Lennox International Inc (LII) 2003 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the Lennox International third quarter 2003 earnings conference call. (Operator Instructions). I would now like to turn the conference over to Bill Motler, Vice President of Investor Relations. Please go ahead, sir.

Thank you, Rita. Good morning and thank you for joining us. We are broadcasting today's review of Lennox International's financial performance in the third quarter of 2003 on the internet. A direct link to the webcast can be found on our corporate website at www.Lennoxinternational.COM. We will be archiving this call on this website and it will be available for replay. On the call this morning, Bob Schjerven, LII's chief executive officer, will comment on our company's progress and performance in Q3 and provide management outlook for the balance of the year. Rick Smith, our CFO, will follow with a review of operating results by business segment and address key income statement and balance sheet item. We'll wrap up the call with a Q&A session.

In the earnings release we issued yesterday after the market closed, which you will find posted on our corporate website we've included several tables providing description and financial details and reconciliations of the financial metrics that Bob and Rick will discussion to US generally accepted accounting principle measures. Before we begin, I'd 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 which is included in our publicly available fillings with the SEC which could cause our actual results to differ materially from those we expressed this morning. I’ll now turn the call over to Bob Schjerven.

Thanks, Bill. Good morning everyone and thank you for being with us this morning. Lennox International achieved solid results in the third quarter with higher sales and improved margins in our manufacturing businesses offsetting soft results in our service experts segment. Total company revenues in the third quarter increased 2% over same quarter a year ago to $839 million.

Adjusting for 33 million in G transfer revenues that were included in last year's sales, essentially all of which are now part of our growing venture with Auto comp Pool and therefore no longer being reported by LII, sales in the quarter increased 7%, which is up some 4% when adjusted for fluctiations in foreign exchange. Operating income for the third quarter was $53 million, up 1% from last year. As a percent of sales, operating margin was 6.3%. Net income was $28 million and diluted earnings per share were 46 cents. Both unchanged from the same quarter last year. Our cash flow performance continues to be quite strong. Lennox International generated $83 million in free cash during the third quarter. We continue to apply the cash that we generate primarily to de-leveraging the company and the strengthening of our balance sheet has been quite notable.

In the past 12 months, we have reduced the debt on the balance sheet by $37 million, plus we have also reduced the amount of our off-balance asset securitization program by an additional $74 million. Over the past three years, we have cut the total debt in half, a reduction of $366 million. Our debt to capitalization at the end of the third quarter dipped below 40% for the first time since LII went public in July of 1999.

Lennox International is well positioned for profitable growth with our resources now strategically focused on the three related business segments, which are worldwide heating and cooling, service experts and worldwide refrigeration. We're particularly pleased with the continued progress that we see in our manufacturing businesses. In the third quarter, combined sales from our heating and cooling and refrigeration segments rose 10%. Combined segment operating profits rose a robust 38%, and the combined segment operating margin for the quarter was a very solid 11.2%. Up 8.9% in the prior year period.

An improvement in the weather as summer progressed and resilience in new housing starts provided the foundation for excellent performance in our residential heating and cooling businesses. Despite stagnant end market demand in our commercial businesses, we aggressively developed new customers and we leveraged existing relationships to improve the profitability. All of our manufacturing operations are seeing margin benefit from the leading manufacturing techniques and cost efficient programs that have been implemented, and which we have previously discussed. Service experts results for the third quarter, however, were clearly unsatisfactory.

While we preserved our top line, we did so on a price competitive environment, lower gross margins and higher marketing costs put significant downward pressure on segment profitability. Several other factors which Rick Smith will identify in his review of our business segment did contribute to the erosion of service expert profitability. Now, while service experts cash is positive we're very disappointed with the current profitability level. Yet without question, we remain optimistic about the prospects of this business and we remain totally committed to our strategies to improving its performance.

Those are continuing to shift our emphasis to the more profitable service and replacement markets. We’ll allow only the best practices employed at the at our more successful service centers, and deploying and leveraging common IT systems that support the implementation of best practices and improved financial control. We are confident that we've developed the right tools to make this business successful and clearly understand that execution is the key to improvement. Now, before Rick gives you additional detail by business segment, allow me to comment on our outlook for the rest of this year.

