Lennox International - Earnings Call - Q2 2025
July 23, 2025
Executive Summary
- Q2 2025 delivered a clean beat across EPS, revenue, and EBITDA, driven by favorable mix/price from the R454B transition and productivity improvements; adjusted EPS was $7.82 and segment margin reached 23.6%.
- Revenue increased 3% year over year to $1.50B while operating income rose 11% to $354M; management raised FY25 guidance to revenue up ~3% and EPS $23.25–$24.25, citing improved cost inflation and execution momentum.
- Both segments expanded margins: Home Comfort Solutions (HCS) margin to 25.3% and Building Climate Solutions (BCS) to 24.9%, with $114M of mix/price benefits offsetting volume declines and inflation.
- Stock reaction catalysts: broad-based beat vs. consensus, higher full-year EPS outlook, and narrative that R454B canister constraints and destock headwinds are normalizing into 2H, positioning for sustained margin expansion and emergency replacement growth.
What Went Well and What Went Wrong
What Went Well
- Record segment margin and EPS beat: Segment margin reached 23.6% and adjusted EPS $7.82, with mix/price driving $114M of profit tailwind; CEO emphasized “revenue growth and margin expansion in both segments” and raised full-year guidance.
- HCS and BCS margin expansion despite inflation: HCS margin rose 200 bps to 25.3% and BCS margin improved 60 bps to 24.9% on favorable mix/price and productivity; management noted R454B adoption (~90% of refrigerant-based sales) fueling mix.
- Strategic growth platforms advancing: Samsung JV and Ariston JV broaden portfolio and should contribute from 2026/2027; emergency replacement rollout (now 5–6 markets) gaining traction with inventory positioning and faster fulfillment.
What Went Wrong
- Volume softness and destocking headwinds: Sales volumes declined (HCS down 9% and BCS down 3% YoY for Q2) with industry R410A destocking and R454B canister shortages weighing on sell-through.
- Cash flow compression: Operating cash flow declined to $87M from $184M YoY and FCF to $58.7M from $151.9M, reflecting inventory investments for R454B transition and emergency replacement.
- Tariff/inflation overhang: FY cost inflation assumption is ~6% and price/mix trimmed to ~9% (from prior ~11%); management maintained sensitivity to tariff volatility, though mitigation and surcharge withdrawal helped.
Transcript
Operator (participant)
Welcome to the Lennox Second Quarter Earnings Conference Call. All lines are currently in listen-only mode, and there will be a question-and-answer session at the end of the presentation. You may enter the queue to ask a question by pressing star and one on your phone. To exit the queue, press star and two. As a reminder, this call is being recorded. I would now like to turn the call over to Chelsea Pulchin from Lennox Investor Relations. Chelsea, please go ahead.
Chelsey Pulcheon (Director of Investor Relations)
Thank you, Margo. Good morning, everyone, and thank you for joining us as we share our 2025 second quarter results. Joining me today is CEO Alok Maskara and CFO Michael Quenzer. Each will share their prepared remarks before we move into the Q&A session. Turning to slide two, a reminder that during today's call, we will be making certain forward-looking statements which are subject to numerous risks and uncertainties as outlined on this page. We may also refer to certain non-GAAP financial measures that management considers relevant indicators of underlying business performance. Please refer to our SEC filings available on our Investor Relations website for additional details, including a reconciliation of GAAP to non-GAAP measures. The earnings release, today's presentation, and the webcast archive link for today's call are available on our Investor Relations website at investor.lennox.com.
Now, please turn to slide three as I turn the call over to our CEO, Alok Maskara.
Alok Maskara (CEO)
Thank you, Chelsea. Good morning, everyone. Let me begin today's call by highlighting the impressive results we achieved in Q2. Results that reflect our team's strategic focus and resilience. In the face of a challenging external environment, both segments delivered revenue growth and margin expansion. This performance was fueled by our continued emphasis on cost discipline, elevating the customer experience, and enhancing our go-to-market differentiation. As we build on this momentum, I want to express my sincere gratitude to our employees for their dedication and to our loyal customers for their continued trust and partnership. Let us turn to slide three for an overview of our second quarter financials. Revenue this quarter grew 3%. Our segment margin was a record 23.6%, an increase of 170 basis points. Operating cash flow was $87 million. Adjusted earnings per share in the second quarter was $7.82.
Our team is performing well despite ongoing challenges, including softness in new construction demand, industry refrigerant canister shortages, customer uncertainty, and inflationary pressures. In HCS, profitability remained strong as we transitioned into selling primarily our R454B products. Restocking in Q2 was largely in line with expectations, though we anticipate some spillover into Q3 as industry lead times continue to normalize. While residential new construction remains subdued, the HCS segment continues to perform well given the broader market conditions. In BCS, factory productivity has improved, helping to mitigate inflationary pressures. Emergency replacement wins have partially offset end markets that have been weaker than we anticipated. In addition, growth from our full life cycle strategy has delivered year-over-year revenue growth and margin expansion. We are raising our full-year outlook to reflect our consistent execution in a challenging environment and continued progress on our growth initiatives.
We now expect adjusted earnings per share in the range of $23.25-$24.25 and revenue growth of approximately 3%. Now, let us move to slide four for a brief look at how we are expanding our portfolio and the value we bring to our customers through joint ventures with leading global partners. As we continue to execute our transformation plan, we are taking a deliberate approach to building long-term value through strategic partnerships that strengthen our heat pump portfolio and enhance customer experience. Our joint ventures with Samsung and Ariston are clear examples of this strategy in action. These partnerships allow us to offer a broader range of products that our customers are already installing, making it easier for them to do more business with us.
With 75% of our dealers already selling mini splits and 50% offering water heaters, these additions are a natural fit that will provide one-stop shopping convenience to all our customers. These joint ventures position us well for future growth. Samsung brings advanced technology, smart things integration, and strong brand recognition that will enhance our portfolio in both HCS and BCS through ductless mini splits and VRF products. Ariston contributes deep expertise in global heat pump water heating, and our North American joint venture strengthens the position of both companies during the ongoing convergence of HVAC and water heating trades. These partnerships align with the growth acceleration phase of our transformation strategy and establish the foundation for the expansion phase. We expect Samsung to begin contributing meaningfully to growth in 2026, followed by Ariston in 2027.
Now, let me hand over the call to Michael, who will take us through the details of the Q2 financial results.
