Lennox International Inc (LII) 2004 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by.

Welcome to Lennox International's earnings conference call for the third quarter 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.

Thank you, Todd.

Good morning and thank you for joining us.

In a moment, Bob Schjerven, our CEO, will review Lennox International's financial performance for Q3, provide an update on our turnaround initiative at Service Experts, and comment on our outlook for the remainder of the year.

Sue Carter, our CFO, will follow with a more detailed look at our business segment performance, and Sue will also address some key income statement and balance sheet items.

We'll wrap up the call with a Q&A session.

We released our third-quarter results this year about two weeks later than we normally would because of the need to become current with our SEC filings.

As you are probably aware, we filed our 10-Qs for the first two quarters of 2004 yesterday.

We can now conduct this call with complete year-over-year comparisons, which was an understandable point of frustration for everyone when we reported first-half results in August.

All of the comparisons we make today with 2003 results will be on a continuing business basis except where specified.

And the 2003 results we reference, of course, will be consistent with our 10-K filing as adjusted, following the conclusion of our internal inquiry.

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 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 actually results to differ materially from those we express today.

I'd also like to welcome our webcast listeners.

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

This call will be archived and available for replay.

I'd now like to turn the call over to Bob Schjerven.

Bob?

Good morning.

We appreciate you once again taking the time to be with us this morning.

I'd like to begin by telling you first how pleased I am that we have Sue Carter, our new Chief Financial Officer, with us on the call his morning.

Since joining us in mid-August, Sue has certainly jumped right into the middle of our business, and as quickly come up to speed.

She was instrumental in helping us get caught up with our SEC filings, and it had become quite clear that she's a great asset for this company.

I know you will enjoy hearing from Sue in just a few moments.

After our robust market for heating and cooling equipment in the first half of 2004, demand softened in the third quarter.

As we had indicated during our first-half earnings call, residential demand was negatively impacted by unfavorable cooling season weather.

And while we had anticipated the recovery in our commercial markets to continue, industry shipments of commercial equipment actually declined in the third quarter.

Lennox International's total revenue from continuing operations in Q3 increased 2% to $772 million.

Sales were flat when adjusted for fluctuations in FX.

And our income from continuing operations, then, was $28 million or $0.45 per share compared with $30 million or $0.50 per share in the third quarter of last year.

Discontinued operations negatively affected earnings by some $9 million in the third quarter this year, resulting in a net income of $19 million or $0.30 per share.

Sue is going to give you a more detailed analysis of the discontinued operations expense.

Commodity price escalation is one of our greatest challenges.

And in the third quarter of 2004, year-over-year increases in the cost of steel, copper and aluminum and related components created a headwind of about $15 million.

Our manufacturing operations are performing very well, indeed, in this difficult environment, and they continue to mitigate the impact of higher material prices to improved production efficiency, along with cost reduction initiatives, price increases, and other hedging activities.

Looking ahead, realizing price improvement is going to be critical to offsetting the future impact of higher commodity prices.

We have, for example, recently announced additional price increases that take effect on the first of December for several of our heating and cooling equipment lines.

The financial performance at our Service Experts unit continues to be unacceptable.

Lower our sales volume and unfavorable mix of maintenance versus replacement, and also the need to increase reserves for excess and obsolete inventory, in conjunction with the rollout of our inventory management and replenishment program, all depressed the segment's profitability.

On several fronts, however, we are making real progress at Service Experts.

We have successfully focused the continuing business on more profitable service and replacement opportunities, which now represent approximately three-quarters of Service Experts' revenue.

The majority of the remaining new construction revenue is in Canada, where the retrofitting of air conditioners after a new home is sold represents a significant opportunity, and therefore has the potential to bolster our core service and replacement business.

All but one of our dealer’s service centers will be on STARS, a common IT platform, by the end of this month.

That one exception is IBS (ph), and although we consider it to be a single dealer, IBS is unique in that it consists of over 30 satellite locations and generates total revenue of about $35 million.

This is a very profitable business with effective systems that are in place, narrowly focused on commercial service and replacement.

The back office accounting at 114 of our 130 ongoing service centers is now handled by one of our two regional accounting centers.

We expect all centers, again with the exception of IBS, to be rolled into the regional accounting centers by the end of the year.

