Ladies and gentlemen, thank you for standing by and welcome to the Lennox International, First Quarter 2020 Earnings Call. As a reminder, this call is being recorded. I’d now like to turn the conference over to Steve Harrison, Vice President of Investor Relations. Please go ahead.

Good morning. Thank you for joining us for this review of Lennox International's financial performance for the first quarter of 2020. I'm here today with Chairman and CEO Todd Bluedorn and CFO Joe Reitmeier. Todd will review key points for the quarter and the outlook, and Joe will take you through the company's financial performance and expectations. To give everyone time to ask questions during the Q&A, please limit yourself to a couple of questions or follow-ups and re-queue for any additional questions. In the earnings release we issued this morning, we have included the necessary reconciliation of the non-GAAP financial measures that will be discussed to GAAP measures. All comparisons mentioned today are against the prior year period. You can find a direct link to the webcast to today’s conference call on our website at www.lennoxinternational.com. The webcast will be archived on the site and available for replay. We would like to remind everyone that in the course of this call, to give you a better understanding of our operations, we will be making certain forward-looking statements. These statements are subject to numerous risks and uncertainties that could cause actual results to differ materially from such statements. For information concerning these risks and uncertainties, see Lennox International's publicly available filings with the SEC. The company disclaims any intention or obligation to update or revise any forward-looking statements whether as a result of new information, future events or otherwise. Now let me turn the call today over to the Chairman and CEO, Todd Bluedorn.

Thanks Steve. Good morning, everyone and thanks for joining us. Let me start with a quick overview on the first quarter, then discuss our current outlook for 2020 and the actions we’re taking in this unprecedented time. For the first quarter, company revenue was $724 million, down 8% on a GAAP basis, down 4% on an adjusted basis that excludes the impact from divestitures last year. GAAP operating income was $36 million, down from $95 million in the prior year quarter that included approximately $47 million of insurance benefit related to the 2018 tornado. GAAP EPS from continuing operations was $0.32 compared to $1.73 in the prior year quarter that included $0.87 from insurance benefit. On an adjusted basis, total segment profit was $38 million compared to $99 million in the prior year quarter that included $40 million of insurance benefit. Total adjusted segment margin for the first quarter was 5.2% compared to 13.1% in the prior year quarter as reported and 7.8% excluding the insurance benefit. Adjusted EPS from continuing operations was $0.56 compared to $1.68 in the prior year quarter that includes $0.75 of insurance benefit. Looking at the business segment performance for the first quarter, there are a couple of overarching comments to make. First, weather continued to have a significant adverse impact. Heating degree days were down from last year and every month down 15% overall for the quarter. Second, we saw an increasing impact on our business in March from the COVID-19 pandemic, first in Europe and then in North America. On the demand side, we saw contractors stop stocking up less residential equipment ahead of the spring and summer seasons due to the rising economic uncertainty, and national account customers in both our Commercial and Refrigeration businesses have pushed orders out. Operationally, HVAC has been designated an essential business in North America, Europe and in Mexico. We have managed the supply chain well across regions that we source from, including Asia and combined with our buffer stock we have not seen an impact on our manufacturing capability in this regard. In late March, we did make the decision to close some of our factories for a couple of weeks and broadly protected the Lennox team from COVID-19 cases at those locations. These factors are all back up and running and of course, protection for the team members are in place. In our Residential segment, in the first quarter, revenue was down 5%. Revenue from replacement business was down high