Michael Quenzer (CFO)
Thank you, Alok. Good morning, everyone. Please turn to slide five. As Alok outlined, in the second quarter, we operated in a challenging environment shaped by persistent inflationary pressures, industry-wide destocking of R410A equipment, and the continued transition to the low GWP R454B products. Despite these dynamics, our team delivered record results with a 3% increase in revenue and 11% growth in segment profit. A key driver of this performance was the successful introduction of our new low GWP 454B products. These enhanced products will replace approximately 70% of our home comfort solutions product portfolio and 40% of our building climate solutions portfolio. During the quarter, approximately 90% of our refrigerant-based product sales contained the new R454B refrigerant, driving favorable product mix and contributing meaningfully to both top line and profit growth. Let's now turn to slide six to review the performance of our home comfort solution segment.
Home comfort solutions delivered strong financial results this quarter despite softness in sales volumes. Revenue increased 3%, driven by favorable product mix and pricing, which rose by 12% as these initiatives reached full effectiveness. As anticipated, sales volumes declined mainly because contractors and distributors are still selling through their 410A inventory. The slowdown was also influenced by continued softness in residential new construction and industry-wide shortages of R454B canisters, which are required for many new system installations. These shortages may have led to an increase in system repairs instead. On the cost side, inflationary pressures on materials and components persisted. However, we successfully offset part of these impacts through effective tariff mitigation and improved factory productivity. Distribution costs were higher this period due to ongoing investments in expanding and strengthening our network.
These investments are part of our long-term growth strategy aimed at improving customer fulfillment rates, broadening product availability, and making it easier for customers to access the solutions they need when they need it. By enhancing our distribution capabilities, we are working to deliver a more seamless and responsive customer experience. Moving on to slide seven. After a slow start to the year, the building climate solution segment delivered a strong rebound in the second quarter as customers regained confidence since Q1. The segment achieved a 5% increase in revenue, driven by an 8% benefit from favorable product mix and pricing, which more than offset volume declines. Like commercial HVAC, which accounts for approximately 50% of BCS revenue, continued to face pressure from soft end market demand with industry shipment volumes down double digits.
However, our segment sales volumes declined just 3%, supported by growth in emergency replacement products and continued strength in our refrigeration and service offerings. On the cost side, material inflation remained elevated. Encouragingly, for the first time in several quarters, we delivered year-over-year factory productivity gains as the ramp-up of our new facility nears completion. Turning to slide eight, let's review cash flow and capital deployment. From a free cash flow perspective, we remain on track to achieve our full-year guidance of $650 million. To $800 million. While we made temporary inventory investments to support a smooth transition to the new R454B products, we expect inventory levels to normalize in the second half of the year. We are also strategically investing in inventory to strengthen our position in the commercial emergency replacement segment and to support the launch of our new Samsung Ductless product line.
On capital deployment, we have repurchased $300 million in shares year-to-date. In the second quarter, we also received authorization for an additional $1 billion in future share repurchases. Reflecting our strong earnings and cash flow outlook, we increased our quarterly dividend by approximately 15% in May. Lastly, we continue to take a disciplined approach to M&A, actively evaluating attractive bolt-on opportunities that enhance our distribution capabilities, expand our product portfolio, and integrate smart technologies. If you will now turn to slide nine, I will review our full-year 2025 guidance. Let me walk you through the updates to our 2025 financial guidance, which reflect a strong first half and improved visibility into the second half of the year. Based on our performance so far and the momentum we are seeing, we are raising both our revenue and EPS guidance.
This speaks to the strength of our execution and the confidence we have in our outlook. Starting with revenue, we now expect full-year revenue to grow by 3%, up from our previous guidance of 2%. This modest improvement reflects a slightly more optimistic view on sales volumes, which are now projected to decline 6% compared to our prior estimate of down 9%. This includes the impact of pre-buy and temporary share gain. On mix and pricing, we now expect a combined benefit of 9%, slightly below our previous estimate of 11%. This adjustment reflects lower-than-anticipated material tariff inflation, as noted in Q1. Our pricing strategy is designed to flex with input cost trends, which have moderated. In line with this, we now expect cost inflation to increase total cost by 6%, down from our prior estimate of 9%. This improvement is primarily driven by successful tariff mitigation efforts.
Looking at other key items, we now expect interest expense to be approximately $30 million and our tax rate to fall between 19% and 20%. Finally, on earnings, we are raising our EPS guidance to a range of 23.25-24.25, up from our previous range of 22.25-23.50. Overall, these updates reflect strong execution across the business and confidence in our ability to deliver on our commitments for the remainder of the year. With that, please turn to slide 10, and I will turn it back over to Alok.
Alok Maskara (CEO)
Thanks, Michael. Let me take a moment to provide a view of how we are positioned for growth and how we see the market evolving across both of our segments. The smooth transition to a low GWP refrigerant maintained our exceptional track record and deepened trust with our customers. We are now selling mostly R454B product, with limited R410A remaining in the channel. While the transition was well executed by Lennox, dealer confidence has been impacted by concerns around R454B canister availability. This may have led to a partial reversal of last year's temporary share gain. We are beginning to see that more homeowners are choosing repair versus replace and trading down as inflation and government incentives continue to influence some consumer behavior. While the broader environment remains challenging, our internal momentum continues to accelerate.
Equipment inventories in the channel are moving towards more typical levels, and the availability of R454B canisters is expected to continue improving. This will enhance our ability to support dealers and meet customer demand in a timely manner. In our Building Climate Solutions segment, we are beginning to see early signs of demand stabilization following prolonged industry softness. Additionally, our strategic investments are generating positive results. Order rates and backlog remain healthy, given steady replacement demand as aging systems approach end of life. Our operational execution has been strong, and we now have the necessary capacity to meet demand. Margins have sequentially recovered as factory productivity improved, which helps offset inflationary pressures on materials and components.
Demand is also increasing for comprehensive RTU lifecycle solutions as national account customers are placing greater value on partners who can support them across the entire value chain, from equipment and installation to service and long-term preventative maintenance. Our ability to deliver across this spectrum sets us apart. We're also seeing growing traction in emergency replacement, where our brand quality, availability, and responsiveness have proven to be a success. Looking ahead, we see opportunities to expand our product and service portfolio through growth initiatives that strengthen our ability to serve customers and deepen our relationships. Now, let's turn to slide 11 and why Lennox continues to be well-positioned for sustained growth and margin expansion. We remain focused on executing the Lennox transformation strategy introduced in 2022 and advancing into our next phase of strategic expansion.
Our growth is supported by steady replacement demand and targeted initiatives across digital customer experience, ductless technology, commercial capacity, and parts and services. We continue to expand resilient margins through productivity and pricing excellence while investing in distribution to further enhance customer experience and availability. We are also scaling digital capabilities across products and customer interactions while leveraging proprietary data and expanding our intelligent product lineups. All of this is powered by a high-performing team and a culture grounded in accountability and results. I am confident in our strategy, encouraged by our progress, and focused on delivering value for our customers, our employees, and our shareholders. As I look forward, our best days are ahead of us. Thank you. We will be happy to answer your questions now. Margo, let's go to Q&A.
