Lennox International Inc (LII) 2003 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the Lennox International second-quarter 2003 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 conference is being recorded. I would now like to turn the conference over to Bill Moltner, Vice President of Investor Relations.

Thank you, Gail. Good morning and thank you for joining us for this report on Lennox International's financial performance in the second quarter of 2003. We are broadcasting today's call on the Internet and have placed a direct link to the live web cast on our corporate website, at www.LennoxInternational.com. This call will be archived on our website and available for replay.

Bob Schjerven, Chief Executive Officer of Lennox International, and Rick Smith, our CFO, are on the call this morning. In a moment Bob will comment on our Company's progress and performance in Q2 and provide management's outlook for the second half of 2003. Rick will follow with an operating review by business segment, as well as address key income statement and balance sheet items. We will wrap up the call with Q&A. In the earnings release we issued yesterday, which you will find posted on our website, we have included several tables providing description and financial details and reconciliations of the financial metrics that Bob and Rick will discuss to U.S. generally accepted accounting principle measures.

Before we begin, I would like to remind everyone that in the course of this call to give you a better understanding of our performance we will be making certain forward-looking statements. These forward-looking statements are subject to risks and uncertainties, a list of which are included in our publicly available filings with the SEC, which could cause our actual results to differ materially from those we expressed today. I will now turn the call over to Bob Schjerven.

Thank you, Bill. Good morning and thank you for taking the time to be with us. I am pleased to report that the second quarter of 2003 was Lennox International's sixth straight quarter of year-over-year improvement in operating profitability. Our earnings in the quarter were up 12 percent excluding gains, losses and other expenses recording this year and also adjusting for restructuring charges that were incurred last year. Operating margins on the same basis expanded 50 basis points. In addition, over the past year we have reduced our debt by $120 million.

Our progress was not just limited to the profitability reported on the income statement and the strengthening of the balance sheet. We also continue to execute the initiatives necessary to position Lennox International for profitable growth. We have achieved improved results despite a rather difficult market condition. Though resilient to new housing starts, did support strong performances in the residential heating and cooling business, unfavorable weather in the early part of the cooling season substantially reduced demand for replacement sales, particularly impacting our Service Experts operations.

Now end market demand in our commercial businesses, which account for approximately 40 percent of our company's sales, does still remain stagnant across most regions around the world. In this difficult environment, Lennox International is benefiting from the strategic initiatives that we have had underway for the past two years. By focusing our resources, we are improving our effectiveness in providing value added products and services in our core heating, cooling, and refrigeration markets. We have exited under performing and noncore international operations and have substantially rationalized our manufacturing capacity to improve productivity.

These actions, which include the closure of unneeded factories in France, England, the Netherlands, Australia, and Canada, have contributed to our profitability improvement. Corporate initiatives that capitalize on cross business synergies are taking hold and are also contributing to our improved performance. Strategic sourcing is focusing and leveraging our procurement activities. The sharing of best practices, including (indiscernible) manufacturing and product development processes, is reducing manufacturing and design costs. And we are optimizing our intellectual resources to the use of centers for excellence and centers for information.

A key element in our company's continued progress centers around leadership changes that we announced earlier this month. As you may know, I have asked Scott Boxer to be President and Chief Operating Officer of Service Experts, our retail heating, ventilating and air-conditioning sales and service segment. As many of you know, Scott had been president of Lennox industries for the past three years, and had also been serving in a dual role as interim president of Service Experts since late March. After a thorough review of potential candidates to lead Service Experts from both inside and outside the Company, it became obvious to me that Scott is a perfect fit. Scott's excellent team building skills have assembled the finest collection of talent that we have ever seen within the Lennox industries group, and while considerable progress has been made at Service Experts over the past year, I felt that someone with a strong track record of building positive and productive internal teams and partnerships will enable us not only to continue to pare costs, but develop and grow our direct-to-consumer business.

