Lennox International Inc (LII) 0 Q0 法說會逐字稿

Welcome to the Lennox International earnings conference call for the first half of 2004.

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.

Please go ahead, sir.

Thanks Tonya.

Good morning and thank you for joining us.

Today's call will review Lennox International's financial performance for the first 2 quarters of 2004.

Before we begin, I'd like to remind you that the financial information presented in the earnings release we issued yesterday and on our call this morning is unaudited as is normal when quarterly earnings are reported.

As a result, we can give no assurance that this informational will not be adjusted prior to the filing of our Form 10-Q with the SEC.

With respect to our SEC filings, LII had announced on July 8, an anticipated downward adjustment of $7 million to the cumulative earnings for the years 1999 through 2003.

These adjustments are the result of the independent investigation that was conducted by the audit committee of our Board of Directors into the accounting practices at our service expert's operations in Canada.

While the investigation has been completed and no further adjustments are expected as a result of the inquiry, additional prior year adjustments to LII's ongoing operations are possible until our SEC filings are current.

The process to finalize our filings with the SEC which we believe is typical, includes completion of the inquiry and determination of the required adjustments.

The appropriate accounting treatment has been established in consultation with our auditors for the adjustments identified, and the results are submitted to the SEC for review and comment which is where we currently are in the process.

Although we are not current with our SEC filings, LII believe at this time that the 2004 financial information presented will not be affected by the adjustments to prior year's financials.

While we expect that our results for both the first and second quarters of 2004 represents an improvement over the prior year period in income from continuing operations before goodwill, until we have filed our 2003 reports with the SEC, we will not be able to make specific year-over-year comparisons.

Also I'd like to remind you 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 including the final adjustments to prior year's financial statements.

A list of these risks and uncertainties including the impact of higher raw material prices, and the impact of unfavorable weather on the demand for our products and services is included in our publicly available filings with the SEC and they could cause our actual results to differ materially from those we express today.

We are broadcasting today's call live on the Internet and there is a direct link to the webcast on our corporate website at www.LennoxInternational.com.

This call will be archived and available for replay.

I will now turn the call over to Bob Schjerven, our Chief Executive Officer for a review of LII's performance for the first half, an update on our turnaround initiative at Service Experts and comments on management's outlook for the balance of 2004.

Bob?

Good morning everyone and thank you for taking the time to be with us this morning.

As Bill mentioned, on July 8th Lennox International announced that we completed our audit committee's independent investigation into the accounting practices at our Canadian Service Experts operation.

All this investigation consumed a great deal of time and resources and has delayed our SEC filings.

We take the integrity of our financial statements very seriously and believe that this was absolutely the correct course of action.

As you are probably aware, on July 14th, we announced the appointment of Susan Carter as our new CFO, replacing Rick Smith.

Sue, who joined us earlier this week comes to us from Cummins where she had served as Vice President of Finance.

Over the past 23 years of her career, Sue has acquired tremendous experience in financial management from both the business unit and corporate perspectives.

Prior to Cummins, she served in Senior Financial Management positions at Honeywell, Allied Signal, Crane Company and the DeKalb Corporation.

We look forward to introducing Sue to you in these future earnings calls.

For today's call, I have asked Bill Moltner to help out presenting our business segment performance for the first 2 quarters of this year.

In the first half of this year, the market for residential heating and cooling equipment was robust with industry shipments in the U.S. and Canada rising approximately 12 percent.

And we continue to see improvements in our domestic commercial end markets.

Our manufacturing operations are running efficiently and have gained leverage from higher production volumes.

Although a demand for commercial equipment in the international markets reserve has been relatively flat, we have benefited from improved operating performance in our international operations and we expect this improvement will continue.

Higher commodity prices, however, are posing a challenge.

In the first half of 2004, year-over-year increases in the cost of steel, copper and aluminum created head wind for us of approximately $17 million.

So far this year we have offset this impact to a combination of hedging, improved production efficiency, cost reduction initiatives and price increases.

At our Service Experts unit, we have moved aggressively in the turnaround plan that we announced in April, taking us closer to making our direct to consumer operations a meaningful contributor to LII's profitability.

This plan focuses Service Experts on service and replacement opportunities in the residential and light commercial markets.

Markets that have higher margins and lower risk and are less typical.

At this time, we have sold 18 of the 47 centers that do not fit this model and which were identified for divestiture.

We also have non-binding letters of intent for another dozen or so and we our on track to complete the divestiture of the remaining centers by year end.

Management at the ongoing Service Experts operation both in the field and at the corporate level is focused on executing this business model.

We are making good progress in our move to regional accounting centers.

The use of regional accounting centers has the benefit of both reducing administrative costs and also enhancing financial control.

