Ladies and gentlemen, thank you for standing by. Welcome to the Lennox International First Quarter 2021 Earnings Conference Call. At the request of your host, all lines are in a listen-only mode. There will be a question-and-answer session at the end of the presentation. Operator provided instructions on how to use the conference call functionality. As a reminder, this call is being recorded. I would 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 2021. I'm here today with Chairman and CEO, Todd Bluedorn; and CFO, Joe Reitmeier. Todd will review key points for the quarter and Joe will take you through the company's financial performance and outlook for 2021. 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 for today's conference call on our Web site at www.lennoxinternational.com. The webcast will be archived on the site for replay. I 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 over to Chairman and CEO, Todd Bluedorn.

Thanks a lot, Steve. Good morning everyone and thank you for joining us. In the first quarter we continued to see strong momentum in our residential business combined with strong improvement in commercial and refrigeration, as the overall company set new first quarter highs for revenue, profit and earnings per share. Overall for the company, revenue was up 29% to a new first quarter record of $931 million. At constant currency, revenue was up 28%. GAAP operating income was a first quarter record $114 million, up 213%. GAAP EPS from continuing operations was a first quarter record $2.20, up 588%. Total segment profit rose 208% to a first quarter record of $116 million. Total segment margin expanded 720 basis points to 12.4% and adjusted EPS from continuing operations rose 305% to a first quarter record $2.27. Looking at our business segments for the first quarter, we realized double digit revenue growth and margin expansion in all three businesses. In residential, we set new first quarter highs for revenue and profit. Residential revenue was up 37%, segment profit rose 197% and segment margin expanded 850 basis points to 15.9%. Replacement business is up more than 40% and new construction was up more than 25%. Breaking it down between our Lennox business and our Allied business, Lennox revenue was up about 25% and Allied was up about 70%, strong growth rates. Let me take a moment to unpack the strength we saw in residential in the quarter. First, with strong operational execution, our residential team is capitalizing on its ability to deliver to meet contractor and distributor demand and gain share. Post the 2018 tornado and initial 2020 pandemic impact, we are back on offense with production, distribution and executing our playbook for market share gains. Second, residential benefited from the colder winter weather with heating degree days up 13% from the first quarter last year. You may recall we had a soft first quarter in 2020. Third, I'd like to note that we had a 6% benefit to revenue for more days in the quarter this year than last year. That happens every four years as we reset the calendar. Conversely, the fourth quarter will have a 6% headwind from fewer days in the quarter this year. This applies to residential as well as all our other businesses. Adjusting for the days, residential grew 31% with Lennox growing nearly 20% and Allied growing about 65%. In addition for Allied, we had approximately $25 million of pull-forward in the first quarter from different distributor loading patterns this year than last year. Adjusted for both days and this pull-forward, Allied was up approximately 35% in the quarter. Working through all this math I gave adjusting for days and the pull-forward in our Allied business which sells independent distribution, overall residential segment revenue was up about 25%. We believe this compares to mid teens sell-through for the industry, driven in part by the favorable cold weather that I talked about. Our performance that is above that is due to market share gains. As I mentioned earlier, we are back on the offense with production, distribution and executing our playbook for gaining share. The team has had strong operational execution to drive this outperformance and we are well positioned for the summer season and our largest seasonal quarters. In commercial, revenue, segment profit and margin were all first quarter records. Revenue was up 12%. At constant currency, revenue was up 11%. Segment profit was up 47% and segment margin expanded 330 basis points at 13.8%. In the first quarter, we saw broad strength in commercial as year-over-year growth turned positive across all of our businesses. At constant currency, commercial equipment revenue was up mid teens in the quarter. Within this, replacement revenue was up mid teens with plan replacement up mid teens and emergency replacement up high teens. New construction revenue was up high single digits. Breaking out revenue another way, regional local business revenue was up mid teens. National account equipment revenue was also up mid teens. Our team won three new national account equipment customers in the quarter. On the service side, the national accounts services revenue was up mid single digits. VRF revenue was up mid 30s percentage. Some highlights to mention for commercial. Schools continue to be an area of focus for us. We have a dedicated sales force and product line that will drive a multiyear growth opportunity for us in this market. Today, K-12 schools are just a little under 10% equipment revenue for this segment. This business was up more than 20% for us in the first quarter. And given the recent stimulus package that benefits HVAC indoor air quality spending for schools, we expect K-12 schools to be a growth vertical for us moving forward. Indoor air quality continues to be an important focus for us with our Building Better Air initiatives. Most interesting activity we're seeing are in this K-12 school segment where conversations are taking place with many customers across many industry verticals. We have launched our new Model L Rooftop unit as we continue to lead the field in energy efficiency. The Model L features variable speed technology and an all new advanced control system. We're seeing high customer interest in this industry leading product for 2021 and beyond. Overall for commercial entering the second quarter, momentum continues with backlog up double digits and strong order rates. In refrigeration for the first quarter, revenue was up 21%. At constant currency, revenue was up 17%. In North America, revenue was up more than 25%. Europe refrigeration revenue was up low single digits at constant currency. And Europe HVAC revenue was up mid single digits at constant currency. In refrigeration, segment margin expanded 560 basis points to 6.3% and segment profit rose to $8 million from $1 million in the prior year quarter. Like in commercial, momentum continues for refrigeration entering the second quarter, with backlog up double digits and strong order flow led by North