Although Service Experts result for the second quarter were disappointing, we are by no means discouraged. We are confident that the initiatives we identified and began implementing during the second quarter will begin to pay off in improved performance. We see the profit and growth potential for this business. We're confident that Scott is the right person at the right time to lead us in realizing that potential to its fullest. As you will realize when Rick Smith reviews our heating and cooling segment results, Scott has a proven track record of profitably building businesses. We know this is the right move and as Scott immerses himself in our retail operations, we look forward to reporting to you on our strategies and progress over the coming quarters.

We have also aligned all of our worldwide heating and cooling operations under Bob McDonough's leadership. Bob, as President and Chief Operating Officer of heating and cooling, will be responsible for the domestic Lennox, Armstrong, Ducane, and Advanced Distributor Products brands, our European commercial heating and cooling operations, and our Hunt Products unit. This move better positions us to realize the fullest potential of our heating and cooling segment by developing stronger synergies across all of the operations. And Bob is certainly the right person for this position. Most recently, Bob was the head of our global refrigeration business segment, where we saw him drive results-oriented synergies across diverse business units located around the globe. He increased market share and posted improved even (ph) margins in the domestic market and grew our international business as well. Bob's skill is our ideal for aligning our heating and cooling efforts, which will be a major step in positioning us for accelerated market penetration.

Now Mike Schwartz, who led our North American distributed products division, now takes over the leadership of our worldwide refrigeration business segment as President and Chief Operating Officer of that unit. Mike's roots are actually in the refrigeration side of our business. He joined the Heatcraft subsidiary of Lennox International in 1990 when we acquired Bohn Refrigeration. Under Mike's leadership, the advanced distributed products business unit was created and has now grown into the leading supplier of third party evaporator coils throughout the industry. Mike also took our regional Armstrong and Ducane businesses and built them into strong national brands. He has shown remarkable skill in consolidating acquired businesses into our operations, as well as building a green field state-of-the-art manufacturing facility in Orangeburg, South Carolina.

All of these talents are going to be critical to our focus on growth in the global refrigeration market in the days ahead. Now, taking a look at second quarter results. Lennox International's total revenues decreased by one percent to $819 million from 828 million for the same quarter last year. Adjusting for the $49 million in heat transfer revenues included in last year's sales, most of which are now part of our joint venture with (indiscernible) and no longer reported by LII, sales in the quarter increased to 5 percent, foreign exchange benefited revenues by 3 percent in the second quarter.

Operating income for the second quarter was $56 million, up 10 percent from $51 million last year. The second quarter of this year, we recorded a pretax charge of $100,000 for gains, losses and other expenses and last year second quarter included $1 million in pretax restructuring expenses that were related to programs that were announced in 2001. Adjusting for these items, operating income increased 7 percent year-over-year. Net income for the quarter was $30 million, up 19 percent from $26 million in the year ago period. Diluted earnings per share were 51 cents, contrasted with 43 cents same quarter last year. When adjusted for this year's gains, losses and other expenses and also last year's restructuring charges, net income grew 12 percent.

On the same basis, earnings-per-share increased to 50 cents in the second quarter this year, compared with 45 cents last year. Before Rick Smith, our Chief Financial Officer, gives you additional details by business segment, allow me to comment on our outlook for the remainder of the year. With still no clear evidence of the sustained recovery in our commercial markets in the back half of the year, and assuming more normal weather patterns, we continue to expect our reported company revenues will be relatively flat for the full year of 2003. We are very pleased with the operating improvements we realized in the first half of this year in our heating and cooling and our refrigeration businesses, and we're confident that this trend is going to continue.

This, together with an anticipated modest improvement in Service Experts profitability in the back half of the year, does make us very confident in reaffirming our guidance of full year 2003 earnings per year share in the range of $1.10 to $1.20. Also, we continue to expect to generate free cash flow for the full year approximately equal to our net income. Well, I will now turn the call over to Rick to take us through our business segment operating results.

Thank you, Bob. My comments on our segment performance in the second quarter will exclude the gains, losses and other expenses and the restructuring charges Bob identified earlier. I'm going to start with heating and cooling. The trade association, the Air-conditioning Refrigeration Institute, recently reported that industry shipments of unitary air conditioner and heat pumps were down 4 percent through May. We don't have June figures, but preliminary indications are that shipments did rebound somewhat in June.

