Lennox International Inc (LII) 2004 Q4 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the Lennox International fourth quarter and full year 2004 earnings conference. At the request of your host, all lines are in the listen-only mode. There will be a question-and-answer session at the end of the presentation, and as a reminder, this call is being recorded.

I would now like to turn the conference over to Bill Moltner, Vice President Investor Relations.

Please go ahead, sir.

Thank you, Kathy.

Good morning and thank you for joining us. This morning, our CEO, Bob Schjerven, will review Lennox International’s financial performance for 2004 and highlight some of our key accomplishments for the year. Sue Carter, our CFO, will then take you through our financial performance for the fourth quarter, including detail by business segment, as well as the draft of the income statement and balance sheet items.

In the earnings release we issued yesterday, we have included any necessary reconciliations of the financial metric that Bob and Sue will discuss and generally accepted accounting principal measures.

Before we wrap up today’s call, as is customary, with q-and-a, Bob will comment on our company’s outlook for 2005.

We are broadcasting today’s conference call on the internet and a direct link to this webcast is provided on our corporate website at www.lennoxinternational.com. This call will be archived on our website and available for replay.

I would like to remind everyone that in the course of this call, to give you a better understanding of our performance, we will be making certain forward-looking statements. These forward-looking statements are subject to risks and uncertainties. A list of these risks and uncertainties, including the impact of higher raw material prices, our ability to implement price increases for our products and services 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 that we expressed today.

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

Good morning. Thank you, Bill.

2004 was a demanding, but ultimately a rewarding year for Lennox International, thanks to our ability to appropriately focus on [inaudible] key areas of our performance despite certain external market pressures that we saw, industry issues and also internal demand. That commitment and the focus of our 15,000 employees around the world served us well in a year that was exceptionally challenging in the climate control market that we serve.

We achieved success, despite dramatic escalations in material costs, unfavorable cooling season weather in key regions of the domestic market and continuing stagnant demand for commercial equipment in Europe. In 2004, LII sales from continuing operations grew 7% to $3 billion with foreign currency fluctuations contributing 2% to the revenue growth. International sales, those outside of the U.S. and Canada, generated 15% of our total revenue.

We achieved record income from continuing operations from $91 million before goodwill impairment, a 7% increase over the prior year.

Our earnings per share of $1.39 on the same basis included 7 cents dilution of our contingently convertible debt. Excluding the impact of this dilution, our earnings per share of $1.46 went to near the top of end of the $1.38 to $1.48 range we had provided at the start of the year.

In accordance with GAAP, including the after-tax $185 million non-cash goodwill impairment charge that we recorded in the first quarter and the $41 million after-tax loss of discontinued operations, LII reported a net loss of 134 million, or $2.24 per share.

Now, we generated cash from operating activities of continuing operations of $62 million and invested $40 million in capital expenditures, providing free cash flow from continuing operations of $22 million. Now, this free cash flow performance was, quite frankly, disappointing, not only in the absolute amount of cash generated, which was substantially below our expectations of approximately $75 million, but the fact that the shortfall hit us in the final closing weeks of the year.

Based on our internal model and our December cash flow performance in previous years, we were on track to achieve our cash flow guidance after about 11 months of 2004. However, in the final month of the year, our working capital performance prevented us from doing so. Approximately $30 million of the shortfall in free cash can be attributed to a combination of higher-than-anticipated accounts receivable, resulting from stronger than expected sales in December and the lower-than-anticipated accounts payable balance at year end. The balance of the miss is due to imprecision in our forecast. And while I am clearly disappointed with our cash performance in 2004, it is worth noting that over the past four years, LII has generated over $500 million of free cash.

And despite the softness of free cash from continuing operations, we continued to strengthen our balance sheet, reducing our total debt in 2004 by $52 million. Over the past four years, we’ve reduced our total debt by some $380 million plus we’ve reduced the balance in our asset securitization program by $130 million, a very solid performance.

Our heating and cooling and refrigeration segments performed exceptionally well in 2004. They more than offset the $47 million in higher costs for steel, copper, aluminum and related components to manufacturing efficiency, cost reduction programs and price increases. Combined, these manufacturing businesses achieved 8% sales growth in 2004, increased segment profit by a strong 16% and posted a very solid segment profit margin of 10.8%.