The leverage that we gain from using regional accounting centers will lower expenses for Service Experts, but more importantly, it ensures the consistent application of accounting practices, and that of course, enhances our financial control.

In addition, recognizing the critical role that the general manager at the dealer service center plays in the successful operation at that local level, during the third quarter we kicked off a new GM development plan.

This well-constructed program recruits general manager candidates based on a very disciplined profile, and it includes a comprehensive three-month training programs both in the classroom and in the field.

The divestiture activity surrounding the discontinued Service Experts centers remains on schedule.

Of the 48 centers that will be divested -- now this count includes the 47 originally identified plus one that is a branch of an ongoing center.

Of that total, 30 have been sold at the end of the third quarter, and we had an additional 13 non-binding letters of intent.

We continue to expect that this divestiture activity will be completed by the end of the year.

With respect now to our outlook for the balance of 2004, we are reaffirming our guidance of a full-year loss per share on continuing operations of $1.53 to $1.63, including the goodwill impairment charge that was taken in the first quarter.

Excluding this charge, full-year earnings per share from continuing operations are anticipated to be at the lower end of the $1.38 to $1.48 range that we previously provided.

This guidance excludes the impact of EITF 04-8, which addresses the effect of contingently-convertible debt on diluted earnings per share.

This accounting change, which goes into effect December 15th and is retroactive, will reduce our reported 2003 EPS by $0.07, and 2004 earnings -- again, before the goodwill impairment -- by about $0.09.

Sue Carter will now provide you with additional detail of our performance at the business segment level.

Sue?

Thank you, Bob.

Good morning, and I too would like to thank everyone for taking the time to be with us today.

It's good to be here participating in this review of Lennox International's performance in the third quarter.

I'm looking forward to getting to know you and having productive dialogue as we move forward.

Now, taking a look at the financial results for each of our businesses in Q3.

LII's heating and cooling revenue increased 2% to $528 million, with foreign exchange benefiting the top line by 1%.

Segment profit increased 11% to $65 million, with margin gaining a full percentage point to 12.3%.

In both our residential and commercial heating and cooling businesses, improved performance in our factories and improved pricing helped us offset higher material prices.

As Bob said earlier, unfavorable cooling season weather depressed demand for residential cooling equipment in many key markets.

Cooling degree days, as reported by the National Oceanic and Atmospheric Administration, or NOAA, in the July/August time period, were 8% below normal and 15% below last year.

The residential piece of our heating and cooling business had sales of $362 million in the quarter, down 1% from last year or 2% when adjusted for foreign currency fluctuations.

Revenue in our hearth products business was very robust, increasing by more than 20%.

This gain helped offset lower sales in our traditional HVAC line.

Our premium Dave Lennox signature collection equipment continues to sell well, with sales year-to-date up over 25%.

Despite the modest decline on the top line, segment profit rose 9% in Q3 to $45 million, and segment profit margins expanded 120 basis points to 12.4%.

With the cooling season now behind us, we are encouraged by its (indiscernible) start to the heating season in the fourth quarter.

Despite a downturn in the light commercial market in Q3, LII had very strong performance in this segment.

Our commercial heating and cooling sales of $166 million were up 9% over last year or 7% when adjusted for foreign exchange.

We had solid growth both domestically and in Europe.

Our national account business continues to grow.

And as we've expanded our core product offering to include larger rooftop units up to 40 tons, we're well-positioned to continue building our customer base.

Significantly improved profitability in Europe, due in part to lower fixed costs, helped drive a 15% increase in segment profit to $20 million.

Segment margin improved 60 basis points to 12.1%.

Revenue from the 130 dealer service centers that compose our continuing Service Experts business segment was $151 million in Q3, down 7% from the prior year.

Unfavorable weather depressed sales and also contributed to a skew in our revenue mix towards more maintenance business and less replacement business.

The maintenance business is less profitable.

This segment incurred a quarterly operating loss of $1 million or 0.8% of sales compared to a profit of $3 million last year.

Lower revenue was the largest factor in the erosion in profitability, reducing gross margins by almost $4 million.

In addition, we continued to roll out our inventory management and replenishment program, which entails an assessment of the current inventory at the dealership level and actions to optimize truck inventories.

While this program has proven effective in contributing to a reduction in working capital requirements, we determined it was necessary to increase our reserves for obsolete and slow-moving inventory by approximately $2 million.