America. With strong performance for the company overall in the first quarter and outlook for the second quarter and year, we are raising 2021 guidance. We now expect 7% to 11% revenue growth and adjusted EPS from continuing operations of $11.40 to $12. We are also raising free cash flow guidance to $375 million for the full year. We now assume about 55% of earnings in the first half of the year compared to the prior guidance of about 50%. This reflects the strong first quarter performance and second quarter outlook. We repurchased $200 million of stock in the first quarter and plan on another $200 million for a total $400 million in our guidance for the year. Now I’ll 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 and cooling. In the quarter, revenue from residential heating and cooling was a first quarter record $606 million, up 37%, volume was up 32%, price was up 1% and mix was up 4%. Foreign exchange was neutral to revenue. Residential profit was a first quarter record $96 million, up 197%. Segment margin expanded 850 basis points to 15.9%. Segment profit was primarily impacted by higher volume, favorable price and mix, higher factory productivity, sourcing and engineering led cost reductions, distribution and freight savings and favorable foreign exchange. Partial offsets included higher commodity, warranty and other product costs and higher SG&A. Now turning to our commercial heating and cooling business. In the first quarter, commercial revenue was a first quarter record $199 million, up 12%, volume was up 15%, price was flat and mix was down 4%. Foreign exchange had a positive 1% impact to revenue growth. Commercial segment profit was a first quarter record $27 million, up 47%. Segment margin was a first quarter record 13.8%, which was up 330 basis points. Segment profit was primarily impacted by higher volume, lower material costs and lower SG&A. Partial offsets included unfavorable mix. In refrigeration, revenue was $125 million, up 21%, volume was up 15%, price was up 1% and mix was up 1%. Foreign exchange had a positive 4% impact to revenue growth. Refrigeration segment profit was $8 million in the first quarter compared to $1 million in the prior quarter. Segment margin was 6.3%, up 560 basis points. Segment profit was primarily impacted by higher volume, favorable price and mix, lower material costs and higher factory productivity. Higher SG&A was a partial offset. Regarding special items in the first quarter, the company had net after tax charges of $2.7 million. That included a $2 million net charge for other tax items, a $1.9 million net charge in total for various other items and a $1.2 million benefit for excess tax benefits from share-based compensation. Corporate expenses were $16 million in the first quarter compared to $14 million in the prior quarter. Overall, SG&A was $145 million compared to $131 million in the prior quarter. SG&A was down as a percent of revenue to 15.6% from 18.1% in the prior quarter. In the first quarter, the company used $18 million in cash from operations compared to a usage of $99 million in the prior quarter. Capital expenditures were approximately $24 million in the first quarter and in the prior quarter. Free cash flow was a negative $42 million in the first quarter compared to a negative $123 million in the prior quarter. The company paid approximately $30 million in dividends in the quarter and repurchased $200 million of stock. Total debt was $1.17 billion at the end of the first quarter. And we ended the quarter with a debt to EBITDA ratio of 1.8. Cash, cash equivalents and short-term investments were $40 million at the end of the first quarter. Now before I turn it over to Q&A, I'll review current market assumptions and our updated guidance points for 2021. We now expect the industry to see high single digit shipment growth in residential, commercial unitary and refrigeration markets in North America for the full year, up from our prior assumption of mid single digit growth in these end markets. For the company, we are raising guidance for 2021 revenue growth from a 4% to 8% range to a new range of 7% to 11%, and we still expect foreign exchange to be neutral to revenue for the full year. We are raising guidance for 2021 GAAP EPS from continuing operations from a range of $10.55 to $11.15 to a new range of $11.33 to $11.93. And we are raising our 2021 adjusted EPS from continuing operations from $10.55 to $11.15 to a new range of $11.40 to $12. Now, let me run through the key points in our guidance assumptions and the puts and takes for 2021. First, for the items that are changing. We have announced a second round of price increases and now expect a benefit of $90 million in price for the year, up from our prior guidance of $50 million. We now expect residential mix of $10 million, up from our prior guidance for neutral mix. We expect a benefit of $15 million from sourcing and engineering led cost reduction actions, down from our prior guidance of $25 million. And this change reflects inflationary pressures from suppliers. For commodities, we now expect a $55 million headwind, up from our prior guidance of $30 million. Corporate expenses are now expected to be approximately $95 million, up from prior guidance of $90 million, primarily due to higher incentive compensation. And now for the guidance items that remain the same. We still expect a $20 million benefit from factory productivity with 30 new Lennox stores planned for this year will be at a more normal run rate with distribution investments compared to last year. Freight is still expected to be a $5 million headwind and tariffs are also expected to be a $5 million headwind. We are planning for SG&A to be up approximately 7% for the year or a headwind of about $45 million. Now within SG&A, we are making investments in R&D and our IT for continued innovation and leadership in products, controls, e-commerce and factory automation and productivity. A few other guidance points. We still expect neutral foreign exchange. We still expect interest in pension expense to be approximately $35 million. We continue to expect an effective tax rate of approximately 21% on an adjusted basis for the full year. We are still planning capital expenditures to be approximately $135 million this year, about $30 million of which is for the third plant at our campus in Mexico. We expect construction to be completed at the end of 2021 and have the plant fully operational by mid 2022. And we expect nearly $10 million in annual savings from the third plant. Free cash flow is now targeted to be approximately $375 million for the full year, up from prior guidance of approximately $325 million on the strong earnings performance in the first quarter and our current outlook. And finally, we still expect the weighted average diluted share count for the full year to be between 37 million shares to 38 million shares, which incorporates our plans to repurchase $400 million of stock this year. And with that, let's go to Q&A.

