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Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Ladies and gentlemen, thank you for standing by. Welcome to the Lennox International First 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 first 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 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 thanks for joining us. In first quarter of 2018 Lennox International posted strong revenue and profit growth. They set new first quarter highs for revenue, total segment margin and profit and adjusted EPS from continuing operations.
Revenue on a GAAP basis was a first quarter record $835 million, up 5% on adjusted basis excluding non-core refrigeration businesses in Australia, Asia and South America that we are in the process of divesting as previously announced, revenue was up 6% to record $788 million. At constant currency revenue in both cases was up 4%.
On a GAAP basis operating income was $53 million in the first quarter including $13 million in pretax charges for the write-down of assets and divestiture of costs associated with Australia and Asia transaction.
GAAP EPS from continuing operations was $0.90 including $0.30 in charges for the write-down of assets and divestiture costs associated with the Australia and Asia transaction.
On an adjusted basis total segment profit rose 12% to a first quarter record $69 million. Total segment margin expanded 50 basis points for a first quarter record 8.8%, and adjusted EPS from continuing operations rose 33% to a first quarter record $1.13.
Turning to the key points on our business segments for the first quarter residential established new first quarter highs for revenue, segment margin and profit. Revenue was up 8% with a replacement business up high single-digits and new construction up mid-single digits.
Residential had strong price performance and a richer mix than a year ago with replacement business growing faster than new construction. Residential segment profit rose 21% and segment margin expanded 120 basis points to 11.3%.
Turning to commercial in the first quarter; revenue and profit hit new first quarter highs. Revenue was up 3% at constant currency and segment profit was up 2%, segment margin of 9.5% was up 30 basis points from the record first quarter level a year ago.
In North America, commercial equipment revenues was up low single digits for the quarter, replacement revenues was up mid-single digits and new construction revenue was down mid single digits.
Looking at equipment business another way, national account revenue was flat in the quarter and regional and local was up mid single digits. On the service side, national account revenue was up a strong mid 20% rate.
In Europe, commercial flat and quarter in regional local revenue was out digits on the server-side national account service revenue was up a strong of mid-20% rate, in Europe commercial HVAC revenues down mid-teens at constant currency.
In our core refrigeration business, revenue was down 5% at constant currency. In North America, refrigeration system revenue was relatively flat. Refrigerated display case revenue was down high teens from year ago.
In Europe revenues up mid-teens at constant currency on strength in both food and nonfood refrigeration business, refrigeration segment profit was down 14% and segment margin was down 100 points to 7.4%.
To update you on the sale of our non-core refrigeration businesses, as announced in March we signed a binding agreement for the sale of our Australia and Asia business to Beijer Ref. We expect the sale to close in the second quarter.
As I mentioned earlier, in the first quarter we had a $13 million pretax charge or $0.30 to GAAP EPS for the write-down of assets and divestiture costs associated with the transaction.
In April, we signed a binding agreement for the sale of our South America business to Elgin, a privately held Brazilian company. We expect the sale to close later this year. Subject to Brazilian antitrust approval in the second quarter, we expect to take approximately $30 million in non-cash charges associated with the transaction which is approximately $0.73 factored in to GAAP EPS guidance.
We're also in the process of selling real estate in the Sydney metro area that was formerly related to Australia operations and we expect that to be concluded before the end of the year. Given the low book value of the property and the strong Sydney real estate market, we would expect a sizable gain on the sale.
As previously announced, we are broadly estimating total net proceeds from these transactions of approximately US$110 million, which we expect to receive over the course of the years as the sales are closed.
We are excited about the streamlining our refrigeration portfolio to focus on our strong market position in North America and Europe, and the market opportunities in these regions.
Overall for the Company 2018 we will continue to invest in our core businesses, grow the dividend and repurchase stock. We directed 150 million of stock repurchases in the first quarter and have announced plans for a total of 350 million of stock repurchases for the full year.
The first quarter was a record start to the year, and as we enter our largest seasonal period we continue to expect strong growth and profitability on our way to another record year in 2018.