On a positive note, Service Experts SG&A costs in the quarter were down $2 million year-over-year, reflecting the refinements made in our corporate overhead structure to better alignment it with the size of the ongoing business.

We had another terrific quarter in our refrigeration segment as sales grew in all regions.

Segment sales increased 16%, or 11% when adjusted for foreign exchange, to $112 million.

We continue to increase our sales to the supermarket industry, although we do not believe this is reflective of increased demand in this sector.

Segment profit increased 18% to $11 million, and operating margins expanded 20 basis points to 10.0%.

Higher sales volumes and improved pricing helped offset higher material costs in this business.

We reported $9 million of after-tax expense for discontinued operations in Q3 or $11 million pretax.

This expense on an after-tax basis consists of $4 million in operating losses in the quarter, $1 million in other divestiture costs, plus a loss on the sale of centers that were divested of $4 million.

At the end of the third quarter, our total debt was $319 million, down $54 million from the same point last year.

This decline was partially offset by an increase in the utilization of our accounts receivable asset securitization program, which did not appear on our balance sheet.

The asset securitization balance was $130 million at September 30, up $44 million from a year ago.

This increase reflects, in part, cash used to prepay balance sheet debt in the second quarter.

In the third quarter, our cash from continuing operations was $34 million.

During the quarter we invested $10 million in capital expenditures and we reduced our asset securitization balance by $5 million, resulting in free cash flow of $29 million for the quarter.

On a same basic year-to-date, our free cash flow is a use of $42 million.

But as has been demonstrated over the last few years, the fourth quarter is typically a very strong cash generator for our company, and we believe we are on track to deliver approximately $75 million in free cash flow this year.

Our total interest expense in Q3 of $6 million was half $1 million less than a year ago due to lower average debt balance.

Corporate expense in the quarter was $10 million higher than prior year, primarily due to Sarbanes-Oxley compliance costs, as well as some residual expenses from the independent investigation into Service Experts' accounting practices in Canada.

And finally, capital expenditures in the third quarter were $10 million, bringing our year-to-date total to $25 million.

We see the rate of our capital expenditures increasing in the fourth quarter, largely due to initiatives tied to the January 2006 Mega 13 (ph) peer standards.

We continue to expect full-year CapEx will approximate depreciation.

However, we are now tracking to a full-year depreciation level of about $45 million, down from the 50 million we had previously indicated.

This concludes our prepared remarks, and at this point we would be pleased to address any questions that you may have.

(OPERATOR INSTRUCTIONS).

Curt Woodworth of J.P. Morgan.

Quick question on the raw materials.

You mentioned the year-over-year increase of 15 million.

Can you talk a little bit about the dynamics as we move into '05, in terms of specifically for steel -- how the contract negotiations are looking?

And the pricing dynamics of those contracts?

Are you looking to lock in at significantly-higher prices, and are there escalators associated with those contracts?

And also if you could talk a little bit about the movement to 13 Cier (ph) and capital spending implications for '05?

And maybe operating expense implications as you move to 13 Cier productions?

Thank you.

First of all, relative to -- unless you probably go in reverse order.

We talked about 13 Cier.

Certainly the capital expenditures for that, like most of our competitors are finding, are reasonably substantial, and we program those issues, and for sure.

Through the remainder of this year the lion's share of capital expenditures that you see us make will be in the area probably of the 13 Cier.

We're certainly on track to have all of the products well online and in production by the deadline.

And what (indiscernible) there will be more capital investment next year that we'll see, along the lines of 13 Cier, equipment and tooling.

But we're really not in a position to comment on that.

We generally comment on that more completely, I think, when we have our next update in the first quarter of next year, as we go through the results for 2004.

At that time we'd also talk about guidance as well.

Once again, your first question -- would you mind giving me a little more flavor of what particularly --

Yes, I guess I'm just trying to get a sense for how much you think your raw material costs are going to go up in '05, given the current spot price for steel is significantly above I assume what you are currently paying, even with the surcharge on top of your contract price.

Maybe just walk through a little bit how you -- what the magnitude of that cost could be for you in '05.

And what you're seeing in terms of contract pricing right now with steel.

And maybe if you would talk about -- I know you mentioned the price increase for December.

Could you talk about what that was?