single digits impacted by the warm weather. New construction revenue was up high single digits as the warm weather generally enabled homebuilders to get an early start in the year. Residential segment profit was $33 million, down from $87 million in the prior year quarter on a reported basis that included the $40 million of insurance benefits that I mentioned earlier. Segment margin was 7.4% in the quarter compared to 18.6% as reported or 10% excluding insurance benefit in the prior year quarter. In Commercial, revenue was up 3% in the first quarter and segment profit rose 24%. Segment margin expanded 180 basis points to 10.5%. Commercial equipment revenue was up low single digits in the quarter. New construction revenue was up high teens and replacement revenue was down high single digits. Breaking out the business another way, revenue from regional and local business was up low single digits. And national account equipment revenue was also up low single digits in the quarter. On the service side, Lennox national account service revenue was up low double digits. In Refrigeration segment for the first quarter, adjusted to exclude the impact from divestitures in the prior year, revenue was down 11% at constant currency. Segment margin declined 730 basis points to 0.7% and segment profit was down 93%. The segment has approximately 55% of its revenue from North America and 45% from Europe, which has seen soft markets for some time and that was impacted earlier from the pandemic in North America, including shut down at both of our French factories. North America revenue was down mid-single digits and Europe revenue was down high teens. Looking ahead for the company overall, market conditions are highly uncertain and there are significant challenges we are addressing. But Lennox has a focused and seasoned team with experience managing through economic downturns in difficult times. For me personally, I managed Carrier's HVAC business in Southeast Asia in the wake of the Asian financial crisis in the late 90s. Those of you who don't remember, I urge you to go Google it. I managed Carrier's North America HVAC businesses through the impact from 9/11 and then as CEO at Lennox through the residential new construction collapse in the global financial crisis a little over a decade ago. Based on how HVAC markets performed in those prior downturns, our current view is that the North America residential and commercial unitary HVAC and refrigeration markets will be negatively impacted about 20% this year by the pandemic. We have reset our financial expectations for the year based on that level of market impact and now expect revenue to be down 11% to 17% from last year versus our previous guidance for growth of 4% to 8%. We expect adjusted EPS from continuing operations in the range of $7.50 to $8.50 for the year. We have already taken cost reduction actions to realize approximately $150 million in SG&A savings for the balance of the year. The decremental drop-through on the guidance reduction on our revenue is 25%, which reflects our aggressive cost actions. We expect cash generation to remain strong for this year as working capital requirements shrink and capital expenditure plans have been reduced from $153 million to $120 million this year. We tend to think of maintenance CapEx levels of being around 10% to 15% of that. We are targeting $340 million free cash flow for 2020. Lennox is rated investment grade by both S&P and Moody's and we expect to remain well within our debt covenants. Our bank revolver and asset securitization line do not have to go through renewal again until the latter half of 2021 and our senior notes will not mature until November 2023. The company's quarterly dividend plans are unchanged. Most recently $0.70 per share or more than $150 million in total for this year. We repurchased $100 million of stock in the first quarter of our $400 million planned going into this year. But we have placed repurchase plans for the second quarter on hold and we will review plans for the third and fourth quarter as the year progresses. As I turn it over to Joe to discuss financial results, I will just say that while we execute on what is required in these current economic conditions, we remain mindful of the future and are confident we will once again strengthen our position in the market as we emerge in the recovery. Now I will turn it over to Joe.