Our manufacturing businesses are clearly seeing traction from the operating improvements they have implemented. These businesses are benefiting from new products that have been introduced, and sales and marketing efforts aimed at attracting new customers and strengthening existing relationships. And we certainly expect these trends will continue. As service experts, we anticipate modest profitability in the seasonally soft fourth quarter. Based on the strength of our performance in the first nine months of the year and the momentum that we're carrying into the final quarter of the year, we're comfortable with our guidance for the full year 2003 earnings per share of $1.10 to $1.20. We are, however, raising our outlook for free cash flow. Now projecting a full year of free cash flow to substantially exceed our net income.

Our total reported company revenues we expect will be flat to slightly higher for the full year of 2003. Rick Smith, our chief financial officer, will now take you through our business segment operating results. Rick?

Thanks, Bob. I'm going to start with our heating and cooling business, which in the third quarter got some nice help from favorable cooling season weather in many of our key markets. From a market standpoint, year-to-date through September, cooling degree days on a population weighted basis were 4% above normal. Now, that's a bit behind last year. 12% behind last year, but, again above normal.

The air conditioning and refrigeration institute reports are out through August. They reported that industry shipments of unitary air conditioners and heat pumps in July and August were 1% above the strong levels of a year ago. Now, for Lennox, we had excellent performance in the heating and cooling business segment.

Revenues rose 11% to $519 million. Adjusting that number for fluctuations in currency exchange rates, sales were up 8%. Segment operating income increased 44% over last year to $60 million. And operating margins expanded 270 basis points to 11.5. Breaking that heating and cooling business performance in to the underlying residential and commercial pieces, our residential heating and cooling segment continues to outperform the market.

Its revenues grew 7% in the third quarter to $368 million. Those revenues are up 6% when you adjust for FX. The Lennox and the Ducane brands of home comfort achieved double digit sales growth and the Dave Lennox signature collection is selling very well and Ducane continues to benefit from expanded distribution of its products. The healthy new housing market did support strong sales of gas furnaces as well in the summer months, which complimented the increased sales that are normal, seasonal sales of cooling equipment.

Shipments of whirlpool branded heating and cooling equipment, which are distributed through our alliance with WASCO, our tracking to our internal plan, and we're also encouraged by the continued growth in the top line of our Hearth products unit, which is supported by the strength in residential new construction as well. Segment operating income, and, again, this is residential for the quarter, increased 24% to $42 million from the same quarter a year ago. And segment operating margins expanded 160 basis points to 11.5.

Again, driven primarily by higher volumes. But also by our purchasing strategies that have translated into lower product costs. On the commercial side, we had terrific performance. Commercial heating and cooling, revenues increased 20% in the third quarter to $152 million. That's up 16%, adjusted for foreign exchange. Strong growth in the top line of our north American business was driven primarily by increased sales to new and existing national account customers.

But we also achieved sales gains within the contractor community. In Europe, in local currencies, revenue improved modestly. The market there is still relatively stagnant. But taken altogether, the commercial heating and cooling segment operating profit more than doubled to $18 million, with operating margins in the quarter, that same 11.5% that we saw on the residential, but that is up from 5.9% the prior year. The additional volume, good increases in productivity at the factory level, and the benefits realized from the shutdown of a redundant facility in Europe earlier this year contributed to the margin rate improvement. Turning to service experts, the retail segment.

Revenues were relatively flat, but, actually, on a constant currency basis, sales were down 3%. Just as was the case in the first half of the year, that modest revenue growth in residential new construction and residential and commercial service and replacement was offset by declines in commercial new construction. Service experts, the segment operating income declined from $13 million in last year's third quarter, to a 0.3 million this year.

Margins, consequently, contracted from 5.2% to 1/10 of 1%. As Bob mentioned, we were more aggressive defending the top line, which depressed gross margins and increased marketing costs. The margin squeeze there was compounded by higher costs for insurance, inventory valuation adjustments and bad debt expense as well as cost increases in over overhead categories.