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 first quarter revenue from residential heating and cooling was a first quarter record $454 million, up 8%. Volume was up 5%, price was up 2% and mix was up 1%, foreign exchange was neutral to revenue.
Residential profit was first quarter record $51 million, up 21%. Segment margin was a first quarter record 11.3%, up 120 basis points. Segment profit was positively impacted by higher volume and factory productivity, favorable price and mix in sourcing and engineering lead cost reductions, partial offsets included higher commodity and freight costs, higher SG&A and distribution investments.
Now turning to our commercial heating and cooling business. Commercial revenue was a first quarter record $206 million, up 5%, volume was up 3%, price was up 1% and mix was down 1%, foreign exchange had a positive 2% impact on revenue.
North America commercial HVAC equipment revenue was up low single digits, national account services revenue was up at a mid 20% rate, European commercial HVAC revenue was down low single digits. Commercial segment profit was a first quarter record $20 million, up 2%.
Segment profit margin was 9.5%, off 30 basis points from the first quarter record level a year ago. Segment profit was positively impacted by higher volume, higher price, sourcing and engineering lead cost reductions, lower other product costs and lower SG&A, partial offsets included unfavorable mix, higher commodity and freight costs and distribution investments.
In our refrigeration segment which now excludes the non-core businesses in Australia, Asia and South America that we are divesting, revenue in the first quarter was $129 million, down 2%, volume was down 6%, price was up 1% and mix was flat, foreign exchange had a positive 3% impact of revenue.
By region our actual currency on a reported basis, North America was down high single digits and Europe was up 30%, refrigeration segment profit was $10 million, down 14%. Segment margin was 7.4%, down 100 basis points, segment profit was impacted by lower volume and factory absorption and higher commodity costs, partial offsets include higher price, sourcing and engineering lead cost reductions and lower other product costs and lower SG&A.
Overall for the company on an adjusted basis, the first quarter had net after-tax charges of $9.4 million. This included $10.3 million for the asset write-down and $1.9 million charge for the divestiture costs associated with the Australia and Asia transaction, $1.5 million for asbestos-related litigation and a net total of $1.3 million for various other items,
As partial offsets we had a benefit of $4.3 million for excess tax benefits from share based compensation and profit of $1.3 million for non-core business results. Corporate expenses were $11 million in the first quarter, flat with the prior quarter.
Overall SG&A was $155 million or 18.6% of revenue, down from 19.2% in the prior quarter. Net cash used in operations in the first quarter was $83 million compared to $180 million in the first quarter a year ago. Capital spending was $23 million compared to $25 million in the prior quarter.
With respect to free cash flow, we used approximately $106 million in the first quarter compared to a use of $132 million in the prior quarter. Due to the seasonal nature of our business the company uses cash in the first half of the year and generates cash in the second half of year. We continue to target $395 million of free cash flow for 2018 overall.
Total debt was $1.29 billion at the end of the first quarter, and we ended March with debt to EBITDA ratio of 2.2. Cash and cash equivalents were $57 million at the end of March and the company paid approximately $21 million in dividends and $150 million for share purchases in the first quarter.
Before I turn it over Q&A, I'll review our outlook for 2018. Our market assumptions for 2018 aren't changed. For the industry overall we expect North American residential HVAC shipments to be up mid-single digits.
We expect North America commercial unitary shipments to be of low single digits and we expect North American refrigeration shipments to be of low single digits. Based on this underlying market environment and our targets for market share gains adjusted revenue growth guidance from a Lennox International is 4% to 8% including a positive 1% benefit from foreign exchange. Our prior guidance was 3% to 7% growth with a minimal impact from foreign exchange.
GAAP EPS guidance from continuing operations for 2018 loose from a range of $9.75 to $10.35 to a new range of $8.79 to $9.39 after incorporating first quarter results and the expected second quarter charges associated with the divestiture of the South American business.
As Todd mentioned we expect a sizable gain on the sale of our Sydney real estate and this is not factored into our GAAP guidance for the year. For adjusted EPS from continuing operations guidance for 2018, we are reiterating our range of $9.75 to $10.35.