Operator provided instructions on how to use the conference call functionality. Our first question is from Jeff Hammond from KeyBanc Capital Markets. Please go ahead.

Hi. Good morning, guys.

Hi, Jeff.

Good to see you back on the offensive. Just on mix, it seems like kind of Tale of Two Cities here with residential mix really good and commercial negative. Just kind of explain what was going on there and how you see that persisting going forward? I know you raised the mix guidance.

For residential, it’s just a positive benefit from the premium product. We're seeing traction on the new furnace line that we launched, which is our premium product now part of the ultimate comfort and we're coming out with 26-year residential units. So we feel good about the mix and we saw that in the quarter. I wouldn't read too much into commercial. That just has to do with the lumpiness of customers in the quarter. So we feel good about mix full year for commercial.

Okay. It looks like the incrementals were a little better than your run rate. Can you talk about what went right in the quarter and how you're thinking about the moving pieces of price and cost and their incremental impact into the selling season?

The things we did well was we managed the factories in the face of lots of pressures on the supply chain and on labor because of COVID, managed the factories well. We executed on MCR. But there's some timing involved here obviously, Jeff, as you know. That's why you asked the question. We're getting the benefit of the price increase and we're getting benefit of lapping the SG&A cuts that we did in April of last year. But we don't have the full inflationary pressure set of commodities and components in the numbers yet. So the incrementals will soften as we go through the year, but it will still be overall for a full year basis nice, but they won't be as strong as they are in first quarter balance of the year.

Where do you think price-cost will be the biggest challenge, timing-wise? Will that kick in during the second quarter or later?

It will be second half of the year; third, fourth quarter.

Second half of the year, okay. Thanks. I’ll get back in queue.

And our next question is from the line of Tommy Moll with Stephens. Please go ahead.

Good morning and thank you for taking my questions.

Good morning, Tommy.

Hi, Tommy.

Todd, I wanted to start on the residential market, specifically on your comment back on offense, good to hear. So I wanted to ask what levers you've pulled in the business behind that strategy. You mentioned a couple of points, distribution among them. But what specific changes to the business or the strategy would you call out? And then as you look to the full year, just bridging from Lennox to the industry, it sounds like the outlook for units now went from mid to high singles. Should we think about Lennox is in line there, maybe outperforming or too early to tell for the full year?

Well, we're certainly expecting to outperform the market. I'll answer that question first. We raised the market outlook from mid to high for residential and for the other end markets. Our goal is always to gain share, and we certainly have been gaining share and expect to do that for the full year. Being back on the offense feels like a long time coming. Since mid‑2018 we had a tornado, then the pandemic, and we were stalled on driving new business. Coming out of the tornado in 2019, right before the pandemic hit, we had won back the dealers and were gaining their business, and that creates a multiyear effect. You start to get the flywheel going on new business development, which really helps. We've had strong momentum in our Allied business, where it's not signing up dealers but signing up distributors. It also continues to be the flywheel effect of investments we keep making in digital, our e-commerce initiatives, and our ability to support dealer contractors with our control systems. We continue to invest in product. Our residential dealers are excited by our new ultimate home comfort system and our new heat pump products. We have a full product lineup, we're making significant investments to make it even better, and we're seeing the benefits of that.

Thank you, Todd. That's all helpful. One quick follow up on the stores. It sounds like 30 is still the number for this year. Rough timing you could give us on when you think you'll execute through that plan? And just given the strength to the market at least through one quarter, any potential that number might go higher?

I don't know if the number will go higher just in terms of the lead time to find the real estate to put it in place. And the majority of the stores are second half of the year. We put a handful in first quarter. We'll put some in second quarter. But it's really third and fourth quarters once we get through the summer selling season that we really start to stack up the stores.