How much pricing you do think you need to offset some of those cost increases in '05?

I think probably the best way to answer that question is to come at about three different directions.

Probably I would be a little bit more general than you prefer, but first of all, it is our expectation for next year that we will be able to offset all of the material price increases that we see with corresponding increases for our product in the marketplace.

Just as a reflection on that comment, if you look at this past year, what you would see is that virtually everybody in the industry had been quite successful at obtaining the magnitude of price increases that they felt were necessary.

Which, of course, is not always the case in a mature, fairly-competitive market.

I think what we're seeing is a pretty solid realization on the part of all of our customer base, irrespective of which channel you talk about, of the impact of the material costs, the fact that these things are real.

And the ultimate fact that the consumer has to pay for these kind of increases.

Again, a bit general -- if you look at our expectations for the three major raw materials, we certainly see the opportunity for all three of those to continue to increase next year.

However, that said, I would not anticipate that we would see copper pricing continue to increase at the same pace that we saw through, for example, the first nine months of this year.

Steel, we certainly expect to see increases, further increases in steel.

But again, as in the discussion with copper, we anticipate that that will be certainly more moderate with respect to what we saw last year, based on all the indication we've seen with respect to supply and conversations.

You asked a question relative to negotiations, for example, with steel.

Certainly those discussions are going on at this point in time.

And in fact, I don't really have an updated, if you will, look-see into what exactly the status of those negotiations are at this particular time.

But certainly, as we look at steel, the procurement sourcing group that we have are looking at contract lengths of anywhere from between three months and one year for steel, to give you a better idea of the kind of forward protection we're looking at.

And again, when you look at both copper and aluminum, you know there's a number of things that can be done.

Certainly we hedge, generally speaking, in time periods between six and 12 months, but frankly we decline to be much more specific than that.

Jeff Hammond, KeyBanc Capital Markets.

To follow-up on the raw material and I guess pricing issue, can you maybe -- it looks like, looking at your first and second-quarter Q, your raw material costs kind of went 5, 12, 15 in this quarter.

Can you give us a sense of what you're anticipating for the fourth quarter impact?

Does it move incrementally higher relative to the third quarter?

Well, we expect the fourth quarter to be very much in line with the increase that we saw in the third quarter.

And then on the pricing side, can you maybe remind us what your average price increase was earlier in the year?

Announce maybe what your price realization has actually been?

And then a little more color on price increase that go through in December, which you mentioned, order of magnitude?

Sure.

We can try to ballpark that for you a little bit.

Go back to -- let's talk about the residential piece first.

Roughly in the May to June timeframe, depending on the individual product, we went out with price increase -- announced price increases of between 2, and in some cases, higher than 6%.

On average, we probably -- just try to wait a little bit as I look across the numbers.

I would say on average 1.5%, plus or minus a tick, probably would be what -- on the first (indiscernible) price increase we saw.

What you realized?

In the neighborhood of about 1.5% would be a ballpark.

It's very different for the different pieces, different channels and so forth.

But just trying to write that as I look at the numbers.

If you look at, for example, products that have a lot of steel in it, like our hearth products, varying price increases when out.

Again, depending upon product and so forth, between 2 and 5%.

And the realization was between 3.5 to 4% of that, to try to give you the flavor of how that went.

Certainly if you look at some of those channels like -- with respect to commercial heating and cooling.

You see you give contracts that can extend for a portion of the remaining year and so forth.

So we have varying degrees of success with those channels.

But as a general statement, we saw price increases that were announce about mid-year.

And the actual realization there was something less than a half of a percent.

Maybe end of March, as we look forward, we're looking at price increases on commercial announced in December.

Again, depending upon product and our need, between 3 to 9%, and in residential products, similarly, 3% to 9%.

Once again, depending on which products you talk about.

When you speak of commercial, are you talking both about commercial heating and cooling and refrigeration or --

No, I'm sorry, that was an air conditioning comment.

If you look at refrigeration, we've realized in the course of this year price increases pretty much in the neighborhood of between 3 and 4% realized.

And Europe is slightly less than that, 2 to 2.5%.

And then moving over to Service Experts -- you talked about the $2 million hit for obsolete or slow-moving inventory.

Do you feel that you're largely through that analysis?

Or do we see maybe more of that flow out over the next few quarters?