Now let me run through some of the other key points in our guidance assumptions and the puts and takes for 2018. We continue to expect $50 million of headwind from commodities in 2018 which includes Section 232 tariff impact on steel and aluminum and are confident in offsetting that with $50 million of price increases for the year.
We continue to expect $35 million in savings from our sourcing and engineering lead cost reduction programs. We still see $7 million in savings from our residential factories as we focus on automation on our U.S. plants and other productivity initiatives.
We continue to expect a $5 million benefit from foreign exchange for the full year and investments and distributions will still be a $10 million headwind this year, and SG&A growth will be another $10 million headwind.
Now, just a few more guidance points, corporate expenses are still targeted at $85 million for this year, net interest expense is now expected to be approximately $35 million for the full year, up from prior guidance of $32 million.
Tax rate guidance remains 22% to 24% on an adjusted basis for the full year. We are planning for capital expenditures of approximately $100 million for 2018 and the expected average diluted share count for the full year is still expected to be 41 million to 42 million shares, which includes our plans to repurchase $350 million of stock this year and $395 million in free cash flow is still targeted for the full year.
And with that let's go to Q&A.
[Operator Instructions] First on the line is Jeff Hammond with KeyBanc Capital Markets. Please go ahead.
Hey, good morning, guys.
Hey, Jeff.
So, just on price, it sounds like you guys are – as it moves up you're covering it. We heard chatter in the channel about June price increase. Is that something you're contemplating, would that be additive? Maybe just a little more color there?
Yes, I mean, first just let me reiterate the fact Jeff that, may we said it in the script but I'll just reiterate it. We got $11 million of price in first quarter, 2% of revenue of price in residential where you get priced the earliest, and 1.5 for LII overall. I think that's a strong as I've seen since I've been here. We had 9 million commodity headwind in Q1. For the full year we're confident, we're going to get 50 million of price to offset the 50 million of commodity, maybe even better given the traction that we got in first quarter.
As you know it's both the announcing of price increases, but it's the yield you get on much announced. As so, we watch what our competitors do in terms of announcing an official next price increase, but the clear message is we're getting price in the marketplace, we're going to continue to get price in the marketplace. If commodity costs were to move up again we would get additional price to offset that.
And then, refrigeration I think you’re still saying the market’s low single-digit, but you did come out of the gate here weak and it seems like more on the display side. What gives you confidence that you start to see better trends there and then just maybe update us on margin expectations for refrigeration, just given that you have started the year in the whole? Thanks.
The North America refrigeration market, we expect the industry – I think we're a little bit more conservative than what you said, we expect it to be up, low single digits and we expect our business to be up a little bit better than that. The softness in Kysor/Warren is just a reflection of the lumpiness of the grocery business, which is a large part of what they do on the display case side and there are some lumpiness ahead impact both on factory absorption and the volume impact.
In terms of margins, we’ve driven nice margin improvement in refrigeration in the last couple of years and there is more to come in 2018 and 2016 margins were up a couple hundred basis points. Last year they were up about 50 basis points and while we were down at first quarter we are still expecting our margins to be up 52 to 100 basis points full year within our refrigeration segment. Again adjusted for the businesses that were disposing of sort an apples-to-apples, we think it’s going to be up 52 to 100 basis points.
Okay, thanks guys.
Thanks. Sure.
Our next question is from Steve Tusa with JPMorgan. Please go ahead.
Hey, guys. Good morning.
Good morning Steve.
You know further delve into bit, prices cost hysteria out there, but on the refrigeration side specifically did you guys say what price cost would be there?
I am just looking at some notes to make sure. We offset commodities with price and in the first quarter and in all three segments, including refrigeration.
Okay. So going forward here over the course of the year you are optimistic you can get price in that channel?
Yeah. That’s a short answer.
Okay. And are you seeing on the Resi side, are you seeing everybody behave relatively well, any holdout so far. I know there have been, as Jeff said, few of your peers have kind of gone out with letters but maybe there is a couple guys missing there. Have you seen everybody kind of move forward?