Distributor shipments over that same May year-to-date period declined 10 percent, showing signs of end market softness. On the weather front, year-to-date through June, cooling degree days, this is population weighted, we are 7 percent below normal, down 20 percent from last year, and so despite this difficult market environment, we had what we consider to be excellent performance in our heating and cooling business segments.

Revenues rose 10 percent to $509 million and adjusting for fluctuations in currency exchange rates, those sales were up 7 percent. Segment operating income increased 32 percent to $55 million from 42 million last year, and operating margins expanded 180 basis points to 10.8 from 9.0.

Let's separate out the underlying residential and commercial pieces of heating and cooling business. Starting with residential, heating and cooling revenues grew 8 percent in the second quarter to 377 million. That is up 7 percent adjusting for foreign exchange. We achieved increases across all of our home comfort equipment brands, as well as for our hearth products. Sales gains were driven by strong acceptance of new products, including the Dave Lennox Signatures collection and the Healthy Solutions line of evaporator coils. The gains were also assisted by expanded distribution of our Ducane brand into key cooling markets.

I just want to remind everyone on the call that in the second quarter we also began shipments of Whirlpool heating and cooling equipment, which are distributed through our alliance with Watco (ph). Residential segment operating income for the quarter increased 27 percent to $46 million from 36 million last year. Segment operating margins expanded 180 basis points also to 12.2 percent, supported by higher volumes, a favorable mix of higher margin premium product, and improved performance in the hearth products business. These gains were partially offset by margin pressure in residential new construction as we gained penetration with the nation's top builders.

Commercial heating and cooling revenue increased 15 percent in the second quarter to $132 million. Revenue is up 8 percent for commercial HVAC adjusted for foreign exchange. In the North American market, we continue to enhance our strong position with national accounts, with 33 new national accounts signed so far this year, including organizations like Exxon Mobil, the Container Store, (indiscernible) and Best Buy Canada. We have also achieved sales gains within the contractor community, and so our segment operating profit jumped 59 percent in commercial heating and cooling to 9 million, with operating margins in the second quarter increasing to 6.9 percent from 5 flat the prior year.

Higher volumes increased productivity at our factories and the benefits of cutting back some under performing international operations more than offset expenses associated with closing a plant in Europe, where production ceased at the end of the second quarter.

Revenues at Service Experts, the retail business segment, declined 3 percent $243 million. Decline was 5, adjusting for the impact of currency exchange. As was the case in the first quarter of this year, the entire sales decline in Service Experts can be attributed to the commercial new construction business. Sales in the service and replacement and residential new construction parts of Service Experts grew modestly for the second straight quarter. Reduced margins in the new construction business is higher insurance expense, and increased investment in advertising reduced Service Experts segment operating profit to $8 million from 16 million last year.

Operating margins were about half, at 3.1 percent compared with 6.3 percent last year. It's certainly a difficult market environment for Service Experts, dealing with soft end market demand for replacement sales, stiff price competition in the new construction sector, but having said that, there are several initiatives we have identified to improve it's profitability. The highest profile is project TIGHTEN. That is our program to implement the best practices currently utilized at centers with superior operating profitability and establish consistent and efficient processes throughout Service Expert's dealerships.

We are moving aggressively to rollout project TIGHTEN to all residential service and replacement centers. To deal with the erosion in new construction margins, we have focused on improved project management and are working aggressively to develop a higher mix of more profitable maintenance and service business at our commercial centers. Even while we take all these actions to improve profitability, it is important to note again as we did at the end of 2002 that Service Experts has had positive cash flow on a trailing twelve-month basis.

Our refrigeration business also had to contend with a difficult environment. The large retail chains, notably supermarkets, both here and abroad have cut back or frozen expansion plans, depressing final demand. In this environment, we believe the refrigeration business really performed pretty well. Refrigeration segment revenues in the second quarter were up 5 percent at $97 million. Refrigeration being our most global business had the greatest benefit from positive fluctuations on local currencies. Adjusting for foreign exchange, revenues for refrigeration were actually down 3 percent in the quarter. Segment operating income was flat at 9 million, with operating margins declining 50 basis points to 9.2 percent. The impact of those lower local currency revenues was partially offset by improved factory performance and consistent cost control.