We have essentially completed our analysis of the obsolete and slow-moving inventory at this point.

So we are not projecting that there will be future expense associated with that.

And finally, it looks like you have a fair bit of cash on the books, and certainly fourth quarter is a big cash inflow quarter.

What's the best use of cash from here going forward?

I think from a cash perspective, we will continue to pay down debt.

We will continue to look at other opportunities in the balance sheet.

And we will continue to invest in the business through capital expenditures.

Kit Case, Southwest Securities.

Year-to-date, what is your corporate cost viewed as one-time for the audit and for the Sarbanes-Oxley issue?

What we've said, Kit, is that for the year the non-recurring portion of the expenses for Sarbanes-Oxley and the investigation costs that were included in corporate was about $0.15 for the total year.

Our expectation is that most of those costs are behind us as of the end of the third quarter.

But we are still on that track for the year.

Could you talk a little bit about inventory, the increase there?

How is your furnace or you heating business looking versus the cooling products?

I mean, the buildup in inventory is where?

In terms of our inventory levels, if you compare year-over-year, we came off a very, very robust Q3 last year, so inventory levels were a little on the low side.

Inventory levels that we're seeing this year we feel are more appropriate, given the customer service levels we like to maintain.

As we're looking ahead at the heating season, as Sue had mentioned, we're encouraged.

Cooling season is now behind us, and we always predict normal weather when we give our guidance.

And we're seeing some normal to favorable weather in many parts of the country.

So you are not uncomfortable with the cooling inventory?

We're not uncomfortable with the cooling inventory.

Kit, this is Rob Schjerven.

Good morning, by the way.

You may recall back when we had our last call, which was discussing the first-half results, we were probably one of the first folks who came out publicly with what we were seeing with respect to the impact of weather, particularly on the residential cooling products.

And again, that's one of the attributes of -- I think the way that we go to market, because we now have direct lines of communication intelligence, both to the consumer, to the dealer, as well as to the distributor.

And based upon all that we were seeing at that point in time, we felt very secure in what we were telling everybody, which I know was a bit of new information, if you will, back then.

But at the same time, our manufacturing operations and our sales organizations took very swift action to respond to what we saw as a greatly significant shortfall in topline compared to what a normal year would have been.

So for that reason we did not find ourselves with the same levels of inventory as perhaps we might have, had we been a month later, for example, in realizing what the dynamics of that market were.

So in fact, if you look at the working capital ratio at the end of the third quarter, we are down, looking at something like 18.4% on revenue turns compared to about 19.1% a year ago.

So in terms of the overall control of working capital, not just inventory, we feel very good about what we're doing.

(OPERATOR INSTRUCTIONS).

Kieran Hurson.

I wonder if you could just comment in general on your end-market outlook, and if you could kind of touch on the residential, the commercial and maybe the refrigeration.

And kind of as a second part of that, tie that residential outlook into what you would expect to say at Service Experts with respect to the profit line?

Can we expect that to be positive again in the fourth quarter?

And then maybe if you could give a little look into '05 for Service Experts.

First of all, with respect to general markets, which I think was your first question, I think based upon all that we are hearing and all that we are seeing, we do not expect any large change in those markets as contrasted with the current vectors that we see those markets on.

That is to say we would expect, as we always do when we do our planning, that we would see a more normal weather pattern, which is something which, of course, would indicate that we expect a bit more robustness in the area of the residential market, particularly as you would look at the end of the second quarter, the first half of the third quarter of next year.

That said, I think that the external impact of having a fairly quickly-resolved election process in this country and getting under a full head of steam certainly gives the market -- not just Wall Street, but gives our market, which is comprised, to a large extent, of consumer confidence -- reason for some optimism.

That said, however, I do not think that we are going to see a large spike, for example.

I have, over the last couple of years, spoken at different times, most in response to questions, about latent demand on the part of consumers for residential products.

And I think that we've seen some of that expended over the last couple of years, but perhaps not all of it.

So, if anything, we're slightly bullish, I guess I would say, on those markets.

If you look internationally and you look at the refrigeration outlook, certainly we've seen nice growth in Southeast Asia.

When you look at Europe, that unfortunately has been a bit more stagnant and reasonably flat.

We don't see anything that's going to change that markedly in the forthcoming 12 months as we look ahead.