At this time approximately 80 of the 130 Service Experts centers are supported by our 2 regional accounting centers.

We're also making progress rolling out a new inventory management and replenishment program which entails an assessment of the current inventory at the dealership level and actions to optimize truck inventories, ultimately contributing to a reduction of working capital requirements and technician efficiency.

Now, taking a look at LII's performance for the first half, Lennox International began 2004 with a solid first quarter.

Our total Company revenue from continuing operations in Q1 grew to $664 million.

Fluctuations in foreign exchange rates benefited the top-line by about 4 percent.

In the first quarter, we reported a net loss of $195 million or $3.27 per share on a GAAP basis.

It is helpful to break down the composition of this figure.

We recorded a pretax goodwill impairment charge related to service experts in the first quarter of $208 million or $185 million after-tax.

Additionally in the first quarter, discontinued operations negatively affected earnings by $20 million pretax or $16 million after-tax.

Our first quarter income from continuing operations before goodwill impairment was $7 million or 11 cents per share.

Bill will provide additional detail on that goodwill impairment and discontinued operations just a bit later in the call.

In the second quarter, total Company sales rose to $805 million with FX boosting sales by about 1 percent.

Our second-quarter income from continuing operations was $36 million or 58 cents per share.

Discontinued operations adversely affected earnings by $4 million pretax or $2 million after-tax resulting in a net Q2 earnings per share of 54 cents.

As I said, we've had a solid start for this year.

We see continued improvement although at a moderate pace in our commercial market during the back half of the year.

However, based on weather patterns that we've experienced thus far in the third quarter we are considerably more conservative in our expectations in residential demand.

In July, cooling degree days in the U.S. as reported by NOAA were 3 percent below normal and more than 7 percent under last year.

That's on a population weighted basis.

Also, ARI recently reported that distributor shipments of unitary air conditions which is an indication of end market demand, were down already 3 percent in June.

Balancing our strong first-half performance with this somewhat mixed outlook for demand, the projected impact of higher material cost in the back half of the year and higher corporate expenses including Sarbanes-Oxley compliance costs, we expect full year's earnings per share from continuing operations before the goodwill impairment charge we took in the first quarter will be at the lower end of $1.38 to $1.48 which we previously had been providing.

We expect continued strength in our cash flow generation with cash flow from continuing operations less CapEx to exceed $75 million.

We are on track for CapEx in 2004 to approximate depreciation at about $50 million.

Bill will now provide some additional detail on our performance at the biggest segment level.

Bill?

Thank you Bob.

LII's heating and cooling business performed well in the first half of 2004 with revenue of 433 million in Q1 and 552 million in Q2.

Segment profit was 34 million or 7.8 percent of sales in Q1 and 72 million or 13.0 percent of sales in Q2.

The residential piece of our heating and cooling business had sales of 324 million and 401 million in the first 2 quarters respectively.

Sales of both our premium Dave Lennox signature collection and our Ducane brand which is aimed at more price sensitive consumers were exceptionally strong in the first half of 2004 as were sales in our hard products business and at our ADP unit which is a leading provider of evaporator coils.

Segment profit was 33 million in Q1 equating to a 10.1 percent margin.

In Q2 segment profit of 55 million translated to a very solid segment profit margin of 13.8 percent.

As Bob had indicated, higher production volumes and strong factory performance have offset higher material costs in the first half of the year.

We are seeing improved demand for commercial heating and cooling equipment domestically with industry shipments up approximately 4 percent for the first half of the year.

LII's Commercial Heating & Cooling segment continues to perform very well with revenues of 109 million and 151 million for Q1 and Q2 respectively.

Sales to national accounts supported strong domestic performance while revenue in Europe where demand remains depressed, benefited from positive currency exchange impact.

We had segment profit of $1 million in Q1 and segment profit of $17 million in Q2 resulting in margins of 1.3 percent and 11.1 percent respectively.

Accelerating revenues drove the sequential improvement and in addition in Europe in the first quarter, savings realized from last year's closure of our factor in North Hampton England were more than offset by some additional expenses taken to further reduce our cost structure.

Second-quarter margin subsequently benefited from these actions.

Revenue from the 130 dealer service centers that comprise our continuing Service Experts business was 139 million in Q1 and 168 million in Q2.

The segment had an operating loss of $8 million or 5.5 percent of sales in Q1 and in Q2 moved to a segment profit of $6 million or 3.3 percent of sales.

Implementation costs for the STARS IT system in Canada which is on schedule to be completed by the end of the year and higher marketing expenses to drive sales puts downward pressure on margins.

Also, for the short-term, the continuing Service Experts business is burdened with a larger overhead structure than this business will ultimately have.

From this perspective, 2004 is a transition year as we proceed with the divestitures and move to right size the cost structure for ongoing operations.

