Ladies and gentlemen, thank you for standing by. Welcome to the Lennox International Second Quarter 2018 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. 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 second quarter of 2018. I am 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. 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 unless otherwise noted. You can find a direct link to the webcast of today's conference call on our website at www.lennoxinternational.com. The webcast will be archived on that 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, Steve. Good morning, everyone, and thank you all for joining us. Lennox International posted a record quarter in the second quarter of 2018 with new highs set for revenue, total segment margin and profit, and adjusted EPS from continuing operations. Revenue on a GAAP basis was a record $1.18 billion, up 7% on an adjusted basis excluding non-core refrigeration businesses in Australia, Asia and South America that are being divested in 2018; revenue was up 9% to a record $1.16 billion. Foreign exchange was a 1% benefit to revenue. On a GAAP basis, operating income was a record $195 million in the second quarter up 11%. GAAP EPS from continuing operations was a record $3.39 up 25%. On an adjusted basis, total segment profit rose 13% to record $206 million. Total segment margin expanded 50 basis points to a record 17.8%, and adjusted EPS from continuing operations rose 30% to a $3.67. Turning to the key points on our business segments for the second quarter, residential set new records for revenue and profit. At constant currency, revenue was up 9%. Revenue from replacement business was up 10% and new construction was up high-single-digits. Residential segment profit rose 9% and segment margin remained at a record level of 21.5% of a year ago. Turning to commercial, revenue and profit also hit new highs in the second quarter. Commercial revenue was up 12% at constant currency. Segment profit was up 18%, as margin expanded 70 basis points to 18%. In North America, at constant currency, commercial equipment revenue was up low-double-digits for the quarter, replacement revenue was up high-single-digits and new construction revenue was up high teens. Looking at the equipment business another way, national account revenue was up low-double-digits and regional and local revenue was up high teens. On the…

Thank you, Todd. 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 second quarter, revenue from Residential Heating and Cooling was a record $716 million, up 10%. Volume was up 8%, price was up 2% and mix was down 1%. Foreign exchange had a positive 1% impact on revenue. Residential profit was a record $154 million, up 9%. Segment margin remained at a record 21.5% level. Segment profit was positively impacted by higher volume, higher price, sourcing and engineering-led cost reductions, lower SG&A expenses and favorable foreign exchange. Offsets included unfavorable mix, higher commodity and freight costs, distribution investments and higher other product costs. Residential also had a smaller favorable annual warranty adjustment this quarter than in the prior quarter – prior year quarter, which resulted in a $2 million headwind year-over-year. Now turning to our Commercial Heating and Cooling business. Commercial revenue was a record $292 million, up 13%, volume was up 10%, price was up 2% and mix was flat. Foreign exchange had a positive 1% impact on revenue. North America commercial HVAC equipment revenue was up mid-teens. National account services revenue was up more than 25%, Europe commercial HVAC revenue was down mid-single-digits. Commercial segment profit was a record $53 million, up 18%. Segment margin was 18%, up 70 basis points. Segment profit was positively impacted by higher volume, higher price, sourcing and engineering-led cost reductions, and favorable warranty adjustment. Partial offsets included unfavorable mix, higher commodity and freight costs and higher other product costs. In our Refrigeration segment which excludes the non-core businesses in Australia, Asia and South America being divested in 2018, revenue in the second quarter was $150 million, up 2%. Volume was up 1%, price was…

[Operator Instructions] And our first question will come from the line of Jeff Hammond with KeyBanc Capital Markets. Your line is open.

Hey, good morning guys.

Hey Jeff.

Good morning, Jeff.

Hey, just a couple questions on residential, one, did you see any pre-buy in your allied brands, and two, can you just speak to the negative mix dynamics?

On the pre-buy, it’s always hard to know, but our guess is zero to 10 million of pre-buy across all the brands. On the residential margins, as we said in the call, it’s 21.5, a record levels. Our first price increase that we put in at the end of last year was to offset the headwind from commodities and we did that in the quarter. But in Q2, residential also had $4 million of headwind from freight rate increases. The mid-June price increase will offset the headwind from both commodities and freight and we will be better positioned for margin expansion in the second half of the year with residential.

Okay, and then, can you just – so it seems like the incremental costs are really freight and then this tariff dynamic, can you speak? What are you seeing on the tariff specifically? Is that sourcing motors, et cetera?

Yes, the short answer is, yes. It’s the 301, the one that came out that’s already been implemented plus the – our best understanding of the 200 – excuse me, $36 billion or $34 billion that’s already been implemented and then the $200 billion that’s going to be implemented. Our sort of best understanding of the future, one, plus our current understanding of the one that’s already been implemented for this year about $5 million headwind. And then, yes, it’s primarily motors and electronics and to a lesser degree some of our controls from [indiscernible].