Great. Thank you. I’ll turn it back.

Thanks.

Our next question is from the line of Stephen Volkmann with Jefferies. Please go ahead.

Great. Good morning, guys. Todd, can I just ask you to give us a little more on sort of the shift a little bit toward the first half from the second half? The 55% in the first half now, it used to be 50%. Is that all kind of Allied or distributor channels or anything in commercial that might be moving that at all?

No, it's not commercial. A large part of it's the Allied reshuffling and that's sort of best expectations.

Okay. Thanks. And then you talked about the K-12 opportunity. It seems like that's taking off. What are you actually seeing those guys doing? Are they upsizing systems? Are they putting in just more indoor air quality or what exactly is driving that growth?

It's replacement. So I think about it as replacement rather than new systems. They have older systems and are now comfortable that they'll have financing and available capital to upgrade them, so they're doing that. They're talking a lot about indoor air quality, but that really isn't what moves the needle. What moves the needle is replacing the entire system, which provides better efficiency and better ventilation and therefore better indoor air quality.

Great. I appreciate it. Thank you.

Thanks.

Next, we’ll go to Julian Mitchell with Barclays. Please go ahead.

Hi. Good morning. I wanted to circle back on earnings seasonality. I think your guidance implies, at the high end, around $5.40 of EPS for the second half. Last year the second half was about $1 higher. Could you help us understand year‑over‑year how that dollar decline breaks out — how much is just residential volume versus a broader price and cost headwind firm‑wide? You mentioned a days sales impact; are there any other factors I haven't captured?

If I were to put them in order, I think it would be inflationary pressure on commodities, then the days impact. I also understand there are a lot of questions, and rightfully so, about what we're doing with full-year guidance. As you know, Julian, I've been doing this for 14 years. I don't think I've ever raised guidance after the first quarter. Yet we raised guidance by $0.85 for the full year after the first quarter. I said I'd never ever do that, and we did. Let's get through the second quarter, then we'll have a clearer view of what we should do for full-year guidance. Obviously, our guidance stands right now, but after the second quarter I think we'll have a clearer view of the second half of the year.

Fair enough. Thank you. And maybe just to switch to commercial for a second, you mentioned the replacement activity in the education vertical just now but it was interesting to see the high single digit revenue growth in new construction in commercial in Q1. I think that’s surprising for people given all the macro data on the U.S. non-residential market starts and so forth. So maybe help us understand what drove that new construction growth in the quarter, and how you see that new construction growth in commercial over the balance of the year?

Again, not to get too hung up on the math of things, you make the adjustment for days, it's low single digits. It's a good number. It's not quite impressive as high single digits. And then it was multiple verticals. It certainly wasn't K-12. It was some of our retail customers. But maybe the largest driver was the distribution customers, people like Amazon, building new distribution.

Got it. Thank you very much.

Thanks.

Next, we’ll go to the line of Jeff Sprague with Vertical Research. Please go ahead.

Thank you. Good morning, everyone.

Hi, Jeff.

Todd, I missed a little bit at the open, but did you also comment on kind of the margin impact of kind of the revenue pull forward and if there's any kind of distortive effects on the margins in residential, in particular?

I did, but short answer there really isn't. The revenue would have dropped through on the normal margin line. So when I think about the margin expansion in residential, I would hang my hat on the pool. I quite frankly would hang my hat on factory productivity, the SG&A cuts that we took at the end of last year, the ability to get price, and the fact that commodities and inflationary pressures haven’t worked their way into the numbers, Jeff.

And just thinking about the price given the inflationary pressure, it sounds like there's talk of kind of round two actions this year and some of those are out in the market I think already. But what do you see the kind of the likelihood of kind of a second bite of the apple one price and any kind of pushback in the channel on that?

I think the second bite’s already taken place, Jeff. We announced a second price increase effective June 1. Trane announced a second price increase, Daikin announced a second price increase, Rheem announced a second price increase, Goodman announced a second price increase, and Carrier businesses announced a second price increase. So we've all announced second price increases. And we feel, as you know, we have given price to offset commodities as recently as 2018 and 2019. We got about 2% in price and we're taking a little bit more this year, but inflationary pressures are greater this year. So we feel pretty good about the price increases.

Great. Thanks. I'll leave it there.

Thanks.

And your next question is from the line of Nicole DeBlase with Deutsche Bank. Please go ahead.

Good morning.

Good morning, Nicole.

Hi, Nicole.

So Todd, you kind of alluded to some challenges on the supply chain side. Could you just provide a little bit more color on what you’re seeing and what the bottlenecks are, and I guess the level of concern as we see disruptions?