Our Refrigeration segment benefited from improved market conditions with first-quarter revenues of 109 million and 2nd-quarter sales of 108 million.

We achieved solid top-line performance in all regions with Asia-Pacific and Europe both also benefiting from currency fluxuations.

We are seeing noticeable improvement in some segments of the market such as large cold storage projects.

In other segments that remain stagnant, notably the supermarket sector we are improving our penetration.

Segment profit was 10 million in both Q1 and Q2 with solid operating margins of 9.0 percent and 9.4 percent in the first and second quarters respectively.

As mentioned earlier in the call, we took a pretax goodwill impairment charge of 208 million in the first quarter.

This charge is related to Service Experts and is the result of the annual goodwill impairment test mandated by FAS 142.

The outcome of this analysis was independent of the divestitures announced as part of our Service Experts turnaround plan.

Let me take a minute to walk you through the discontinued operations charges that we took in the first 2 quarters.

These charges relate to the 47 Service Experts centers designated to be divested as well as 4 centers that as previous announced, have already been closed.

The $20 million pretax charge for discontinued operations reported in Q1 consist of an additional $13 million in goodwill impairment based on anticipated proceeds for the centers we expect will be sold. $3 million in impairment of long lived assets and $4 million in operating losses incurred during the quarter.

The after-tax charge for discontinued operations in Q1 was $16 million.

In Q2, the 44 million pretax loss from discontinued operations or $2 million after-tax, consists of 2 million in operating losses in the quarter; 1 million in other divestiture costs; plus a pretax loss on the sale of centers that were divested of approximately $500,000.

We expect to incur an additional $20 million in divestiture related charges during the balance of 2004.

It is important to note that this $20 million excludes any operating losses from divested centers in the back half of the year.

The $20 million represents our initial estimate of 25 million in divestiture expenses that we provided in April less the 3 million in impairment of long lived assets; the 500,000 loss on sale of centers already sold; and the 1 million in other divestiture costs that have already been recorded in the first 2 quarters of this year.

In total, the divestiture activity is expected to be cash flow positive with the anticipated proceeds from the sale of vendors and related tax affects more than offset in cash expenses.

LII continues to make good progress reducing our balance sheet debt.

Our total debt at June 30th was $317 million, down from 365 million at March 31st.

During the second quarter we made $10 million in scheduled debt payment and prepaid an additional 35 million that was due in 2005.

At the end of the second quarter, our total debt was $73 million lower than it was at the same time the previous year.

The utilization of our accounts receivable asset securitization program which does not appear on our balance sheet was $65 million at March 31st, and 135 million as of June 30th.

The June 30th balance is $19 million less than it was a year ago and the increase from the first to the second quarter reflects normal seasonal working capital needs as well as the cash used to reduce balance sheet debt.

Our total interest expense in Q1 was $7 million reflecting slightly higher rates due to a greater proportion of fixed-rate debt.

Q2 interest expense was $9 million and was impacted by $2 million in fees related to the debt prepayment.

Included in corporate expense in the first top of the year was the cost of the independent investigation into Service Experts accounting practices in Canada.

Capital expenditures in the first and second quarters were 7 million and $8 million respectively.

And finally, our effective tax rate on continuing operations for both the first and the second quarter was 38 percent and we expect to sustain this level for the balance of the year.

So at this point, Bob and I will be pleased to address any questions that you might have.

(OPERATOR INSTRUCTIONS) Basil Batt (ph) with KeyBank Capital Markets.

Good morning guys.

You mentioned a negative impact from raw materials in the first half.

That does really not appear in the results.

So what changes in the second half of '04 because I would anticipate that the raw material had ranged incrementally higher in the second half would be offset by price increases that you instituted on June 1st?

A couple things, first of all, raw material program that we have includes hedging.

But we don't hedge for an infinite amount of time into the future and as we move into the second half as those hedges largely roll off.

A major component of cost, steel, is one that nobody hedges on, nobody can hedge on.

In addition to that, we are seeing continued upward pressure in steel prices sometimes at an alarming pace.

That is certainly part of the mosaic that we've got painted in here.

As far as price increases are concerned, certainly we have seen good success at the price increases that we have instituted across particularly the residential market through our various brands and various channels that we serve.

It also had some success although it is a bit more limited of course in the commercial markets because of longer-term contracts and such as that.

In terms of the residential business, can you be more specific in terms of topline growth in the second half?

Are you anticipating it to be flat, down or grow moderately?

Again until we are current with are SEC filings we are not in the position to make year-over-year comparisons for the quarters.

Fair enough.

For Service Experts, how should we look at the operating margins in the second half of '04 versus first half of '04?

There are a couple of things about that.

This is clearly a transition year with the divestitures and turnaround activity that we announced back on the 5th of April this year.

