind of in the second half for BCS as that factor ramps up.
Thanks, Michael. I'll pass it on.
Yep.
Speaker Change: We'll go next to Dean Dre with RBC Capital Markets. Please go ahead. Thank you. Good morning, everyone.
All right. Bye.
Speaker Change: Hey, I'll echo some of the previous comments. You provided some really good calibration on what you think the pre-buy was for you guys
Speaker Change: and Alok, could you expand a bit, you referenced some of your competitors who had stock outs because they switched over earlier. How much of a surprise was that? How tactical were you in and how you positioned in the fourth quarter?
Speaker Change: Could you give us a sense of how the individual months played out? Was it a big like windfall in December or was it level-loaded?
Yeah, first of all, we were not surprised that
Speaker Change: a competitor had a misstep almost always happens in any of these regulatory transition. But yeah, we were surprised as to which competitor had that misstep. I mean, we would have expected somebody else to have it. So from that perspective, there was a bit of a surprise.
Speaker Change: How it impacted us was like we were fully loaded and we had really high fill rates throughout. So we were able to capture additional share. And now the whole challenge is to take that share and make it more of a permanent share.
Speaker Change: and we know that's going to be a challenge and we baked that in. In Q4 it was fairly even across all three months and part of it was driven by just
Speaker Change: So it was more constrained by manufacturing capacity and where we had different inventory stationed in our supply chain. Some of the temporary share gain did start in Q3. So I think if you think from the share gain that happened.
Speaker Change: and we remain very optimistic that will convert a part of that to more permanent share gain. But tactically, our response was, you know, we were very selective.
Speaker Change: to make sure that customers that we took on were customers who would stay with us for more permanent and were not buying from us just during the stockout. So I think we were able to gain some new customers and convert some loyalty from
You know, existing customers as well.
Speaker Change: Yeah, let's be clear that that's a high quality problem to have to talk about temporary market share and windfall from a pre buy and a tough comp. So that's
Speaker Change: I appreciate all the calibration. And then the second question, Alok, can you expand on your comment where you said some of your best deals in 2024 were those that you did not do?
Speaker Change: Was it just a question of price, but I have a hunch there's probably, there was a data center opportunity.
but any kind of color there would be helpful.
Speaker Change: Sure, yes, there were data center opportunities that we passed on. There was international expansion opportunities that were passed on. There was some domestic consolidation opportunities that we passed on as well. And it all came down to a very disciplined framework. I mean, helps having a conservative CFO to give Michael some credit for this, right? I mean,
We have ROIC target we are kind of you know
Speaker Change: Don't wear rose-colored glasses to look at the industry and we feel that often we can get more share with better execution versus going and buying share through M&A.
Speaker Change: So I think we were kind of proud of those calls. I was hoping somebody would catch on to my comment. We had a lot of fun with that comment when we were writing the script.
Speaker Change: All right, good. I'm glad I didn't let you down, Alok.
Thank you.
Speaker Change: We'll go next to Nigel Coe with Wolf Research. Please go ahead.
Nigel Coe: Thanks good morning everyone. Um look maybe can you just maybe just dig into the BCS you know bottom guidance for the year you know up in mid-single digits.
Speaker Change: Any way to quantify how much is baked into the Sotelo ramp-up?
Speaker Change: and I'm thinking, you know, is it industry-flavish and that mid-single digits is all share gain? Anything there would be helpful.
Speaker Change: Yeah, we think there's a little bit of market growth in there. Remember, we have three businesses, a service business, refrigeration, and an HVAC business, so a little bit of market growth, but about one or two points of that would be a share gain specifically around emergency replacement.
Speaker Change: Okay, that's helpful. And then just back to Fortana. I don't know if you want to sort of put your industry hat on, but
Speaker Change: 2024, would that be a million or, you know, any way to size that? And then just thinking about your inventory levels in 4Q, obviously, a little bit higher Q per Q, I don't know, $25 million, perhaps higher than I would expect it. Is that a good way to think about the 410 of inventory held at your end?
Speaker Change: So first of all, on the previous one, there are lots of industry reports, and I will first admit I'm no industry expert, but I think the units or estimate range is from low end of 300, high end of 600. So it's in that number, not a million.
I think it's half of the million that.
Speaker Change: talking about. So that's a range and we think it's within that range and
Nobody has more insight to be more precise within that.
Speaker Change: On our own internal inventory, I mean, it was a case of two things, right? I mean, commercial, we are building a bit of inventory. To get into emergency replacement, you need inventory positioned in the local market. So we are building inventory for commercial, and you will probably see that trend continue in Q1, because Q2 is our peak season. But that's probably driving the variation to your model there. Unknown Speaker
Okay, that's helpful. Thanks, Olga.
Speaker Change: We'll go next to Damon Karras with UBS. Please go ahead.
Hey, good morning, everyone.
Speaker Change: Morning. I wanted to ask you about the free cash flow guide and so
Speaker Change: Cashflow obviously came in a good bit better than you had expected in 2024, but the guidance for this year, the range is pretty wide. So could you just maybe spell out the moving pieces there?