Yes. The highest-level message I would give is that, as you can see from our Q1 performance, we're delivering a lot of product and we're set up to deliver a lot in Q2. Our customers tell us they think we're as good as or in better shape than anyone else in the industry. The areas we're wrestling with, and that I think everyone in our industry and much of corporate America is wrestling with, are integrated circuits—both in our own control systems and in components we buy. Steel, resin and other raw commodities are under some pressure to ensure supply. Since the pandemic started over a year ago, the hopscotch of hotspots around the globe has put pressure on supply chains. Right now we think that's largely behind us because we don't source much from India, but when Mexico had problems we had issues, and when the U.S. had problems we had issues. The final piece, which we’ve talked about over the years, went away last year and is now back: a shortage of direct labor in our factories and in our suppliers’ factories. Making sure we have enough workers to meet this high demand is something we continue to work through. Employment has snapped back nicely. I'm supportive of the President's policies and I'm a Democrat, but I would observe that when you pay people to stay at home, they're less likely to come to work, and we continue to wrestle with that.

Got it. Thanks, Todd. That's really helpful. And I guess just one follow up a little bit about channel inventory and how you're positioned as we move into the summer selling season, maybe how that compares to last year?

Yes. We think we're in really good position, as you know, but I'll say it for others on the phone call, 80% of our business is Lennox residential. And there that's when the homeowner decides to buy a product, the dealer replenishes the stock. And so we sort of have direct sell-through almost to the end customer. So dealers aren’t carrying inventory. I saw one sell-side analyst note that suggested maybe because of price increases, homeowners were deciding to preemptively replace their systems. Ain't no way that's happening. People aren't going to do that because of a 2% price increase. For the portion of the market that we sell independent distribution, we talked about the $25 million pull forward. And we got that number broadly speaking by talking to our distributors understanding their inventory levels, and so one way of thinking about it is inventory levels are $25 million higher than last year. At this point in time it’s a pull-forward inventory.

Got it. Thanks, Todd. I’ll pass it on.

Thanks.

And next we’ll go to the line of Joe Ritchie with Goldman Sachs. Please go ahead.

Hi. Good morning, guys.

Good morning, Joe.

So Todd, maybe my first question just starting on just the growth outlook for the rest of the year, if I think about the second quarter if we resi for Q1, you still come up against the easiest comp in 2Q. And it sounds like the backlog trends are really good. So is there any reason why like the second quarter growth number can't be as good as you put up in Q1, again, kind of normalizing for the residential days and the inventory portfolio?

We're set up to have a strong second quarter. I hate hypotheticals or giving reasons why we might not; yes, I can list reasons, but we're set up for a strong second quarter and we obviously just need to execute.

Got it. And then just like talking through the comments you made earlier, I think to Julian's question around the guidance, it's just too early for you guys to take up the back half guide at this point. But as you see today, things seem really good. And the 7% to 11% looks like a beatable number at this point, it looks conservative.

So let's try nuances. The guide’s the guide, number one. So the guide’s the guide. But as I said earlier, we never raise after first quarter. We raised $0.85 cents. I’ve learned many things since the tornado and the pandemic is things can change quickly. If we stay on the trend line we are in North America, because we're a North America business that we've looked the pandemic and we're back to normal economy with all the government investments in the economy. I have a nice run for a couple of years in all three of our businesses and we're prepared for that. So we feel good about 2021. Quite frankly, I feel good about 2022. But the guide’s the guide is I guess the short answer.

Yes, I don't mean to back you in but that makes a lot of sense. I guess one last one is just thinking through this: you mentioned the pull forward on the Allied side of the business this quarter. Do you think there are any dynamics with the pricing that are going into effect in June, where you continue to see stronger demand ahead of the June pricing increases?

I think there may be some effects. Distributors right now want to make sure they have enough to get through the summer selling season, and they're going to pay what they need to make that happen. So I think there will be some pull forward. But again, given the demand levels we're at, we may not have all the product when they want to load the barns early; they may just have the product when they need it. We'll continue to work through what will happen and there may be some pull forward. But again, that's 20% of our business, and I don't think it'll be a material impact to us.

Got it. Nice quarter, guys. Thank you.

Thanks.

And next we’ll go to John Walsh with Credit Suisse. Please go ahead.

Hi. Good morning.

Hi, John.

I was just wondering — you mentioned heat pumps earlier. I wanted to get your sense of where your capacity is for this product, and whether you might be spending any CapEx to increase production of heat pumps in particular?

We can always continue to manage capacity versus demand. And we make them on the same line. So when we talk about adding a third factory in Saltillo, that's adding overall capacity to heat pumps and every other product line that we do. So heat pump continues to be a growing market for us. We came out with a cold-weather heat pump that allows us to play north of the Mason-Dixon line, be very competitive in northern climates and we think that's a growing market. And I would have said five years ago, we lagged the competitors in our heat pump offering. I'd say now we're on par with the big boys — Carrier and Trane — and further ahead of our other competitors. And so we like that market and we're well positioned to compete there.