Okay, thanks guys. I’ll get back in queue.

Thank you. Our next question comes from the line of Tim Wojs with Baird. Your line is open.

Hey guys. Good morning. Nice job.

Thanks, Tim.

Thank you.

Hey. So, just on mix, in residential it looks like the new construction and R&R markets grew kind of similar rates. So just kind of curious what you are seeing in terms of mix? Are you seeing any sort of trade-down within R&R around the price increases?

No, no. I mean, we continue to see within each of the segments sort of the natural mix up and that continues to be the case. And so, no, we haven’t – it’s sort of the opposite when people know that price increase is happening, they’ll do the preload plans that we’ve put in place and those tend to be a richer mix. So, no, I mean, we haven’t seen any push back on the price.

Okay. And then, just on raw materials, I know you are mostly hedged for this year. But any flexibility to hedge more now that copper and aluminum have moved the largest as you look into 2019?

We have a – I think the right word will be thoughtful hedge strategy where we have a band and [indiscernible] be the middle of the band to high-end or the low-end of the band and we have rules in place that we react to it. So, we are not commodity speculators, but we try and react to drops in the market.

Okay, great. Good luck on the rest of the year.

Thanks.

Thank you. Our next question comes from the line of Ryan Merkel with William Blair. Your line is open.

Hey, thanks. Good morning everyone.

Hey, Ryan.

Hey, Ryan.

So, first on incremental margins, I think you put up 23% this quarter adjusted. I think we were talking about 30% for the year, but is that still in the cards and why or why not?

I think if you take the midpoint of our guide, we are a little bit below 30% and I think the thing that we’ve seen is, first half of the year, we were chasing freight and chasing the tariffs and we’ve now put in place the price increase. I think second half of the year, we’ll probably be closer to 30% on a full year basis, we’ll probably be a little bit below it.

Okay. And then, secondly on price cost, it sounds like in the second half you expect the spread to be a little bit better, but just clarify that for me if you would.

I think what we are saying, again, to repeat is, what we saw in second quarter was, if you added freight of $6 million to the commodity increase year-over-year, it was greater than what we got with price, because the first price increase was really focused on just offsetting commodities. Second price increase will help us offset the freight. And so, for the balance of the year, while we are guiding – or on a full year basis, we are guiding $75 million of price headwind of $50 million from commodities, $20 million from freight and $5 million from tariff. So, on a full year basis, we’ll offset everything. First half of the year we weren’t able to offset freight. So second half of the year should be positive.

Got it. And then, just lastly, you mentioned July is off to a good start. Can we just get a few more details in terms of the growth rate and any segment color?

I am not going to give the exact growth rate. It’s just – I mean, you all can read a weather map and when it’s just hot it helps us quite a bit. So, it’s early, but July is off to a nice start. We also had a nice backlog in our commercial businesses both commercial HVAC and Refrigeration in North America. For the quarter – or for the third quarter July and August are about 30% of shipments in each and in September, it’s just under 40%. So we still have a lot of work [indiscernible].

Thanks, Todd.

Thanks.

Thank you. Our next question comes from the line of Gautam Khanna with Cowen & Company. Your line is open.

Yes, thanks. Good morning guys.

Hey, Gautam, how are you?

Well, thanks. I wanted to follow-up, I thought I heard this right that national accounts service was up 25%.

Yes.

Plus, and that was on a – if I recall, a big comp from last year, right. So, what’s going on there? Can you…

We have a really good team there and we’ve – when things start to kick in on a business model, you get a really positive flywheel effect. And so, all the work that we’ve done on our national account equipment business tied into our service business and then increasingly what we are trying to do with our controls business with our icon controls, we’ve put together a nice package. We think where we have the right cost structure to go after these large national accounts who want service from us. And so, it’s a reflection of a multi-year strategy. We’ve been showing charts for four, five years saying that this is a good business for us. We want to grow it and the second quarter was nice quarter for us.

And so presumably the momentum should continue into Q3 despite the tough comps.

I think it continues, I am not sure we grow it 25% a year or 25% each quarter. But we said we are going to grow double-digits, mid-teens in this business and that’s what we’ve done the last four or five years and that’s what we expect to continue to do.

Okay. I wanted to also know if you could calibrate us on Q3 given last year you had some weather – the hurricane disruptions. Just how should we think about the incremental margins in Q3 given the price that you mentioned, either price actions plus, I don’t know if you ever had a chance to quantify what the negative drag last year was in Q3 from the hurricane disruptions?

Yes, I think we’re going to reasonably balanced around that. I don’t think we’ve bitched too much about it in the third quarter and then we haven’t promised too much coming out of it. So, I mean, it had some impact in Houston and Florida. But I don’t think it had a major impact. What we’ve said for the second half of the year is that we have price to offset commodities and freight and we should expect a better drop through second half of the year than we saw first half of the year.