Thank you, Todd and good morning, everyone. I'll provide some additional comments and financial details on the business segments for the quarter, starting with Residential Heating & Cooling. In the first quarter, revenue from Residential Heating & Cooling was $442 million, down 5%. Volume was down 6% and price and mix combined was up 1%. Foreign exchange was neutral to revenue. Residential profit was $33 million, down 62% as reported, or down 30% adjusted for the insurance benefit in the prior year quarter. Segment margin was 7.4%, down 1,120 basis points as reported, or down 260 basis points adjusted for the insurance benefit in the prior year quarter. Segment profit was negatively impacted by the year-over-year difference in the insurance benefit, unfavorable weather, the COVID-19 pandemic that led to lower volume and factory shutdown costs, higher other product costs and unfavorable mix. Partial offsets included favorable price, lower material costs, lower tariffs, favorable warranty costs, lower freight costs, lower SG&A expenses and favorable foreign exchange. Turning to our Commercial Heating & Cooling business. Commercial revenue was up 3% to $170 million. Volume was down 2%, price and mix combined was up 5% and foreign exchange was neutral to revenue. Commercial segment profit rose 24% to $19 million. Segment margin expanded 180 basis points to 10.5%. Segment profit was favorably impacted by favorable mix, lower material costs and lower SG&A expenses. Partial offsets included the COVID-19 pandemic that led to lower volume and unfavorable warranty costs. In Refrigeration, on an adjusted basis, first quarter revenue was $103 million, which was down 12%. Volume was down 12%, price and mix combined was up 1% and foreign exchange had a negative 1% impact on revenue. Refrigeration segment profit was $1 million in the first quarter, down 93% and segment margin was 0.7%, down 730 basis points. Segment profit was impacted by the COVID-19 pandemic that led to lower volume and factory shutdown costs, higher other product costs and unfavorable mix. Partial offsets include favorable price and lower SG&A expenses. Regarding special items in the quarter. The company had net after tax charges totaling $9.2 million. This included $8.3 million in total for other tax items net and excess tax benefits from share based compensation, $1.3 million for loss from natural disaster net of insurance recoveries and a net benefit of $0.4 million for various other items. Corporate expenses were $14 million in the first quarter, and overall SG&A on an adjusted basis was $131 million or 18.1% of adjusted revenue, down from 18.7% in the prior year quarter. In the first quarter, the company used $99 million of cash from operations compared to a usage of $141 million in the prior quarter. Capital expenditures were $25 million compared to $37 million in the prior year quarter that also included $7 million of proceeds from divestitures and insurance. Free cash flow was a use of approximately $123 million in the quarter compared to a use of $171 million in the prior year quarter. Due to the seasonal nature of our business, the company tends to have a use of cash early in the year and generates cash later in the year. The company paid $30 million in dividends and repurchased $100 million of stock in the quarter. Total debt was $1.44 billion at the end of the first quarter and we ended the quarter with a debt to EBITDA ratio of 2.3. Cash, cash equivalents and short-term investments were $43 million at the end of March. Now, before I turn it over to Q&A, I will review our current market estimates for 2020. For the industry overall, we now expect North American residential HVAC shipments to be down mid-teens compared to prior expectations to be up mid-single digits, a 20 point negative impact from the COVID-19 pandemic. We expect both Commercial unitary shipments and Refrigeration shipments in North America to be down 25% compared to our expectation for flat markets. Under these market assumptions, we expect our revenue to be down 11% to 17% from the prior year compared to our prior expectations of 4% to 8% growth. We expect GAAP EPS from continuing operations to be in a range of $7.07 to $8.07 for the year, including a pre-tax charge of approximately $10 million expected in the second quarter for restructuring actions. We expect adjusted EPS from continuing operations to be in the range of $7.50 to $8.50 for the year. Previous EPS guidance for both of these was a range of $11.30 to $11.90. Looking at the various puts and takes in our financial assumptions for 2020, we now expect a benefit of $25 million in net price for the year compared to our previous guidance of $30 million. We now expect a $20 million benefit from sourcing and engineering led cost reductions compared to prior guidance of $25 million. Residential factory productivity is expected to flip from a $10 million benefit to a $10 million headwind given the significantly lower volume. Residential mix is now expected to be flat compared to prior guidance of a $5 million benefit. Tariffs are now expected to be neutral compared to prior guidance for a $5 million headwind and commodities are still expected to be a $20 million benefit and freight is still expected to be a $10 million benefit. A few other points to mention in our current financial outlook. Corporate expenses are targeted at $75 million compared to $90 million previously. Net interest expense and other expense is now expected to be approximately $40 million compared to previous guidance of approximately $50 million. We still expect an effective tax rate in the range of 21% to 22% on an adjusted basis for the full-year. We continue to expect weighted average diluted share count for the full-year to be between 38 million to 39 million shares. And as Todd mentioned, our repurchase of $100 million of stock in the first quarter of our $400 million plan going into this year. But we have placed the repurchase plans for the second quarter on hold and we will review plans in third and fourth quarters as the year progresses. The company's quarterly dividend plans are unchanged. Most recently $0.77 per share or more than $115 million for the total year. We are targeting capital expenditures of $120 million this year, down from $153 million previously. Free cash flow is expected to be $340 million this year compared to previous guidance of $410 million. And as Todd talked about, we have taken SG&A cost reduction actions to realize $115 million of savings over the remaining three quarters of this year. We are well-prepared to manage through these market conditions and make adjustments as needed along the way. And with that, let's go to Q&A.