Moving on to some items below the operating income line and on the balance sheet, interest expense in the quarter decreased by $400,000 to $8 million, reflecting reduced debt levels. Our total debt at the end of June 2003 was $390 million, down, as Bob mentioned, $121 million from the same point a year ago. At the end of the second quarter, our debt to total capitalization ratio was 42.2 percent, which we think compares pretty favorably with a 53.2 percent a year ago. We used free cash flow in the second quarter in the amount of $21 million. That brings the year-to-date figure to a use of 73 million.

Due to the seasonal nature of our business, we typically have used cash in the first half and generated cash in the second, so this performance is not atypical. We continue to make solid gains in working capital productivity, expressed as a percent of sales on a trailing twelve-month basis, our operating working capital ratio has improved significantly to 19.2 percent, down from 21.1 percent last year. And inventories are in good shape at the end of the second quarter. They were down 10 percent or $29 million year-over-year.

At the end of the quarter, the amount of our accounts receivable asset securitization program, which does not appear on our balance sheet, was $154 million, down from $162 million at the same time last year. And these changes in asset securitization balances being non-operating do not get included in our free cash flow calculations or guidance. And finally, capital expenditures for the second quarter amounted to $5 million. They were $8 million in the second quarter of last year and, as you can see, capital expenditures continue to run below depreciation levels. I think at this point Bob and I would be pleased to address any questions you might have.

(CALLER INSTRUCTIONS) Michael Regan of Credit Suisse First Boston.

Thanks, good morning. Can we talk about Service Experts a little bit more? Obviously, the trends there continue to be difficult. Can we get some more detail or clarification on how we go from where we are today to where you want to be over the next three years? What are the building blocks to get there?

Let me talk to that. First of all, when you look at the Service Experts performance over the first half of the year, one thing does become a little bit more clear and that is the commercial new construction sector has really been the lion's share of both top line and bottom-line construction we see, and certainly when you look at the markets they are involved in, and also I guess there's a fact that that particular sector of business is not particularly best suited to this type of a model. It's a little bit easier to understand what is happening there.

When you look at the rest, both the residential new construction and the repair replacement, both commercial as well as residential, we have actually performed quite well with respect to last year. When you look deeper into the performance issues, and the thing that will allow this business to realize the potential that we see for it, the types of things that are embodied in this project TIGHTEN, and we may have just touched on this briefly before, but allow me to spend just a moment. Project TIGHTEN is a compendium of best practices that have been assembled by between 15 and 20 of the best, most successful general managers that are out there in the business, whose centers have performed and continue to perform at well above the 10 percent EBIT level at the center, some of them performing in excess of 20 percent.

And there are definite patterns and the patterns change a little bit when you go from let's say repair replacement to residential new construction, but the fact is that there's a real pattern around critical processes that go on in the business that separate the people who are really great at it from the people who are just moving along day-to-day. As this group of best practices was assembled by people who are in the field, who understand it, who have the track record, and who actually put the money were the mouth is so to speak, as we have begun to roll this out, that process really started in the latter part of April, first part of May. We have been very careful; we have got now four teams that are located in the field working with the centers and as they go through a process and get a center up and running under best practices, they also deploy one or two people from that center to the next center to help and train the trainer type of a mode. Because this process has great credibility, i.e. having been designed by people in the field who have the record, and also being implemented by people in the field who understand the vagaries of operating that dynamic atmosphere, particularly this time of the year, in the cooling part of the season, we are seeing people embrace this and in fact ask to be put in the front of the line because they are seeing the kind of results that are just now beginning to create those centers that (indiscernible) the processes.