In the course of that, we've streamlined the management structure.

We've changed the financial management and financial reporting structure.

We've eliminated a headquarters operation that were involved and all of these things which quite frankly has also been complicated a bit by up until recently the ongoing investigative work that was being done at all of our Canadian centers has caused us to translate a little bit -- couple of months let's call it -- the improvement curve that we had established.

Clearly they are.

I think this is the key thing for any transition such as this.

They are executing well on all of the things that we had enumerated were important such as the implementation of process control and standardization, better financial controls and such as that.

That of course is something we have mentioned before which is in just about 75 percent of the centers as we speak.

All of that is going well.

You will see continued improvement in the profitability and continuing operations, I'm pretty confident of that, through this year.

Again, our focus this year is to be sure that they are executing and have the resources to execute cleanly on this change that we've outlined so that we get to that business model that we believe is going to be very successful.

Can you comment on the organic growth that you saw in the Refrigeration segment?

I don't think that that would really be appropriate at this particular time because of where we are at in the filings and so forth.

At a later time we certainly -- probably could be in a position to do that.

Just in very general terms, when you look at the market and we see that large cold storage certainly has come up.

The supermarket portion of Refrigeration is one that's been hard hit I think as everybody knows the (indiscernible) (ph) we believe that we've made some share gain in the supermarket segment as well.

Just as a general comment on that entire market, it has really been slow to respond and of course if you have been following that probably know that it really began to tank back in 2001.

It's been a long dry spell for that whole industry.

Lastly, the corporate expense outlook for full year?

Yes.

Can you comment on that?

I guess to this extent -- and that is that for the full year we've got a number of items which are truly unusual, nonrecurring type expenses and those very roughly estimating are probably something north of about 15 cents a share.

Thanks guys.

Thank you.

Justin Mauer (ph) with Lord Abbott (ph).

A lot of numbers Bill has thrown on us here, Bob.

I want to get a sense of a couple of things.

First, guidance, does that include discontinued ops or is that excluding discontinued ops?

Justin, that excludes discontinued operations.

It excludes.

Okay.

So I know and appreciate your comment that you just made about not wanting to compare to last year but if I simply -- the only comment I want to make relative to that is if I look at your earnings to last year's second half and just add it to what you guys have done this year first half, that implies, it my math is right, about $1.41 in earnings which isn't too far from the low-end of your guidance.

That includes about $10 million of losses.

Of course last year at the end of the year in particular the fourth-quarter of Service Experts so I know and can appreciate your conservatism because of raw material costs and a little bit of inventory maybe in the channel.

But can you give us a little bit of sense, clarify that a little bit to the extent you can?

Again, Justin, we can't comment on quarterly earnings for last year and particularly in the back half of the year due to possible fluctuations in those quarterly numbers.

Our outlook based on what we see right now is that we expect earnings to be in the lower end of $1.38 to $1.48 range.

So again we can't bridge from last year for you.

But the residential business is not impacted by this thing at all, right?

It's mostly confined to Service Experts?

So I think we are all trying to figure out how to back in what your assumptions are for your big business for the back half of the year and how much deceleration on the topline combined with how much raw material cost you guys are anticipating just understand how much the business is slowing down.

Again, as Bob had indicated, we see something north of 15 cents per share in fact based on the factors that we outlined.

That's higher expenses that we don't expect to be recurring.

We see a slowdown in the residential market based on what we've seen in the market so far in Q3 and that certainly impacting that major part of the business.

15 cents -- is that second half only or is that full year?

That is a full year number.

You had mentioned the extra costs, not just what that but to set up the regional accounting centers, the inventory management system that you guys want to allow you to have better visibility.

Of inventory.

Is there any guess at this point in terms of permanent costs going forward?

Is it a million dollar number, a $10 million number?

Any sense as to when we look at your numbers here going forward how much we should assume margins are being impacted by that?

Are you talking about cost improvement or cost?

No, like you said the -- you're putting in the regional accounting centers obviously to have more control over hopefully this does not happen again, and the inventory IT that you talked about to hopefully help you reduce working capital.

I mean those things are obviously going to cost you money on an ongoing basis going forward.

I'm just trying to get a sense of the order of magnitude of some of those programs.

I see where you are coming from.

Actually as it turns out even though we're getting better control, the cost associated with organizing that fashion we feel is certainly offset by the elimination of the headquarters operation and some of the inefficiency that we had.

That said, and just parroting a little bit of what you said, the control over a distributed business such as that is really important.

We’re doing everything we possibly can to get that and at certainly no cost penalty because after all inefficiency improvement is part of the overall improvement that we're mapping for that business.

Perhaps said another way, I wouldn't really be looking for a delta upward of cost to go ahead and support those 2 initiatives because it is our plan to offset those with the other changes that we made which would reduce cost.

