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Lennox International Inc  (NYSE:LII)
Q3 2018 Earnings Conference Call
Oct. 22, 2018, 9:30 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the Lennox International Third 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.

Steve Harrison -- Vice President, Investor Relations

Good morning, thank you for joining us for this review of Lennox International's financial performance for the third quarter of 2018. I'm here today with Chairman and CEO, Todd Bluedorn; and CFO, Joe Reitmeier. Todd will review key points for the quarter, 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 requeue 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 also will be archived on the site for replay.

I'd 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.

Before I turn the call over to Todd, I would like to announce the date of our annual investment community meeting, the event will be held the morning of Wednesday, December 12 in New York City. Please mark your calendars; invitations and more details will follow. The meeting will also be webcast. Now, let me turn the call over to Chairman and CEO, Todd Bluedorn.

Todd M. Bluedorn -- Chairman and Chief Executive Officer

Thanks, Steve. Good morning everyone and thank you for joining us. There are a lot of moving pieces and noise from the tornado impact on the reported results to walk through for the third quarter and as we look ahead. First, let me level set everyone with our estimates on the impact from the tornado that damaged our Marshalltown, Iowa residential manufacturing facility on July 19 and also make the overarching comment to keep in mind that the lost profits in 2018 and 2019 from business interruption due to the tornado will be fully offset by insurance proceeds in 2019 and be a benefit to us in that year. On our last conference call one month after the tornado hit, we estimated the impact on our core business for 2018 of approximately $100 million of revenue and $55 million of segment profit and about $1.05 of EPS. Our initial view is that about one-third of this impact would hit in the third quarter and about two-thirds would hit the fourth quarter.

Further along, with more visibility, our current view is that the impact to our core business in 2018 will be approximately $115 million of revenue, $65 million of segment profit and a $1.25 of EPS. We now expect approximately 40% of this impact was in the third quarter and 60% will be in the fourth quarter. So in the third quarter, we had $0.52 of tornado impact on our core business, which was approximately $0.17 more than originally estimated.

From an operational viewpoint, the recovery is at or ahead of schedule in all key areas. The Lennox team and our partners in the recovery have done a tremendous job and the Marshalltown community in Iowa have provided strong support. We still have a ways to go, but we expect to come out of this even better positioned than before. The change in the 2018 financial estimates come from a clearer view on customer dynamics in the near term relative to our original round number estimates. For example, with the Lennox high efficiency equipment shortages, we are seeing a lower number of visits to our PartsPlus stores during his time and lower sales of accessories, parts, and supplies. We have maintained close relationships and strong lines of communications with our dealers and we remain confident that we will win the short term borrowed market share back given the many reasons these customers were doing a majority of their business with us in the first place.

Looking ahead to 2019, we are introducing a view on the tornado impact on our core business for next year. We're estimating approximately $85 million of impact to revenue, $35 million to segment profit and $0.70 to EPS. To reiterate, the lost profits in 2019 are fully covered by insurance and we expect to receive the proceeds in the same year. Below the line for 2018, non-core special pre-tax charges related to the tornado are still expected to be approximately $80 million, offset by insurance proceeds in 2018. In the third quarter, we had $49 million of these charges, offset by $49 million of insurance recovery. Below the line for 2019, we are estimating non-core special pre-tax charges relating to the tornado impact of $15 million. We expect these to be more than offset by insurance proceeds, in line with the cost to replace.

Turning to the business results as reported today, for the Company overall, revenue on a GAAP basis was $1.03 billion, down 2%. On an adjusted basis excluding non-core Refrigeration business in Australia, Asia and South America divested in 2018, revenue was up 2% to a third quarter record $1.02 billion. Foreign exchange was neutral to revenue. On a GAAP basis, operating income was $145 million in the third quarter, down 6%. GAAP EPS from continuing operations was a third quarter record $2.65, up 8%. On an adjusted basis, total segment profit declined 3% to $155 million. Total segment margin was down 80 basis points to 15.2%. Adjusted EPS from continuing operations rose 8% to a third quarter record $2.72.

Turning to the key points on our business segment for the third quarter, our residential and commercial businesses set new record highs for revenue and Refrigeration set a new all-time high for segment margin. In residential, of course impacted by the tornado, revenue rose 1%, profit was down 1%, and segment margin was down 40 basis points to 19%. Residential revenue from replacement business was up low-single digits and new construction was down low-single digits.

Turning to commercial, revenue was up 2%, segment profit was down 7%, and margin was down 170 basis points to 16.9%. Commercial's performance was impacted by the lumpiness of shipments in our commercial national accounts equipment business, lower factory productivity, and the timing of about $2 million of expenses on a year-over-year basis. Breaking down commercial revenue for the third quarter, national account equipment revenue was down low-single digits compared to 20% growth in the prior year quarter. Year-to-date, national accounts revenue is up low-single digits, which includes being up low-double digits in the second quarter and flat in first quarter. As is typical, not straight line growth here. As we look at the first three weeks of October, the backlog is strong, up double-digits and we are tracking and having (ph) strong growth in the fourth quarter.

For our local and regional commercial businesses in the third quarter, revenue was up mid-single digits. Overall for North America equipment, revenue was up low-single digits at constant currency. Replacement revenue was up high-single digits and new construction was down high-single digits at constant currency. On the commercial service side, Lennox account services revenue was up high-teens and Europe commercial HVAC revenue was down low-double digits as market softness continues.

Turning to our core Refrigeration business, revenue was up 4%. In North America, constant currency revenue was up mid-single digits. In Europe, the constant currency revenue was also up mid-single digits led by double-digit growth in our non-food refrigeration business. Refrigeration profit rose 19% in the third quarter and segment margin expanded 190 basis points to 15.4%. We completed the last of the divestitures planned for this year closing on the sale of our South America business in the third quarter. In the second quarter, we closed on the sale of our Asian, Australia businesses as well as the sale of real estate in the Sydney area. Total net proceeds from these transactions were $116 million.