Our drive to make continuous operational improvements across our entire organization with a focus on making positive impact on the bottom line is clearly paying off.

Lean manufacturing initiatives are allowing us to more effectively leverage our global manufacturing resources which today encompass 24 facilities in nine countries. Through increasing utilization of common product platforms, we’re reducing development and product costs, while accelerating our speed to market. We are increasing efficiency and cutting costs while maintaining meaningful brand differentiation. We’re also leveraging our procurement activities through purchasing counselors [ph] that are identifying low-cost supply sources and combining requirements across our businesses. And this is especially critical with the sharp rises in commodity prices that we’ve experienced.

Reflecting our strategy to drive growth to product innovation, over one-third of our total manufacturing segment’s equipment sales in 2004 came from new products that were introduced over the past three years. Sales of our top-of-the-line Dave Lennox Signature Collection of residential heating and cooling equipment grew a strong 25% in 2005. And we expanded our commercial heating and cooling product line with the introduction of the Lennox L Series 40-ton rooftop unit which offers the highest energy efficiency rating and one of the lowest profiles of its class.

Now, in the emerging indoor air quality market, or IAQ, as it’s called, our equipment sales increase 23% last year. We are aggressively pursuing this opportunity from both product and service perspectives. To help educate homeowners on the benefits of indoor air quality, Service Experts introduced the home health report card. This is a service that includes an in-home air quality analysis and provides guidelines for improving the indoor environment. And Lennox launched the Healthy Advantage Program, which helps to demystify indoor air quality by allowing Lennox dealers to monitor and to analyze indoor air quality and share the results with homeowners and to offer a needs-based solution to IAQ problems that they may have.

Almost half of Lennox Industry’s dealers participated in this program during the first year, with many of them reporting significant growth in their indoor air quality sales as a result.

Service Experts faced many operational challenges in 2004 as we restructured this business to focus on the more profitable service and replacement opportunities in residential and light commercial markets. During the year, we completed the divestiture of 48 centers that did not fit our business model going forward. The remaining 130 service centers, located primarily in major metropolitan markets in the United States and Canada, are firmly focused on driving toward success.

While service expert sales for the year were flat, the segment did incur a marginal loss. We are encouraged by the improved performance as the year progressed. In 2004, we demonstrated our commitment to improving the performance of Service Experts. We completed the implementation of a common information technology system at our dealer service centers and we established regional accounting centers, improving the consistency and efficiency in the critical accounting functions across our Service Experts’ operations.

And we also began the roll-out of our inventory management and replenishment program to optimize the supply chain and to achieve the best customer service with the lowest inventory level, reducing our working capital investment.

Developing our employees is as important to our long-term success as developing effective systems and programs. Service Experts now have the largest network of service technicians certified to the North American Technical Excellence Program, or NATE. Over half of our Service Experts, 1,200 service techs, are now certified to stringent NATE standards and the number continues to grow. This is good news for consumers who have indicated in independent studies that they prefer to deal with certified technicians. We also continue to strengthen the leadership at our service centers through our general manager development program, an intensive three-month program that includes both classroom and field training.

We’re confident our initiatives to focus Service Experts on more profitable end markets and improve operating synergies across the dealer network are beginning to take hold.

Well, before I say a few words on our outlook for 2005, I’d like to turn the call over to Sue Carter to take a closer look at the fourth quarter performance of our company and that of each of our business segments.

Sue?

Thank you, Bob.

Good morning, everyone. LII’s total revenue from continuing operations in the fourth quarter increased 6% to $741 million. In constant currency, sales were up 4%. Year-over-year increases in the cost of steel, copper, aluminum and related components created headwind of approximately $15 million in Q4, impacting our income from continuing operations, which declined 7% to $19 million, equating to 29 cents per share. This earnings per share figure includes 1 cent in dilution from our contingently convertible debt.