Speaker Change: Yeah, I think that if you look at it from a conversion perspective, the midpoint of our free cash flow guide to the midpoint of our net income guide, it's about an 85% conversion. So a little below the compared to the 90% conversion that we've
Speaker Change: Traditionally targeted mostly because of us having to reinvest in inventory both in BCS and HCS as we depleted some of that, as well as the capital expenditures continue to be a little bit higher than depreciation.
Speaker Change: But we think when we get back into 2026 and beyond, we're going to be well into the 90% again. High end of the range would obviously reflect just better performance on receivables and accounts payable initiatives that I'm leading.
Got it. That's helpful.
Speaker Change: And then, Alok, you talked a little bit before about, you know, potential policy implications from tariffs and immigration policy.
Speaker Change: Just curious, you know, thinking about the pause on IRA funding.
Is that something that, you know,
Speaker Change: and what that might mean for heat pump penetration, where I know you guys are very confident that you'll be gaining some share in the market.
Speaker Change: Yeah, I mean, I think the good news with the IRA pause is that was not making a huge difference in our volumes in 24 or 23. We were all sort of waiting for that to come through the states and come back to it. Now the tax part of it is already there, right? So the energy efficiency rebates on tax, that has not changed.
Speaker Change: So no, I think the IRA has no, whether it was paused or going on, did not have a material impact for us in 24 and not going to have a material impact in 25, even if it's paused. So it's a bit of a no news for us.
Okay, great. Thanks a lot.
Thanks.
Speaker Change: We'll go next to Steve Tusa with J.P. Morgan. Please go ahead.
Hey, good morning.
Bye, Steve.
Speaker Change: So I just wanted to kind of clarify a couple things. So are you guys still saying that there was no pre-buy in 3Q? You're saying that most of like the vast vast majority came in in 4Q?
Speaker Change: Yeah, yes, that's true, Steve. But also with the caveat that Q3, we did see some share gains.
Speaker Change: which we were calling the temporary share gain when some of the OEMs were not able to fulfill demand.
Speaker Change: But yeah, right. Otherwise, all of us we buy, we expect was in Q4.
Speaker Change: And then on that share gain, do you think the share gain in 4Q was kind of like commensurate with that rate that you booked in the 3Q? Or was there any, you know, difference? Because obviously, I don't think those guys kind of changed it. Maybe they did change the strategy a little bit. But do you think like commensurate split between, you know, the share?
in 3Q and 4Q.
Speaker Change: I think Q4 was less. They did improve their position and then they launched the 454B and they were aggressive in the marketplace with that. So I think from that perspective, I think share gain was more of a Q3 story. It obviously bled into Q4, but towards the tail end of Q4, I think it was almost all pre-buy.
Speaker Change: That total cost, sales minus profit, about $4 billion to cost.
Speaker Change: Yeah, okay. That's super helpful. And then, sorry, one more. Just on Mexico, what is the plan for you guys? Will it be mostly price increases, or can you shift some back here if they do go through with some of these things, which I'm not sure that they will, but if they do, will it be mostly price increases, or can you shift some stuff back to the U.S.?
So in the short term,
Speaker Change: Besides any impact from peso devaluation and productivity, it'll be mostly pricing. On the long term, if it is a long term, then yes, we'll start looking at getting more in Marshalltown, more in Orangeburg. Some of these factories used to make this product, but to ramp that back up will take us some time.
Speaker Change: We'll go next to Jeff Sprague with Vertical Research. Please go ahead.
Jeff Sprague: Hey, thanks. Good morning. Just one more on inventory, if I could. You addressed it a little bit, but actually your inventories relative to sales, right, were a lot lower than normal here in the fourth quarter, right? So, obviously, you're blowing out 410A, but if I think about what you said about, you know, kind of some commercial inventory build.
Jeff Sprague: It doesn't really jump out to me that you have a lot of 410A left in-house to be pushing into the channel in the first half or the first quarter.
Can you just triangulate me on that?
Speaker Change: you know, a little bit more color on the position. And maybe a second part of that too, Michael. Sorry, just you did give us kind of the 45-55 revenue split.
you're
Speaker Change: Yeah, I think it's a good point on the inventory and what we're seeing is we did have some 410A availability at the end of the year, but a lot of that was pre-bought into Q4. So we'll kind of sell that through kind of early into Q1.
Speaker Change: fully gone by the second quarter. But I think that's really the depletion of that inventory you're going to start to see going into the first quarter. And then on the absorption side, you're right, we will start to ramp up the new 454B product in the first half of the year. And that should give us actually some more tailwinds on HCS. On the BCS side, though, we're going to
Speaker Change: Unfavorable comparisons in the first half as we continue to launch that new factory. Second half of the year you'll get a lot better productivity from that absorption on BCS.
Speaker Change: Thank you for joining us today. Since there are no further questions, this will conclude Lennox's 2024 fourth quarter and full year conference call. You may disconnect your lines at this time.
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