And lastly, percentage of completion accounting adjustments in the commercial new construction business adversely affected segment profitability. On the refrigeration segment, revenues in Q3 were up 4% to $97 million, but as most of you know, more than half of our refrigeration sales come from international markets, and so this business can be more affected by fluctuations in currency exchange.

When we adjust for FX, refrigeration revenues were actually down 4% in the third quarter. End market demand for this business in both domestic and international markets we serve, it remains soft, but we've had a continued focus on cost control and improved manufacturing efficiency, and that has resulted in a very satisfactory earnings performance. Segment operating income increased 8% to $10 million. With margins expanding 30 basis points to just shy of 10 at 9.8%.

Moving beyond the segment operating results to some additional items from the financial statements, we did report earlier that during the third quarter we sold our electrical products division to Emerson Electric, realized a gain on that sale but the financial impact of this transaction was not material to Lennox International's operating performance.

This gain was more than offset by reserve requirements related to the heat transfer joint venture agreement entered into with Autocomp, just over a year ago. The net result of those two items was an after tax loss of $2 million, or 3 cents per share and that 3-cent figure is included in the 46 cents of earnings per share that we reported in the third quarter. The strengthening of foreign currencies on balance against the dollar, this is primarily for us.

The Euro, Canadian dollar and Australian dollar had a positive impact on the quarter benefiting EPS by 2 cents and interest expense in the quarter decreased 2 million on a year over year basis, to 7 million, reflecting the reduced debt levels that we're reporting. Total debt on the balance sheet at the end of September of 2003 was $373 million. That's down $37 million from the same time last year. That debt level would drive a debt to capitalization ratio at the end of Q3 of 39.9%, which compares nicely with the 46.7% of a year ago.

Free cash flow in the quarter, quarter three, was positive. $83 million. That compares with positive $65 million in the same quarter last year. That now brings our year-to-date 2003 free cash flow to $8 million positive, and as most of you know, our free cash generation pattern is very much tilted to be the strongest in the second half of the year. We continue to show a good results in terms of asset efficiency in the working capital category, expressed as a percentage of sales on a trailing 12-month basis.

Our operating working capital ratio improved again to 19.1% from 20.3% last year. And the gains we've made really in working capital management, receivables, inventory and liability items over the past few years have been consistently impressive. We are seeing the, over the last three quarters the working capital ratio begin to level off and looking forward, we really don't anticipate that to be a, as significant a contributor to free cash flow as its been in the last couple of years. And on the inventory front, for example, at the end of quarter three, inventories are down 3% year over year and that's $7 million, as part of that free flow cash calculation. Bob mentioned our asset securitization program.

At the end of the third quarter, the amount of accounts receivable securitized, again that’s off-balance sheet, was $86 million, down from $160 million, same point in time last year, and as a reminder, changes in our asset securitization being not operating in nature, do not affect our free cash flow calculation, which we really measure internally on an operating basis. Capital expenditures for the third quarter ticked up a bit to $12 million compared with $7 million in Q3 of last year. And year-to-date now, our cap ex in 2003 stand at $22 million above the rate of a year ago, but still well below depreciation levels.

And now at this point, Bob and I would be pleased to address any questions you might have.

Rita, if you would please prompt the callers for any questions.

Thank you, ladies and gentlemen. (Operator Instructions) Our first question is from the line of Michael Reagan. Please go ahead.

Thank you. I was wondering if you could just dig a little deeper into service experts. This is one of those issues that's not going to go away. Doesn't look like it's going to go away.

Michael, this is Bob Schjerven. How are you this morning?

Great, Bob, thanks.

Good. We indicate, we certainly have been disappointed with how the numbers came together for the third quarter. As we had recounted before, we are still in a, very much in the process of retooling in this particular business and instituting a number of changes, such as the roll-to and the best practices, and extending the control and the efficacy of the financial controls we have over, all parts of the organization. And while we were disappointed with the way these numbers came together this time, there were a number of issues in the market as well.