As you are probably aware, Emerging Issues Taskforce issue 04-8, which addresses the effect of contingently convertible debt on diluted earnings per share, took effect December 15th of 2004 and its application is retroactive. Adjusting for this accounting change, earnings per share was 30 cents in the fourth quarter of 2004. Foreign exchange benefited earnings per share in Q4 by 2 cents per share.

Discontinued operations relating to the divestiture of the 48 service expert centers negatively affected earnings by $13 million in the fourth quarter, resulting in GAAP net income of $6 million, or 11 cents per share. The discontinued operations on an after-tax basis consist of $3 million in operating losses, $2 million in other divestiture costs, $1 million in goodwill impairment, plus a loss on the sale of service centers that were divested of $7 million.

Our total debt at December 31st was $310 million. As Bob mentioned, this was $52 million lower than it was at the end of 2003. We had a zero balance in our off-balance-sheet assets securitization program, the same as the end of 2003.

Despite the goodwill impairment charge, our debt to total capital ratio was a solid 39.6% at the end of the year. It is also worth remembering that almost one-half of our total debt is in the form of a convertible note, the dilution of which is included in our earnings per share numbers. We feel good about the strength of our balance sheet.

In the fourth quarter, our cash used in operating activities of continuing operations was $50 million. During the quarter, we invested $16 million in capital expenditures and we reduced our asset securitization balance by $130 million, resulting in free cash flow of $64 million for the quarter.

As Bob mentioned, this disappointing cash flow was due to higher working capital at the end of the year. We closed the year with $56 million more in accounts receivable, in part driven by our strong sales in the final month of 2004. Inventory on our balance sheet was up $33 million and our accounts payable were down by $10 million.

Together, we invested almost $100 million in operational working capital in 2004, which, quite frankly, is more than we would like to see. Management across our organization is taking a renewed focus on working capital in 2005.

Benefiting from a lower debt balance, our total interest expense of $5 million in Q4 was down $2 million from the prior year. Corporate expense in the quarter was $3 million higher than prior year, primarily due to Sabanes-Oxley compliance costs. We had previously estimated that we would have approximately 15 cents per share in non-recurring costs in 2004 associated with Sabanes-Oxley compliance program implementation and with the independent inquiry conducted by the Audit Committee of our Board of Directors. Based on actual costs incurred, we now believe the non-recurring portion of those costs to be 13 cents per share.

And finally, our effective tax rate on continuing operations before goodwill impairment was 37% for the full year of 2004.

Now, taking a closer look at our business segment performance, fourth quarter revenue in the residential piece of our heating and cooling business increased 3% to $333 million, driven by growth in our Lennox and Duquesne units, as well as in our Hearth Products business. Sales adjusted for foreign exchange were up 2%.

Residential Heating and Cooling segment profit for the quarter was $37 million, down from $45 million last year, with operating margins declining from 13.9% in last year’s fourth quarter to 11.2% this year, as higher volumes and improved pricing were not sufficient to offset the impact of higher material costs in the quarter. Our commercial heating and cooling segment continued its improvement trend, driven by strong performance in North America.

Revenue in Q4 advanced 18%, while 15% adjusted for foreign exchange to $155 million. Segment profit increased 7% to $13 million, but operating margins squeezed by higher material costs contracted 90 basis points to 8.4%.

Sales for Service Experts continuing operations were down 3%, or down 4% when adjusted for currency fluctuations, to $154 million. Service Experts had an operating profit in the quarter of $1 million, or .6% of sales, compared with an operating loss of $4 million in the prior year. Year-over-year margins improved in the core service and replacement business and the segment benefited from a lower head count and other cost-control initiatives.

While only marginally profitable, we feel good about posted [ph] year-over-year and sequential comparisons for Service Experts and we feel we are beginning to see some of the benefit from actions taken in 2004 to focus this business and improve its infrastructure. We believe that we’re moving in the right direction.

In our Refrigeration segment, revenue rose 12%, up 7% in constant currencies, led by strong sales growth in the Americas. Segment profit increased 26% to $10 million supported by price improvement and operational improvement in the Americas and Asia-Pacific regions. Profitability improved in all areas expect Europe, where it has been difficult to get price increases. Operating margins grew to 8.5% from 7.6% in the prior year’s fourth quarter.