Overall for the Company, price cost was favorable in the third quarter. We had $27 million of price benefit, more than 2.5% of revenue, which more than offset commodity, freight and tariff headwinds in the quarter. We have even more confidence on price for 2018 and are raising our guidance for price benefit (ph) from $75 million to $80 million for the year. We plan to repurchase $100 million of stock in fourth quarter for a total $450 million this year as we look forward to a strong close to 2018 and ahead (ph) to 2019. We remain focused on normalizing residential production and continuing to execute on our corporate initiatives to drive Company performance and shareholder value. Now let me turn it over to Joe to talk more in detail about third quarter performance and the full-year outlook.

Joseph W. Reitmeier -- Executive Vice President & Chief Financial Officer

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 third quarter, revenue from Residential Heating & Cooling was a third quarter record $595 million, up 1%, volume was down 2%, price was up 3% and mix was relatively flat. Foreign exchange was neutral to revenue. Residential profit was $113 million, down 1%. Segment margin was down 40 basis points to 19%. Segment profit was impacted by the tornado and the business had lower volume, higher commodity freight, distribution and other product costs and other favorable foreign exchange in the quarter. Partial offsets include higher price, sourcing and engineering-led cost reductions, factory productivity and lower SG&A expenses.

Turning to our Commercial Heating & Cooling business, commercial revenue was a third quarter record $276 million, up 2%, volume was up 1%, price was up 1% and mix was flat. Foreign exchange was neutral to revenue, Commercial segment profit was $47 million, down 7%. Segment margin was 16.9%, down 170 basis points. Segment profit was impacted by higher commodity, freight, distribution and other product costs, higher SG&A expenses, and unfavorable foreign exchange. Partial offsets include higher volume, favorable price and sourcing and engineering-led cost reductions.

In our Refrigeration segment, which excludes the non-core businesses in Australia, Asia and South America that we divested this year, revenue in the third quarter was $153 million, up 4%, volume was up 4%, price was up 2% and mix was down 2%. Foreign exchange was neutral to revenue. By region, on a reported basis at actual currency, North America and Europe were both up mid-single digits. Refrigeration segment profit was $24 million, up 19%. Segment margin was 15.4%, up 190 basis points. Segment profit was impacted by higher volume, higher price, sourcing and engineering-led cost reductions, and lower SG&A expenses. Partial offsets include higher commodity and freight costs.

Overall for the Company, on an adjusted basis, the third quarter had net after-tax charges of $2.4 million. This included $2.4 million for the net loss on the sale of business and related property, a total of $3.1 million for various other items and $1.7 million benefit for excess tax benefits from share-based compensation, and a $1.4 million net benefit for other tax items. Corporate expenses were $28 million in the third quarter, up from $24 million in the prior year quarter.

Overall, SG&A on a GAAP basis was $149 million in the third quarter or 14.5% of revenue, down from 15.1% in the prior year quarter. On an adjusted basis, SG&A as a percent of revenue was 14.4% in the third quarter, down from 14.5% in the prior year quarter. Net cash from operations in the third quarter was $266 million including $45 million in cash from insurance proceeds compared to $177 million in the third quarter a year ago. Capital expenditures were $18 million compared to $17 million in the prior year quarter and free cash flow was approximately $248 million compared to $160 million in the third quarter a year ago.

Total debt was $1.13 billion at the end of the quarter and we ended September with a debt-to-EBITDA ratio of 1.9. Cash and cash equivalents were $46 million at the end of September, the Company paid $26 million in dividends in the third quarter.

Before I turn it over to Q&A, I'll review our current outlook for 2018. Our underlying market assumptions for 2018 are unchanged. For the industry overall, we still expect North American residential HVAC shipments to be up mid-single digits. We expect North America commercial unitary shipments to be up low-single digits and we expect North America refrigeration shipments to be up low-single digits.

We are reiterating our 2018 guidance for GAAP revenue growth of 2% to 4% and for an adjusted revenue growth of 4% to 6%. We are updating our 2018 guidance for GAAP EPS from continuing operations from $8.38 to $8.78 to a new range of $8.11 to $8.51. We are updating 2018 guidance for adjusted EPS from continuing operations from $8.90 to $9.30 to a new range of $8.70 to $9.10. The updated GAAP and adjusted EPS ranges include the additional $0.20 of tornado impact expected this year, $0.17 of which were in the third quarter. This will be a benefit to 2019 upon receipt of insurance proceeds next year.

Now let me walk you through the various puts and takes in our 2018 guidance starting with the ones that are changing. As Todd mentioned, we are raising our guidance for price for $75 million to $80 million on even more confidence on capturing yield this year. And as we look ahead to 2019, our commercial business has already announced a price increase of up to 4% to be effective January 1.

For commodities, we now expect $45 million of headwind for the full year, down from our prior guidance of $50 million. Freight expenses are now expected to be $25 million for this year, up from the prior guidance of $20 million. And we now expect $30 million of savings from our sourcing and engineering-led cost reduction programs, down from prior year (ph) guidance of $35 million.

For the 2018 guidance points that remain the same, foreign exchange is expected to be neutral for the year. Tariffs are still a $5 million headwind for 2018. We still see $7 million of savings from our residential factories as we focus on automation at our US plants and other productivity initiatives. Our distribution investments are a $10 million headwind, SG&A is still expected to be about $10 million over last year and the corporate expense target for this year remains approximately $85 million.

Now just a few other guidance points, net interest expense is expected to be a bit over $35 million for the full year, tax rate guidance remains 22% to 24% on an adjusted basis for the full year, capital expenditures are still planned to be approximately $100 million excluding the impact of the tornado repairs. We are planning a total of $450 million of stock repurchases for the full year and our reiterating guidance for an average diluted share count of approximately 41 million shares on a full year basis and we are still targeting approximately $395 million of free cash flow for the full year. And with that, let's go to Q&A.

Questions and Answers:

Operator

(Operator Instructions) Our first question is from the line of Jeff Hammond with KeyBanc Capital Markets, please go ahead.