So essentially, we sailed against a head wind I think pretty much the last two months out of the quarter. If you look at essentially what the issues were, you know, certainly margin accounted for probably some four-plus million dollars in this wing. We had a number of -- as we get ready to complete the implementation of the stars accounting program, a number of adjustments and other things identified, and prudently taken, maybe a bit on the conservative side getting ready for that and these last operations we have up north of the border.

So essentially, it was a month where we had mostly head wind in just about every area. But on the other side of the ledger, as you look at the progress that's being made as we roll through the organization, the best practices, which go under the code name of project Titan, in that process we would certainly expect to be complete sometime next year, I guess. Probably about the third quarter.

We see the improvement, and we understand where it's going to come from, and in a nutshell, looking at that business, it now all comes down to execution, and primarily execution at the same level, and that hinges on a number of things. How quickly these best practices are assimilated, and wielded in an efficient manner, and also the caliber of the management that we have at multiple levels at each center, driving the new best practices to fulfill the role model that we’ve got out there, or the business model that we've got for each one of those centers.

Can you just talk specifically -- I mean, third quarter or second. So looking at it sequentially, revenue's up $8 million. Profit down $7.3 million.

Of course, we did have an issue with respect to the currency exchange on the sales on the Canadian side, but when you look at margins and the competitive environment that we found ourselves in in a number of places as well as the continuing substandard that performance we have on the commercial side, I think it's pretty clear to us, at least, that the direction that we're going with the strategy and that is, to continue, albeit maybe in the short term it’s painful to shift to the more possible service of replacement business and to continue to roll out of the best practices, systemic control of the operation, we're going to get there.

But, as you go from 2-2 to 2-3, we saw a number of issues that hit both at the margin line, all the way down through, you know, the PNL.

Okay. And if we could jump to the commercial business. It looked like 11.5% margins, commercial air conditioning. Up from 5.9. So, you know, substantial improvement. 200 basis points improvement, second quarter, over second quarter year over year, and then over 600 basis points, a little less, sorry, than 600. 560 basis points, in the third quarter. What kind of happened here?

Yeah, Michael, it’s Rick Smith.

Hi, Rick.

I'll take the first shot at that, and I have to give credit to the management of the commercial heating and cooling business. I think the top line efforts, and, again, this goes to both what we call the national accounts as well as the local contractors.

We've always had strength in the national accounts. We continue to gain more of them and penetrate those that we already have, but that business is also very much a local business, a replacement business. We're starting to increase our emphasis there, and it really starts on the top line.

What was top line ex-currency Rick? Just for that business?

In the -- bear with me a second. I'm going to make sure I get this right. Revenue was up 20 before currency.

Yep.

16 after currency. In other words, adjusted for --

right. 16 core.

16.

Right.

And, of course, this business is both a north American and European business for us. I think on the European side, I mentioned this, probably didn't talk enough about it, but earlier this year, the management stepped up to some capacity re-alignment issues there.

Did close a facility, and they had promised us that we'd see payback in the second half of the year. That, in fact, is happening. So that -- it's a combination of factors. Both revenue side and cost side that are contributing to that greater operating income increase relative to the sales increase.

I guess -- this is Bob. I guess I would add only one other thing to that, and that is -- We have, and a number of these conversations talked about, the focus around Lee manufacturing and we see that extended to all of our manufacturing operations and certainly you visit our corporate operations and you see ample evidence of that technology, that methodology, having taken hold. These folks are doing a superior job. There's just no other way to put it.

Thank you.

Thank you, Michael.

And Mr. Reagan is with credit Suisse first Boston. Our next question is with Kit Case and he is with SW securities.

Hi, good morning.

Good morning, Kit.

Quick question here on the JV. Is that thing going to be possible in the fourth quarter, do you think?

It’s Rick Smith, Kit. How are you?

Good.

We actually have a number of JVs, the largest of which is, I think the one you're talking about, the heat transfer joint venture with auto comp, it has always been a profitable business. That hasn't changed since we formed the JV, and I would expect it to continue to improve its performance. A lot of that market, those customers are OEM-type customers. And as the commercial economy improves, I would expect its results to improve as well.

Could you discuss a little about the disk connect here? You're getting strong commercial activity on the manufacturing side, but yet the commercial is killing you in service experts. Why isn't that a little bit more consistent?