Before we take your questions, I’ll turn the call back to Bob to provide our outlook for 2005.

Looking ahead, we’re optimistic about 2005. We expect full-year earnings per share will be in the range of $1.50 per share to $1.60 per share, which represents an 8 to 15% improvement over our 2004 performance of $1.39 per share. This range includes approximately 10 cents of dilution due to our contingently convertible debt and based on our preliminary estimates, the impact from expensing stock options.

We expect that LII’s revenue growth will be in the mid single digits, supported by low single-digit market growth in the major markets that we serve, realizing price improvement in 2005 will be critical to offset the impact of higher commodity prices in our manufacturing businesses.

We expect that Service Experts will be a modest profit contributor in 2005, but keep in mind that the first quarter is seasonally the softest quarter, so it would not be unusual for us to report a segment loss for that period.

We project our capital expenditures to increase significantly in 2005 to approximately $80 million, driven by increased spending to comply with the new National Appliance Energy Conservation Act, the 13 Cier industry standard that increases the minimum efficiency for residential air conditioner by 30%, as well as investment in other new products and also IT systems. The level of CapEx spending beyond 2005 is expected to move back into line with depreciation.

And finally, we project an effective tax rate of 37% for the year.

At this point, now, we’d be pleased to address any questions that you might have.

[Operator instructions]. Our first question comes from Curt Woodworth with JP Morgan.

Please go ahead, sir.

I just wanted to drill down on the guidance a little further, because I think you said that you had 13 cents of non-recurring charges for Sabanes. And given a lower interest expense, to me, and based on my model, that should save you about a nickel. So it looks like you’re going to have an 18-cent improvement just driven by those two items, which, if I add that to the 139, gets me to a 157 number. And your guidance is between 150 and 160. So, to me, given that Service Experts looks like it’s going to be improving, you know, can you just kind of talk about that? Because it seems conservative based on my first look.

I think as we look at 2005, there is several things to look at in there. And you’re right on the non-recurring charges. That is an add-back to the 2004 numbers. However, we also have items included in 2005. There will continue to be Sarbanes-Oxley compliance costs in 2005. There will also be some dollars associated with stock options expensing in 2005 that are included in our guidance numbers. And we have some questions on the business side as we move forward and perhaps we’re being slightly conservative on that with the change-over to 13 Cier. But we think that our guidance is in the right range for where we’d like to start. And we feel good about that.

Okay. And can you talk a little bit about the pricing dynamics that you’re experiencing thus far this year? Maybe talk about what your expectations are for price that’s embedded in your guidance. Thank you.

Well, first of all, I think across the industry, and it’s sort of the consensus, is that we’ve seen a pretty good recognition amongst our customer bases in the various channels of the urgency and imperative associated with the-- keeping up with the escalating price for raw material. It’s also true that in 2004, the first price increases, I think, that we pretty much saw in the industry, including ourselves, was about mid-year. Also had some other effects that were out there, such as we, like I presume a number of other people, were working off of hedge prices that we had for, like, copper, for example, through a major part of the year. And we also saw continued steel escalation continue, even along in the third quarter.

So when you put all that together, a couple things happen. First of all, the price increases began to be seen about mid-year. And they certainly continue as we speak. And we also saw the fact that the price increases were, to a fairly good extent, sticking like perhaps they hadn’t in previous times.

As we look forward into this next year, or the year that we’re currently in, 2005, we have every expectation that we will be able to cover the increased costs and impacts of the rising materials prices, what we’ve already seen and perhaps a little bit more that we may not have yet seen, with the price increases that are out there and that will be out there.

Okay. Thanks.

We’ll now go to the line of Craig Irwin with First Albany.

My question is about two specific markets. Both commercial and refrigeration appear to just continue strong growth that’s somewhat above the markets. I know that in the commercial markets you have initiatives of the 5 to 40-ton units. But refrigeration is just really continuing to contribute overall.

Can you give us a little more color on what you’re doing to drive growth in these markets and really where you see things going potentially over the longer term?