I think I would answer it this way. I would say, we had strong revenue growth in the quarter. I think we outpaced the market and we got price. So that means we gained share raising price that implies in an industry structure, others are doing the same thing, and then as I have always said, our competitors have the same cost structure we do and they hedge the same way we do, and they got a pass on commodities just like we do. So, at any given point, if I like talk to sales guys there is a city where somebody is being a rational on pricing but across the board the industry structure is a good one. We all know we have to go get price.
Okay, that's fair. And then one last thing, I know aluminum is kind of moved up here recently, when you look at your commodity cost estimates, I assume that reflects kind of like what you know as of April 23rd as opposed to March 31st?
Correct. It’s our best bet right now, and again I mean more 50 is a pretty round number. So it’s plus or minus that to be totally sincere, but 50 is sort of the number and if it goes up or down a material amount then we update it, but we feel – I think the high-level message I deliver and I know there is concern about this in the marketplace is we are confident. We are going to offset commodities with price and we had a very good first quarter and demonstrate at least for one quarter we are doing it.
Right. Just curious, how are our April volumes kind of starting off here in resi?
Anytime the Cubs and the Mets are being snowed out. It’s not a good sign for air-conditioning sales. So to honest answer, the April started cooler than last year, but it’s very early in the quarter, 80% of the of the quarters in May and June and we have plenty of time for the weather to warm up, but it’s been cold in the first couple of weeks of April and that's [Indiscernible]. And last year you may recall it got hot early. So we were hot in April and then cooled off at the end of the quarter. So, we still have plenty of time for the heat to come, but a bit soft a little bit of the slow start.
Yeah, they always say sticking your head out the window is not fundamental analysis. So the weather is what it is. Thanks guys.
Exactly, right.
Next question is from Tim Wojs with Baird. Please go ahead.
Hey guys, good morning.
Hey Tim.
Maybe just think about residential and maybe the business more broadly too, but how are you guys thinking about next in the context of just some of the price increases that you are seeing in residential, anything that you have seen – I know the summer selling season is kind of ahead of us, but any context around, any sort of trade down or anything like that you are seeing from the mix perspective or expecting?
No, I mean we had positive mix in the quarter in resi in part, because add-on and replacement was up more than what new construction was in that leads to it, but even within our add-on replacement we continue to see mix-up and that’s all part of the strategy around I comfort and what we were doing with our Dave Lennox Signature Series.
So, no, again we sort of talked about this at the end consumer level 2% of price based on something about 15 years ago where the equipments half the cost and labor installations the other half is to be unnoticeable and so once you get to pass the contractor, dealer to accept to it the homeowners are going to take the price increase.
Okay, great. And then just in terms of the use of the cash proceeds on some of the refrigeration sales is that incorporated into your guidance at this point or how would we just kind of think about offsetting some of the dilution as you work through '18?
I think it’s not explicitly incorporated into the guidance if you are sort of asking a question of, are we anticipating a share buyback that we haven’t announced to lower the share account to get to the GAAP or to get to the EPS guidance, that’s not incorporated but sort of the mantras is consistent of, we will be disciplined, we will invest in the core business, we’ve sort of said what CapEx is going to be, we are going to have dividends grow with earnings and then what’s left we are going to do share buyback with.
Great. Well, good luck on the rest of the year.
Thanks.
Next, we will go to Julian Mitchell with Barclays, please go ahead.
Hi, good morning thank you.
Hey, Julian!
Hey! Just a question maybe, you have talked a lot about commodity costs thus far. I just wanted on the freight costs. You called those out as headwinds in the residential and commercial businesses. Maybe any kind of sizing of how big headwind that was in the quarter and how you are thinking about the subsequent impact over the balance of the year from freight costs in the guidance?
For the quarter it was a couple million – 2 or 3 million and we have been able to offset that through distribution and transportation productivity and other areas, as well as sort of broadly managing the cost of the business and again I would broadly say, take that and multiply times 3.5 [ph] and I think it sort of get the full-year impact of it, but again we are offsetting it on other elements of cost on the P&L.