Jeff Hammond -- KeyBanc Capital Markets -- Analyst

Hey, good morning guys.

Todd M. Bluedorn -- Chairman and Chief Executive Officer

Hey, Jeff.

Jeff Hammond -- KeyBanc Capital Markets -- Analyst

Hey, just -- so on the impact, one, what's informing the higher amount for '18 and then what is that -- the $85 million, what does that imply that you'll be back to normal production by? And then just also it looks like you're using lower incremental margins or margins on the '19 impact, if you could just kind of touch on why that is? Thanks.

Todd M. Bluedorn -- Chairman and Chief Executive Officer

Let me see if get all parts of the question, if not, jump back in and correct me. First on, I think first part of the question is why did we sort of raise the '18 guide for the tornado impact and I think I'd answer it a couple of ways. One is, the first guide we gave was about three weeks after the tornado and we did a high level estimate of round numbers and I sort of made the point, $100 million was a big round number. $100 million of revenue and $55 million of segment profit or $1.05 of EPS for 2018. We've refined those estimates now that we're several two, three months into this thing and we've got further along and have a clearer view quite frankly on the customer dynamics in the near term and as I said on the call or on the script, operationally, we are ahead of or at where we thought we'd be on sort of building a product ramping up, it just reflects our customers, our buying specifically as I mentioned in the -- on the script about the attachment rate of parts and supplies and accessories to when we sell major pieces of equipment. I think the other part of that question was just operationally, where do we stand and where we're being ramped up. When we look at full production capability for Lennox Residential and this includes all three residential factories: Marshalltown, Orangeburg, Saltillo and that's how I'll talk about it sort of full production capability. In Marshalltown, the heating products section of the factory had the most damage and the cooling products section had relatively less damage. So for cooling products, we expect Lennox to be back up to full pre-tornado production capability early in fourth quarter in '18. So here in the next month or so. For heating products, we expect Lennox to be back up to full production capability in first quarter of 2019. We will have a bit of lag from the perspective of fully meeting market demand due to having to catch up on rebuilding our inventory in the channel and just sort of the tornado impact if you will, will sort of lead into second quarter even though we're up to full production as we'll have to sort of ramp up this to build even more inventory. And I think the other question is, why was the drop through different in '19 versus '18, this is a function of the mix of products and the product here is impacted -- really sort of short hand, I'd point to furnaces are more profitable than air conditioners and we are more impacted by furnaces in 2018 than we will be 2019. Hopefully, I think that's everything you asked.

Jeff Hammond -- KeyBanc Capital Markets -- Analyst

Yes, you covered it great. And then just, just can you just talk about how you're thinking -- you mentioned the price increase in commercial? How you're thinking about price cost as you move into '19? And then, you lowered the material cost savings bucket for this year, how should we think about that bucket into '19? I'll get back in queue. Thanks.

Todd M. Bluedorn -- Chairman and Chief Executive Officer

We lowered the price or excuse me, the material cost reduction bucket just reflecting sort of more inflation because again this is always in that number. I also mentioned on the call that third quarter -- yes, third quarter we turned the corner -- (inaudible) in third quarter we turned the corner and had a $27 million of price more than offset commodities, freights and tariffs, excuse me. And as we go into 2019 that's clearly going to be the case as we're selling (ph) up now unless commodities move on us very quickly. We have announced a commercial price increase, we thought it was quite frankly bad form to announce a residential price increase right now with all the moving pieces, but we're clearly going to announce a residential and refrigeration price increase as we go into 2019. I'll give more specific math at the December Analyst Day, but price, commodities, tariffs and freight will be a net-net positive to us in 2019.

Jeff Hammond -- KeyBanc Capital Markets -- Analyst

Thanks, Jeff.

Operator

Next we go the line of Steve Tusa with JPMorgan.

Steve Tusa -- JPMorgan -- Analyst

Hey guys, how is it going?

Todd M. Bluedorn -- Chairman and Chief Executive Officer

Hey Steve.

Steve Tusa -- JPMorgan -- Analyst

Thanks for all the detail on the unfortunate situation there. Just on the market, you guys were down in resi and new housing related business, can you maybe just discuss what you think kind of the markets have done this quarter, so just so we can kind of figure out where the impact for you guys is kind of most pertinent or maybe it's split between the two new housing versus replacement in resi?

Todd M. Bluedorn -- Chairman and Chief Executive Officer

I think it's split between the two and when we really started seeing a tornado impact in September. So the vast majority, I don't want say all, but the vast majority of the tornado impact was in September, in July and August, we were off to a strong start in residential both in new construction in and in add-on replacement and to give a read through to the other guys, I think the market was pretty strong in the third quarter, July and August, we're up (ph) mid to high-single digits in residential, both segments of the marketplace and then obviously we saw as we ran -- start to run out of equipment, we saw the impact in September and I think the weather was reasonably good in September. So I think overall the market was probably strong for the quarter.

Steve Tusa -- JPMorgan -- Analyst

Got it and then with regards to tariffs, what are you, this new round that's come out or at least the new couple of rounds. I can't even keep track anymore, but how are you kind of thinking about that specifically for now for 2019 and how much of that impact, I don't know if you gave it yet, but what is the specific impact did you think from that on 2018?

Todd M. Bluedorn -- Chairman and Chief Executive Officer

For 2018, we think the overall impact is $5 million and that's the guide and again that's included, what's been implemented, what's been announced with detail but doesn't include any tweet said sort of even add more to it than that. So it's sort of, it's what you can do the math on, we think that 2018 order of magnitude is going to be $5 million and I've publicly said that's in essence sort of less than half a year and so 2019 is going to be something probably little over twice that. And then the other point I'd like to make is, we're proactively taking action. I'm not sure that Chinese tariffs are going to be short term and so we're taking action to sort of avoid the tariff spike moving to Southeast Asia and other low-cost countries that can meet our requirements.

Steve Tusa -- JPMorgan -- Analyst

And that's the gross number, that just basically taking what you buy and kind of marking it up by the amount of the tariffs or is that kind of the net number?