Operator (participant)
Thank you. At this time, if you'd like to ask a question, please press the star one on your telephone keypad. You may remove yourself from the queue at any time by pressing star two. Once again, that is star one to ask a question. We'll take our first question from Jeff Hammond with KeyBank Capital Markets. Please go ahead.
Jeff Hammond (Managing Director)
Hey, good morning, guys.
Alok Maskara (CEO)
Morning, Jeff.
Jeff Hammond (Managing Director)
Hey, so the gap between price and cost was pretty stunning and obviously showed through in the margin. I'm just wondering what you're seeing with the A2L manufacturing costs, given that there are some added costs related to that equipment, and then tariffs, if they really showed up or came into Q2, or do they step up into the second half? Just trying to understand that price-cost gap better as we go forward.
Alok Maskara (CEO)
Sure. On the A2L conversion, both our cost and price are very close to our expectations and our previous communication, Jeff. There has been no change. What we have been able to do is get more factory productivity, and we have done significant headcount retrenchment as we finally were able to get out of some of the factory inefficiencies that came into play during the A2L conversion. I think, as expected, and mostly driven by productivity, not price in that case. Both price and mix were as expected, and it is holding just fine.
Michael Quenzer (CFO)
Jeff, your question on tariffs, in the second half, we do have tariffs increasing a little bit in the second half, but that's all built in the guide. Both businesses are still reflecting margin expansion in the second half of the year, demonstrating our good price-cost excellence.
Jeff Hammond (Managing Director)
Okay. And then, can you walk through kind of what your volume assumptions are for the second half? Looks like you bumped it up a little bit, or it's less bad in HCS. And then, should we expect price mix to be similar to Q2 in the second half as it was in Q2? Thanks.
Michael Quenzer (CFO)
Yeah. Implying the guidance for the HCS segment is the balance of the year volumes, including the destock, and just overall volumes are down about 8%. That compares to about down 6% year-to-date. A little bit more decline in the second half than the first half. On price mix, it implies about up 10% in the second half in line with where we saw the first half. BCS, down volumes in the second half of about 4% compared to down 6% year-to-date. Balance of the year, price mix similar to what we saw in the first half at up 6%, 6 or 7%.
Jeff Hammond (Managing Director)
Okay. That's helpful. Thanks so much.
Michael Quenzer (CFO)
Yep.
Operator (participant)
Thank you. We'll take our next question from Julian Mitchell with Barclays. Please go ahead.
Julian Mitchell (Equity Research Analyst)
Hi, good morning. Just wanted to circle back to the margin outlook there for a second. Just wanted to confirm the sort of full-year EPS guide. Is that embedding kind of 50-60 basis points of operating margin expansion, that type of rate? When we're thinking about kind of third versus fourth quarter, anything to call out there in terms of moving parts, maybe as kind of the tariff effect comes in for that 6% cost inflation number? Any more color around that, please?
Michael Quenzer (CFO)
Yeah, Joelen, that's correct. For the full year, we're projecting about a 50 basis point expansion in margin. We had about 50 basis points in the first half, another 50 basis points in the second half. For the full year, HCS will be up a little bit more than the 50 basis points, and BCS will be closer to flat with the volume reduction that we just took. Both businesses will show margin expansion in the second half. A little bit more margin expansion in BCS as that factory productivity kicks in.
Alok Maskara (CEO)
Julian, I think there's lots of moving pieces here, but overall, this is consistent with our journey as we are looking to make margins both as a manufacturer and distributor. If we just go back three years, we can see that our margins in Q2 have expanded 680 basis points over the past three years. We do not think of this current margin expansion as anything but just part of our overall trajectory to earn margins both as a manufacturer and a distributor.
Julian Mitchell (Equity Research Analyst)
That's helpful. Just to follow up on that, I understand the sort of margin increase first half, second half, year-on-year is a pretty similar delta. I suppose the sort of first versus second quarter was quite a big difference. Just trying to understand, would you argue that the second quarter represents a more natural performance given where we are in the A2L cycle and plant productivity, whereas Q1, you're obviously dragged down by the early phase of A2L plus the Mexican plant issues?
Alok Maskara (CEO)
Yeah, I think you're right, Julian. Q1 was tainted by significant inefficiencies in our manufacturing, both as we transition our BCS factories into A2L products. We obviously had an air pocket that we talked about both from sales and production perspective. Yes, overall, in Q2, we saw a mix shift more towards 454 versus 410A. Just Q1 inefficiencies and then more normal mix for the year. Both makes us confident that Q2 is a better gauge of our margin versus what abnormal Q1 margins look like.
Julian Mitchell (Equity Research Analyst)
Thank you. Michael, I do not know if you mentioned sort of anything on Q3 versus Q4. Maybe I missed it.
Michael Quenzer (CFO)
Yeah, we do not get the quarterly guidance, but what I will say is the second half, you will have more of that comp issue in the fourth quarter as we add $125 million in the second half of last year for pre-buy and temporary share gains. That will weigh a little bit more in the fourth quarter.
Julian Mitchell (Equity Research Analyst)
Makes sense. Thank you.
Michael Quenzer (CFO)
Yep.
Operator (participant)
Next, we'll go to Damien Carras with UBS. Please go ahead.
Damian Karas (Executive Director)
Hey, good morning, everyone.
Michael Quenzer (CFO)
Morning.
Alok Maskara (CEO)
Morning, Damien.
Damian Karas (Executive Director)
I actually wanted to ask you about the Ariston partnership. Obviously, interesting move to get involved in water heaters. Alok, could you maybe share some of the early feedback you've gotten from your dealers on the water heater business? What's a reasonable expectation for the pace that you could start to see some of those sales showing up in your results?
Alok Maskara (CEO)
Sure. Great question. Early feedback from our dealer and overall from our channel has been very positive. As we mentioned in our script, 50% of our current dealers or contractors are already selling water heaters. For them to be able to buy from us would significantly change the kind of logistics hurdles that they have to go through. We can consolidate shipments. More of our tech advanced dealers are excited about the fact that we can integrate the controls, and they can provide a common service option. If they are going twice a year to change filters, they can also flush the water heaters while they are going there. The dealer reaction has been very positive. We are going to launch the product in Q1 next year, which means from a practical perspective, we will see meaningful growth starting in 2027.