With respect to Service Experts, again, it would be a little bit premature for us to comment at this point in 2005, but maybe I can grant your question and give you a little bit -- a different feel from a different perspective.

That is, when the management of Service Experts -- (indiscernible) executive management relative to the restructured program, which was in fact a very dynamic, very bold move on their part, first began those discussions in the first quarter of this year.

The actual change in the entire program was announced, as you may recall, on the 5th of April.

At that time we had a certain expectation relative to how long the transition period would look, both with respect to the -- not just the divestiture, but with respect to the continued focus that the 130 centers would provide on repair and replacement.

And particularly with respect to the introduction of a number of different programs that we previously talked about, which are important.

So what you have there, as I look at it from where I sit, you have really two pieces.

You've got the forward-looking piece, if you will, the prognosticators of how they are going to perform, which are how well are they doing the fundamentals, how quickly and how well are they putting in the important programs.

The attributes of the project type, for example.

As well as extending the financial control and the financial forecasting capability that they need to have.

Then the other piece, of course, is the actual performance.

What actually has happened this year is the investigation that was primarily focused, not totally, but primarily focus in Canada, had turned out to be extremely disruptive to those operations.

As I think I mentioned to various audiences before, we left virtually no stone unturned.

And I certainly don't think it was overkill, but I absolutely think that what we did was very prudent.

But the net effect of that scope of what we did was to really, I think, delay by about a quarter, the anticipated results in terms of actual numbers that those folks are cable of delivering.

That said, there was a profile of improvement, a trend of numbers that we expect going forward.

Just looking at the real operating run rate, excluding some of the one-time adjustments and some of the charges that we took that, for example, Sue responded to, we see the profile, the actual run rate of the last couple of months to be very satisfactory.

And it does look like it's going to be translated by about a quarter from what we would have anticipated in early April.

So, long story short, I am guardedly pleased with the core operating run rate that I see.

I am very pleased with the success that they have had and the diligence that they've displayed in introducing the very robust operating systems and programs that they need, both to control and as well to be successful.

So I am positive about where that operation is going in the future.

But it had been a very difficult road for them this past year because of all of the additional things that we thrown on top besides this restructuring, which in and of itself, was massive.

I don't think I answered your question in quite the detail you'd like, but honestly, that's the best perspective that I think I can provide at this time.

And one housekeeping follow-up.

The tax rate was lower in the third quarter.

I'm wondering what we can expect for fourth quarter?

We are looking at a full-year effective tax rate of 37%.

Craig Owen, First Albany.

I was wondering if you could comment a little bit about the relative contribution from your Armstrong and Ducane brands versus your premium Dave Lennox and Lennox-branded products to the residential heating and cooling results?

Well, we don't divide quite that finely in our public reporting.

But I guess I would suffice it to say, with respect to the two-step market, the one-step market, both of them have done well.

Both of them experienced a lag in sales because of the aforementioned weather situation.

And quite predictably, as we've seen for a number of years, the dip that you would see occurs in the one-step probably about a month to six weeks in advance from the time that you see it, and what we call the two-step, or the distributor channel.

That said, from an operating standpoint, both of them are operating very well.

I just got off of an annual sales meeting with a large number of the customers on the two-step side of the business.

They appear to be very bullish about what is going in their marketplaces.

So, just as a general comment around residential, I think it is quite clear that what we saw and a lot of other people in the industry saw in the third quarter, it was not a market problem, it was a weather problem.

As probably confirmed by fairly robust activity in the heating sector, now that we've moved into the heating products (indiscernible) of the season.

Great.

And just to follow -- can you comment on the relative mix there?

Has there been much of a change over the last couple of years?

Between Lennox and between Armstrong, for example?

Yes.

Well, we're certainly are seeing Ducane has just gotten legs.

It's certainly gotten stronger and is doing quite well.

And because of the channel, how that serves, that's absolutely not representing any cannibalization on our part.

So that's all new strength, which is good.

And then as an overall comment, we continue to become a bigger player on the residential new construction side.

And that would be particularly true, I guess, of the Lennox brands and the work that they do at national accounts.

Frankly we also see that in the other two brands as well.

So I guess from my view, we are pretty much hitting on all eight cylinders.

If I could just add to Bob's comment.

The growth that we are seeing on the Lennox side, a lot of that has been driven by innovation and innovative new products.