Very helpful, thank you! And then my follow up would be around the commercial segment in particular how quickly you think we should see margins start to move up year on year, whether that’s in the second quarter we have to wait till the second half? And also whether you saw much impact from weather in the first quarter in terms of any kind of activity push outs or project delays that kind of thing?
No, there wasn’t much. There is always sort of push outs at the end of quarter. So, there wasn’t anything weather driven, what we saw in first quarter for our commercial business is just the lumpiness of national account revenue and national account revenue is more profitable for us than our regional and local business and our regional local business grew faster than national accounts, and that caused to mix down.
We are focused on driving margin expansion in commercial and we had strong fourth quarter, we had margins decreased in first quarter, but we were committed to having them grow for the balance of the year.
Great, thank you.
Thanks.
Our next question is from Gautam Khanna with Cowen & Company. Please go ahead.
Yeah. Thanks good morning guys.
Hey Gautam!
So, couple of questions. First, now with the refrigeration exits announced, are there any assets in that space you would like to add to the portfolio to the remaining refrigeration business to help shore it up or you do you sort of have what you need and that’s not really a focus of M&A from here?
I think there could be some opportunities, both in North America and now that we’ve parsed our business back and not in the display case business, but sort of in our more core traditional refrigeration business for may be opportunities, and we talked more broadly in Europe, both HVAC and refrigeration there is opportunities, but I wouldn’t expect us to pull the trigger on refrigeration in the near-term. I think we still have organic opportunities, both for growth and to continue to grow margins to get our three year target. So if we do something refrigeration I would look for that to be sometime next year or later.
Okay. And then just as a follow-up when you look at the industry landscape it all seems pretty rational and everything, but are there any combinations out there that would do you think pose a threat to Lennox, because we have heard a little bit about you UTX, may be splitting up their company eventually and who knows what happened with JCI, post the separation of the auto battery business. Are there any combinations like with that combination be a threat or change the landscape significantly from where you guys sit? Anything out that scares you?
No, I mean short answer is no. I said it three times but I guess I will underline it and say. Where we play North America residential and North America like commercial or unitary were three in our end markets and we are at critical mass and scale, and so if two of these other sort of large applied companies that also have residential businesses and in its early in JCI’s case almost an afterthought sort of combine that doesn’t bother us at all and again I without being too snarky about it haven’t spent a lot of time at UTC when these conglomerates combine people worried about or they are going to still have a corner office and or they going to still have the VIP parking pass rather than customers, and so it doesn’t bother me when sort of combination actually think we gain a lot of share of that.
Now, that’s I guess is the snarky answer. The more constructive answer is I do think there can be value creative combinations in this industry and I think we demonstrated that we are pretty good operators here and if something comes available I think we could create value if we were part of the combination.
Appreciate it. Thanks a lot Todd.
Next question is from Jeff Sprague with Vertical Research. Please go ahead.
Thank you. Good morning everyone.
Hey Jeff!
Hey, the good news is that aluminum is down 8% this morning on a little Russia relief, but I have a got a question about China if you don’t mind. You had made a point Todd historically about outsourcing significantly to China and highlighted that the Investor Day, as you knows there is a lot of motors and compressors on that list that came out a couple weeks ago, can you give us a little color on how you might deal with that? Can you shift back to the U.S? Is there anything preliminary that you are doing or do you just need to wait and see how these cards fall?
I think I will answer the latter part of the question first. We had to wait and see how the cards fall. I have learnt. We have all learnt. You’ve got to sort of see how it plays out. You can’t react to the tweets or sort of early pronouncements and this is obviously more than a tweet they put it on paper, but we discus and see how it plays out.
The answer is we have options. We have options both to move it back to North America, to move it other places in Asia. So, we will wait and see how it plays out, but we have multiple suppliers and flexibility on almost all the components, including the motors and we will just see how it plays out and react.
Can you give us a sense of how much of your sourcing is still in the U.S. on motors and compressors?
We do over half our compressors in the U.S. We have a joint venture from decades ago with Emerson that we do, we have base load of our compressors come from there and then some of the premium motors, we still source in the U.S. but even our U.S. suppliers of motors make a lot of those in Asia and source them for us from there. So, compressors more than 50 in the U.S., motors more than 50 outside the U.S.