Todd M. Bluedorn -- Chairman and Chief Executive Officer

It's sort of -- it's the net number. So the $5 million is what -- order of magnitude $5 million is what we expect to see on the P&L and we haven't guided yet on '19, but I would sort of take you know over twice that amount and sort of if I stored (ph) it in a model and assume that for '19.

Steve Tusa -- JPMorgan -- Analyst

Okay and then again, just to be clear on -- it's a lot of everybody's kind of approaching their communications around this in different ways. That would reflect the new round of stuff that's coming through at kind of a higher rate. Correct? So that's the -- that would reflect the incremental. Okay, got it, all right, and then just one more, you talked about doing something in resi, but obviously not exactly the right time to go through with something additional, there have been others that have gone through with other price increases, is your sense that if you did go out with something in resi here in the near term excluding the tornado impact that customers have yet to kind of push back on that price or everybody is generally understanding of that i.e., price discipline in the industry and the acceptance of that price is still pretty strong in the channel.

Todd M. Bluedorn -- Chairman and Chief Executive Officer

I think it impacted a couple of ways. To that question, I'd say, which is a direct question, customers expect price increases and some -- several of our competitors have announced some things, we announced in commercial. They're not surprised, they're accepting it, point one. Point two is we raised our price guide in 2018 from $75 million to $80 million and that $5 million is I think I'm comfortable saying it's exclusively residential. So, quite frankly, we didn't have to announce a price increase, it's always about the yield and how you hang on to it and so we're getting better price yield in residential just like we speculated we might given the shortage of inventory, but we didn't want to announce something new just sort of continuing those -- toe the line and getting a better yield than what we thought we were and then as we go into '19, we're confident again that we'll announce another price increase and get more price in 2019 both in res and in our other businesses.

Steve Tusa -- JPMorgan -- Analyst

Okay, sorry, one more quick one, sorry to dominate the early innings here. You made some comments at a recent conference -- a competitor conference that you kind of opined on consolidation in the industry and you said that you believe that there could be consolidation among the top four resi guys out there despite what looks like a reasonably consolidated situation. Can you maybe just clarify that or maybe I read that in the transcript the wrong way. Can you maybe clarify what you said there on industry consolidation of potentially one of the top four resi guys?

Todd M. Bluedorn -- Chairman and Chief Executive Officer

I was asked a question -- I think you got it what I said pretty close. I always get in trouble when I opine, so maybe strike the opine, I was asked a question, I answered a question, but I don't know YORK's residential market share, but I think it's -- has one digit in it and so I think they could combine with other players in the industry, certainly could combine with us. I think their commercial unitary share starts with one digit and then their applied is a larger part of the business but the YORK business can certainly combine with us and when I look at the other residential businesses, it's other players. Again, I think they could combine with YORK or maybe even us. So I think those were the -- that was sort of the broad question of, did I think anything was prohibit -- are there things that couldn't (ph) happen, certainly, but the combinations that could happen, certainly.

Steve Tusa -- JPMorgan -- Analyst

Right, I guess you commented on YORK very specifically, can you comment on Carrier very specifically?

Todd M. Bluedorn -- Chairman and Chief Executive Officer

I'm not -- their share starts at two digits, I know that and then beyond that, I'm not exactly sure where they're at, so my guess is they could combine with us. I think they could -- well, certainly they could combine with YORK and I think they could combine with us, but I don't know that for certain. It also depends what's being in force at the time, but I think it'd be -- I don't know the exact number because I don't know Carrier's share.

Steve Tusa -- JPMorgan -- Analyst

Okay, I'll leave it at that. Thanks a lot.

Operator

Next we go to the line of Jeffrey Sprague with Vertical Research Partners, please go ahead.

Jeffrey T. Sprague -- Vertical Research Partners -- Analyst

Well, I can't help but to cook up on that. It's a good (multiple speakers).

Todd M. Bluedorn -- Chairman and Chief Executive Officer

You guys are a feeding frenzy on this side (multiple speakers).

Jeffrey T. Sprague -- Vertical Research Partners -- Analyst

At least I'm not talking about tornadoes, right?

Todd M. Bluedorn -- Chairman and Chief Executive Officer

I know for a fact Greg (ph) knows to carry our share, so you should ask him.

Jeffrey T. Sprague -- Vertical Research Partners -- Analyst

We think you know it, too, but we won't press you. This consolidation makes sense. You know, what would be gained in your view given kind of this great pricing discipline that we're observing especially in the resi business?

Todd M. Bluedorn -- Chairman and Chief Executive Officer

Well, I mean the industry consolidation well obviously with the caveat of at the right price but I'd think it will be traditional horizontal integration of an industry. So, and I would view it as distribution forward. So consolidating factories, consolidating supplier spend, taking out SG&A, taking out corporate expenses. We're making significant investments, we as a company and digitization of the business, significant investments in control systems. Again, that could all be leveraged over a larger volume business. We have a great Mexico campus, most of our competitors on residential don't and so the ability to leverage that Mexican campus to lower costs and so I just sort of think traditional cost take-outs in an assembled product business like we have -- I think you could create lots of synergies and then again, it'd have to be at the right price, but I think it's clear industrial logic of how we take out costs.

Jeffrey T. Sprague -- Vertical Research Partners -- Analyst

How about on the distribution side, Todd, some companies have chosen to kind of third-party the distributions, others like you know own it, putting that type of footprint together. Do you see any particular challenges there?

Todd M. Bluedorn -- Chairman and Chief Executive Officer

My experience having seen this done at other places up and at is -- I think the challenge is to make sure you don't lose market share when you rip all the cost out of the back end and so my perspective on it would be in an industry like this when you consolidate that there be some period of time you leave distribution alone and so whatever it was you optimize it and manage it as it was. I don't think you want to sort of go from one model to another model quickly, but the investments that a company was making in digitization and support of dealer contractors whether it was company-owned distribution, a JV or independent distribution, you could leverage those investments with those distributors. So I don't think you have to physically make a change in distribution to leverage some of the investments that a company was making.