Sure. I think there’s a couple of stories here. And you’re quite right. First of all, take the commercial HVAC market. If you look at the overall market for the year, the market was up a minimal amount, maybe 1% or a smidgen one way or the other. Also, it’s true, I think, if you look at that commercial market, again, as you well know, we’re talking about the unitary part of the commercial market here. Towards the latter part of the year, I think everybody’s acknowledged that they’ve seen a little bit more strengthening in that market, which is a good sign, I think, for all of us in the industry.

As far as our operations are concerned, they continue to operate in a very efficient fashion. And a great deal of the product that we produce is designed for-- well, I should say is it’s configured to order. Pardon me. And because of that, the benefits and features that our technology makes available for people, such as a number of the national account people, big box retailers and so forth, is recognized for the value that it brings. Furthermore, the factories operate in a very efficient fashion and are capable of producing these configure-to-order units with literally, I guess, millions of permutations in a matter of just a couple, three weeks, which is excellent, indeed.

So there are some various stories embedded in what our folks on the commercial air condition side are doing that we feel are accountable for the growth. We also see them attacking successfully additional channels that we had not been necessarily that large a player in before. I think that that’s a good trend that bodes well for the future of that business.

Refrigeration, as you know, is a very strong business and it’s a business that’s got excellent product platforms, but I think perhaps an important difference that has been important for our company is in the focus that this business segment has placed upon being very attentive to what it is that the customer wants. They rate themselves very hard. In fact, from the standpoint of customer service and supporting what the various channels they serve need, they have literally reinvented themselves a couple of times over the past several years.

So I think it’s that attention and that focus, plus a very solid product technology that’s making the difference. And of course, we’re seeing it in the share.

Just to follow up on the refrigeration side, on past conference calls, you had suggested that maybe the growth that you saw in refrigeration might be the result of some, I guess, pent-up demand after a prolonged downside. Well, the sustained growth that you see in this business, do you still think that this could be related to pent-up demand? Or do you really think that this is moving beyond that?

Well, first let me make a distinction. I know that I spoke on the pent-up demand on the residential air conditioning side on a number of occasions, because certainly as we went through the period of the latter part of 2001, all the way through the end of last year, we felt that that was out there. But having said that, going back to your question on the refrigeration side, if you look back historically, 2001 was the year when the markets were precipitous, almost a 20% drop and remained really sick for the following two years. And our refrigeration folks did a very good job in increasing share during that particular time, doing the thing I just spoke of a moment ago.

And to the extent that there’s pent-up demand out there, I’m not sure that I would quite characterize it that way. But we certainly see that because we serve several different segments that different types of improvement, for example, supermarket maybe at some points in time, or probably in the contracting business that we do or the service that we provide and products to OEMs, give us a nice blend of end demand for it, so that it help keep our penetration up and also keeps us very busy.

So rather than pent-up demand, I would think it’s the manner in which we serve the several channels that that business is focused on, as well as the attention to the customer.

So then is it fair to say, in a nutshell, that both in the commercial HVAC market and the refrigeration market there’s really just share gains from solid execution?

Well, I like the way you said that.

Okay. Excellent. Now, I was wondering if you could give us a little more of a breakdown of the CapEx for 2005. You did mention 13 Cier and IT and other programs. Could you give us a little more color on your capital programs and where you’re looking to spend this year?

Well, first of all, categorically, we don’t really go in and tear apart that amount of detail for public discussion. But I think I’d have to reflect on the fact that certainly a significant part of the increase in a year-over-year basis, just like I’m sure all of our competitors are doing, is going into the retooling. And I think I should mention the fact that the new product platforms we’re bringing forward are not in our view just an exercise to comply with different standards, but to also bring exciting new products that are both cost efficient to manufacture and pleasing and useful for the homeowners’ comfort, as well. And so we’re really excited about what we’re going to see on the product line.

I should also mention, too, that there will be some expenditures for software in the area of what we do on the financial side, accounting, forecasting and consolidation activities to make us more efficient in that area, as well.