Okay. Last one for me, if you will. You upped the buyback a little bit now with the proceeds from the divestitures. Could you talk a little bit about the M&A pipeline if there has been any change there?

No, I mean, the M&A pipeline we’ve been – we have the luxury of growing organically, both with end-markets that are growing and gaining share. We’ve been pretty clear that we’d want to consolidate the North America HVAC, unitary HVAC market, but others would have to decide they wanted to exit. We’ve said that, the right acquisition in Europe might make sense, but that’s not a priority for us and so, I guess, that’s consistent with what we’ve said in the past and that’s still true today.

Thanks. Great results. Congratulations.

Thanks.

Thank you. Our next question comes from the line of Nigel Coe with Wolfe Research. Your line is open.

Thanks. Good morning. Just a couple of quick questions. We covered a lot of ground here. You mentioned the Marshalltown facility. And first of all, apologies if that's all affected. What demarcations [ph] you mentioned very clearly in your PR that you got kind of measures in place, but what does this do to factory loading in 3Q in Mexico and South Carolina? And the – I am assuming there will be some freight costs explains as you rebalance the manufacturing? Would you exclude those cost in 3Q?

To just be clear about it, we are still fully assessing the extent of the damage. The manufacturing facility in Marshalltown sustained damage to sections of the roofs and the walls and portions of the manufacturing floor. Our distribution center that’s located there wasn’t damaged at all. So lot of the finished goods products ready to ship. As you said in the call, we are in action recovering operational contingency plans very early. And so, I understand your questions, but the honest answer is, we are not sure internally exactly how we are going to handle this and what we are going to do except for the point that we made in the press release that we are committed to taking care of customers and one of the luxuries of owning your own distribution is we have a lot of products in the field more than 40 days and for some of the products we produce in Marshalltown significantly more than 40 days is out in the distribution network. And so, we are going to work through it and we’ll keep investors updated as we finalize the status and progress of how we are going to respond.

Thank you. And then, just quickly - quick one on Europe. I know you are not – Europe is not a big for you, but we saw strong trends in Refrigeration. We saw weak trends in Commercial HVAC. There is a little bit of noise around European trends, but just from your perspective in your approach what are you seeing in Europe? Would you expect that market to weaken over the balance of the year?

Our HVAC business was down just because of lumpiness of a couple major customers. So, significant piece of business that we did last year didn’t repeat this year. Our Refrigeration business is up nicely. We think Western Europe is where we play predominantly. France, Spain, Germany, we think it’s going to be up low-single-digits and we think that will remain for the balance of the year. But again, I am – I always use the phrase that, we just have a small PO on this market. We serve portions of it, but the portions we are serving were cautiously optimistic for the balance of the year.

That’s great. Thanks, Todd.

Thanks.

Thank you. Our next question will come from the line of Julian Mitchell with Barclays. Your line is open.

Hi, good morning. Maybe just a question, Todd, for you, sort of during on your long experience in this industry, looking out beyond the sort of price cost gyrations week-to-week this year, when you are thinking about the typical period after you’ve had a lot of input cost inflation and price reaction by the HVAC manufacturers, how much of a carryover does that tends to be in terms of a tailwind for HVAC margins in the subsequent period once that cost inflation dies down. If you see this impact sort of historic cycles and any reasons why, say next year might be different versus history?

Well, if I understand the question right, I’d answer this way, is, once we get price, we don’t give it back and so we get price to offset commodities and then, if commodities go to home, then margins go up and we had several years where that was the case. And so, I would think about it as the price increases that we are getting in June will have round half year impact this year and then there will be carryover in the next year. And if commodities continue to rise and we’ll pass on additional price. So I think that’s how I think about it. We get price, we never give it back, commodities go up and down.

When the competitive dynamic is pretty similar now, have you seen any changes there in the recent months or quarters?

We’ve seen all our competitors announce similar price increases. Our best sense in the field is that they are implementing them and I think you can see by our results that we are certainly now losing share and my guess is we are gaining share through the first half of the year both in res and in commercial. And so, we are not giving up any market share position by implementing prices and I think our competitors are doing the same thing not gaining share, but I think our competitors are passing on price.

Thanks, and then, lastly, the gross margins were down in Q2 having been up in the first quarter. Do you think we should see them coming back in Q3 or it’s more towards the end of the year, you will get the gross margins up again?

I think I’ll take it on the round and say, we think gross margins will be up second half of the year and so what we saw in the second quarter was, for the corporation, we had about a $6 million headwind from freight that wasn’t offset by price. But the June price increase we now will be able to cover that plus commodities. So, we think second half of the year, our gross margins will start to grow again.

Great. Thank you very much.

Thanks.

Thank you. Our next question will come from the line of Rich Kwas with Wells Fargo Securities. Your line is open.

Hey, good morning everyone.