Thank you. Our first question comes from the line of Ryan Merkel with William Blair. Please go ahead.

Hey, thanks. So first off, Todd, can you break down the resi mid-teens decline into your replacement and new construction?

We haven't broken out that guide. We usually don't give the annual guide, but I think the phenomenon that you saw in first quarter will play out for a little bit longer, which is the starts that have started will continue. And so I wouldn't be surprised to see in the near-term new construction up as replacement continues to go down. But I think certainly during the second half of the year the new construction will start to pull back significantly.

Okay. And then maybe talk about the sales cadence through March and into April. Are you seeing resi down 10% plus at this point?

Yes, we are. What we've seen is through the end of March, it sort of hung in there. And then during the first two weeks of April, it's been down mid-to-high teens. That's what I would expect. What we're seeing is we really have two broad buckets of replacement this time of the year. The demand business, where a dealer sees a job, buys the equipment and installs it, is hanging in there relatively well; it's down low single digits. But where we're seeing a real slowdown is dealers stocking up for the summer selling season. They're just not doing that given all the uncertainty.

Right. Thanks.

And I will get a little bit more into this later: we are an essential business and so we're going to continue to produce. People need our products and that will continue to flow.

Okay. All right. And just lastly, on the $150 million of cost saves, how much of that is temporary versus permanent? And then what's the quarterly cadence for our model?

I would think about the $150 million cost savings this way. About 20% of the savings comes from salaried headcount reductions, about 40% comes from discretionary spending cuts like travel, marketing, incentive trips, etc., and about 40% comes from pay actions: zero executive incentives and a salary reduction for our salaried employees, 50% for me, 12% for other executives and 6% for other salaried employees. When you think about those snapping back, if I were modeling 2021, I would certainly assume that the salary reductions snap back in 2021 because if you do longer than 8 or 9 months, it's really not temporary. The other two categories, we will wait and see how market conditions evolve.

Okay, great. Thank you.

Thank you. Our next question comes from Julian Mitchell with Barclays. Please go ahead.

Hi. Good morning.

Good morning, Julian.

Just my first question around decremental margins. Those were pretty steep in Q1. I think you're expecting a narrowing of those as we work through the year, even though the sales trends deteriorate, presumably in Q2 and Q3. So maybe just help us understand the logic behind that. And also, what impact did the under absorption that you've cited back at the Q4 call end up being given you had an additional volume shortfall?

There is a lot to unpack. The decremental margins in the first quarter were primarily driven by the bad mix in residential. We discussed publicly earlier that warm weather had impacted our furnace sales and our parts and supply sales, which are our most profitable business lines and that had a real impact. For the balance of the year, the reason we're able to get to 25% decrementals is we've taken $115 million costs out of the business. Our normal contribution margin is on the order of 38% to 40%. If we took no cost actions, decrementals would be around 40%, but we took out $150 million of cost. So we're now going to see decrementals in the order of magnitude of 25%. To be clear, the 20% market impact is an uncertain number; it feels right given prior downturns but it's a ballpark. We were able to get 25% decrementals on a 20% drop in the market. If the market goes down more than 20%, the cost levers are harder to find and decrementals would be more like 30% to 35% beyond that. For the first drop of 20%, the $150 million cost takeouts allow us to deliver a 25% decremental.

That's very helpful. Thank you. And maybe just my follow-up. You've talked a fair amount about residential trends. Maybe just clarifying on the commercial side of the business. What are you seeing in terms of the aftermarket parts of commercial and any bifurcation you'd call out in your guide for commercial unitary between OEM and aftermarket for 2020 as a whole?

The broad guide we gave is down 25% for North America unitary. We haven't bifurcated it publicly. Without putting numbers on it, what will happen is similar to residential: new construction continues until projects that have started wind down. Planned replacement continues to flow for a little while until decision makers pull back. Planned replacements have been slowing over the last two weeks. The third piece, on-demand replacement, continues to flow even in tough times because people need HVAC. My experience from running Carrier during 9/11 is that commercial can drop quickly; the marble rolls off the table quickly. The marble hasn't rolled off yet; we're down, backlog and order rates are down maybe 10%, not 25% yet, but our view is it will get there.

Great. Thank you.

Thank you. Our next question comes from Jeff Hammond with KeyBanc Capital Markets. Please go ahead.

Hey, good morning, guys.

Hey, Jeff.

So can we just talk about, obviously a lot of moving pieces here, what you're seeing from a share dynamic and being able to get that back and just what plans have changed if any for parts plus build out?

The parts plus build out: we put the 20 stores we planned for 2020 on pause for now. We are not adding new stores at the moment. We'll revisit this mid-year along with the share buyback. We're focused on protecting investments that help us gain share. We've protected all of our new product development programs and key digitization programs. While we aren't adding new stores, we're not decimating our distribution network; we're keeping it intact. We've asked for shared sacrifice of employees with salary reductions rather than cutting key programs.

Okay. And then just on the seasonal build, what kind of feedback are you getting from contractors in terms of the selling season and people being able to get out? Just wondering if if you go into the season with less inventory, do you get some spring loading or catch up?

Short answer is yes, to that final piece. We have inventory and we're going to manage it to hit our free cash flow target. We're prepared for the spring back. I hope we're wrong on the 20% number and if the market starts to come back, we'll be ready and our dealers will be ready to sell. Dealers are optimistic in many parts of the country, but if you rely on dealers to tell you the market is turning, you've waited too long. It's better to cut costs now, get it behind you and be ready to take advantage of any recovery.