And then my last question is really just to look forward in the markets. With your Service Experts segment, I know you have a few weeks on everyone. It’s still the cold season. But I was wondering if you could share with us a little bit of your insight on the potential order rates for the spring and summer and really how things look for you for the residential market in the early selling season.

Well, first of all, I don’t have a crystal ball. I wish I did. But I think probably the only thing that I really can say which would be true is that thus far in this year, we’re very pleased with what we’re seeing. So if the Good Lord delivers up some decent air conditioning season weather and a few other things, I think the whole industry probably will have a good year.

Great. Thanks a lot, guys. Good job.

We now have a question from Jeff Hammond with KeyBanc Capital Markets.

Please go ahead.

I guess I want to go around the-- about the raw material issue and price realization a little bit differently. Can you give us a sense-- you mentioned the 47 million in ’04. Can you give us a sense of what the incremental headwind looks at like in ’05? And then on the price realization side, I think you said in the third quarter the price realization you had gotten was about a point and a half. I wanted to kind of just get an update of where you’re running in the fourth-- or where you ran in the fourth quarter.

Well, first of all, relative to the quarter, I haven’t got that number right ahead, but let me just say this, we had decent-sized price increases that were executed right at the end of the year. And certainly, again, consistent with my earlier comments, our ability and I presume the competitors’ ability to get these price increases are based upon a real acknowledged need for this, because of what’s going on in the market.

Now, going to the first part of your question, and I’ll give you some flavor on this, certainly we see that the escalation next year is greater than what we saw this year. So it’ll be bigger than $47 million. And again, that is just simply because we’re looking at a full year, in fact, of all of the escalated price increases that we saw last year, plus netting against that any fluctuations that occur in the course of the year 2005. And that wouldn’t be different, I’m sure, for anybody else.

Okay. And then maybe in terms of ’05, can you talk a little about free cash flow? It sounds to me that the working capital is a little bit of a timing issue. Can you maybe give us a sense on ’05 what free cash flow looks like? You mentioned CapEx, but maybe focus in on that working capital line.

For 2005, we’re not going to go out and give guidance on free cash flow. There is a lot of uncertainty in 2005 as we look at where we might want to go as a business with commodity purchases and pricing and also different inventory levels. I can tell you, though, that in terms of the working capital and the questions that you’re asking, we are really focused in on getting ourselves back together on working capital. We’re putting in systems. We are putting in improvement tools using some of our step-plus type of programs, working capital counsels, et cetera, and we’re going to get that to a place where we feel good about it. But we are not going to give guidance at this point in time on 2005.

Okay. Maybe to ask a different way, can you kind of give us a picture of what DSOs and inventory days on hand look like in the quarter and maybe relative to what your long-term targets might be on those metrics?

Which quarter are you referring to, the fourth quarter?

The fourth quarter.

Our DSO was around 60 days. And what was the second part? I’m sorry.

Inventory days on hand.

We measure the inventory in terms of inventory turns and we were at about six and a half turns.

Okay. And how should we look at that relative to longer-term targets?

Let me just talk to that for a second. We have, over the past three and half or so years, done a number of things that we felt were important and quite sweeping in the area of lean enterprise activity and also focusing on not just the working capital, but also the manner and the effectiveness of what we do on our capital spending. And our organization certainly has lost none of that activity. Now, we will be quick to agree that we could use some more precision in our forecasting. That’s certainly was some of the tools that Sue talked about and are going at this particular point in time. But again, because of the ability of this organization to focus on things like that and because of-- your opening phrase, I think you said that there is certainly some timing effects that are in this. You know, we’re not all alarmed about this, but free cash flow is extremely important to us, as we know it is to the investor. And you can see that focus produce results this year.

Okay. And then finally, I think you mentioned in your ’05 guidance you see kind of mid single digit revenue growth, a little bit above the market. Can you maybe give us a little more detail in terms of the different business units what’s maybe a little bit better than that, what’s maybe a little bit worse?

Across the board, we’re seeing those-- the comment on low single digit market growth really applies to all of our manufacturing and end-market businesses and Service Experts, as well. And beyond that, we’re really not providing segment guidance.

Okay. So not a whole lot of variation?

No. In our assumptions, that’s right.