Jeffrey T. Sprague -- Vertical Research Partners -- Analyst

And then just one on the quarter for me, just to kind of make sure I've got my head around really what's going on in your margins. Right, so the resi margins we're seeing today, obviously you have a revenue impact on the top line but you have little or no overt profit impact on insurance recoveries, right. So we can kind of calculate an underlying margin that's lower than your headline margin. Is that difference primarily this negative I'll call it ripple effect for lack of a better term in the PartsPlus and other parts of your business or how would you characterize that?

Todd M. Bluedorn -- Chairman and Chief Executive Officer

I'm not sure I understand the question. You had me right to the end when you started talking about PartsPlus.

Jeffrey T. Sprague -- Vertical Research Partners -- Analyst

Well, I'm just saying your underlying margins arguably were down, right, I'm just trying to understand the composition of that in resi?

Todd M. Bluedorn -- Chairman and Chief Executive Officer

I'll ramble and see if I answer the question. I mean, margins were down because of the tornado impact on revenue and the corresponding impact on EBIT is why they were down and even from the guide that we'd given earlier, which was 120 (ph) and 55 (ph) of EBIT, a third of it in fourth quarter, we're now saying it's 40% in third quarter and the overall number is going up to $65 million of EBIT and $120 million of revenue and we performed extremely well in residential. So if I understand the question right, it's all because of the tornado.

Jeffrey T. Sprague -- Vertical Research Partners -- Analyst

Okay, got it. Thank you.

Operator

Next we go to the line of Julian Mitchell with Barclays, please go ahead.

Julian Mitchell -- Barclays -- Analyst

Thanks a lot. So maybe just trying to stick to two questions. The first one on the commercial business. If there was any extra color you could give on US trends as they stand today. And also on the margin front, margins were down a bunch in the third quarter. How quickly do you think that comes back and any extra detail you can give on the factory productivity you cited?

Todd M. Bluedorn -- Chairman and Chief Executive Officer

First talking about commercial and I talked about it in the call I think at some detail, it is just a lumpiness in national accounts and so we feel confident in fourth quarter, still a lot of work in front of us, but through the first three weeks of our quarter, backlog is strong, up double-digits and we're tracking to have another strong revenue quarter for commercial in fourth quarter and so second quarter -- first quarter we were flattish in commercial, second quarter we were up 18% (ph), third quarter we were flattish and fourth quarter, we're going to have strong revenue growth. In terms of the margin, as I mentioned in the call was impacted by a couple of things, one was the timing of some expenses just sort of the year-over-year differences of when you make adjustments for expenses like warranty and LIFO we are (ph) getting too accounting on county on you and then the other one I think more operational was we had some factory productivity issues in third quarter and really what's driving the factory productivity issues is we're seeing labor shortages in our Stuttgart facility and we've been addressing it with overtime and extra shifts to be able to meet customer demands and we're in the process of staffing up with full-time workers. We've historically used quite a bit of temporary workers. Now we're moving to full-time workers and converting the temp workers to full-time workers and this will have -- the issue around labor productivity and not having enough folks will have impact in Q3 and we'll also see a bleed off into Q4. On the fourth quarter call, I'll also be talking about this because it just takes a while to get it in place, but we expect to have it fully resolved by first quarter 2019.

Julian Mitchell -- Barclays -- Analyst

Thank you for the detail. My second question would be on refrigeration, one of your peers had talked about the retail refrigeration market may be bottoming out. Your own revenue growth numbers suggest you are taking some share. So maybe just any commentary on how you see the market in the US retail refrigeration?

Todd M. Bluedorn -- Chairman and Chief Executive Officer

I still I think it's tough, I mean Dover refers to it as retail refrigeration, we refer to it as grocery (ph) that's what you're talking about and that has the biggest impact us in our Kysor/Warren segment, we still saw our revenue down in KW even though we were up in North America. Where we're seeing the growth in our North America business is driven -- the year-over-year growth is in large part driven cold storage and so it's not the retail segment or the grocery segment, it's sort of other parts of the cold storage channel -- cold chain and cold storage market where we've seen the growth.

Julian Mitchell -- Barclays -- Analyst

Great, thank you.

Todd M. Bluedorn -- Chairman and Chief Executive Officer

Thanks.

Operator

Next is the line of Gautam Khannal with Cowen, please go ahead.

Gautam Khannal -- Cowen and Company -- Analyst

Thanks, good morning.

Todd M. Bluedorn -- Chairman and Chief Executive Officer

Hey, Gautam, how are you?

Gautam Khannal -- Cowen and Company -- Analyst

Doing well. I was wondering Todd, could you just talk a little bit about your confidence level in recapturing the share that you're sort of giving up in the interim while you're recovering from the tornado. What specifically can you do to kind of -- what gives you that confidence and what are you doing to make sure on the other side of it, we're not going to see an impact at PartsPlus or elsewhere?

Todd M. Bluedorn -- Chairman and Chief Executive Officer

Yes, I mean we're working hard to do that and I mean as I've spoken about before, you've heard me say, Gautam, I'll say it for everybody else is we're communicating very clearly with our dealer partners who are out there, daily talking to them about what we have and when we're going to have it back and allowing them to make the transition. I've used the phrase a week early rather than a week late. So we don't want to run out of equipment and then have them feel the pain. So we want -- we'll feel the pain and allow them to move over. I think that honest open communication helps a lot. And then, the second thing is going to be on the flip side that as we reach full production capability and as I spoke about, we expect air conditioners in fourth quarter and furnaces in first quarter will be up full production capability, that as we start to make new commitments to people and turn them back on that we execute against those new commitments. So we don't let them down on the way down and then we don't let them down on the way back up and we're very focused on doing that. Overall, we have a loyal Lennox dealer base and as I've mentioned also on prior calls almost all dealers carry multiple brands and we think the majority of this borrowed share will be someone who did business with us and with competitor B and they'll move some volume to competitor B while we're not able to provide supply and then when we come back online, then they will move the share back to us and so we're very focused on this and we'll put incentives in place for our sales guys and so do all the right things to make sure we have laser like focus on '19, but we're committed to doing that.