Great. And then just maybe a second question here on capital allocation, taking up the free cash flow, taking up your share repo, should we think that the majority of the excess cash goes to buy back stock or might there be anything in terms of M&A bolt-on or otherwise we should be thinking about?

Yes, I'm not breaking any news. I would think about it and I'll say for others, I know you know this is we don't want to delever. So we'll do something with the cash. And we'll have dividends grow with earnings. And we will invest in the business. And we'll do type of M&A we've spoken about, but we've done one deal of any size since I've been here and then the balance will give back a share buyback.

Great. Thank you for taking the questions.

Thanks.

Our next question is from the line of Nigel Coe with Wolfe Research. Please go ahead.

Thanks. Good morning, Todd.

Hi, Nigel.

So I think I've got the numbers, the underlying numbers for Allied is plus 35% ex the days and ex the $25 million. Just to be clear. The $25 million, is that the full extent of the inventory restock dynamic or is there some inventory restock within the plus 35% as well?

The $25 million is our best guess at the extent to the inventory. The 35% is ex any pre-buy.

Okay. So plus 35% is kind of an apples-for-apples, this is basically dealer market share gains, not inventory stock dynamics going on there.

It is. The 35 versus say the 15 or that I said was sell-through, the difference is we're winning new distributors. And when you win new distributors, you have a big sort of wash of volume that flows through your business. So it's not necessarily winning at the dealer level, it's winning at the distributor level. We're converting dealers from our competitors. And when we convert them, we get a slug of new volume.

Okay, that’s fair. And then your inventory levels, I think $502 million at the end of the quarter, definitely a lot lower than what you'd normally have. And you answered Nicole’s question very well on supply chain, but I'm just curious, all things being equal, is that low level of inventory, is that caused by just a surge in demand and then therefore completion of end equipments or was it some of the pricing constraints that meant you weren't able to replenish your inventory. Just curious in terms of what caused that level of inventory to be so low and your confidence in sort of rebuilding those levels?

It’s primarily the demand. Look, I knew we were out first quarter. I didn't think resi was going to be up 37% six months ago. And so I think that's a primary issue. And then once you see the white of their eyes, if you will, and you see the demand rising, then you try and ramp up production to catch up with it. And then when you start to ramp up production, then you run into some of the issues that I talked about, which is if you're going to try and raise production 50%, 60% to get ahead of everything, then you run into integrated circuits and you're running away, but then you run into other things. So, look, I've said we're doing as well or better than anyone in the industry. But everyone, when you have this kind of demand levels, you're sort of not grinding gears, but you're running hot. And we're running hot.

Right. Okay. Thanks, Todd.

Thanks.

Next question is from the line of Ryan Merkel with William Blair. Please go ahead.

Hi. Thanks for fitting me in. So first off, you mentioned K-12 and the good outlook there. If everything goes well with the stimulus money, what kind of growth rates could you see from K-12 the next couple of years?

I understand the question. I'll be honest with you. We haven't really modeled it in any great detail. I've seen some of the sell-side notes, including yours, sort of take cracks at it. We think it could be a material opportunity for us and I know people are modeling it externally. I just want to give the number that's about 10% of our segment revenue. And so whatever growth rate others are modeling looking at the stimulus number, 10% of our business will grow at that same speed.

Okay, that's helpful. And then just talk about the residential new construction outlook, any signs of moderation or just full steam ahead there?

I think it's full steam ahead. I think the only moderation is trades. The employment issues I spoke about, it impacts builders also. And then inflationary pressures, but I don't think inflationary pressures will slow things down right now. I think people need homes. And there's not much inventory on used or existing homes right now. And so builders are trying to build. We feel pretty good about new construction for the balance of the year.

Got it. Thanks.

Thanks.

And next is from the line of Josh Pokrzywinski with Morgan Stanley. Please go ahead.

Hi. Good morning, guys.

Good morning, Josh.

Todd, just on the mix front, I guess that number stood out to me on residential that it was plus 4, even with all that strong growth in Allied. I would imagine you have some sort of long-term model of like how much the industry should mix up or homeowners kind of buy up on features or SEER in a given year. Did we just jump like several years forward, like what's going on there? And how much ahead of where you would have been in recent years are we today on that mix dynamic?

I wouldn't read too much into long-term macro. What I would note is our highest-margin business benefited: after a warm winter last year and a cold winter this year, furnace sales likely grew the most. I don't have exact numbers, but furnace sales grew strongly in the quarter and helped our mix. I think that's the biggest driver. That, plus the launch of some new products, has helped. That said, saying we'll be up about $10 million in mix for the full year is a fairly normal guide. The bigger question is why we guided to flat mix for the full year in residential. We guided flat because of uncertainty around the pandemic and whether consumers would stick to entry-level products due to economic concerns. That uncertainty is behind us now, and we feel confident about the full year.