I think 2026 is going to be more of a launch year, and we will work through all the launch pieces. At this stage, it is kind of early to give you numbers, but I think over the long term, we see this convergence between the two continue to play out and positions us really well as a lot of the water heaters have to make the transition to heat pump. At that point, the overlap and the growth will go up even higher. That, as you know, happens in 2029 when all electric water heaters over 35 gallons need to be heat pump-based. We think a lot of acceleration will happen at that point. We would be very well positioned by then.
Damian Karas (Executive Director)
That's really helpful. Thank you. I wanted to ask you about market share. Sorry if I missed this. I know you talked a little bit about starting to gain momentum in emergency replacement. On the residential side of the market, are you still expecting to more or less give back all of the share gains from last year, or has your view changed at all there based on what you're seeing?
Alok Maskara (CEO)
It's too early to say. I think we did expect to give back some of that share. We think we might have given back some in Q2 already because of the R454B canister shortages. That has kind of guided our view of the rest of the year. Overall, we are pleased with where we stand. We are pleased with how we have been able to renew most of our contracts and continue to improve our availability, hence attract more dealers. Yeah, I think we are not banking on keeping all that share. We'll give back quite a bit or partially that share back.
Damian Karas (Executive Director)
Got it. Got it. Thanks a lot. Good luck out there, Alok.
Alok Maskara (CEO)
Thanks.
Operator (participant)
We'll go next to Ryan Merkel with William Blair. Please go ahead.
Ryan Merkel (Co-Group Head of Industrials)
Hey, everyone. Thanks for the question. I had a two-parter on BCS to start. You lowered the volume to mid-single digits for the year. Could you just talk about why that was? Is it I think you mentioned industry softness, but if you could expand on that. What do you mean by commercial is nearing a bottom? Just unpack that.
Alok Maskara (CEO)
Sure. I think they're related. I mean, we were expecting BCS industry volume to start hitting bottom by the end of Q1. It turned out it kept declining as the industry volume all throughout Q2. Now we are seeing signs of stabilization. We do expect things to kind of bounce along the bottom for a bit before the uptick back to more normal levels starting maybe late in the second half. That's the reason we brought our overall BCS volume guide down based on what we saw in Q2. At the same time, we do see signs of stabilization. Hence, we called out that we are kind of bouncing along the bottom at this stage. You never know how long this will last, but things are no longer getting worse.
Ryan Merkel (Co-Group Head of Industrials)
Okay. Got it. That's helpful. And then just a question on weather. People were worried about the mild weather. You did not mention weather as a headwind in the script. Just curious if you thought it was a headwind. Maybe just comment on the shape of the quarter. Did you see better trends as you got into late June, July, just given the heat wave?
Alok Maskara (CEO)
Yeah, that's part of my rule, Ryan. I think you would have talked about it. I don't think we should ever blame weather for our numbers, so we shouldn't talk about that. Obviously, we have seen over the past many years that there's been late start to the summer. That seems to be continuing this year. May was very soft. Towards the end of June, we saw much stronger sales. Yes, there's clearly a pattern that's related to weather. That June strength continues as we look at the first few weeks of July as well. From our perspective, there's some anecdotal data about May being the coldest May in the past, whatever, 20 years plus or so.
For us, as we look at the replacement demand and we look at where consumer confidence and R454B canister shortages, those all probably played an equal amount of role into the softer Q2 for HCS. Yeah, there definitely was a weather impact that got better throughout the quarter.
Ryan Merkel (Co-Group Head of Industrials)
Got it. All right. Thanks. Congrats on the quarter. I'll pass it on.
Alok Maskara (CEO)
Thanks, Ryan.
Operator (participant)
Thank you. Next, we'll go to Stephen Volkman with Jefferies. Please go ahead.
Stephen Volkmann (Equity Analyst)
Hey, great. Good morning, everybody. I wanted to dig in a little bit into the price mix question, maybe Michael. I'm curious. It sounded like from Alok's comments that maybe the mix was negative. So was price a little stronger and mix perhaps a little bit negative? Did I read that right?
Michael Quenzer (CFO)
Yeah. It's the opposite. We've had very strong mix and also continued price. We blended the two together just because at this point, we started the year with a 10% increase for mix on the R454B product and then followed on with two price increases. It's a bit challenging to spike out the difference between mix and price, but overall, the mix is still achieving what we believe is that 10% increase that we began the year with.
Stephen Volkmann (Equity Analyst)
Got it. Okay. I guess what I'm really trying to think about here is whether, on the repair side, Alok, I think you mentioned that it was sort of canister related. Are there any signs of just kind of price pushback in the sense that affordability is just getting tough for some people and therefore they're perhaps looking to trade down or repair versus replace? Is that a dynamic, or is it all, in your mind, more just canister related?
Alok Maskara (CEO)
It's hard to be extremely precise with this, Steve, but I think the way we have looked at it, the R454B canister shortage had impacted the dealer confidence. They are the ones who typically do a great job convincing the consumer on the benefits of replace versus repair and benefit of upgrading. I think that was a primary. On secondary factor, yeah, we have seen consumers trade down. The entire industry has moved to 17% as the minimum SEER equipment. That continues to be the case for many years. I do see that trade-down trend continues. We have not seen any impact of kind of consumer price elasticity or anything like that. It remains a necessary purchase. We do see consumers getting two to three quotes if earlier they were getting one to two quotes.
I think there's a lot more consumers who are able to get multiple quotes versus during COVID, they were delighted if they just got one quote and somebody willing and availability to do that. We do see some more consumers looking to get deals. I think that puts multiple dealers into play at any given time. We are watching all those trends, but nothing unusual this quarter compared to what we had seen earlier, except the 454B canister was unusual. That's why we called that out.
Stephen Volkmann (Equity Analyst)
Got it. Okay. Thank you so much. I'll pass it on.
Operator (participant)
Thank you. We'll take our next question from Jeff Sprague with Vertical Research Partners. Please go ahead.
Jeff Sprague (Founder and Managing Partner)
Hey, thank you. Good morning, everyone. Just a point of clarification before I get to my question. Just on the inflation number you're giving us, the 6%, that's on total COGS and total SG&A. And then investments and productivity numbers you gave us are separate and apart from that?
Michael Quenzer (CFO)
Yeah. That's correct. It'd be on the total cost, both the cost to get sold and SG&A. From there, you add on top of it any investments and subtract productivity.
Jeff Sprague (Founder and Managing Partner)
I wonder if you could thank you for that. Can we just maybe address kind of managing price mix? I think we've kind of tiptoed around a little bit in some of the earlier questions, but it does sound like you're seeing some price elasticity come into play. It also looks to me like you're "getting more price than you need." And congratulations if you can do that. As you try to toggle price you need versus price you can get and the impact that it has on the consumer buying decision, is there some clear trade-off there in your view in terms of making sure price is not at a level that it negatively impacts mix and then has other ramifications on the whole repair versus replace dynamic?