Gautam Khannal -- Cowen and Company -- Analyst

Okay and just a quick follow-up on just the national account equipment and service pipeline as you look out to 2019. Can you make any comments on how rich an environment it is?

Todd M. Bluedorn -- Chairman and Chief Executive Officer

You know, '19, a little early to sort of speculate or even give guide because the order book tends to fill up three, four, five months ahead of itself. So, '19 is still very early and then the other caveat I'd make is we always know much more about national accounts once we get through the Christmas selling season, retail, while we've reduced our exposure to that, still about half of our national account business. So getting a better take on the Christmas selling season will help us. All that being said, retail is strong right now. Consumers are spending money, consumers feel good, retailers are spending money on things they weren't a year or two ago in our industry. So we feel pretty good as we go into '19, but we'll give more of a guide at the December Analyst Day.

Gautam Khannal -- Cowen and Company -- Analyst

Thank you.

Operator

Next we go to the line of John Walsh with Credit Suisse, please go ahead.

John Walsh -- Credit Suisse -- Analyst

Hi, good morning.

Todd M. Bluedorn -- Chairman and Chief Executive Officer

Hi, morning.

John Walsh -- Credit Suisse -- Analyst

So I apologize if I missed it, but you know as we think about the moving parts for the free cash flow, can you help us think about maybe a finer point on this year and then next year as you're looking to rebuild inventory and how that kind of impacts the conversion ratio?

Todd M. Bluedorn -- Chairman and Chief Executive Officer

I don't think we have done into that kind of detail quite yet about sort of how it's going to impact, I mean I would point out we had a very strong quarter in cash generation in the third quarter and so we continued to generate cash, but we sort of haven't put a fine-tooth answer about the inventory bleed out and an inventory rebuild. The only point we made on cash is that the below the line impact of $80 million, I'm looking to make sure I have that number right, that we'll expect to have a minimum (ph) cash proceeds to offset that. So we'll be neutral on cash on the below the line charges, if you will. And in third quarter, we saw that 47, 47 (ph) on the offsets. And then for the above the line impact sort of the core impact we expect to have cash proceeds in 2019 to offset the EBIT in this or the EBIT that will shift or that we're not going to get in 2018 because of the lost revenue. We'll get that back in EBIT payout from the earn -- payout from the insurance companies in cash in 2019.

Joseph W. Reitmeier -- Executive Vice President & Chief Financial Officer

And we're compensating with the lost profits, which are a proxy for cash flow. We're going to obviously offset that or compensate with lower investments in working capital and inventory, which will keep us hold on target for the $395 million for the full year.

John Walsh -- Credit Suisse -- Analyst

Okay, thank you. And then can you just remind us your comfortability or where you're comfortable taking the balance sheet in terms of leverage?

Todd M. Bluedorn -- Chairman and Chief Executive Officer

Yes, we've said our guide has been 1.5 times to 2 times debt-to-EBITDA and that allows us to remain investment grade and we think that's an important place to be in an uncertain world and then we always put the caveat around that for the right opportunity to create shareholder value, we will look to go higher with the path to come back down that it's an industry that others like Goodman had gone private over the years a couple of times and have had debt-to-EBITDA maybe twice that amount and had been fine with it and I think we would be too, but I don't think I'd want to do that just as a natural course of events. I think we have something that could create real shareholder value like an industry consolidating acquisition, we would think about it but in a more normal course of business, I think the right balanced approach 1.5 to 2.

John Walsh -- Credit Suisse -- Analyst

Great, thank you.

Operator

Next, we'll go to line of Rich Kwas with Wells Fargo, please go ahead.

Rich Kwas -- Wells Fargo Securities -- Analyst

Hey, good morning everyone. On price so I think the guide implies $22 million for the fourth quarter. You did $27 million in Q3, what drives it down in terms of contribution given the number of price increases this year?

Todd M. Bluedorn -- Chairman and Chief Executive Officer

I think it's just the volume that third quarter seasonally higher volume.

Rich Kwas -- Wells Fargo Securities -- Analyst

Okay and then the lap over benefit into '19 should be meaningful right, I mean you'll be comping against some contribution, but it should be a decent contributor, right. That's the way we should be thinking about it?

Todd M. Bluedorn -- Chairman and Chief Executive Officer

Yes, I mean, I think you could shorthand, I would take the $50 million that we initially gave and sort of assume how much of that was in first half of the year versus second half of the year and then we've now raised it to $80 million and that incremental $30 million is all second half of the year and you might even expect even sort of more back-end loaded than that. So I think if you sort of do some of that and then you lay on top of that some new price that we would announce going into 2019, I think you can start to back into a number that's going to be meaningful and as I said will offset the inflationary pressures we're feeling from commodities, freight and tariffs.

Rich Kwas -- Wells Fargo Securities -- Analyst

Cost base should start coming down too as '19 plays out, right even with the hedge --

Todd M. Bluedorn -- Chairman and Chief Executive Officer

Say again.

Rich Kwas -- Wells Fargo Securities -- Analyst

The cost base should start getting incrementally improved even with the hedges as we start rolling through '19, right?

Todd M. Bluedorn -- Chairman and Chief Executive Officer

If commodities continue on the trend they are on, yes.

Rich Kwas -- Wells Fargo Securities -- Analyst

Okay and then just on as you think about affordability, I mean everybody's some put through three (ph) you've put in a couple, you're going to put in another one. There's going to be another price increase on the residential side across the board one would think at the start of the year, any impact on mix as we think about mix has started to get better for everyone. How do you see this playing out over the course in '19 on the resi side?

Todd M. Bluedorn -- Chairman and Chief Executive Officer

Not sure I understand the question per se.