Got it. And then I guess, just thinking about entering the selling season here, the first quarter, I don't know, isn't really indicative of much, but we're through April at this point. When does the industry, whether dealers or independent distributors, even though they don't represent the bulk of the business, decide they're ready? Are they still positioning inventory and deciding what price level they want to be stocked at right now, or are they saying they're ready to go for the season?

And again, you know this, Josh. I'll say for others, 80% of our business we're selling to dealers. They don't think that way; they're not stocking up inventory or preparing in advance. They see demand, they sell it, and they buy some more. Some may have about a week of inventory; well-capitalized dealers may have a couple of weeks, but that's not how it works. For independent distributors, order rates remain strong. They still want inventory and they're still selling product right now, and homeowner demand remains high. They're coming out of a very good first quarter and they want more inventory, and we're selling it to them.

Got it, that's helpful. I apologize, I’m just going to try to squeeze in one more. The Allied color that you said where a lot of that growth is new distributors, any sense on kind of same-store growth within Allied versus the contribution from new customers there?

Yes, I don't have a map in front of me because I tend not to think about same stores. I know our internal people do within those businesses. I don't have that number in front of me. We're also focused on existing distributors, getting them to grow. My guess would be the existing distributors who were selling to dealers, they were buying at 15%, 20% also, if that's what the end markets were growing.

Got it, that’s helpful. Thanks.

Thanks.

Our next question is from the line of Gautam Khanna with Cowen. Please go ahead.

Thanks. Good morning, guys.

Hi, Gautam. How are you?

Doing well, thanks. Two questions. First, on the commercial side, I was wondering, Todd, if you could maybe give us some perspective on how quickly the deferred replacement from last year, with the commercial market down nearly 20%, how quickly that catches up and how much of it catches on?

Yes. Our experience here after the financial crisis, and in my experience — I was at Carrier after 9/11 — is that it is like a marble rolling off the table and plan replacement goes down dramatically. At the trough last year, we were down 50 to 60 percent year-over-year on plan replacement, and then it comes back strongly. My experience is it takes 18 to 24 months for it all to come back. So over the next 18 to 24 months, assuming the environment remains benign as I suggested, I would expect all the demand we missed during that time period, the pent-up demand, to come back, plus the normal plan replacement that was scheduled during the same time period. That’s why we’re pretty optimistic on the commercial end markets for the next 18 to 24 months.

Got it. In fact, that math would suggest the guidance might be a little low. I'm recognizing nobody knows. Okay. And then just secondly on residential, I was curious, did any competitors have any issues, production issues, COVID outbreaks, whatever that may have benefited Lennox's results that might be nonrecurring? We saw the Tyler roof collapse at Trane. Goodman had issues last year. Just wondering if anything stood out to you one way or the other?

Yes. Our competitors – or better stated, Steve always gets worried when I bash competitors too much. So I actually have in my notes to say you can ask them. But I won't listen to Steve. I'll give a little bit more color. Look, our competitors had issues. When we talk to our customers, we hear about JCI having issues, we hear about Goodman still having issues. And again, I don't think about that as a one-off thing. I think it's when they aren't able to provide support, we step in and we win it, either by signing up new distributors who convert over to us in our Allied business or we win with our own dealers in the marketplace. So the competitors’ dealers can't sell product, our dealers can. We win share, we win. And that's not a one-time thing. We sort of get it and we keep it and we keep moving.

I appreciate you not sticking to the script on that. Thank you very much.

Thanks.

And we have a question from the line of Chris Dankert with Longbow Research. Please go ahead.

Hi. Good morning, Todd. Just thinking about R&D priorities, I guess where is the investment focus at the moment? Is it still controls and user experience? Is it efficiency? Is it footprint and noise reduction? I guess when you think about where you want to see the team’s prioritizing investment, kind of any rank order there, any thoughts on the targeting of that spend?

Yes. I think you said some of them. I think number one is digitization of the business. We continue to make significant investments, both in product, on controls, but also significant investments in the e-commerce in the back end of the business and so significant investments. And we continue to make those investments, and that's driving the productivity in part that you see in our numbers. We continue to make investments in what I would call environmental sustainable product, and so having industry-leading energy efficiency. As we go through a refrigerant change that we're going to see over the next few years to lead the industry there and do it in the most effective and cost-effective manner to lower our greenhouse gas emissions is important. I think those are probably the two big areas, right? It's about digitization of the business and environmental sustainability of our product line. Those are the areas.

Got it. Yes, thanks so much for the color there. And again, second question, forgive me if you commented on this in the past, but thinking about the Mexico facility, will there be kind of a flexible construction to it in terms of will you have the ability to build everything from entry level on up to the high-end series there, or is it a little bit more focused?

We don't quite build everything there. There are certain products that we only build in Marshalltown and some products that we only build in Orangeburg or in our Grenada, Mississippi factory. But we continue to build our capabilities in Mexico; started as cooling, then went to furnace, then it was just entry level. Now it continues to be almost the full product line. So we continue to develop our capabilities in our Mexico facility.