Alok Maskara (CEO)
Sure. As you know, you never get pricing exactly right. You're always going to be a tad too high or a tad too low. I think pricing excellence remains overall a very core initiative for us. We often find that we may be underpriced in certain markets and maybe overpriced in certain other markets. I'm talking geographically within the U.S. because each region and each local zip code has its own pricing. We continuously, on a daily basis, manage that and have now started using some really good tools, AI-based tools, and a lot of data to make those decisions. That's probably behind when we talk about why our pricing has yielded good results. Overall, we remain very sensitive to the trade-off between pricing and share or pricing versus consumer price elasticity. Keep in mind, the consumer price elasticity depends on dealers selling to consumers, not us selling to dealers.
There's a significant markup because of labor, installation, permits, and supplies that happens between when we sell to a dealer versus a dealer sells to consumer. Net net, I don't know if I would say that our pricing turned out to be much better than expected. I think it was as expected. Tariff costs continue to come through. Remember, we did two price increases, one price and one surcharge that we talked about in Q1. We landed withdrawing a large portion of that surcharge as some of the tariffs came out lower. We remain focused on making sure we price fairly and we price competitively in the marketplace.
Jeff Sprague (Founder and Managing Partner)
Great. Thank you for that. I'm sorry I missed the first five minutes of the call, but has the line length increase on OEM units going out the door not fully addressed kind of the issue of the canister shortage, or do you think we're going to be done talking about canister shortages here as we move through the third quarter?
Alok Maskara (CEO)
Yeah, I hope we are done talking about the canister shortages. The line length issue, and we all have done that, right, gone to 30 ft line length. That has addressed the concerns from our dealer. Unfortunately, a lot of that inventory hit the sales or our warehouses only in June. We started to see some of that impact where dealers' concerns were less towards the end of June versus beginning of May. I think all of us now have inventory with 30 ft line length pre-charge. That, plus there are more canisters available than there were two months ago. Overall, I sincerely hope that we won't be talking about this when we talk about Q3 earnings. We're talking about it in a more positive way.
Jeff Sprague (Founder and Managing Partner)
Great. Thank you for that color.
Operator (participant)
Thank you. Next, we'll go to Noah Kay with Oppenheimer. Please go ahead.
Noah Kaye (Managing Director and Senior Analyst)
Thanks for taking the questions. I wanted to ask about the inventory build. You provided some color, but I was hoping to maybe unpack a little bit further what drove the sequential build between just more build of 454B versus the channel being able to take that. You had Samsung and a couple of other things you called out. To put a bow on it, how we should think about kind of the cadence of inventory reduction and where you expect to be at year-end.
Michael Quenzer (CFO)
Sure. Yeah, just to add some clarity. We always wanted to make sure we did a successful transition to the new 454B product. Within that, we thought there might be this air pocket coming in the second quarter, but we wanted to have sufficient inventory for the season in case that air pocket did not come in. It came in a bit as expected.
What we are going to do in the second half of the year is to decelerate some of that inventory and drive it down to more normal levels. There will still be a growth year over year at the end of the year, mostly for these investments for Samsung and the emergency replacement, but it will normalize in the second half of the year. That is all built into our free cash flow.
Noah Kaye (Managing Director and Senior Analyst)
Okay. Just a quick follow-up on that. That inventory that you built, that you expect to come down, does most of that kind of remix towards the longer line length that we were just talking about in the prior question?
Alok Maskara (CEO)
Yeah. For residential, that would be true. I think that puts us all in a really good position. We also have some of the older line length as well. I think it's a good mix. Most of the ones we built recently were the longer line length.
Noah Kaye (Managing Director and Senior Analyst)
Yeah. I think people just want to understand any risk around strained inventory. It sounds like that's not an issue. Last question. 25C, you mentioned there's a little—yeah, yeah. You mentioned a little bit about the 25C expiration. Of course, that's eligible through the end of the year to claim. Any anticipation in the guide of a demand pull forward around that? Are you driving any initiatives with dealers to kind of try to get the credit monetized before it expires?
Alok Maskara (CEO)
I don't expect a significant demand pull. As you know, it was only in single digits that units are compared to units sold that took advantage of the 25C credits. I think it's a small amount. In 2026, maybe the mix would be slightly—I mean, again, it's only 6-7% of the units were impacted. No, at this stage, I don't expect any demand pull forward because of that.
Noah Kaye (Managing Director and Senior Analyst)
Perfect. Thank you.
Operator (participant)
We will go next to Brett Lindsay with Mizuho. Please go ahead.
Brett Linzey (Senior Analyst)
Hey, good morning. Appreciate all the detail.
Alok Maskara (CEO)
Morning, Brett.
Brett Linzey (Senior Analyst)
Yeah. Wanted to start with commercial. You noted the manufacturing productivity continues to ramp in the Mexico facility. I guess as that capacity gets stood up and you're back in the emergency replacement market, do you have any updated thinking on factory output and how that might ramp over the coming quarters as you're filling it out and driving more revenue there?
Alok Maskara (CEO)
Sure. First of all, I'm delighted that we're talking about factory productivity versus factory inefficiency. It seems like for the past four or five quarters, all we were talking about was factory inefficiencies. Yes, delighted that we now have two factories, both doing well. One in Saltillo, very focused on standard product for emergency replacement, non-configured. The one in the U.S. in Stuttgart, very focused on configured products, mostly for key accounts and other applications. I think that balance is going very well for us. We have scaled back our labor force in the factories as our inventory has come to a good level, mostly through attrition and otherwise. We will continue to kind of balance demand across both to make sure that we serve the customers in the most appropriate way and get the right financial outcome.
I think we're just pleased with that balance and that flexibility we have, which we have never had before. I do expect our productivity run that started in Q2 to continue for the next multiple quarters as we continue balancing those two.
Brett Linzey (Senior Analyst)
That's great. I just wanted to follow up on the repair versus replace discussion. You noted the trade down. I guess, is there any data you can share on the rate of growth in the parts categories versus equipment or something fundamental in the second quarter driving that sentiment? I guess, how do we think about that dynamic in the context of the raise in the guide for this segment against some pretty tough comps here in the back half?
Alok Maskara (CEO)
Sure. I'll take it one at a time, right? On the repair versus replace, we are underweight in parts, as you know. I mean, I'm actually interested to see when others declare their results to see if they have noticed an uptick. If there was a big uptick in repair parts, we won't necessarily see that. Our part sales were pretty normal in Q2, so no evidence. This is more based on just talking with dealers, talking with our key accounts, and looking at other industry trends. This was our comment based on that, but no numerical evidence to support that. On the second piece, as we look at it, when we gave the guide for 2025 at the end of Q1, our view was shaped by a potential impending recession.