Okay. And then the refrigeration margins got hit pretty hard — could you speak to what happened there?

There were a couple of things that drove margins down. We had our two French factories shut down, which was about $2 million of EBIT negative impact. We had a year-over-year difference in refrigerant sales; last year there was a windfall that did not repeat. Volume was down about 10% and we hadn't taken all the cost actions yet, so we had painful decrementals. As we go through the balance of the year, hopefully the factory shutdowns are behind us, the refrigerant effects are behind us, and we've taken cost actions to adjust costs for lower volume.

Okay. Thanks, Todd.

Thank you. Our next question comes from the line of Steve Tusa with J.P. Morgan. Please go ahead.

Hi, guys. Good morning.

Hey, Steve.

Thanks for all the detail. A lot of companies are not giving guidance. The color is very helpful and you guys are on top of the stuff. I appreciate it.

I'll give an advertisement for my colleagues. We've always been transparent, but every training and leadership instinct I've ever had is in a crisis you want to be even more transparent. Pulling guidance and hiding isn't the way to go now. We're putting large caveats around our guidance, but we're trying to give you a view of our decrementals, the 20% and how costs will behave when the market recovers. That's what we're trying to communicate.

Right. I mean, I was giving more credit to Joe and Steve anyway. How much of your business is housing now? A couple of years ago you were a little overweight on housing. How much of your business is builders and housing?

Residential is about 15% to 20% of the business.

Got it. On the guidance, if I do the midpoint negative of about 14% revenue and 25% decrementals, it looks like closer to $7 of EPS rather than $8. Am I missing something like below-the-line items?

Rates are down and so we have lower interest costs, that may be part of it. But take it off line and we can work through the detail with you.

I think so.

Okay. How are you balancing cost cuts with the drive to recapture some of the tornado share?

We still have some share gain in the plan, but much of that is already in the pipeline from dealers we were converting in the third and fourth quarters. We've protected our key investments to gain share and our sales teams are still engaging customers daily, even if not physically calling. There's not heroic share gain in the numbers, but some is included.

Okay. One last quick one: usually commercial has a weak Q1 and then steps up in Q2. Given you haven't yet seen the drop-off there, should we assume a flat to up seasonal step or expect seasonal dynamics to change?

Our commercial team was on a roll before the virus hit and they are gaining share. The market is going to go down 25% but they're winning in the marketplace. That should be consistent even with the market down 25%.

Okay. Got it. Thanks a lot, guys. Really appreciate the details.

Thank you. Our next question comes from Nicole DeBlase with Deutsche Bank. Please go ahead.

Yes, thanks. Good morning, guys.

Hi, Nicole.

So with respect to the 20% revenue impact you've embedded for the full year, is all of that coming in the second quarter? Was there any in Q1 and are you embedding a pretty quick snapback in the second quarter? Trying to get a sense of where that impact lies.

I'm not giving quarterly guidance, but for the full year the guide is down 20% and the balance of the year is down even more than that on a weighted basis relative to Q1. We have loaded it equally across quarters in our internal models because there are too many variables to know how it will play out precisely. It may be worse in Q2 than Q3 and Q4, but we've treated it evenly for now.

Totally fair. Thanks, Todd. And then maybe drawing on what you've seen in past downturns, is there a risk in residential of a big shift away from replacement toward repair Band-Aid solutions over the next several years as this plays out?

Yes, if we end up with 25% to 30% unemployment, people will try to Band-Aid their units. We'll likely see a spike in parts and repair and a decline in units. That assumption is broadly baked into our numbers. The silver lining is, like after the financial crisis, that demand doesn't disappear — it gets pushed out and will come back. When it comes back, we expect to capture much of that pent-up demand.

Thanks, Todd. I will pass it on.

Thank you. Our next question comes from Tim Wojs with Baird. Please go ahead.

Hey, guys. Good morning.

Hi, Tim.

Among some of your third-party distributors and larger stocking dealers, how do you feel about their financial profile and access to credit more broadly?

We keep a close eye on our dealers and distributors. Broadly, they're in good shape. We’ve reached out to the dealer network with webinars and training around small business loans and grants. We've worked with our partners to ensure access to those programs. Most of our customers survived the financial crisis and are savvy business people; they know how to manage through tough times.