And then if I could sneak one more in, Service Experts, can you just update us on where you’re at in the divestiture process with the non-core centers?

Of the 48 centers that we announced the divestures on, we completed the divestitures as of 12/31. There will be a few cleanup-type of items that you’ll see in the discontinued operations in 2005, but those are related to receivables and items that were retained in the closures. But the divestitures were completed and done at 12/31.

Okay. Thanks.

[Operator instructions]. We’ll go to the line of Michael Coleman with Southwest Securities.

Please go ahead.

I wanted to ask you about the indoor air quality. You mentioned that it was up 22% in the quarter. You talked also about your marketing plans. I guess what I want to ask is how aggressive or how prepared are you to aggressively spend in the marketing in this and grow that piece of the business to where it becomes a meaningful-- given the market opportunity of it?

Well, first of all, we view it as a very exciting part of not only 2005, but the future going forward. And we also have a number of excellent products that are in that space. And one of the issues that we have focused in on and we think is extremely important are a couple of things that I spoke to dealing with the interaction with the homeowner in terms of helping them to understand what indoor air quality really is and to help them analyze their present situation so that they can see what kind of improvements are available with the suite of products that we have to offer; and then on a follow-up basis, to be able to show them the efficacy of those products after they’re installed so that they are confident and also are that much more, I guess, knowledgeable, if you will, about indoor air quality.

But what we find is that there is a great deal about indoor air quality and technology that is unknown to quite a large percentage of the population at this point in time. And it has a significant impact on the health of families.

And so for that reason, we’re working hard to equip and prepare not only our Service Experts personnel and technicians, but also a lot of the dealers that we sell product to, our Lennox dealers, to make them effective in applying the process that I just described.

In terms of how interested are we in it or how prepared are we to go ahead and expand in it, I’d say we’re looking at that very hard. And we consider it to be an important part of our growing future.

Michael, if I could just add, a lot of the marketing really is in the form of education and it can be done very cost effectively with the Service Experts techs that are already in the consumer’s home educating them about IAQ. And that’s what the Home Health Report Card Program is all about.

I guess I was wondering if you had any plans to do any direct marketing to consumers of these products.

Save the activity that we have through our Service Expert side, the answer to that would be no.

Okay. Thank you.

Our next question is from Adam France with Charlotte Capital.

Please go ahead.

I have a quick question for you all here. If I could get my hands on the fourth quarter 2004 and best guess at ’05 depreciation/amortization--

The 2005, we’re looking at the low 40 million-ish type of area with depreciation. And that's consistent with 2004.

And the fourth quarter number?

Basically, dividing it by four, so about $10 million.

Okay. Thank you.

Our next question comes from Shareen Coddy [ph] with Pilot Advisors.

Please go ahead.

I just want-- I think you threw out some statistics, perhaps gross and I just missed them on Armstrong and Duquesne specifically. Or I’m not sure what you said exactly. But I just missed that.

Bill Moltner Shareen, it’s Bill. We didn’t provide specific growth rates on those businesses. We commented that Lennox and Armstrong had solid growth.

Solid growth-- and is it fair-- the margin impact from the higher commodity costs, how is it different for Lennox versus Armstrong and Duquesne, if at all?

I don’t think it’s much different at all.

Okay.

I suppose there might be something in the [inaudible].

I’m sorry. Lennox and Duquesne had the strong quarters. I was picking up your Armstrong.

I’m sorry, I missed that.

Lennox and Duquesne were the ones that we referenced that had the strong sales performance.

Okay. Perfect. Thank you.

And we now have a follow-up from Curt Woodworth.

Please go ahead.

Just two quick questions, as you look at the 130 remaining Service Experts dealers, can you talk about how many of those are currently generating profitability levels that you think are good? And talk about-- what are those profitability levels and kind of your margin goal for this business?

I don’t think we would price it that finely. But let me tell you this, that we watch that group individual and, of course, rank them. And the President and General Manager of that area, Scott Boxer, has, with his team, developed a very, I think, hard-hitting scorecard with looks at not only what we call lagging indicators, but leading indicators, as well. And it’s significant to note that we’re noting improvement in that, just as we had hoped and planned, as you look back over the third quarter over second and fourth quarter over third. So as we stated, we’re certainly pleased.