Yeah. I would -- I’d certainly want to explain a little bit better how we look at the commercial business. Service experts has a good-sized new construction business, commercial new construction as well as a service and replacement commercial business. And as Bob has indicated, Scott Boxer when he took over at the beginning of this quarter, of quarter three, endorsed and has gotten his team behind the strategy to focus on the service and replacement business, commercial or residential, and what we're seeing is really a split there that the competitiveness, the competition for jobs at the service center level I think, is showing up on commercial new construction, results for service experts.

Yet we as an equipment manufacturer in the equipment segment are benefiting from those things we just talked about. And so we're getting a good flow-through at the manufacturing level because of the Lee Manufacturing and greater penetration. I'm not sure that's responsive, Kit, but that's how we're seeing it.

Gross margins in the commercial manufacturing, have they been suffering as if it's -- since it's so competitive and you're just making your dollar on the overhead? Or is it still getting gross margin there?

Well, if you go back a couple of years, this market was soft in 2001 and 2002 for everybody, and, of course, naturally, gross margins suffer more from a utilization standpoint on the equipment side, but our product cost is coming down this year again because of greater flow-through. More units going through those facilities, and fewer facilities plus manufacturing overhead in general. So on the equipment side, it's a whole host of things that are contributing to the margin expansion. And the market is -- is showing signs of recovery.

Staying on service experts, Bob, you mentioned about $4 million, in income is really due to the gross margin deterioration. How much did the bad debt and inventory adjustment impact you this quarter, versus last year?

Well, in this particular quarter some of the bad debt and inventory adjustment, probably comes close to the $4 million. Let’s say some $3.5 million to $4 million. Something like that.

And, again, as I mentioned, the whole process, completing the preparation for the last segment of the insulation stars in Canada, as we saw when we were in the United States and going through that process there, and it's a number of things that you take very conservatively as you get your accounting system totally in alignment. Across Canada, we're going from some 39 different operating systems spread through that operation to the one cohesive system that we now have working very well across the United States and virtually at all of our centers.

Do these expenses, the bad debt and the write off as one time, or is this going to be a continual issue?

No. It would certainly be those one largely as a one time. And, again we saw similar types of occurrences back, what, a couple years ago I guess, as we were moving through the organization here in the U.S. And getting all of the accounting systems in alignment and so forth. That was definitely be a one-time.

I should tell you, as we target we look at the role model stars in Canada, we essentially see that as something that starts in the beginning of the year 2004. You would expect, it's logical, you go through all the preparation work and so forth that takes a couple months before you walk up to that and start actually doing installations of the new systems et cetera.

Well, if you exclude all of those charges, or those one-time events, and you think you could be fairly profitable in the fourth quarter?

Kit, that's right. I think what I heard Bob say earlier is that we would expect service experts to be profitable in the fourth quarter, even though seasonally that's not our best quarter, but that is our current outlook.

Okay. Another question here on the -- I guess this is more philosophical. But if you could talk a little bit about the strong growth here in manufacturing. Do you think this is an issue where you're tapping into pent-up demand? Or do you think that pent-up demand still exists where you can continue pretty good growth going into next year as the economy improves?

Well, it's got a -- probably a couple of answers to that question. Let me try to take them as it make sense to me. Certainly, if you look at over a Multi-year period of time, back in the history of this industry, there's no question but what there's been good, solid pent-up demand. We have seen some of that demand cut loose as we've had two reasonably good summer weathers, because a lot of this does certainly pivot on how the cooling products sell through the industry. Still, we see evidence, and a lot this is anecdotal. And, certainly a lot of this we see coming on the service expert side. A reluctance on the part of many Consumers yet to accept the fact that the general economy is beginning to become more robust, and that they can step out and make these equipment purchases that are good for them in the long term, in terms of increased comfort and increased efficiency but that still is not happening, in my view, on a widespread basis.

So I think there are probably no one would question the fact there's still some pent-up demand up there, in talking about the residential sector. When you switch over to the commercial sector, we have done very well.