Got it, makes sense. Just thinking about how having that ability to deflect the need was really brought to the fore just a couple of years ago. So thanks for the color. I appreciate it.

Yes. And quite frankly, it's been brought to the fore right now. I think one of the ways we're able to battle some of these issues around labor and absenteeism because of COVID is that we have multiple factories with significant overlap in what they produce, and we're able to meet demand.

Absolutely.

Thanks.

And our next question is from Steve Tusa with JPMorgan. Please go ahead.

Hi, guys. Thanks for squeezing me in.

Good morning, Steve.

I was just checking all the inventory in my garage. I have a bunch of different HVAC systems in my garage sitting there. I'm going to sell them for a higher price.

And my guess is they're probably Trane and Carrier.

Definitely not, JCI. So you mentioned that the Carrier businesses have gone out with price increases. Have you seen that across all their brands?

What I have in front of me is we've seen it in the ICP brands.

Carrier announced also, Todd.

Carrier announced also? Yes. So Steve's helping me. He's in a different room for security reasons. But yes, so we've seen it in the Carrier brand also. So we've seen it in all our major competitors.

Okay, got you. And then how do you kind of expect the monthlies to play out in the second quarter?

I think as you'd expect, right? So May was the nadir last year for the businesses. And so April will be up, May will be up. And I think June will be up. And again, it depends on the business, quite frankly. Residential didn't go as deep and came back relatively quickly. The commercial and refrigeration business was deep and stayed deep and didn't really start to come back until fourth quarter.

Right. And I guess for sales in the second quarter, you mentioned the 55% EPS seasonality. Can you just maybe update us on what you expect kind of from a sales seasonality perspective on that front, whether it's residential or the total company?

No. I quite frankly don't have it in front of me. I'm not going to give the revenue guide. We just want to give the EPS guide.

Okay. And then just one last one. How much, I guess 2.5% of price for the total company, how much in residential should we assume a tick above that in residential, something in kind of the 3.5% range?

No. I think if I was modeling, because we don't give segment price guide, I would assume 2.5% across the board.

Okay.

Residential is two-thirds of our business. So we give a guide and we don't delineate it then. I just assume residential is our guide.

I don't think you guys have — that's kind of like a record price number year-over-year, at least the data I have looking back 10 years, right? That's a pretty decent sized number looking back historically.

We did $71 million in 2019. We did $72 million in 2018. Steve did have the number that went back I think in 2011, 2012 as a percentage because we were a lot smaller back then. I think we did close to 2.5%. But yes, we've done 2% as recent as twice, two years in a row. I would tell you the inflationary pressure people see and the headlines that they have on it and all our competitors are feeling is unlike anything I've seen, because it's just not in commodities. It's sort of across the board. And better stated, it's just not raw copper, steel and aluminum. It's across the board because everyone sort of has what I would call a COVID surcharge of inefficiencies that they’re trying to pass on. So I feel very confident we'll pass it on. And again, the homeowner, it's opaque to them. They get a new unit once every 15 years, and half the price is labor and half is equipment. And so whether it's 2% or 2.5%, it doesn't matter. The question is, are competitors doing the same thing? And it looks like they are.

And you're sure that there's no – you haven't heard any anecdotes about contractors not necessarily saying, hey, your price is going to go up 2% if you don't replace it today. But that they're saying last year, there were real availability concerns. The industry is extremely tight. There's a new regulation coming in a couple of years from now. You don't think any of those conversations are going on at the kitchen table?

I think those conversations always take place at the kitchen table. So the way it works is there's a catastrophic failure. Compressor breaks, $3,000 to replace the compressor. The homeowner says, I'm not going to spend $6,000 for a new system. I'll just replace the compressor. You don't want to do that, and here's the seven reasons why you don't want to do that. Those are always conversations that take place. My point is, there isn't a bad thermostat software issue that you go to the home and fix that and the system is working fine. You say, you should get a new system because there's a 2.5% price increase. That ain't never happening. What happens is if there's a catastrophic failure, there's a conversation. And I don't think so; there's price increases every year, there's refrigerant changes, there's minimum efficiency changes. All of that takes place year after year after year. And whether it's a 2% price increase or a 2.5% price increase doesn't change that conversation. So the answer is no.

Yes. I don't think it's the price. I would say availability is a bit more of a buzzword and a hot button issue these days than it's been in the past, but fair point.

Our dealers have product. So they have it.

Right. All right. Thanks a lot, guys. I appreciate the details as always.

Thanks.

And with no further questions, Mr. Bluedorn, I'll turn it back to you for any closing comments.

Thanks. To wrap up, 2021 is off to a strong start and momentum continues in the second quarter. The company is executing well to capitalize on market growth and share gain opportunities and we look forward to a year of strong growth and profitability. Thanks again everyone for joining us today.

Ladies and gentlemen, that does conclude your conference for today. Thank you for your participation. You may now disconnect.