Rich Kwas -- Wells Fargo Securities -- Analyst

Well, let's just say 13, I mean is there, does the incremental buyer come in on the remodel side and say, I'm not going to do 17, say I'll do 14 because mortgage rates are up and I'm not going to -- I bought a house, I'm not going to up the ante with regards to the efficiency because the call --

Todd M. Bluedorn -- Chairman and Chief Executive Officer

I think maybe on the margins, but I think when people sit down and do the economics on most markets or in the northern markets, they are going to be in the house three years to five years, it makes sense to get a premium furnace and that's if you are in the South and you are going to be in the house 3 years to 5 years, it makes sense to get a premium air conditioner and that's just the math of it and I don't think that changes with incremental interest rates. The other point around our pricing power as you know, half the cost of a unit is labor and they buy one every 15 years. So our ability to continue to raise price in the marketplace is driven more about at the dealer level and what competitors do rather than the homeowner, homeowners willing (ph) to accept it.

Rich Kwas -- Wells Fargo Securities -- Analyst

Okay and then just last one real quick on commercial was -- did you say new construction was down high-single digits in North America. Did I catch that right?

Unidentified Speaker --

Yes, correct and that was driven in large part by national accounts.

Rich Kwas -- Wells Fargo Securities -- Analyst

Okay. Okay, great. Thanks guys.

Operator

Next we go to the line of Steven Winoker with UBS, please go ahead.

Steven Winoker -- UBS -- Analyst

Thanks, good morning guys. Hey Todd, I just want to come back to the consolidation comments again. So we've been talking about consolidation on and off for 20 years, the industry logic has generally always been there. If you sort of think about what dynamics have changed now to make that increasingly likely despite that some of the moves that have already taken place, what do you think are the biggest factors that would actually make that more realistic in the industry today than say it's been in the past decade?

Todd M. Bluedorn -- Chairman and Chief Executive Officer

I'm just pausing to make sure I answer the question in a way that when the transcript comes back to me, I'm happy with what I said.

Steven Winoker -- UBS -- Analyst

Always wise.

Todd M. Bluedorn -- Chairman and Chief Executive Officer

I'd think I'd answer it this way, I -- we've always talked about focus wins and that's the best place to be as a corporation is to be large enough to be at scale and then be focused on industries and I think at least in my business lifetime, there's never been a time where the investment community feels the same way and I think corporate leaders feel the same way and so that's another way of saying industrial conglomerates are under pressure which two players in our industry are owned by industrial conglomerates who from everything I read are reviewing their portfolio of businesses and so I think there's sort of more optimism that maybe one of them or both of them will decide to do something with our portfolio that could make assets available.

Steven Winoker -- UBS -- Analyst

Okay, so willingness to sell on that front. So, secondly, just going to the replacement demand in a little more detail. I know it's got to be a little hard to tell with working through all of the mitigation actions and recovery on the tornado front, but just from a market level I guess, as you -- and you talked about it a little bit earlier I think on new construction, what are you seeing in terms of replacement demand on the resi front, resi like commercial too.

Todd M. Bluedorn -- Chairman and Chief Executive Officer

It still remains strong, Steven, so July and August our replacement business was up mid to high-single digits and then obviously it slowed down in September and that's why you are seeing the reported numbers and I think September was warm enough and sort of a good enough month that my guess is our competitors will talk about a market that was up mid to high-single digits

Steven Winoker -- UBS -- Analyst

And where are you thinking we are in terms of the overall cycle again, exclusive of what you guys have been personally experiencing with the tornado, but as you sort of look out on the timing, how would you characterize it?

Todd M. Bluedorn -- Chairman and Chief Executive Officer

What we've publicly said and continue to be the case in my mind is that we think there is another 3 years to 5 years of mid single-digit growth in residential and this reflects the echo of all those homes that were put in, in the new housing bubble in the early mid-2000s and that continues to sort of bleed into the replacement market and that analysis that we did, there's a bell-shaped curve around this number, but on average, units last about 15 years before there's a catastrophic failure that has to be replaced. So when we do all that math, we think it's 3 years to 5 years in mid single-digit growth and again that assumes sort of a neutral economy, it doesn't have to be 3.8% unemployment, just a solid economy and then again any given year, it can be swung by the weather, but we're still optimistic that this market still has legs.

Steven Winoker -- UBS -- Analyst

Thanks, Todd, I'll pass it on.

Todd M. Bluedorn -- Chairman and Chief Executive Officer

Thank you.

Operator

Next we go to the line of Ryan Merkel with William Blair, please go ahead.

Yeah, thanks, two quick questions from me. So first Todd, you said as the Iowa factory recovers, you will come out of this stronger than before. Can you just expand upon this?

Todd M. Bluedorn -- Chairman and Chief Executive Officer

I think a couple of ways, one maybe where you're leading me is we're building capability in our other factories to manufacture and fabricate parts for premium product and I think that transfer of knowledge and capability is important for longer term, longer term capability of the Company. I also just think that as we're sort of testing and challenging team members in rising to the occasion, I just think the talent in our Iowa factory has been challenged and pushed and my experience is the way you sharpen a blade is that way and I think the blade of the Marshalltown factory is being sharpened and our capabilities are just being improved.

Analyst -- -- Analyst

Got it, OK. And then secondly, just to clarify. Is the tornado impact a pretty solid estimate now in your mind?

Todd M. Bluedorn -- Chairman and Chief Executive Officer

I think we're most solid on is our production ramp up, but that's still has variables in it also, I mean, I'll be honest with you, there is still some pieces of equipment that are under wrap that we haven't broken out and started back up again after they've sort of been rained on and the tornado hit them and so we still have some risk there and then it's the sort of our best guess on how the customer will play out but, I'd like to say we got all the snow down, but this is virgin territory for us and we're giving you information as we know it.

Operator

Understood, OK, thanks a lot.

Todd M. Bluedorn -- Chairman and Chief Executive Officer

Thanks.

Operator

Next question is from the line of Nigel Coe with Wolfe Research, please go ahead.