And, you know, just as truly with the new products that we feel that in the residential sector, there's a number of things that we have driven in both the commercial and the residential side that have improved our penetration. Market share is clearly up. New products definitely helped us on the residential side, and when you look at the work that's being done, both with respect to new products but also with respect to marketing initiatives on the commercial side. I guess was summed up pretty well by Rick Smith. Gave credit to the management Team, running the commercial aid sect of the business. Because they have done very well including a number of the subchapters that they track, that they service, and they’re involved in this planning. So it's a variety of the things that are there.

One last comment would be on the commercial market. We feel that we see up-ticks in terms of interest and some other indicators that are out there. But I will tell you that nobody, at least in our company, that works in this market feels truly comfortable yet at this point that those kinds of improvements in general market health for commercial is totally sustainable.

Each day it looks like we see a few more positive indicators across the broad economy, but, you know, that seem to support what we think we're saying, but I'm not yet ready to step out and say, ok, the worst is over. The commercial segment of the industry is definitely on the upswing. We're thinking positively about, but I think we need to wait a little longer before we get too tough in our remarks about how good we think it's going to be.

According to on an operating basis, 49 cents versus 41 is not bad. Not bad growth, despite having service experts down so much year over year. You know, so it’s gonna -- you're going to have to execute on Service Experts. And, I guess you're depending on this project Titan, really, for that execution. How many of the dealers have been approached and have been, have had this project Titan and have had this best practices installed? So far?

Well, currently, and, of course, it takes a period of time once the center has it installed before they really begin to internalize and move through all aspects of the operation, whether you're talking about marketing, whether how they are deploying their people or how they're handling the assets and the inventory side, how they are doing their pricing, there's a lot of pieces to that. But just as a broad slope, just slightly more than 40 centers at this point, at which it had been initially rolled out.

Some of those have a few more months experience with it than others do. But, certainly as I indicated in my remarks it is our clear plan to have this rollout, you know, completely behind us about the middle of next year sometime.

You've got -- how many -- when did your first ones go in?

I believe that, Bob, if memory serves, that was right before the cooling season began this year. It would be April and May, and then we paused, Kit, as you know for the busy season and have now revitalized that, and continue the progress as Bob says with a view towards finishing towards next year's cooling season.

Are there any early signs of those initial dealers, of how they're doing? The first ones?

Well, the signs are positive, and one of the things that we have to calibrate for is that it is a very competitive market out there. You've got, you know, in this business, another 30,000 or so competitors for each of these centers in the aggregate, and what we're doing is, we're trying to adjust for or performance generally and look at whether the project Titan exposed centers are beginning to break out, if you will, from where they would have been let’s say in the absence of that, and the signs are very good.

All right. Thanks.

You're welcome.

Thank you, Kit.

Here's a question from Craig Irwin, first Albany.

Hi, guys. I was just hoping you could help me understand a little bit more about the growth of your commercial revenue and your heating and cooling segment. If you could maybe talk about the relative contribution of market share gains, currency, and general end market growth?

I don't have that precisely. As you know, some of the industry data lag and so we haven't really see full third quarter information on the industry. We do believe that they're a combination of things, as I say. Our national accounts continue to do pretty well. We've got a great set of customers, and that's a growing set. That's going to be a bit big part of it.

But, as I say, increased emphasis on the other subsets ever the commercial business, into the educational and the local contractor market, that has helped as well. The European piece, as I mentioned that was more of a cost-driven improvement than top line when you adjust that for FX. So it's really a whole host of different things. Bob, maybe anecdotally, if you have got anything to add to that?

There are a couple of other factors you see, and that is, take you through our operations, for example, in Stuttgart, Arkansas.

Yeah.

You would see an operation that has an extremely flexible mode of assembly. We are capable of delivering on extremely short lead times, and there's a lot of business that's out there that, you know, looks for just precisely that kind of response to replacement impact market. We're doing much better with that.

You look at the overall performance with respect to working capital, and what it reflects and sort of a tangential way is simply the fact that when you really begin to function well in a lean environment in a manufacturing company, you see a lot of the numbers going in the right direction.