On our two-step businesses, particularly with the Ducane brands, over the years we've increased our points of distributions, so that's really contributing to the growth there.

And then my second question was about your refrigeration business.

Obviously, great growth there, but some of it was FX.

But backing out the FX, 11% year-over-year growth seems to be somewhat ahead of the market.

Is there something going on there?

Is there an increase in the adjustable market?

Or are you introducing new products that are gaining share?

Or is this just general sort of economic recovery here?

First of all, if you look at that whole market, going back to 2001 or the second half of 2001, it probably -- without question the market was hit harder by the economic collapse than in any of the other markets that we serve.

And through all of that, we saw that, particularly domestically, we saw that our refrigeration products group gained market share, continued to do things that were really important for the customer.

And as a result, we've seen that momentum carry forward a bit.

As far as products are concerned, they're certainly involved in a number of -- what should I call it?

World platform design projects at this time, which are beginning to move projects that share common platforms into other venues beside one market, one geographic market versus another.

Secondly, you've got in that good strength that they've shown both in the operations that we have in the Latin Americas, and those markets are pretty robust, as well as what is going on in Southeast Asia.

We are, for example, expanding our presence and our footprint in Southeast Asia as well.

So I think that there's a number of elements, both from market share, increased growth within theaters, as well as the impact of new products that work there.

None of them overshadowing the other, perhaps, at this point.

And could you comment, maybe, on the growth in Asia?

If that was maybe more than the overall core growth rate there?

In that particular case, because our presence, our market share is not huge-huge, what we've done is we've got an operation that's been quite successful, albeit rather small, that we are essentially in the process of doubling in terms of the manufacturing capacity.

More than doubling probably, which means both bricks and mortar already in place, as well as additional land, which gives us the opportunity for more expansion.

And that primarily serves -- in fact, exclusively serves the supermarket market, if you will, that's located in China.

And my last question is -- I was wondering if you could comment on your commercial heating and cooling business?

You mentioned that part of the strength was related to your national accounts strategy.

I'm wondering if you could give us a little more color there, and maybe what percent the national accounts contributed to the overall revenue in that segment?

I don't know that we ever have divided up the market that way publicly.

But I will say this -- that in terms of the national account market share, we deem that we have something north of a third of that market.

And with respect to the success of that market, which you see is very close relationship with our customers and very responsive commercial groups that work with respect to design and product and adaptations for those national accounts to make them successful.

As a result of that, we continue to enjoy a favorable position.

If you look at the part that national accounts plays with respect to the heating and cooling segment, it's probably about a little bit north of 20% on a year-to-date basis, if that's helpful to you.

That's very helpful.

And just to follow-up here -- the growth that you're seeing on the national accounts side, is this from new account additions, or is this more spending growth out of these individual customers?

It is both.

Certainly we have a pretty robust and successful new account acquisition.

I haven't looked at the latest number, but I know it went through the first six months, I think it was close to 30 new national accounts we'd picked up.

But it is both, because we are seeing some of the national accounts beginning to expand their efforts and expand their build programs.

We are participating in that very favorably.

Christopher Zepperio (ph) of the Radcliffe (ph) Fund.

Do you have any plans regarding the convertible bond to address some of the (indiscernible) dilution that you're going to have?

We certainly are aware of the opportunities that are out there in the marketplace, Chris.

But it's not our policy to comment on those publicly.

At what point would you consider returning cash to shareholders?

Either through a share repurchase or some type of a dividend increase?

Well certainly on the dividend side, that is a decision of the Board of Directors.

And on the other equity side, that is something that we do not comment on.

Richard Bartolo (ph), Scotia capital.

Bob, I was just wondering if you had an update on your discussions with the UAW in Marshalltown?

That is a good question.

Actually, we are continuing to work; operations are going very well.

I guess it's nothing more to say than that, except that in our history it has not been totally abnormal to be without a contract for a short period of time.

We feel that we've got very good relationships with the folks there.

Everyone is concerned about doing the best job for the company, as well as for the employee workforce.

So with that spirit of relationships that we have, we are not particularly concerned about that at this point in time.

Adam France (ph) of Charlotte (ph) Capital.

Bob, to the extent you'd be able to do this, if we were to line up 114 Service Experts centers, how many are getting what you'd consider to be an A grade?