Our view was shaped by potentially tariffs leading to a lot of inflation and that inflation leading to a lot of demand pullback and consumer uncertainty. Things have just become more stable for the U.S. economy, as you know, since then. That's primarily the reason for change in our guide is just more stable consumer demand, more stable consumer confidence. The new home construction is the one area that remains weak, just like existing home sales. We did take that into account as we came back with the guide. That's the piece that continues to be weak.
Brett Linzey (Senior Analyst)
Okay. Great. Appreciate the detail.
Operator (participant)
Thank you. Next, we'll go to Tommy Malt with Stevens. Please go ahead.
Tommy Moll (Equity Research Analyst)
Good morning, and thank you for taking my questions.
Alok Maskara (CEO)
Morning, Tommy.
Tommy Moll (Equity Research Analyst)
Hello, Coe. I wanted to start on tariffs and associated surcharges or price increases, whatever we want to call them. I heard you earlier say that you ended up removing all or a substantial portion of the surcharge that was, I guess, announced in the second half of April, just as the tariff picture improved. If you could walk us through any of the details there, I think it would help to clarify for folks. As we look forward, what are some of the potential changes in the tariff landscape where you would have to think about potentially needing to come back for another surcharge? It could go the other way as well. There is a lot in flux. Maybe just frame for us, what are you watching over the next couple of quarters?
Alok Maskara (CEO)
Sure. Let me start by giving you where we are on the overall tariff landscape, right? I mean, when we gave our Q1 guidance, we talked about about $250 million in tariff impact to us. If you were to ask us the same question again now, we will say the impact is going to be less than half of that. That is because our teams have done a really good job of mitigating tariffs by switching suppliers and others. As you know, some of the tariffs have been changed or lowered. Putting that, an overall impact is much lower. To offset the impact, we had always talked about we're going to focus heavily on productivity, focus on cost control, which we did, and we did pretty effectively. Then we relied on pricing. We had done one price increase and one surcharge related to tariffs.
Eventually, we did withdraw, I would not say all, but the majority of the surcharge, given that the China tariffs came down substantially from 145-some to a lower number. The first piece continues, and that continues to offset the tariff impact, which we are still facing. That impact is, as I said, less than before. Going forward. There is a lot of uncertainty. You and I both wish we knew what is going to happen on tariffs tomorrow, but we do not. We remain concerned about tariffs coming from South Korea. We remain concerned about some of the August 1st tariff deadlines. We remain concerned about the future of the US, Mexico, USMCA production and exemption. We continue to watch out for those.
Our goal has always been to provide our dealers and contractors a certain level of certainty and a certain level of confidence, which I think we have managed to do successfully by being very disciplined with our tariff versus cost and cost versus price approach.
Tommy Moll (Equity Research Analyst)
Thank you, Alok. As a follow-up, I wanted to address the EPS guidance, which you raised today, and maybe stepping back from some of the numbers and just talking philosophically here if we can do that on earnings today. I do not know if that is possible. I think where a lot of the questions are coming from today are you raised largely on pushing through the beat in the second quarter. Given some of the recent price-cost trends where your incremental margins were pretty impressive this quarter, it might suggest a bigger raise would be appropriate for the year. Maybe there is some conservatism embedded in the second half. Maybe there are some other factors that have not come out in the questions today. Anything you can do to help us understand your philosophy here would be helpful. Thank you.
Alok Maskara (CEO)
Sure. I read a McKinsey article once which said that successful companies, 80% of them have an aggressive CEO, but they are balanced by having a conservative CFO. Apparently, those two make a good pair. Maybe I'll let Michael answer the question. Listen, at the end of the day, there is a lot of uncertainty that still remains in the market. There is lots of uncertainty around tariffs. There are all the pieces we mentioned about R454B. Residential new construction remains weak. We think our range—we kept the range of EPS guide to be $1. Normally, we would have narrowed that range at this stage. Given the uncertainty, we kept that range to be $1. We feel like we are appropriately neither conservative nor aggressive with the new range that we have given out. Michael, anything you want to add to that?
Michael Quenzer (CFO)
Sure. I'll just add, I mean, our goal is to have confidence to make sure that we made our commitments. I think we've done this with the guidance that we've laid out. There is a bit of some conservative in some of the assumptions maybe around some of that cost inflation around 6%. I mean, a half-point difference there can make a difference in the EPS. With the inflation and uncertainty around that, I think it still makes sense to hold it at 6%, but we'll keep watching that.
Thank you both. I'll turn it back.
Operator (participant)
Next, we'll go to Chris Snyder with Morgan Stanley. Please go ahead.
Chris Snyder (Executive Director of Equity Research)
Thank you. I wanted to ask about the back half volume outlook for the resi business. In Q2, volume for down 9% and comp was plus 1%. In the back half, it's calling for volumes mostly maybe a little bit worse than that 9%. But the comp goes from 1% in Q2 to a plus 16% in the back half. I guess in that context, why are you guys confident that volumes will be mostly stable here given those comps? Is it that the destock came through in Q2 and it's now over? Is it the canister issue getting sorted itself out? Any color there would be appreciated.
Michael Quenzer (CFO)
All right. Maybe what I'll do is first clarify the numbers. The balance of the year, we have volumes down in HCS about 8%. It is a little bit more than the year-to-date 6% that we saw. Just recall that we will have the comp issue in the second half, basically the fourth quarter. That is kind of built in there. We have a 10% increase in price mix also on that. We are building in a little bit more decline in volumes in the second half than what we saw in the first half.
Chris Snyder (Executive Director of Equity Research)
I appreciate that. I was kind of asking more about the second half versus Q2. I think Q2 volumes were down 9%, and the comp was plus 1%. And now it is minus 8% versus plus 16%.
Alok Maskara (CEO)
Yeah. I think a lot of that, obviously, is we talked about destocking. You can never get the exact numbers. We think destocking is largely behind us after Q2. We talked a little bit about the canister shortage and how that impacted us, especially before the 30-foot line set units hit the marketplace. Finally, we are also guided by the weather pattern that we talked about, right? We've always had a late start to summer. We ended the quarter with a much better sales rate than we did during the middle of the quarter. It's never a perfect science, Chris, as you know. We feel like we have come and given a fair set of numbers to the best of our visibility at this stage.
Chris Snyder (Executive Director of Equity Research)
Thank you. I appreciate that. Maybe just on price, obviously, the industry has a really great track record of pushing price and holding that. I guess it feels like here, price across, I imagine it is across the industry, seems to be running a bit ahead of cost following the de-escalation. Are you confident that the industry will be able to retain all of this price as you look out over the next 6 to 12 months, just kind of given some of the earlier comments that there is a little bit more of repair versus replace, maybe some trading down in the market? Thank you.