So you can look at that improvement as an additional barometer of the kind of efficacy that this lean effort over the last couple of years has really produced for us. And that, we feel, and which we think we see quite clearly, has allowed us to advance our penetration. And, again, when you look, when you go to the margin, certainly that kind of mode of operation does drive your cost to manufacture down in a way that's quite noticeable.

And a number of other efforts that also worked across all of our manufacturing businesses, looking at improved the, reduced costs of product as we improve our worldwide sourcing efforts. Things we're doing with respect on an ongoing basis with the implementation of six sigma type technology and driving work that takes cost out of the product, and certainly you see that reflected in the margins. So you're capable of competing head to head on a very good basis, because you've got really good costs. That, plus the focus on some of these different sub-sectors we spoke about. And which Rick also talked on-

Yes.

Has created pretty general improvement for us. We're very pleased with what these folks have done.

Great. So, is it fair to paraphrase that really these are just results from a focus on operational excellence?

Yes, if you include in those comments operational excellence and mean the things that we're doing with respect to marketing and how they serve the customer as well.

Yes. Okay. Excellent. Do you have the total contribution of currency to the top line in the quarter?

Yeah. I think that was about 3 percentage points. In other words, on an OAI consolidated basis, I’m taking out from last year the heat transfer.

Yeah, yeah.

And so, again, three numbers, sales up to OM reported, up seven when you take out the heat transfer. But that seven really is a four percents on a currency adjusted basis.

Okay. That's fair. And then, obviously, you guys made some progress on the SGNA as a percentage revenue in the quarter, but it was up very slightly on a sequential basis. Is there much of an opportunity here, or, you know, I guess another way to ask this question is, you know, looking into the fourth quarter, should we expect things to be up on a percentage basis versus year-ago levels?

This is Rick Smith. I'll take a stab at it and, quite honestly, I haven't really done the analysis on the sequential, but, I mean, we're disappointed, actually, in our third quarter SGNA performance. A lot of that has to do with mixed -- the absence of the heat transfer business, which was a pretty lean SGNA operation, which was in last year's numbers.

The flip side is, it gets into service experts performance. Service experts is, unlike our manufacturing businesses, has got a lot of room for improvement. A lot of things that Bob talked about around the initiatives, the strategies, in service experts go directly to this SGNA the rollout of this common I.T. system through the remainder of the centers it going to help. So, I don't know if we'll see that in the fourth quarter but it's definitely on our radar screen as a target.

Great. And then, last question. If you could just help me understand what was in the other expense in the quarter, and what brought it negative? I see it's been positive for the last several quarters.

Yeah. A couple of things, actually. I think this year it's a combination of minority interest and other, and we do have some affect on a year over year basis of what I'll call greater -- this is a good news/bad news situation. Minority interest participation in our consolidated results.

Yeah, yeah. Well, excellent quarter. Thanks, guys.

Thank you.

(Operator Instructions) And we have a question from the line of Terry Webb, A.G. Edwards.

Good morning, gentlemen.

Good morning, Terry

This is sort of a general balance sheet question. Three years ago I probably would have been asking you guys what you were going to do to try and create a more conservative looking balance sheet. You've done a nice job at that. And at this point in the interest rate cycle, it seems to me you might be rewarded by being a little bit more aggressive in the way you manage your balance sheet and I'd just like to hear your perspective on that subject looking forward over the next several years.

Sure, Terry, it’s Rick Smith. Be glad to do that. I mean, we feel really good. The way the organization's responded over the last couple of years, because we shared that view that a little tighter balance sheet was probably in order. I think we've gotten into a range where our comfort level has increased, and I think -- I don't want to speak for the board of directors, but I think they would be there as well, in terms of being in their comfort zone.

I guess the first comment I'd make is, just seasonally, the September balance sheet, the December balance sheet, would tend to be a lot healthier, let’s say, than our annual average. We try to plan around that seasonal peak need that really hits us March, April, May, June of each year, if business is holding up. Having said that I think we certainly feel that when we see capital expenditure requests on our businesses as their penetration and their market grows, we can be a lot more responsive to that and encourage those sorts of initiatives. We feel pretty good about our flexibility at this point in time.