This process is going to take us probably through the second quarter of next year, maybe third-quarter next year to fully put in, go back, double check and be sure that it is operating. But it does go to all of the issues around how you take care of your customers from the moment you first contact them to how you deploy your labor. This is a manpower, there's no kidding about that. As well as how you generate the basic service contract volume that you need to be successful, which also helps in following years as you attempt to (indiscernible) the direct indirect labor that you bring into the businesses. And actually the business does embody a number of the aspects of statements identified in operations accountability that we have spoken to before, which is also successful with respect to planning and executing on the business model. None of this is extremely rapid or extremely fast.

The dimension that Scott Boxer brings to this is, first of all, the terrific result he has had at Lennox Industries and the early work with us a couple years before that Europe notwithstanding. Scott's style is to be very involved. He listens very well. He's had a lot of experience with the people in the field as a result, of our relationship with nearly 7000 independent contractors with whom he has spent a lot of personal time. But he also is meticulous with respect to important details and follow through, he has built really strong teams every place that he has been. And in fact, this kind of teamwork and growing this group again being a people business I see as being fundamental to the long-term success of this business. Frankly I am very pleased that Scott agreed to pick up the challenge, because I know that this is going to be successful in the future.

So, Bob, we give tighten a year to get implemented, we give it another year to kind of be embraced and get up to speed at each of the branches. Two years from now, in your mind, what should Service Experts margins be?

Well, it would be perilous of me to give you a precise answer to that, but let me try to answer this way. You heard us say before that we believe this is double-digit EBIT business, and as you look at the centers that perform well -- the group of centers that perform well, we see that that is certainly possible. Again, the question remains how effectively you can roll through 180, 190 different cultures and get people moving in lockstep. Frankly, I think two years could be a realistic period of time to see that kind of performance. Certainly I would hope to see it a little quicker than that, but we've learned a lot about this business. And I think some of the things that haven't changed is from a strategic vantage point, we're still firm and confident and excited about the business, but the thing that of course we have had a little bit of increased understanding on is how long it takes to move this many cultures, albeit they are individually small, the fact is it still takes time to get those kind of improvements. We have learned a lot in the process as well.

So you are broadly saying perhaps double-digit when it all works, maybe it's two years, maybe even a little bit longer. Which brings up the next question. If two years from now we are running at half that or 5 percent, strategically what would be the kind of thing that would lead you to finally come to the conclusion that strategically this is not the right business for Lennox to be in?

You and I have had a lot of conversations about this and I frankly can appreciate where I think you and probably a lot of other people are watching us from the outside. The fact of the matter is as we look at it from the inside, in my mind I can't construct any such scenario, so it's hard me to go ahead and speculate what it would look like at that point in time. I know that we got a divergence of opinion on this. I certainly appreciate that, the fact is, I think we need to be a little bit more patient and see what it looks like.

Kit Case of Southwest Securities.

Congratulations on a surprisingly great quarter. Real quick, continuing on Service Experts, do you have a same-store growth number on the revenue line in constant currencies?

It is about 5 percent.

All right, so it is not -- positive 5 percent or negative 5 percent?

It is a negative 5 percent.

How many dealers have you closed in the last 12 months?

Let's say I give you an approximate number on that, and again, whether they are closed or they wind up being merged, like making one out of two, the count is probably down by 1, 2 something like that. It's single digits.

Let me ask you this. In heating and cooling, your commercial business did pretty well at 7 percent growth, and some of that I am sure is new construction, and most of that is going to be replacement, but why did the disconnect between the dealer and the manufacturer? Because at the dealer level your commercial business is really hurting, it is really soft.

One of the differences that you see there is the continued growth expansion in national accounts and on the national accounts side of the business, that does not necessarily -- very little of it gets fed back to the C&C (ph) of our organization and service experts. Again, we picked up something like 33 or 34 new accounts so far this year and continue to do well with the existing national accounts as well.

Is this a function of the overall strength and expansion for everybody, or you taking market shares in new accounts?

I think our numbers would indicate we are taking market share. And again, just for a second going back to the question about the apparent economy between the Service Expert C&C level and commercial activity, one of the focuses that we have had on those businesses that are in the commercial new construction side is Service Experts is taking a real hard look at the margins on the business being quoted. And quite frankly, we have been pretty tough and have walked from a number of those jobs where the margin was really thin. We didn't really need to add that kind of volumes that was questionable at best. So (indiscernible) activity level what we've actually taken and operated on was certainly less than what was out there to be bid and taken.