Alok Maskara (CEO)
Yeah. Listen, I mean, our industry still makes less money than some of the other industries like water heaters. And if you think about all the investments that are needed over the past few years, I mean, we spent hundreds of millions of dollars in capital to get to the R454B transition. We are spending hundreds of millions of dollars to get better distribution so we can deliver products the same day and give quotes back within two hours. I mean, all of those investments are not made by just Lennox. Every other player is making that investment as well. And to recoup those investments, I mean, we do need the price impact. And our cost for R454B units are higher. And we are facing other inflations such as refrigerants and other news that we have looked at.
So I can't speak for others, but if history is of any guide, us and other players will continue to be price disciplined so we can invest in delivering safe products to our customer, support them appropriately, and make sure we live up to our quality and warranty standards.
Brett Linzey (Senior Analyst)
Thank you. I really appreciate that. Makes sense.
Operator (participant)
Next, we'll go to Dean Dre with RBC Capital Markets.
Deane Dray (Managing Director)
Thank you. Good morning, everyone.
Michael Quenzer (CFO)
Morning.
Alok Maskara (CEO)
Morning, Dean.
Deane Dray (Managing Director)
Hey. I was hoping you'd give us a progress report on the emergency replacement initiative. I saw that you had added some inventory, so you got to start there to have it ready on that 24-hour notice kind of thing. Just give us an update there, please.
Alok Maskara (CEO)
Sure. Dean, when we talked in Q1, we were talking about one or two pilot markets on where we learned and kind of got our approach finalized. Since then, we have expanded, and we are now up to about five or six of those markets. That is what you start seeing in Q2. Clearly, there is more room for us to continue expanding through that. Very soon in the future, you will also see our commercial products, even in our residential stores, things that we have never done before as we look at using our distribution footprints more effectively and placing that inventory in the most convenient location for our contractors. Overall, early innings, but we are pleased with the progress that we have seen. Our pilots have gone well. Our initial rollout has gone well. There is still a lot of room for us to continue taking this forward.
We are going to be disciplined about it. We are going to be aggressive in our approach. We are going to continue to make a dent in this. As you know, the overall bogey here is much larger than we are seeing in any quarter. We think this is a good tailwind for the next couple of years plus more.
Deane Dray (Managing Director)
Really good to hear. Then second question, Alok, on page 10 of the deck, you gave some hints about the opportunity to expand product and services in the portfolio. I know you're not going to give a lot of detail here, and we can rule out international. Just the idea of where and how are these growth levers? Is it more JVs, more on the distribution side? Anything about the timing of where we would see further initiatives? Kind of like along the lines we saw with water heaters.
Alok Maskara (CEO)
Sure. I think on water heaters and mini-splits, the reason we did JVs is because we needed the global technology platform that comes with that. Because in both of those, the power capabilities could not extend that far. In other areas, and Michael talks about that in capital deployment, that could be parts and supplies. That could be in technology areas. That could be in geographical reach on distribution. We would be obviously very open to acquisitions. I mean, from our perspective, we have a highly underutilized distribution network. As our 250 stores could add a lot more products compared to what we are selling today without adding that much fixed cost. We will continue looking at that from M&A perspective. On the JVs, we only did that because we had companies which had well-established products, well-established reputation that could allow us a faster entry into those markets. Stay tuned.
Definitely more to come.
Tommy Moll (Equity Research Analyst)
Great. Thank you.
Operator (participant)
We'll go next to Joe Ode with Wells Fargo. Please go ahead.
Joe O'Dea (Managing Director)
Hi. Good morning. I wanted to just touch on destock and market share a little bit more. Alok, I think the way you framed it is that your view is the destock headwind you talked about has largely played out. That $125 million, I think you saw it in BCS in Q1. It sounds like you think you saw most of the HCS impact in Q2, obviously back after the year comps, but just in terms of what that downdraft would have been in the first half of the year. Largely done there. Also, to add market share to the question, how many points a share do you think you gained last year? Within the guide, how much are you giving back this year in HCS?
Alok Maskara (CEO)
Yeah. The first one, I would say, yes, all of those statements are largely true, right? You realize that $100 million, $125 million, these are large approximate numbers, right? We do not have precise accurate math behind it. In general, it is fair to say that at this stage, the $125 million in destocking that we talked about is essentially done. There might be some bleed-through in Q3, but I think it is going to be small. The comps obviously remain difficult, right? I think that is the path we watch out for and that we embedded in our guide going forward to make sure that has been very clear to that. Regarding market share, I mean, it is a moving piece. Remember, we look at both Hardy and AHRI because 70% of our sales go directly to dealer.
With stock-up and stocking and destocking, those numbers often have large error bars when we go into the season. I would say that we ended—I am not going to give a number, but I will say that in 2024, we ended up having the largest market share we have ever had in the history of Lennox when it came to residential. Even if we give some back this year, as we expected and as we had broadcast, we will probably still land up in 2025 at a very healthy and a large market share that is better than what we had in the past.
Joe O'Dea (Managing Director)
Got it. For a second, I thought you might actually give the number, but appreciate the color there. Michael, just thinking about the 25.3% margin in Q2 in HCS, as you think about that as a jumping-off point and the bridge into the back half of the year and what is embedded within guidance, is there anything from a mix shift on the trade down you guys have talked about, any cost impact with tariffs or copper, anything that just changes within the complexion of that 25.3%, or is it just normal seasonality from there?
Michael Quenzer (CFO)
Yeah. I think what we built in is a little bit more cost escalation in the second half as the tariffs come back in. Still, overall, we feel confident that margins are going to increase in the second half of this year, at least 50 basis points in HCS. That is with volumes down 8%, up maybe 70 basis points for the full year. We will see where inflation comes. Hopefully, it comes in a little bit lower, and we can maybe do a little better than that. We feel good on price-cost management at the moment.
Joe O'Dea (Managing Director)
Great. Thanks very much.
Operator (participant)
We'll take our next question from Steve Tuzzo with J.P. Morgan. Please go ahead.
Steve Tusa (Managing Director)
Hey. Good morning.
Alok Maskara (CEO)
Morning, Steve.
Steve Tusa (Managing Director)
Congrats on the execution in a pretty choppy environment there.
Alok Maskara (CEO)
Thanks. That means a lot, especially coming from you, Steve.