Okay. And on mix, have you seen changes in the demand-oriented business over the last 4 to 6 weeks and are you embedding deterioration as you go into summer?

It's early, but we'd expect some mix down in residential and that is built into the numbers.

Okay. Thanks for the color and good luck.

Thank you. Our next question comes from Nigel Coe with Wolfe Research. Please go ahead.

Thanks. Good morning and well done on the guidance — it's appreciated.

Thanks.

On the components of the guide, you took down the price by $5 million. Is that purely just lower volumes reducing the price benefit, or is there pricing pressure across businesses? Are you seeing deterioration in pricing?

No, it's broadly due to reduced volumes.

You mentioned shutting down factories at the end of March in the U.S. and Europe. To what degree did that impact productivity in the quarter? And going forward, does testing employees and maintaining distancing limit or raise costs to ramp up production?

We've managed it well so far. We've implemented cleaning protocols, hand gel, plastic barriers between some assembly stations, temperature checks and PPE. We had shutdowns in our two French factories and some quarantines in Marshalltown, but both are now up and running. Absenteeism varies by region. Our supply chain team managed through Asia issues earlier and now it's more about Mexico and the U.S. We've had good supply continuity. Also, with declining markets, we have some flexibility to absorb production impacts because we can adjust factory levels to manage inventory.

On the Mexican supply chain, I hear one or two factories were shut down by the Mexican government. Is that now back up and running?

Our factory was never shut down by the government. We had a federal inspection and received approval as an essential industry and for our protection processes. We did reduce production for operational reasons but not because the government mandated it.

Okay, good luck. Thanks.

Thank you. Our next question comes from John Walsh with Credit Suisse. Please go ahead.

Hi, good morning.

Hey, John.

I think you were talking about decrementals when you said the next tranche would have higher decrementals if revenue falls more than 20%. What indicators are you watching to see if volumes could be worse than your expectation — employment, consumer confidence, something else?

It's an imprecise science. We watch macro trends, but we also look at order rates and what our customers are doing. The demand business in residential has been a comforting indicator — it's down a bit month-to-date but relatively solid. We're monitoring dealer activity; dealers are working across the country and taking care of homeowners. We're being conservative: we measured twice and cut once. We'll monitor through the summer selling season and readjust as necessary.

And a high-level question: energy efficiency regulations and refrigerant changes are tailwinds historically. Are you hearing any conversations about delaying or throttling back those initiatives?

I haven't heard anything yet. It could cut both ways: some might view such initiatives as stimulus, while others might seek to delay them given costs. I don't have a definitive answer.

Thank you. Our next question comes from Deepa Raghavan with Wells Fargo Securities. Please go ahead.

Hey, good morning, all.

Hi, Deepa.

Can you talk through how your residential revenue mix is looking across geographies that are hard hit by lockdowns — New York, California, Pennsylvania, parts of the Midwest — are you over- or under-represented in these places?

I wouldn't say we're significantly over- or under-represented. Over the last few weeks, the Southeast continues to do relatively well; our revenue in the Southeast is actually up year-over-year in April. Canada is down significantly and reflects strict lockdowns there. In the Northeast our business is down significantly year-over-year. So performance is geographically dependent.

Got it. My follow-up: you divested some businesses since the last recession like Hearth. How did repair and replacement dynamics play out historically excluding those businesses, and is there a threshold like an unemployment rate that determines when people return to replacement?

There's not a single mathematical threshold. During the financial crisis it was housing-led and existing home values dropped substantially in many areas, which chilled major purchases. That turned into a broader financial crisis with unemployment and lack of consumer confidence, which prolongs downturns. Today we expect higher unemployment and corresponding drops in consumer confidence, but we haven't seen a crash in housing values yet. There will be more repair versus replace in the near term, but how long it lasts is uncertain.

Thank you. Our next question comes from Walter Liptak with Seaport Global. Please go ahead.

Hi, thanks. Good morning. I wonder if you could talk a little more about why you took the conservative route with guidance versus expecting more of a snapback in the second half.

My experience, especially running Carrier Commercial after 9/11, is it's dangerous to chase the market down. It's better to get ahead of it and size costs appropriately. The cost actions we've taken are recoverable in nature for the most part. The worst thing is to continuously under-forecast and have to chase costs down as the market moves. We measured twice and cut once to give the company stability during the downturn.