And I just wanted some help thinking about the incremental to obviously of targeting kind of 35%, but as you know the way the arithmetic it works, so right if you are getting price of spending cost dollar for dollar that actually erodes margin, right? It works against the conversion rate so to speak. You still see a path drive to 35% incrementals and maybe a little color on how you get there?
A partial little bit and just say, I think it’s closer to 30 than 35, that’s what we are attempting to do with our guide this year in longer-term. So, I think it’s more 30% is what we should see the drop-through on the model. Yeah, we are still pretty confident that we can do it. I mean, we're -- price are offsetting commodities, but we got SG&A productivity for the quarter and we’ll get SG&A productivity for the year. We are offsetting freight and distribution productivity and then we still have the $7 million of factory productivity we are getting in North America. So, we still feel pretty good as long as we get the volume on the 30% incrementals that we talk about.
Alright! And just one point of clarification is the freight of two to three in addition to the commodities of nine that you felt in the quarter or conclusive.
Yes.
Great, thanks a lot guys. Appreciate it.
Okay.
Our next question is from Robert Barry with Susquehanna. Please go ahead.
Hey, guys good morning.
Hey Robert! How are you?
Good, thanks. Thanks for the more detailed color this quarter on the price versus the mix breakout. I appreciate that, but I did actually have a question on a couple of those metrics. That 2% of pricing in resi kind of expressed as a growth rate, how would you expect that to track as the year progresses?
I think in resi it will be relatively consistent and I think on the commercial refrigeration we will see it uptick a little bit. Now, I think there will be some lapping maybe in fourth quarter because we took sort of some preliminary actions going into the year as this commodity spiked up second half of the year.
So, I think maybe I am answering questions real-time. I think maybe a 2% tales it down for resi a little bit second half of the year or commercial and refrigeration tales starts to climb, as we are able to get national account for some of our larger customers with pricing.
Yeah. I mean maybe there is some rounding there but it does look like you are off to a pretty solid start on that front?
Yeah. I mean state the obvious if we do the math of that if we do one and a half or a year on 3.9 billion of sales or whatever you sort of happen your model we are going to do better than what we've said, but that would be good.
Yes. And that mixed components of the guide that five is that just resi?
I mean; yes primarily resi, the guy that gives specifically resi.
Yes, I mean similar question 1% in the quarter is almost five, just in this quarter. I mean is that just conservatism or do you see some offsets there as we go?
It’s conservatism. I mean, it’s quite frankly just not, but let me give a more thoughtfully answer. A part of that mixed in the quarter was add-on replacement outgrowing RNC for the quarter; Residential New Construction. That happens on a four year basis. We'll probably do better on mix than what we guided. If RNC sort of kicks back in, it’s growing in double digits and add-on replacements more like high single digits then we had negative mix the other way that we have to offset. I think that’s sort of the math of it.
Got it. Fair enough.
In our models we still think residential new construction on a full-year basis will grow faster.
Got it. What was the kind of net bottom line on how weather impacted resi growth in the quarter? Do you think?
The degree heating [ph] days were up year-over-year, so I mean it was colder in first quarter than it was a year ago. So, I think that net-net helped. It helped early and it helped sort of on spare parts and supplies, but as we said before when it’s been warm in first quarter, the weather in first quarter is near as impactful as it is in second and third quarter. So, may be a percent or two of revenue.
Got it. Just one quick last one for me. In your cash flow guide of 395, do you contemplate any material kind of working capital, headwind or tailwind in that number?
The tailwind we incorporated was last year – recall at the end of the year we had a disappointing end of the year on cash flow and we pointed it payables until lesser degree receivables is the reason and we said that would flow into 2018 and so we added about 30 million to our initial cash flow guide to reflect that working capital tailwind. And then, there is sort of nothing other than sort of normal working capital performance expected other than that.
Got it! And that normal would be just some modest incremental just lead given – right, yeah got it.
Yeah. So the core working capital metrics for good or for bad when cost of capital, this is slow will spend working capital to drive revenue.
Great, thanks. Thank you.