Steve Tusa (Managing Director)
I wouldn't over-punch the worth of my opinion, but thank you for that. I just wanted to kind of clarify some numbers. You got the 6% on the $4 billion. That's like $240 million. Now you're talking about as far as inflation is concerned. I know there's some moving parts between that and the bridge items, I think, because the product cost numbers in the first half are running at like $45 million, something like that. Are those two numbers the right comparables, or? I think I'm missing maybe something productivity-wise in between those. I guess out of the $240 million, I guess simple question is, how much have you kind of booked year to date?
Michael Quenzer (CFO)
Yeah. Steve, I think what you want to do is look at the product cost and the other combined. Since the inflation's on our total cost perspective, those two combined are about up $80 million in the first half. And it applies about $180 million kind of in the second half.
Steve Tusa (Managing Director)
Okay. $180 million in the second half of that cost. Flowing through.
Michael Quenzer (CFO)
Correct.
Steve Tusa (Managing Director)
Yeah. To get to that. Okay.
Michael Quenzer (CFO)
Oh, sorry. Sorry. 180 on the full year. Sorry.
Steve Tusa (Managing Director)
On the full year. Okay. Right. So that.
Michael Quenzer (CFO)
On the full year.
Steve Tusa (Managing Director)
Yes. That includes that. Productivity and the other numbers above the line on product cost. Okay. That makes some sense. I guess just from a pricing perspective, have you guys booked? Is this kind of a normal now run rate here, or you guys have, did that price get booked kind of midway through the quarter, or is that something that's now kind of fully embedded in a run rate of the second quarter?
Alok Maskara (CEO)
I would say it got booked midway through the quarter. The A2L pricing, as you know, depends on the mix as well. The mix shifted much more towards 454B to the end of the quarter. The tariff pricing, the way the announcement worked, we probably had two-thirds of the quarter where the tariff pricing was in effect on that.
Steve Tusa (Managing Director)
Okay. All right. That makes a lot of sense. Thank you.
Alok Maskara (CEO)
Marco?
Operator (participant)
Joseph, your line is open. Please go ahead.
Joe O'Dea (Managing Director)
Hey, guys. This is Joe. I did not hear the operator. Look, for the quarter, a couple of quick questions. I am sorry if I missed this earlier. When you take a look at the residential volumes down 9% this quarter, what did your independent distribution channel do versus what you sold through the dealer network?
Michael Quenzer (CFO)
Yeah, what we saw is on the two-step total revenue was up about 10%. The one-step total revenue was about flat. That is with volume and price mix.
Joe O'Dea (Managing Director)
That's with volume and price mix. Okay. Got it. And then just kind of the volume assumptions then in the second half of the year, I know that the $125 million isn't a totally precise number, but it implies basically a 6-7% volume headwind in the second half. Really, what you're expecting out of your residential volumes, excluding that one-time impact from the pre-buy last year, is really kind of down, call it like 1-2%. Am I thinking about it the right way?
Alok Maskara (CEO)
Yeah. I think roughly that's about right. I think I haven't done exact math, but yeah, that's a right way to think about it.
Tommy Moll (Equity Research Analyst)
Okay. All right. So that's good. Things getting a little bit better on the kind of volume assumptions as we look at the year. I know somebody earlier asked about pricing and call it like the inelasticity of pricing into next year. I'm actually curious on the surcharge because you didn't fully implement 454B this year. It would seem to me that you should— I'm sorry, I didn't mean surcharge, but I meant on the mix side. You should improve on mix in 2026 as well because you'll be selling all 454B. That's the right way to think about it. Even though mix was very positive in 2025, there should be some improvement on mix in 2026 as well.
Alok Maskara (CEO)
Yeah. I think that's right, Joe. We talked earlier about in 2025, 60% of our product was going to be 454 and 40% was going to be 410A. In 2026, it'll be 100% 454 and 0% 410A. Yes, we do expect mix to improve. You'll see year over year it'll be better in Q1 and Q2. By Q3, Q4, I think it'll start normalizing more. I think that's a fair way to think about it for 2026.
Tommy Moll (Equity Research Analyst)
Okay. That's great. All right, guys. Thanks so much.
Noah Kaye (Managing Director and Senior Analyst)
Appreciate it.
Operator (participant)
Our last question comes from Nigel Coe with Wolfe Research. Please go ahead.
Nigel Coe (Managing Director)
Oh, thanks. Good morning. I really appreciate you going along here, fit us all in. Just wanted to follow up on the direct versus indirect. I think you said two-step up 10% all-in revenues and then direct flat. If we saw the destock happening in 2Q, I would expect that to be expressed more in the two-step channel. Just a little bit confused there. Maybe I'm thinking about it the wrong way, but any thoughts on that?
Alok Maskara (CEO)
First of all, I think our exposure to two-step is much smaller than others. I would not read too much into that from an overall industry perspective. I think one thing to keep in mind is in the two-step channel, because of tariffs and because of the R454B's uncertainty and all of that, people continue to maintain high levels of inventory. That is one thing we referred to, saying some of this might bleed into Q3 as we look at distributors and how much inventory they have. On the one-step, as we looked at it, we did talk about even one-step is not immune to holding any inventory during transition. There was some inventory one-step was holding as well. Net-net, as you put together, I put that within the overall fluctuations and the uncertainty that we experienced. Michael, go ahead.
Michael Quenzer (CFO)
The thing I'll add too is the two-step doesn't have the R&C exposure as the one-step does as well.
Alok Maskara (CEO)
Yeah. That's right, Michael. That's a good reminder.
Nigel Coe (Managing Director)
Okay.
Yeah. That's great color. And then a quick follow-on. Just kind of on the notion of inventories. Your inventories stepped up pretty meaningfully from Q1 to Q2. Normally, we see inventories bleed down in the second quarter. I know we got higher unit costs with R454B. I know that we've got some build with, but any more color in terms of how you see inventories? First of all, why inventory is so high, and then how do you see that progressing through the year?
Alok Maskara (CEO)
Yeah. We wanted to play it safe during the 454B transition and given the industry uncertainty. As you know, the number one complaint from our dealers over the past five, six years has always been around availability of our product. We wanted to address that fully. I think we did that. Yeah, some of it was also the seasonality of having a slow start to the summer. Net-net, as you know, we would generate most of our cash in the second half. We have good confidence on our overall cash outlook. We will bring the inventory, deplete it down over the next several months. We look at it internally and say, "Yeah, is it a little bit more than we thought?" "Yeah." We are confident that it's the right thing to do, and we'll bleed it down before the end of the year.
Nigel Coe (Managing Director)
Okay. That's great. Thanks, Alex.
Operator (participant)
Thank you for joining us today. Since there are no further questions, this will conclude Lennox International's 2025 second quarter conference call. You may disconnect your lines at this time.