Although I will say one other thing, and that is that in the course of this year and this is why I made the comments I did about the transition aspect of this particular year for Service Experts and I think it is important to note, there's just a tremendous number of things that are going on that are very positive in that business.

People are changing assignments and such as that and we've got a number of people that are even though they are part of the continuing operations are spending certainly a significant part of their time trying to support the activities for the discontinued operations.

You've got some costs that's rolling off albeit not instantaneously this year as we've made the transition.

But certainly anticipate to have that all rolled off by the end of the year.

So this 15 cents is a nonrepeatable number in any sense of the word going forward?

That is correct.

Just for clarification, Justin, that applies across our entire business.

Sure.

I understand.

Again, I know this is tough to talk about kind of pro forma numbers here.

But if you talked about Service Experts loss the first quarter -- I think you said Bill it was $8 million.

The second quarter was a plus 5.

How does that -- how do we compare that I guess what I'm trying to get at is how do we know if we compare that ultimately when you file your financial statements to a year ago's numbers, is that going to be apples-to-apples so we're able to measure these service centers that you decided to keep.

The improvement therein as opposed to just simply the fact that you've lopped off the ones that were losing money or the worst performers so we can measure improvement there?

Initially our filings are not going to have the discontinued operations piece of it carved out.

But once we have our filings current we will be able to be in a position where we can talk about those numbers year-over-year and make the direct apples-to-apples comparisons for you.

But was the first quarter, that $8 million loss -- was that --?

That was the continuing operations (multiple speakers).

Same number of centers for both periods?

Yes, that is correct, 130 service centers for both Q1 and Q2.

And lastly, Bob, you talked about steel costs and what not.

Price increases, American Standard talking about a couple that had gone through at least early in the spring they were maybe 3 percent in the first part of the year and then maybe 5 or 6 around June.

I suspect that those are going to be harder to come by because of the inventory out there?

Would you agree with that?

Certainly I would with respect to the cooling inventory.

And of course we are all hoping for an absolutely devastatingly cold winter to try to make up for some of the cooling loss with higher than normal heating equipment sales.

That would be if you look at what we've done pretty much parallels everybody in the industry and I think quite frankly that everybody in the channel with respect to -- all the channels at different places in the different channels that serve the residential market have good visibility in what's going on what the raw materials and nobody likes to receive price increases but life is what it is.

So we have been more successful there.

In your commercial type products as I did mention because of the contractual obligations and what not, the application of price increase is just not possible to do that in as universal a fashion.

However, once again, we like probably everybody in our market are very concerned about our profitability and our shareholders and we are being realistic but we will be employing price increases whenever appropriate where we think that's going to work.

Just one last thing.

Sorry.

On the new Sear (ph) regulations, those go into effect January of '06, correct?

That is correct.

Yes.

What you guys do, when you look to next year presumably there's going to some prebuy -- not prebuy -- but buying in next year for guys wanting to get some lower-priced stuff, if you will, in order to be able to satisfy the people's needs into '06 before those kick in.

Is that true?

I mean are they able to do that so therefore if a deal or a distributor buys the '05 old standard products, are they able to install that product in homes in '06 without a problem?

And if so, are you guys anticipating any buildup of inventories which would be certainly beneficial to '05 but maybe problematic to '06?

You just have to go back to history a little bit.

We had a similar change when Neka (ph) was first introduced which took effect in January of '92.

I think that there probably was maybe a smidgen of that kind of opportunistic prebuying but quite frankly that didn't appear at that point in time as a very large factor at all.

While I wouldn't say that that might not happen to some degree, I think the effect would be fairly low.

If I could just add on to Bob's comment.

Over the last couple of 3 years the trade channels have been much more aware of the cost of caring inventory and what have you and the whole supply chain has worked with a much lower inventory level than historically.

That would support Bob's comments as well.

All right guys.

Thanks and good luck.

Thanks.

Fritz von Karp (ph) with Sage Asset Management.

Good morning gentlemen.

Could you discuss a little bit your normal practices in buying and where applicable hedging metals?

In particular curious to hear about the timing aspects of when you might lock in prices and for how long and so forth?

First of all, the forward buying, the hedging is done and controlled at what we call our purchasing console level.

Process is in place.

I don't know if there's such a thing as a typical situation, and it does vary between the approach that we take with copper and aluminum.

But as a general rule the amount of hedging that's done would not exceed probably between 6 and 9 months into the future.

That's historically been what we've done.

There are certainly different situations where that number moves one direction or the other for what we feel are very good reasons.

We try to employ good discipline in that process because we want to be sure that this isn't high-level gambling as opposed to very prudent hedging so that we can maintain stability in our standard costs.