Thanks, good morning. You've covered a lot of ground here. Appreciate the detail guys. Want to go back to price. I'd imagine that the problems you are having with the heating production makes the market very, very tight as we go into the heating season. So I'm curious whether pricing actually improves short-term i.e., in 4Q from the 3% you showed this quarter and then as you then come back online in 2019, does that then put the facing pressure on price, I'm just curious to dig into pricing and maybe focus more on the near-term pricing impact?

Todd M. Bluedorn -- Chairman and Chief Executive Officer

I think our guide of raising price from full year from $75 million to $80 million for the corporation. The $5 million increase was really tied to residential and our ability to yield the price that we've already passed on. I don't think we'll get price back in 2019, I think it will be the office, I think there will be another price increase and we'll get even more in '19. So I think short answer is, we've recognized some benefit of price increase price in '18 maybe we do better, maybe we do a little bit worse, but we'll see, but that's our guide for today. And then in '19, we think we'll get even more press.

Operator

But does the tightness in 4Q on the heating side mean that rebasing and discounting activity might be more moderate and therefore realized price goes higher in 4Q?

Todd M. Bluedorn -- Chairman and Chief Executive Officer

I think you know our attempt on raising the price guide by $5 million was our attempt to capture that.

Operator

Okay and then just quickly on tariffs, you're obviously minimal impact based on what you know right now, are all of your China imports right into the current one to three right now. So if we do get further actions in list four, list five, are you pretty much done at this point?

Todd M. Bluedorn -- Chairman and Chief Executive Officer

Ask the question one more time, please.

Operator

Yes, I'm just wondering about your China imports, are they all covered by lists one to three or are there some other potential impacts if we do get a broadening of the tariffs?

Todd M. Bluedorn -- Chairman and Chief Executive Officer

I think the vast majority of what we import from China is impacted of from list one, two and three, but there may be some that aren't impact. So if we move to sort of -- if the administration moves the tariffs on everything imported from China, there's probably some more risk.

Operator

Okay and just a quick one. So going back to the European weakness in commercial HVAC, is that a broad impact you're seeing across the whole market there or is it just lumpiness and any comments on that European weakness would be helpful?

Todd M. Bluedorn -- Chairman and Chief Executive Officer

I think it's more broad in the European market. Early in 2018, there was a regulatory change in Europe regarding minimum efficiency in refrigerant policy, refrigerant that you can use. These changes combined added about specifically on our rooftop business there, which is our largest business, these changes combined added about 15% or so to the cost of a rooftop and in the near term, leading customer slowed down the replacement cycle 2018 sticker shock as we and all our competitors had to make these changes and that added (ph) cost to the system. As we started to sort of go through the year, the market is absorbing the new reality and quite frankly, they have to replace the units they have and build new stores. So, the year-on-year comparisons will start to become more favorable and fourth quarter -- fourth quarter certainly as we go into 2019, but I think in large part, it's an industry phenomenon.

Operator

Got it. Thanks, Todd and the good luck with the recovery.

Todd M. Bluedorn -- Chairman and Chief Executive Officer

Thanks.

Operator

Next is the line of Walter Liptak with Seaport Global, please go ahead.

Hi, thanks, good morning and thanks for taking my question. Was hoping to go back to the balance sheet and just get some detail about, the receivables were up pretty nicely and you know I think typically this time of year, there's some seasonality to look better, I wonder what that was related to an inventories presumably were down as you worked off any inventory they were building for the heating season, but I wonder if you could talk about the inventory for the fourth and first quarter as well related to heating and then with production ramping for heating next year in the first quarter, is it early in the year or early in the quarter or is it late in the quarter, do you miss the heating season because you're -- as you ramp up production?

Todd M. Bluedorn -- Chairman and Chief Executive Officer

I'll answer the last part first. We're clearly missing some of the heating season and that's reflected in the lost revenue guide that we've given so short answer is, we're missing some. Second point is we expect by the end of first quarter to be up and running in our heating production or have the capability to do heating production and I would also say that we sell furnaces all year round, it's seasonal, but it's not as seasonal as air conditioners typically when someone's going to replace an air conditioning system if it's a 10 or 15-year-old system, they'll buy a new furnace also and so there's an attachment rate of furnaces that go with that. In terms of the working capital flow, it's going to be off from where it's been in prior years because it's a tornado impact, but I think about inventory being down because we're selling out of our product, our receivable is a seasonal effect where we typically have big third quarters and we did not relatively not as well as we have traditionally done, but still up year-over-year revenue wise and that drove the receivable increases.

Joseph W. Reitmeier -- Executive Vice President & Chief Financial Officer

And I'd say the impacts that you see on working capital are directly related to the impact of the tornado.

Operator

Okay, all right, great. Thank you, guys.

And we have no further questions. You may continue.

Todd M. Bluedorn -- Chairman and Chief Executive Officer

Okay, great. Thanks, operator. To wrap up. We look forward to a strong close to 2018 as we remain focused on executing on all our corporate initiatives to drive Company performance and shareholder value. We hope to see everyone on December 12 at our annual Investment community meeting in New York as we look ahead to 2019 and our long term plans. Thanks everyone for joining us today.

Operator

Ladies and gentlemen, that does conclude your conference for today. Thank you for using AT&T Teleconference service. You may now disconnect.

Duration: 62 minutes

Call participants:

Steve Harrison -- Vice President, Investor Relations

Todd M. Bluedorn -- Chairman and Chief Executive Officer

Joseph W. Reitmeier -- Executive Vice President & Chief Financial Officer

Jeff Hammond -- KeyBanc Capital Markets -- Analyst

Steve Tusa -- JPMorgan -- Analyst

Jeffrey T. Sprague -- Vertical Research Partners -- Analyst

Julian Mitchell -- Barclays -- Analyst

Gautam Khannal -- Cowen and Company -- Analyst

John Walsh -- Credit Suisse -- Analyst

Rich Kwas -- Wells Fargo Securities -- Analyst

Unidentified Speaker --

Steven Winoker -- UBS -- Analyst

Analyst -- -- Analyst

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