Hey, Rich.

Just on the freight thing. So, with regards – I mean, that doesn’t seem like that’s going to slowdown anytime soon. So as we think about 2019, we have to put an incremental price increase to cover what could happen as we think about 2019?

There is a couple sort of what ifs and I think I just directly answered it. We’ll keep our eyes on commodity, freight and tariffs and just like we’ve priced – at least second half of the year to offset those as we go into 2019 we’ll price to offset them too. Similar to commodities, our competitors will see freight just like we will and our competitors import the same motors and controls and electronics from China that we do. And so, short answer is, we’ll price to offset inflationary headwinds that we see.

And the current price increase that you just put through mid-year, does that cover the incremental $5 million on the tariffs over the next year?

Yes.

Okay. All right, so…

Sorry, sorry, the price increase we put in effect this year offsets the $5 million we are going to see in 2018 for the tariffs. That’s the guide I gave.

Sorry. But so then, there would have to be an incremental price increase at year-end to get in to cover would flap over impact?

Well, I think if you take a look of us guiding that from $50 million or $75 million in price, an additional $25 million coming from the mid-year price increase, I think you can sort of do the math that there is going to be significant, but carryover that price increase that I think will offset some of the commodity increases that you are talking about. Some of the tariff increases you are talking about.

Right. But on the freight standpoint, it sounds like, the likelihood of you being caught again, as we go into 2019 less, you are watching it more closely or…

We are certainly watching it more closely. I think it’s similar to what commodities do to us. Last year 2017 as they start spiking up during the middle of the year, I mean, we are going to keep our eye on it and see what happens. Unfortunately, I think tariffs and freight will move in opposite directions, right. So if tariffs goes up, maybe there won’t be quite as many freight requirements.

Right. And then, two other quick ones. On the guide for the incremental for the second half, that does not include any potential negative impacts from Marshalltown.

Yes, I think it’s trying to – the short answer is, yes. But, we are going to sort of work through and try and minimize all of that.

Right, right, right, understood. And then, just it seems like in the field, one of your value-oriented competitor is still struggling on a fulfillment standpoint. So, with the mix this quarter, was 13th year [Ph], 13/14th year [Ph] a bigger percentage of the mix that we are able to pick up some share here this quarter with a clear – what we are seeing out there?

No, I think the mix was about the same this year as it was the year ago. And I think it reflects, we are trying to gain share multiple places. I think overall, we gained share. We are competing at the low-end, but we are also ready to mix up and as I talked about, when you have these price increases and you sort of moving product out, you have a tendency to mix up.

Okay. Thanks for the color, Todd. Appreciated.

Thanks.

Thank you. And the final question will come from the line of Walter Liptak with Seaport Global. Your line is open.

Hi, thanks. Good morning.

Hey, Walter.

Wanted to ask about the tariffs and just wanted to clarify that, in your view, all the discussion about the tariff is more of a cost issue and not a supply issue. And I guess what I am trying to get at is, do you start to look at North American suppliers, especially U.S. more favorably with what’s going on with kind of trade war with China?

I think right now, it’s just a cost issue and the ground keeps moving. So we are constantly assessing what’s going on, where we are at and what’s the right play. So, depending on what happens, maybe we change our supply chain, but right now, it’s $5 million of headwind. We have good suppliers in China and we are talking to our suppliers, as Joe mentioned and I mentioned in the script about are there other options on where they can produce some of our components other than China, that will be cost advantage to us or cost advantageous to us and we continue to work through those strategies.

Okay. And then just a last one, I don’t think you talked too much about cold storage, but there is some discussion that tariffs are having an impact on meat inventories and I wonder if that it’s too soon that they are thinking about more cold storage going into the U.S.?

I am not sure we’ve seen that phenomenon, sort of play out the tariff impact more broadly. Little bit of slowdown in the first half of the year in our cold storage business and you saw a little bit in the revenue numbers in this quarter in North America where we were down in our Refrigeration business, but we have strong backlog going into the second half of the year. Cold storage has been a growth segment for us over the last two or three years and after slowing down a little bit in the first half. We are pretty optimistic second half, I don’t think that has anything to do with tariff, but I think that’s just longer-term macro trends around people wanting prepared food and fresh food either delivered to their homes or supported in their grocery stores and we think we are in a good position to handle that market.

Okay. Sounds good. Thank you.

Thanks, Walter.

And with that, speakers, I’d like to turn it back over to you for any closing comments.

Thanks a lot operator. To wrap up, with record performance in the first half and the strong start to the third quarter, we are raising our guidance for 2018 and look forward to continued strong growth and profitability in the second half of the year. Thank you all for joining us today.

Thank you. And ladies and gentlemen, that does conclude your conference call for today. Thank you for your participation and for using AT&T Executive Teleconference Service. You may now disconnect.