Fritz, in addition, the hedging is limited to copper and aluminum.

We really have not had nor has anyone had the ability to hedge on steel.

How much of these metals roughly like in pounds or however you have if you buy every year?

Ballpark?

We don't disclose that.

If you take a look at our cost of goods sold, approximately 70 percent is materials and components.

The other thing that's going on as well, it's probably logical, I will say it anyway.

And that is you also have an impact that the industry is seeing with increased cost for components and such as well as the raw material impacts for those individual suppliers impact what their costs and our prices for those of the components.

Are you seeing -- are these price increases going pretty smoothly all the way down the chain?

In other words, you're happy to pay the motor manufacturer for his raw materials and your channel will pay you for them etc. etc.

Is that pretty much the scenario?

First of all, I wouldn't characterize it as we’re being happy to go ahead and (multiple speakers)

Poor choice.

Sorry.

But it is all within the course of the jurors, in sort of staccato fashion, but as I have said, working very hard with all of our suppliers to be sure that none of our suppliers are imprudently trying to penalize us or gouge the corporation, if you will, if I can be that crass.

On the -- of where there is a very large or raw material problem.

Not just in cost, but also in terms of availabilities through this year.

And so we have policed that up and down very well and in similar fashion, the price increases that we have employed and put out there -- we certainly have shown to be very justified and have been very forceful this year in deploying them.

Just simply because of the seriousness of the raw material problem.

Just housekeeping.

The 15 cent expense, I just couldn't quite hear exactly, that is the 15 cents is a headwind this year that reflects what expense exactly?

Just the compliance or the managerial type expenses in Service Experts or just tell me that again if you don't mind?

It's a combination of 2 things.

Certainly all of the expenses that we've incurred with respect to the Service Experts investigation and also the cost of one-time costs associated with the Sarbanes-Oxley compliance work that is being done.

Understanding that of course would be net of the ongoing stock's cost that we and everybody else will see forever as we go forward because there is a lot that you have to put in place.

There is an additional piece to that as well and that is that as part of the work that we are doing with Service Experts in Canada, we are completing the extension of the STARS program which is an operational and accounting program which had not been part of the Canadian operation heretofore.

That also was a certain component in that 15 cent estimate that we gave you.

Thanks very much.

Daniel Gotvald (ph) with UBS.

Daniel Gotvald;

How are you doing?

Fine Daniel, how are you sir?

I wanted to ask as of June 30, what was your cash balance and your shareholders equity balance?

Dan, again we're very limited in the number of balance sheet items that we can talk about.

You know we gave an indication but until we have our SEC filings complete, our balance sheet can shift, so we can't provide those numbers.

Can you give the net cash flow from operating activities for the first quarter and second quarter?

Same thing.

You can't comment on that either?

No we can't comment on that.

I apologize.

But you gave the CapEx numbers.

Our estimate for the year.

Yes.

Well I thought you said CapEx was 7 million in the first quarter and 8 million in the second quarter.

I didn't know if that was just -- if that was total Company or --?

That was total Company.

For the year you are saying that basically free cash will be 75 million?

I think?

Does that imply -- I think you said earlier that D&A was 50 million and CapEx would be similar.

Does that imply that net cash flow from operating activities for the year should be 125?

Is that what we should read from that?

Yes, our guidance of 75 million is cash flow from continuing operations less CapEx and the guidance for CapEx was approximately $50 million.

So it's like 125 in net cash flow from ops?

Yes. 75 plus 50 gives you 125.

Can you guys give any collar on -- you're guiding basically at the low end of the guidance, 138 in EPS -- how that would shake out in the third and fourth-quarter?

Or can you not do that?

It you look at history, seasonally, second and third are our strongest for us and the first and third are the weaker quarters.

We expect that to continue.

However, we have talked about seeing a weakening in third quarter due to weather-related and some softening we expect to be there.

Could you comment on terms of year-over-year revenue growth that you've seen in the residential HVAC business -- maybe how it looked in June, July and what you are seeing in August?

I'm sorry, could you repeat the question?

The year-over-year revenue growth rate in residential HVAC, how it might have trended June, July, August by month?

How much it has decelerated?

We wouldn't break that out precisely like that.

There was a clear deceleration that we saw.

Still better than perhaps the previous period by a smidgen but certainly down from the trend and the momentum that we saw through like the first 3 weeks of June.

One thing that is bit different about our Company I think relative to most other people in the industry to keep in mind is the fact that our Lenox industry's products which is a large part of that segment, are sold directly to the independent dealers and not to distributors.

Also of course, we have solid connection with the market place and consumers through Service Experts and that we are providing directly to the consumer.

Our ability to see what's happening in the marketplace typically comes several weeks in advance of the time that perhaps other people who are in the 2-step side would see that.