How many are B's, and how many C's and D's left out there?

Are you able to give us any color on that?

At this time, I guess I wouldn't.

We (indiscernible) talked about that.

And the reason is pretty simple -- we are really in the middle of transition at this point.

And I certainly won't mind doing that a bit later next year.

Next year we see it being probably the first full year of transition.

With a lot of these things already in place, and certainly all of the other disruptions that those folks had to tolerate this past year in the history books.

And I think it would be of a lot more value at that point in time.

Besides, which we will have continued to update our expectations around the rate of improvement, and probably would be in a better position to do that.

Don't mind doing that at that time, but it would be really less than totally meaningful, because at this point in time, there's 130 centers with 130 stories.

Jeff Hammond, KeyBanc Capital Markets.

Actually, it was a follow-up to the Cocoa's (ph) issue -- you said you are aware of the opportunities.

Can you maybe just run through the different options you could go with that?

Certainly, Jeff, from the side of looking at the transaction, we can first of all allow the convertible to stay as it is.

And we will get the dilution for the accounting pronouncement as of year-end.

So that's, of course, option number one.

In terms of the other options, we could go into a structure where we had some cash options on the shares going out into the future.

In terms of the overall, I think we'd rather not go into too big a detail on what all of those options are and where that might lead.

And then on Service Experts, if I recall, there was a portion of overhead associated with the discontinued ops that was continuing to flow through continuing ops until those businesses were sold.

How is that flushing out as you transition, as you sell some of the centers?

I'm not sure that I know precisely what you're talking about.

Say a little more, help us calibrate what it is that you're addressing.

I guess there was an additional overhead cost associated with the service centers that you were selling that is in your continuing ops versus your discontinued ops.

Okay.

I think I know where you're coming from.

We had made the statement that, because there were some things -- what shall we call them?

That are more-or-less still shared services, if you will, that the discontinuing ops recorded and drew on, that we had some folks at the overhead level.

If you look at the progress that they made, you'll see that the overhead is down about $2 million in the third quarter.

And so they've been successful at continuing to move that out as those requirements are no longer (indiscernible), and as the centers begin to fall away.

So there's no question but what Scott and his folks will be able to bringing this thing into (indiscernible), they're probably ahead of schedule, according to the way I keep score at this point.

Now, how much room is there on cost savings of those shared services when you get all of them sold versus today?

Well, I probably shouldn't use the word "shared services."

I know that's another buzz term for something else.

What we're talking about is the level of personnel at the corporate location to support all of the activity and the interaction that you have with people in the centers.

As you reduce from the 180 centers down to 130 in round numbers, those requirements are less, those requirements are fewer.

Those are the people we're talking about in terms of the overhead.

As far as shared services, again, that would be a misnomer in this particular case.

There are a number of corporate functions with respect to marketing, with respect to (indiscernible), with respect to the accounting and the financial side of it that is ongoing.

So you're seeing a couple of things happen at the same time.

You are seeing the requirements diminish, simply because of reduction in scope.

But you're also seeing an improvement in overall efficiency because of the alignment of the organization, essentially around the replacement and service as opposed to a large contingent of commercial new construction that we had, which took a fair amount of overhead, unique overhead.

And then also you've got the benefit that we are accruing as a result of being in two large regional accounting centers, and as we move the accounting work out of all of those centers and into a highly-controlled environment that is much more efficient.

So, you've got those things going on pretty much at the same time.

We have no additional questions.

Please continue, Bob Schjerven.

Well, first of all, I'd like to thank everybody for their questions.

It certainly makes it stimulating on this end.

Just by way of wrap up, I would say that it's important to note that our manufacturing business has continued to perform very well.

And I really believe that we are making progress at Service Experts, doing the right fundamental things at this point.

We expect full-year earnings per share from continuing operations, before goodwill impairment charge accounting we took in the first quarter, and excluding the impact of EITF 04-8, to be in the lower end of the $1.38 to $1.48 range, as we previously discussed.

As we talked about earlier in this call, higher material costs certainly is a great challenge.

And we're offsetting their impact through pricing, and this continues to remain a high priority.

We expect that Lennox International will continue to be a strong cash generator with cash flow from continuing operations, less CapEx, to be approximately $75 million in 2004.

Thank you very much for joining us this morning.

Good-day.

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

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

You may now disconnect.