The businesses that have demonstrated the ability to grow that we can fund those, and so I think, again, we're getting as an organization to the point where without any specific comments on use of funds, we really are pleased that we have the flexibility to consider alternative uses.

I guess just sort of following on that and knowing you don't want to get too specific about it, just by business line, where do you think maybe the greatest opportunities for growth are going to be?

Well, I think we've said all along that our -- all of our businesses have tremendous organic growth potential. When you think about some of the innovative products we've got. Both recently introduced and in the pipeline. In addition, we've also said publicly in the past that our refrigeration business, our most global business, is one where there are opportunities of an organic and other nature.

So I would certainly say as Mike Schwartz who heads that business Has headed it now for the last three months, begins to get his arms around it, that's another area, where, again, we're glad to have the flexibility to respond to ideas he might have in that regard.

That's great. Thank you very much.

Okay. Thank you, Terry.

Adam France, Charlotte Capital.

Yes, good morning guys. Rick if I can ask you about -- perhaps I'm not thinking clearly this morning. When I'm looking at your nine month free cash flow and where you need to be by the end of the year, I'm no expert in asset securitization. Are you going to see that kind of big number again in the fourth quarter? Is that what's going to allow you to get -- to be above net income, you'd have to have free cash flow, mid-60s, and we're at 8.2 for nine months. Could you just walk me through the mechanics?

Sure. Glad to do it, Adam. I guess first, and maybe I didn't say this well enough. The securitization for us is a tool to use to address, among other thing, the seasonality in our business. A very cost-effective tool. It tends to gets utilized, therefore, more heavily in the first and second quarter. So we decided internally to measure free cash flow before any increases or decreases in securitization. That's kind of a fallout of what the businesses are doing. And that's how we've reported it.

Now, I think if I try to piece together how we've done in the last couple of years, as I mentioned, the second half of the year is always a good free cash flow period for us relative to the first half. And in fact, last year in the fourth quarter alone, I think we generated free cash flow of something around $100 million. And so I don't want to indicate that that's a good proxy for what we might have this year, but, again we think the -- the free cash flow, even though we're only a plus eight for the year, still is on track to exceed by a healthy margin the net income for the year.

And I'm not sure I've answered all of the specifics, and what I'm really saying, and maybe I could cut it short is, we're going to work in the fourth quarter as we do in every fourth quarter, and for the last couple of years that's shown the kind of free cash flow that is consistent with what our, just updated guidance is for this year.

Rick, could you speak to where you expect cap ex to end up for this year and if you care to take a stab at next year?

Yeah. We really haven't. I'm going to answer the second part of the question first. We really haven't finalized our plans for next year. I think intuitively I would guess that our cap ex for next year will be up, versus 2003. Again, I'm an optimist around the business cycle, and I think our businesses will have more and more opportunities that will present themselves, but this year has been a year where we've been surprised a little bit on the down side, that although cap ex is up, as I think we indicated in the release on a year-to-date basis, we're only at $22 million.

Let's say a quarterly pace, on a run rate of something in the 8 to 12 area, you could see us in the vicinity of 30 for full year 2003. That's a number that I think is -- is going to be stronger than last year, than 2002. But, again, well below as bill commented in some of his one-on-ones, a lower depreciation levels.

Super. Thank you, guys.

Good.

Thank you.

And we have no further questions. I would now like to turn the call over to Mr. Bob Schjerven.

Thank you, Rita. On summary, what I'd like to say is that we are really pleased to report the quarter of solid performance at Lennox. Our manufacturing businesses as has been discussed are truly operating well, and the fact remains that we are totally committed to improving the performance at Service Experts. We think we have a lot of really important tools in place and we certainly have the focus and the intensity to get that job done.

As indicated before, we formulate our earnings guidance for 2003, and we expect earnings per share will be in a range of $1.10 to $1.20. Also, we are raising our free cash flow guidance, as was discussed and we would expect a full year cash flow to substantially exceed net income. I want to thank everybody for taking the time to be with us today. Have a good day.

That does conclude your teleconference for today. Thank you for your participation. You may now disconnect.