Next, we will go to Ryan Merkel with William Blair. Please go ahead.
Hey, thanks. Good morning and thanks for fitting in.
Yeah.
So, first questions just back on residential new construction. Why was it slower in the quarter and it sounds like you think it'll still be strong for the year, but just what did you hear and why do you think its going to pick up?
I think is mainly weather-driven. The flip side of it being colder this year rather than last year as jobsites don't get started in and projects don't – or houses don't get finished, and so I just think it's the reverse of the weather. I don't believe so far when we talk to our builders and I think continue when we talked to our builders, big builders they remain confident, they're not intimidated by the interest rates, they are sort of more constrained by making sure they have the property and the trades and we still think it's going to be up a year?
That makes sense. That's helpful. And then just the follow-up on the commercial margins, it sounds like you think the national account mix is going to improve going forward and that's going to be the big drive of why we should see margins starting to improve year-over-year, but is it also secondary that you should gain a little more price as the year goes on, I think you said that, so price costs actually start to improve a little bit as well?
Yes, exactly.
Very good. Thank you.
Okay, thanks.
Next question is from Robert McCarthy with Stifel. Please go ahead.
Good morning, everyone.
Robert, how are you?
Good. Three quick questions and I'll try to keep it on point, because so you don't go from snarky to snide with me. But in any event, because I know that it's a slippery slope with me in particular. So in any event, number one, could we just talk about maybe the hurricane impact in terms of anecdotal what you could see in terms of rebuild activity? And then maybe just the second part of that question is just level set us for the compare and the disruption in the third quarter as we kind of address our models as we're making concern the turn here?
When you talk to the team in Houston or to the team in Florida what they'll tell you is we saw a spike in spare parts right after each of those events. And we saw it for a quarter. And then I think the variable that's unaccounted for that we just have to see how it plays out is, those are places that it's hot year-round, so they had to repair their units. And the question is will they replace them when we get into the summer selling season if there's another issue on the unit.
So, I think it's still yet to be seen and -- but I think quite frankly it's on the round. And then I'll have to double check Robert what we said last yet. I don't think we complained. We had a weaker third quarter. We were down low single digits. And we were the part of the impact of that were the hurricanes, but as I recall from memory it was much more about the weather in third quarter than it was then. Joe, I don't think we blamed it when it happened and then I don't think we were as bullish as others have been about how it's going to bounce back. I think it's on the round both times.
Moving around this national accounts, definitely strong growth, obviously a bit of a shoulder quarter, but could you talk maybe a little bit about – it was there any compare benefit or as you're kind of weathering kind of the retail Armageddon, may be in terms of trends overall, how should we think about national account growth playing out for the year?
I think it continues to be a good story for us. And again we've – as you know, Robert, we've made explicit efforts to diversify away from retail. And increasingly our mix of business is less retail and when you look at new accounts we won in the over last two or three years, a higher percentage of them are non-retail than retail, and so we're working our way around. And then the other point as you've heard me talk about is some of our customers are figuring how to compete and have a business model that works whether its Home Depot, whether it's Lowe's whether it's Best Buy and to continue to compete against Amazon.
And so, those going to continue to be brick-and-mortar and a lot of those have roof tops that we put on place during the last big bubble of new construction and retail which mirrored housing construction a decade ago. Those units are now aging and have to be replaced our business model is not replacement model two thirds rather than a new construction model which used to be two-thirds of our business.
Final question is just PartsPlus, any update there, the trajectory of store ads and any trends positive or negative in terms of deployment and traction?
Yes. We our -- focus as you know in 2018 was to not open the same 25 to 30 stores you've opened the last few years that have to be more like five or six, I forget the exact number. We opened one in first quarter, but we increasingly we're talking about the need to drive parts and supplies as a mix of the sales and we had a nice, again, weather helped us because it was cold, but we had a nice growth in parts and supplies. We outgrew our total revenue growth in resi, parts and supplies grew double digits rather than the high single digits overall. So parts and supplies had a nice quarter. One quarter doesn't make a trend, but sort of our increased focus appears to get bang off and we look forward to good year in parts and supplies.