Okay, and also on Service Experts I think a big question here, and you have been talking about this, with project TIGHTEN, that makes sense let's get the good guys, teaching the guys who are suffering how to do it, and that makes sense, but I think the biggest question is what is different now than say two years ago, because you guys have been working on this for some time. What is different about project TIGHTEN versus earlier improvements or efforts in Service Experts?

I think it is that internal, that bottoms up desire. The request for those best practices coming from the other centers, this is something that the organization is asking for, and we are going to roll it out on that basis.

In other words they do not want corporate coming to them and telling them how to do it. They want other dealers -- they are more responsive to other dealers coming to them.

I think Naturally successful dealers have a lot more credibility. Now, they do want assistance from the field organization, the central organization at Service Experts to make that happen. All the tools that we can do these teams that Bob mentioned that do go from center to center, but again it is just important to point out that these are people who have been there, done that. There is maybe another piece too and people will hear me say time and time again that the Service Experts speaks more than anything else we have as a people business. If you look at the turnover that we have had among the general managers, that turnover is as a general statement I guess I would say is largely complete at this point in time. The people that we have in there right now do not have resistance to change, particularly when they see, first of all the credibility in terms of how the businesses and the attributes of the program how they look, but also with respect to the kind of performance of the people who designed and participated in development of the program, what they actually do. So the credibility factor is important, but it is also coupled with a cadre of general managers who are very professional and who are very enthusiastic about what these businesses can look like in the not too distant future.

On the cash flow, based on your guidance, you would be producing about $130 million in free cash flow the second half of the year after dividends. And assuming your free cash flow equates to net income, that is a pretty substantial amount, and I'm wondering what the uses of that cash will be? If you pay down debt you could reduce your debt to total cap down to 30, 35 percent, but what are your uses planned for that cash?

We've got a number of different uses. I think the securitization program, for example, that we have, we really consider that to be a debt equivalent, and that is one factor that we would consider. I would continue to say that debt reduction is the odds on favorite for that, but we're going to look at the situation at the time. We are seeing a lot of good ideas come out of the businesses in terms of funding, additional cost reduction and new product development programs. We got to get ready for that for 2004. We're going to factor all that in, but I think debt reduction is top of the list.

Chris Terry with First Dallas Securities.

What percentage of your business is related to new construction? And what do you see in the new construction market going forward?

I think the percentage really differs business to business. For example, you heard Bob talk about the strength in our commercial business, for example, around the national accounts, so that new construction and commercial HVAC would be the majority of our business. At the same time, the residential new construction would be less important. The Lennox, Armstrong, Ducane brands altogether probably have a minority of their business. We're split more like 70/30 on the residential heating and cooling side. Service Experts, something like 60/40 replacements to new construction, but when you roll it altogether, we are probably a 60 percent replacement and service company and 40 percent new construction, all segments combined. Does that answer the question?

Yes, it does. What do you see going forward in that market?

Again, we have had a lot of good news come out of the residential new construction side, as you can guess with housing to be as strong as it has been. It is hard to see, in mind, that getting to be larger portion of the total. When we step back and think about the overall state of the refrigeration and commercial HVAC markets, our sense is that they have bottomed, we are beginning to see signs of recovery, so that should pick up the overall LII affect there. And I think when you mix it altogether, and considering the strong base we've got in our residential replacement business, you're not going to see much change in that going forward.

(CALLER INSTRUCTIONS) Mark Johnson of First Albany.

Just following up with a question someone else asked; I will ask a little differently. If you look at the corporate capital structure, do you have targets in mind with free cash flow generation? Word is dividend increases or share repurchases fit into that strategy. What kind of debt-to-capital ratio makes sense for running the business at?