Quite frankly, that was anecdotally reinforced for us again this time by comments from a number of our suppliers who would said that you guys saw this thing coming about 3 to 4 to 5 weeks ahead of anybody else.

So there is that difference and that is a difference between being 1 step and being 2-step.

Dan, I just want to clarify.

Second and third quarters are strong quarters.

First and fourth, I think I said third -- it's first and forth are the weaker quarters seasonally for us.

No problem.

Do you guys measure factory tonnage or production year-over-year in the residential HVAC business?

Those are not metrics that we report internally.

We do measure but they're not numbers that we report.

Typically in the industry the metrics that you've got are units that are sold and to all the reporting and references to market share and so forth are driven from those unit calculations.

One thing is a little bit misleading about those is sometimes they are presumed that all of the units cost the same.

So it's sort of an (indiscernible) and mushes together all of the several tiers -- particularly when we talk about residential together but that's an industry -- pretty good numbers.

I was just wondering if you were going to have to reduce factory production second half due to what you are seeing I guess real-time?

I will tell you this.

Based on what we've seen, we are taking appropriate action with respect to Manpower and also with respect to expense and so forth.

Anything any prudent company would do.

Again those plans have been worked very diligently over the past couple of weeks as we reflected upon what's happened in the cooling side of unitary.

One last question, on the commercial business.

Have you guys seen that start to accelerate and be an opposite trend relative to what you've seen in residential during the third quarter?

If we're talking about Commercial Heating & Cooling, the air-conditioning piece of the business, domestically, yes.

We have seen unit recover first half of the year, industry shipments up about 4 percent.

That's coming off some soft years that we'd seen.

We are expecting that pace to continue too.

Continue through the balance of the year.

You don't see commercial slowing down in the third quarter?

At this point, we don't.

Thank you.

That's all I have.

Alex Mitchell (ph) with Corpus Asset Management (ph).

We were wondering if you've seen any type of drop off in the industry numbers like you had last month?

Alex, again, the last industry numbers that were reported were the June numbers.

There's several numbers that are reported, one of them is factory shipments; the other is distributor shipments and distributor shipments is a better proxy for end market demand.

In the last month of the second quarter which was the last numbers reported, distributor shipments were down 3 percent.

But have you seen that before in the past or is the first time you seen that type of drop at least for either side of those numbers?

That would be atypical.

I think the last time we saw something perhaps similar to that might be what would that be -- 2001, Bill?

We saw an early cessation to summer -- God decided to make things colder that year and this year as well.

So the last time you saw that was back in June around 2001?

I believe that is correct.

I'd have to go back to my records but that is etched in my memory.

Thank you very much.

Sure.

Keerin Pearson (ph) with Midwest Research.

Just a clarification on the commercial market.

In your press release you said you would expect North American commercial demand to continue to improve but at a moderate pace.

Would that not imply a slowdown?

You have been growing that segment in the double-digit pace for the first half.

I'm wondering if that implies a slowdown there?

And if so, what are the factors that are causing that?

Keerin that comment applies to our outlook for market demand for commercial equipment.

As mentioned, it was up 4 present which is arguably a moderate pace in the first top of the year and we see that continuing.

So the comment was not relative to LII's performance.

It was market demand for the products that we sell.

In other words, compared to the first half of the year we see the market relatively unchanged continuing the way it has been.

Thank you.

Justin Mauer with Lord Abbott.

More follow-up here.

Bob, I think just relative to the prior question about the drop in distributor inventories, June like you said it was unusual but wouldn't you also say relative to the spring from what I saw at least from the amount of inventory that they were carrying was generally very low compared to historically.

I know all these guys have gotten smarter over the years in terms of needing to carry less but it seems like they have been running it down maybe too low.

It may have caused a shock to their system, April, May, to run it up but maybe coming off relatively low levels?

You are quite correct, Justin.

In referring to the fact that with respect to working capital management people and the distributor level of the channel have gotten progressively better -- at their end and it does make comparisons of little bit difficult.

I guess the other thing that we've got to draw on are some of the anecdotal inputs that we've gotten from distributor's relative to their internal strategies and what they are seeing to our association on our 2-step side of the market.

So my comment was driven by a composite of both the anecdotal conversations that I had periodically as well as what the ARI number were.

Just to ask more of the nitty gritty on the Service Experts, at least the charges I want to understand the fact that you guys have charges in the first quarter and the second quarter and you expect another 20.

Can you give us a sense as to how much cash is going out the door for these things just in terms of cost to transfer ownership or whatever?

Who are the people or the guys generally buying these things?

What are they paying?

Give us some sense of cash flow of how much in terms or proceeds you are getting in versus how much you are spending on this whole thing?