Perfect. Thanks.
Next, we'll go to Chris Belfiore with UBS. Please go ahead.
Good morning.
Hey, Chris.
So, in terms of residential replacement picked up sequentially, again pretty tough comp from last year. But do you think that you guys are seeing any pre-buy ahead of like price increased being fully baked in? And with regard to that have you seen channel inventory levels? Are they normal or higher than last year?
No. The price increases were effective at the end of the year and so if we put anything we will put it in the fourth quarter last year. The other is and I know you know Chris, but I'll mention it for others. I mean its tough to do the year-over-year against the hard comp point because last year we were up significantly because we had more days in first quarter, the number of days versus last year, this year difference of one, so its on the round where last year was up by four or five days from the prior year. So it's hard to look at the percentages year-over-year and say those up on a tough comp.
But the answer, I think what you're trying to probe is, we think was real demand, underlying homeowner confidence to replace units when they break demand and that foreshadows even with the weather being cool right now, confidence as we go in the second quarter both for us and for our contract.
Right, great. Thank you. And then just on the – you called out factory absorption [ph] negatively affecting profitability for the quarter? Was that only in refrigeration? And how should we expect that kind of continue -- go through the year or is just kind of largely behind them at this point?
Its only refrigeration and we think it's largely behind us. Again we sort of communicated that we think we can build, while the margins on refrigeration were down to 100 basis points for the quarter, we're still confident that we're going to have margins up full year 50 to 100 basis points and we look to grow margins for second quarter.
Okay. And then just one last kind of on the commercial side in terms of mix, I think last quarter you guys talked about the mix improving there and trying to potentially gain some more share on the emergency replacement side of things, with your product there? So just any color there in terms what you're seeing or any trends there?
No. I mean, we continue to focus on growing not only our national accounts business but our local and regional business. And as I spoke about we had a pretty good first quarter in our regional national account business which actually grew quicker than our national accounts business, so they sort of focus on regional and locals working out and we're focused on growing it.
Okay, great. Thank you.
Thanks.
And we'll go to Rich Kwas with Wells Fargo Securities. Please go ahead.
Hi, everyone. Just a couple ones on that local regional piece, is that better margin than national account?
National accounts is actually better margin, believe it or not and so that is why we felt margin pressure, in part we had mix down in the quarter from that part of the business growing faster than national accounts. And again, you know this Rich but for the broader audience its counterintuitive when you think about who our customers are on national accounts, but it's also our most expensive, most premium energy-efficient product who we sell them or the product we sell to them.
Okay. And then on mix for resi, so a point benefit in the first quarter, my recollection was last year you face stronger growth on the construction side, so you're confident against replacement, its little bit weaker, so should we expect this mix of say, 100 bps, does that going to continue next couple of three quarters?
You know, Steve asked the question or someone asked the question earlier and I said popped all the way around that I – the short answer is if -- we are mixing up and always sort of mix up and add on an replacement and so that's been the trend for the last two or three years. We expect that to be the trend this year. The variable that's offset it over the last couple of years is residential new constructions grown faster than add-on replacement has both as a market and our sale. And so if the rest of the year looks like first quarter which is our add-on replacement business grows faster than residential new construction we're going to have nice mix tailwind. We don't think that's going to be the case in our internal models. We think residential new construction was impacted by cooler weather in the quarter and for the balance of the year the market will probably outpace add-on and replacement.
Okay. So that's potential upside once all is said and done?
Correct. I mean, its potential upside on mix but maybe less volume, we like both of them to be up strong.
Right, of course. And then SG&A, should we think about half of sales growth?
Yes. Although we're off to a good start, but yes, that's how we model it.
Okay, cool. Thank you.
Thanks.
With no further questions, I'll turn it back to the company for closing comments.
Great. Thanks again everyone for joining us to wrap up. First quarter was a record start to the year. We entered our largest seasonal period. We continue to expect strong growth, profitability and cash generation for another record year in 2018. Again, thanks everyone for joining us.
Ladies and gentlemen, that does conclude your conference for today. Thank you for your participation. You may now disconnect.