We have said from a policy standpoint that our debt-to-capital ratio is really about where we want it to be, and I can see us two or three quarters from now seeing that number actually being a bit less than we are at the center point of our ranges, so from a shareholder value standpoint, we would certainly look at investment opportunities, whether it is investment in further debt reduction, share repurchases, increased dividend, or potentially growing some of the businesses. I think you heard Bob say that our residential HVAC business and our refrigeration businesses are both very high return on capital businesses where we are willing to put money behind the good ideas coming out of there as well. So there are a whole host of things and it is really the second half of the year where we take a hard look at the strategic outlook for each of the three core businesses, and I think at that time we would make some decisions.

Kit Case of Southwest Securities.

Yes, well it sounds like from your comments that most of the growth in your heating and cooling has really been coming from new products, new commercial customer accounts, and also general contractors and new construction and so forth. So you are still seeing a soft end market, I suppose, for the replacement market. Do you think -- are we seeing any pent-up demand results from pent-up demand over the last couple years or is there demand still being pent-up now?

At best I can give you a qualitative answer to that. I think there is still unquestionably a certain level of pent-up demand, but the phenomena is that some of that demand gets called simply because of the demise of the equipment, so typically when people have equipment they are considering replacing, it is some issue around comfort that initially gets them in the market so to speak when we are talking replacement. And it is at that point that a decision is sometimes possible, as we discussed before, to go ahead and defer an investment for a larger system or rather a new system that is perhaps more efficient, which also has a number of upscale features that add to the comfort and the overall quality of the interior of the home. We're saying if you look at the number of people who are interested in the new product on the residential side, certainly those people are people who are concerned about their home and wish to upgrade that environment, and they are being well received.

Naturally I am sort of biased I think that the reason for that is because of the real high quality and the genuine innovations they bring to the marketplace. But when you look at the total market, the total available market that is out there, I think one would have to still conclude that there still is a substantial level of pent-up demand that is out there. Again, I think that the economic forces on the external side are really the thing that are going to go ahead and pull that train when it starts to come lose.

Will these new customers that has been driving revenue so far this year, will those be the source of the successful operations in the second half of the year?

Are you talking about residential customers on the replacement side? Or are you talking commercial?

Both. In the heating and cooling division its really been strong growth so far this year, and it has been driven by the new customers and do you think that will continue, that scenario will continue through the rest of the year? In other words, you're not depending on a strong replacement market occurring.

No, actually -- first of all I've got to take a look and continue to perform well, but having said that, we know that the climatic conditions has a lot to do with the impact buying patterns. And in fact there is an interesting phenomena everybody is sort of watching right now because the actual performance in the industry, as well as all the reported data, were quite clear up through the month of May, that the fact was that things were down and those of us close to the business saw major pieces of geography in this country and Canada that were well behind both in terms of degree days, as well as in terms of their buying patterns.

June in fact by the second week in June, things in a lot of parts of the country for a period of timer approached more normalcy and indeed, people were extremely busy at that point in time. We still do not have solid data. There will probably be a few weeks yet but the industry as a whole to understand what happened throughout the quarter, both here and in Canada, and my guess is we will see at that time two things. One, we'll see evidence of the fact that compared to May that June was strong, but probably in all likelihood still see that the second quarter was perhaps a couple three percent below the level of last year.

So going forward, we are assuming what we always have to assume to be prudent, and that is we will see reasonably normalcy in terms of the health of the climate. I think all of us feel as though the economic thing out there is maybe in the minds of consumers, beginning to approach some kind of normalcy, so while we are cautious about the top line, we are not at all disappointed or distressed by what we think we see.

Gentlemen, we have no further questions in queue. Please continue.

Okay, well in summary, I think you have to surmise we are pleased to be able to report to you another quarter of operating improvement at Lennox International. With our cost reduction and business building initiatives continuing to gain traction, we feel we've got the momentum to continue the trend that you have seen. The management team, I can tell you is energized, and with the recent changes we've made, we are very optimistic about our company's future. As indicated earlier, we are confident with our earnings guidance for 2003 and expect that earnings-per-share will be in the range of $1.10 to $1.20 for 2003. Thank you for taking the time to be with us today.

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

(CONFERENCE CALL CONCLUDED)