And again, I think we have to look at the fact that this business has just gone through a 2004 very substantial restructuring and also a fair amount of disruption as well. So for that reason, again consistent with the way that we put guidance together, I guess I would just reinforce our comments about 2005 and that is I guess we used the words “modest profitability.” I think that would be an accurate take on the way we view what will happen in that business. And again, continuing improvement picture with a lot of work on the fundamentals and quite frankly, a lot of excitement around what’s being accomplished.

Can you just give us a sense for-- like, I’m just curious as to how profitable some of these dealers are. Like if you were to look at the top ten dealers, can you give us any sort of insight as to what type of margins your best dealers are making? Or is it-- you don’t have that level of specificity?

No. I’ll just tell you this, when you look at a number of the dealers that are at the top, they’re all in double-digits. And some of them are booked quite solidly. And again, we’re seeing improvement on the rest. I think we talked about-- yes, in fact, both this time and last time, the work that was done with the development program-- training and develop program for general managers in those businesses. And we believe that over four plus years of rather expensive tuition that we paid that we’ve got a very good fix on what the attributes are of the people that are really successful in that business. And we’re appropriately preparing very good candidates to go ahead and continuously fill that pipeline and deliver the kind of performance that we know they’re capable of.

Great. And quickly, on 13 Cier, can you talk a little bit about the migration of your manufacturing operations in terms of retooling and getting everything ready to go to 13 Cier and above? And if there’s any-- do you foresee any margin impact to that? Or are all of those costs capitalized as you kind of make that transition? And also, if you could, give any insight as to your expectation for what you think pricing for 13 Cier will do, as that market becomes the base market.

Well, first of all, with respect to any-- I like your word “migration.” There is a lot of exciting new products being launched in the course of 2005, you know, in anticipation of this change. The fact is, yes, we’ve capitalized all the expenses and things that we see with that, so we wouldn’t expect any untoward margin hiccups on it. But at the same time and in the same breath, I’ll tell you that it’s a pretty aggressive plan that we’ve put together. And so for that reason, there will be a lot of effort done to control those launches, be sure they come off on time. And I’ve got every confidence that they will.

As far as the pricing is concerned, when you look at-- the products are definitely different. There is certainly a lot of cost reduction and other activity that’s going on parallel in the design processes that we follow to try to help offset, which are the obvious, and that is that the material content is certainly quite a bit larger in these products, which is no secret to anybody.

And it certainly is not our intent to go ahead and see any kind of margin-beating because of the transition. I think that what we’re going to see is product families that are extremely exciting that have a lot of good features and benefits for the consumer. And as always, we expect to get paid for that.

Great. And then one final question, I know this is somewhat hypothetical and maybe hard to answer, but is there any way to help us quantify if-- or to think about if steel prices were to fall, say, 20% this year, can you give us any insight in terms of the sensitivity to what that could mean for you in terms of maybe just tell us what your steel spend is?

I know that we could go back and calculate that, but I guess I wouldn’t want to, in this form, to go ahead and speculate on that.

Can you tell us what your steel spend was in ’04?

Other than to say it’s the largest of the commodities that we identify, we don’t break it out, Curt.

Okay.

Profit alone [inaudible] to that.

Is it fair to say commodity is about maybe 40% of cost?

The way that we break it out is we talk about our materials and components combined and they are 70 to 80% of the total cost of goods sold. But we don’t give any further breakdown beyond that.

But components is a greater percentage, right, than commodities?

Probably.

Yes. Okay. Thank you.

And we have no further questions, Mr. Schjerven. Please go ahead with your closing remarks.

Okay. And thank you.

Well, Lennox International had a very successful year in 2004. Our earnings were at the high end of the range that we provided at the beginning of the year, despite the $47 million in commodity cost headwind that we experienced. Our manufacturing businesses continue to perform very strongly and with the restructuring of Service Experts now in back of us, we believe that we’re making progress in this segment.

I want to thank you all for taking the time to be with us today. Good day.

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