Bad debts in the quarter didn't look that bad yet. How should we think about bad debt trends given the outlook and how they behaved in prior recessions?

Bad debts held up well last time and we didn't have much of a debt problem. We sell to many small customers but also to high-caliber national accounts. I don't expect a major increase but we're focused on monitoring it closely.

Thank you. Our next question comes from Robert McCarthy with Stephens. Please go ahead.

Good morning.

Hey, Rob.

Two quick questions. One: on commercial real estate, we could be in a prolonged downturn for dining, retail, independents — could this be 2 to 3 years of tough conditions for commercial real estate and how do you manage the business beyond the guide?

Our commercial business is roughly two-thirds replacement. That buffers us from new construction declines. We also have large national customers like Amazon, Costco and Walmart that provide stability. New construction could be bad, but our replacement orientation and large customers provide resilience. We've sized the business for a middle path and will adjust if necessary.

Anything else on cash collection — should we be nervous about cash conversion this year?

I think it's manageable. We'll shrink working capital, collect receivables and reduce inventory. Historically, even in the financial crisis we generated more cash because we took down working capital faster than earnings declined. We expect to manage cash similarly this year.

And from a financing perspective, markets remain robust — do you confirm that?

I would say we have no concerns. We're in great shape from a liquidity and covenant standpoint.

Thank you. Our next question comes from Damian Karas with UBS. Please go ahead.

Hi. Good morning, everyone. Appreciate the preparedness detail and the 20% forecast. Quick follow-up on residential mix: during the global financial crisis you saw a bifurcation to minimum efficiency. Have you started seeing that dynamic yet, and can you remind us how price and margin vary from minimum efficiency to premium?

Roughly, a 26 SEER product is about twice as expensive as a 13 SEER. Margin percentages don't scale exactly the same, but we have a greater margin percentage at the high end than the entry level, though the gap has closed as we've taken costs out of entry-level products. We expect some mix down and in the first few weeks of April we are seeing some of that.

With current lockdowns, have you seen changes in trends on your online platform? Could there be acceleration there?

Our online platform is for dealers and contractors. Sales teams are engaging customers daily by phone and are placing orders. It's not like consumer retail online; our dealer relationships haven't changed much and many orders still come through direct communication rather than an online storefront.

Makes sense. Appreciate the color and good luck.

Thank you. Our next question comes from Gautam Khanna with Cowen. Please go ahead.

Thanks, guys. Appreciate the detail.

Hi, Gautam.

Todd, could you give historical perspective on how pricing behaves in downturns and why the industry will be more rational this time?

Even during the financial crisis we obtained price increases — I recall getting $15 million to $20 million of pricing on a smaller business then. We're seeing cost pressures now related to COVID protection and absenteeism, and we've had conversations with customers about pricing. My expectation is competitors will behave similarly and we'll be able to pass through price where necessary.

On consolidation: do you think the current environment makes it more or less likely?

A textbook answer: if a company gets into liquidity trouble it makes acquisition more likely. Equity values would need to remain depressed for a while before large deal activity resumes. It's hard to imagine many deals getting done near-term.

One last: when might you expect to get back to 2019 levels — is this a 3-year or 5-year recovery?

I don't know. The medical timeline is a major determinant. If effective therapeutics appear in two months, recovery could be rapid. If not and a vaccine takes years, recovery will be much slower. There's a wide range of possible outcomes.

Thank you. Our last question comes from Joe Ritchie with Goldman Sachs. Please go ahead.

Thanks. Good morning, guys. Two quick items: are the cost outs linear? And if the market is worse than down 20%, what other levers do you have?

The cost takeouts are broadly linear, though some actions kick in later in the year. Restructuring actions are already effective; salary reductions take effect May 1. If revenue falls more than 20%, the next tranche of decrementals will be closer to 30% to 35%. The remaining levers are still the same three buckets: headcount, discretionary spending, and pay. They become harder to find as revenue declines further.

Makes sense. Thanks very much, guys.

Thanks. Appreciate it. Okay, everyone. Appreciate the time and interest. To wrap up, these are unprecedented times, but Lennox has a focused and seasoned team with experience managing through difficult challenges. We will execute on what needs to be done near term while being mindful of the future and are confident we will again strengthen our market position as we emerge in recovery. Thanks, everyone for joining us today. Have a good day.

Thank you, ladies and gentlemen. That does conclude our conference for today. Thank you for your participation and for using AT&T events conferencing service. You may now disconnect.