Because that process first of all is currently ongoing it would be inappropriate for me to provide too much detail but let me try to direct your question in a different direction.

And that is as we had laid out all our expectations which were of course embedded in all the numbers that we've provided for the sale of these businesses through -- on sale of all the businesses thus far, we are getting very much the numbers that we were looking for.

How that's going to look as we continue through the program is anybody's guess but again our projections also project some tailoff as you get to the last few.

I guess that there is a concern relative to is this thing going to cost us more than what we thought compared to book for example, I don't think so.

And again we pointed out on in all in basis, when you look at the divestiture thing, this thing is going to be cash flow positive for us for this year.

I guess the reason for the question is seeing the $208 million charge in the first quarter for goodwill which I am guessing would have written the goodwill off, but then you said, or Bill said, there was in the first quarter from the operating perspective there was a 20 million charge to discontinue ops, 13 million of which was goodwill.

So I don't know if that was on top of the 208 or inclusive of ?

And then the second-quarter, the 4 million loss, 2 million of which was operating loss -- that's fine, but then there was a $500,000 loss on sale.

I would have expected you guys to write those businesses basically down to zero or close to.

Therefore the talk of the $20 million of charges in the second half -- I'm trying to get an understanding of where that's coming from if in fact these have been identified and essentially written off?

So I'm wondering why there would be additional charges coming in the second half for it?

First of all, the 13 million goodwill impairment, that is part of the discontinued operation is in addition to the 208 million pretax.

The loss on sale is recorded as it is incurred which is the $0.5 million that we saw in the second quarter on the centers that were divested.

So the 20 million in the second half, are those amounts also for a loss on sale or are there other goodwill impairments in that?

There is no goodwill impairment in that.

That is locked on sale but other divestiture related expenses which could be severance payments, breaking leases, those kinds of things.

Thanks.

(OPERATOR INSTRUCTIONS) Christopher Zapharu (ph) with Radcliff Funds (ph).

I was wondering if you comment a little bit on what your target debt to capital is and what your plans are with free cash flow going forward?

First of all I think that we have been reasonably consistent in terms of our expectations around what we have been calling our comfort zone relative to free cash flow.

On the basis that we're currently stated both all of the changes of FAS 142 and so forth, we typically now are saying that about a 50 centerpoint might be around 50 percent debt to cap.

With again, or internally we talk about plus or minus 10 percent as being the range around which we prefer to operate.

So 40 percent to 60 percent debt to capital.

With respect to going forward, I think that historically it's important to note that over the past 3 years or so we have been diligently working, taking steps to rationalization of 1 type or another to identify the strong segments which we of course now have which we report.

We've undergone a number of divestiture of businesses and so forth and also been very prudent and aggressive in terms of what we're doing with working capital on the inside.

Of course a lot of credit goes to our manufacturing people and the folks in that whole logistics supply chain as we've employed what we call Six Sigma Lean throughout our manufacturing operations so we've done some really good things that way.

I'll tell you the focus on good management in working capital continues and so there's nothing abated with respect to that.

Now on the other side of that question I think might be the question -- what are your plans going forward for the business with respect to what you've achieved under debt to cap ratio?

Again, we don't talk about acquisitions or things of that nature until they are absolutely imminent and on their way.

But we have from time to time on a strategic basis outlined the areas that we have for interest.

We will probably be doing another discussion around that sometime in the relatively near future.

Just suffice it to say, certainly in the short-term, we continue to pay down debt and strengthen our balance sheet.

You don't have any plans going forward to raise your dividend or do -- initiate some share repurchases?

The dividend question, how much you pay and whether pay it, that is of course is a Board of Directors question and I am only 1 director on that Board so I can't really answer that question for you right now.

That is subject to what they do.

Like any company, we look at all the options all the time and we are very aware of our capital structure and try to manage it aggressively.

Thank you very.

Thanks for the question.

We have no further questions in queue.

Please continue.

To wrap up for this morning.

I'd like to reiterate that we are pleased with Lennox International's performance for the first half of 2004.

With the internal inquiry of Service Experts Canada now behind us we are working to get our 10-K for 2003 and 10Qs for the first 2 quarters of this year filed just as soon as is practical.

We expect the full-year earnings per share from continuing operations before goodwill impairment charges we took in the first quarter to be at the lower end of the previously stated range of $1.38 to $1.48.

And again, based on a conservative outlook, I feel for the demand for residential products and services, coupled with the projected higher raw material costs and those increased corporate expenses that we've been discussing.

We expressed that LII will continue to be a strong cash generator with cash flow from continuing operations less than CapEx to exceed $75 million.

We certainly want to thank you for joining us on the call today.

Ladies and gentlemen, that does conclude your conference for today.

Thank you for your participation and for using AT&T Executive Teleconference.

You may now disconnect.