Lennox International Inc (LII) 2005 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 2005 earnings conference call. At the request of your host all lines are in a listen-only mode. There will be a question-and-answer session at the end of the presentation. As a reminder, this call is being recorded. I would now like to turn the conference over to Bill Moltner, Vice President of Investor Relations.

Thank you, Mary. Good afternoon. Thank you for joining us for this review of Lennox International's financial performance for the fourth quarter and the full year 2005. On this afternoon's call our CEO, Bob Schjerven, will highlight some of LII's key accomplishments for the year and comment on management's outlook for 2006. Then Sue Carter, our CFO, will take you through our financial performance for the fourth quarter including detail by business segment as well as address key income statement and balance sheet items.

In the earnings release we issued this morning we've included any necessary reconciliations of the financial metrics that Bob and Sue will discuss to generally accepted accounting principal measures. Also included in the release are restated financial statements for the first three quarters of 2005 adjusting for futures contracts accounting revisions. We'll wrap up today's call as is customary with Q&A.

We have placed a direct link to a webcast of today's conference call on our corporate website at www.LennoxInternational.com and the webcast will be archived there and available for replay.

Before we begin I'd like to remind everyone that in the course of this call, to give you a better understanding of our operations, 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 is included in our publicly available filings with the SEC and includes the impact of higher raw material prices, our ability to implement price increases for our products and services, the impact of unfavorable weather and the decline in new construction activity on the demand for our products and services and the potential impact on operations related to the implementation of the new [NAKA] efficiency standards. These risks and uncertainties could cause our actual results to differ materially from those that we stress to you today. I'd now like to turn the call over to Bob Schjerven.

Good afternoon; 2005 was a record-breaking year for Lennox International. We delivered on our commitment to increase the focus of our core businesses and solidly execute our value building strategies. The results are clear, supported by enhanced operational efficiencies, improved pricing, unfavorable weather patterns and a sustained strength in the residential new construction market; we set several key performance records for the year. The sales, net income and earnings per share we achieved in 2005 all set new records.

And speaking of records, you probably noticed that the length of the earnings release we issued this morning -- early this morning set a new record -- well, at least for us. And I truly -- I apologize for the book, but we thought it was important to give you a comprehensive explanation of the futures contracts accounting adjustments and the impact that they had on our financial statement so that you could better understand the true strength of our operating performance. Make no mistake, 2005 marked the absolute best performance in the history of our 111-year-old company.

Now before I recap results let me, briefly on the futures contracts accounting issue. Our Company has effectively used copper and aluminum futures contracts for many years to stabilize our product costs. An internal hedging committee oversees these activities subject to established policy. Economically our hedging activity has been very good and has benefited both the Company and our shareholders. As you know, hedge accounting is very complex and also challenging to apply.

As we completed year-end procedures related to the accounting for futures contracts, we determined that futures contracts for our nonferrous metals did not qualify for hedge accounting treatment. This determination resulted in non-cash accounting entries that enhanced our reported results for 2005 by $0.20 per share. Sue will give you the detail on the impact on our financials and I will now turn back to reporting the results.

Our Company sales increased 13% in 2005 to a record number of $3.4 billion with all of our business segments contributing to the growth. Our reported net income was $151 million or $2.11 per diluted share. Adjusted for those items Sue will talk about, our adjusted income from continuing operations for full year 2005 was $130 million or $1.83 per share. This exceeds any previous EPS we've recorded and it compares favorably with the $1.39 per share that was earned from continuing operations before goodwill impairment back in 2004.

Our continued focus on cash flow and debt reduction has proven to be very effective. We generated cash from operations of $227 million and invested $53 million in capital expenditures providing a very robust full year free cash flow of $164 million. In October 2005 we completed the conversion of our outstanding convertible subordinated notes eliminating $144 million in debt and $9 million in annual pretax interest expense. Our balance sheet is in terrific shape. It's the strongest that it's been since we became a public company in 1999 reflected in the 13% total debt to capitalization ratio. Just two years ago our debt to cap was 39%. We're pleased with that progress.

It's notable that approximately 30% of our equipment sales in 2005 came from products introduced in the last three years. Our drive for product innovation is a vital part of our past, present and our future and nowhere was that drive more evident than in our residential heating and cooling business as we prepared for the new NAKA regulation that raised minimum efficiency for residential air-conditioning by 30% to 13 SEER.

This change had a major impact on all of our residential cooling lines and it was easily one of the largest and most comprehensive project in this Company's history. Not only did we comply with the new energy efficiency requirement, we also used the opportunity to standardize our product platforms across our brands while maintaining meaningful brand differentiation through unique product features and visual design.

Our management team did a superb job managing the transition to 13 SEER. Organizational alignment and close cooperation across our business units allowed us to be ready with a comprehensive and a competitive range of new products from entry-level to full feature when the regulation took effect on the 23rd of January.

Very strong demand in part driven by the transition to 13 SEER provided a positive impact on our fourth-quarter results. The impact of the transition on our different brands, however, was notably different. Our Armstrong, [Aire], Ducane and other brands, which are sold through our two-step distribution, they clearly benefited from final buy orders for 10 SEER equipment. Unit sales of cooling equipment for these brands more than doubled in the fourth quarter and equipment 13 SEER or higher represented less than 10% of total units shipped.

The story with our premium Lennox brand which is told directly to a (indiscernible) dealers was quite different however. Due to our one-step distribution model the Lennox brand is much less susceptible to inventory loading. 13 SEER and higher equipment accounted for fully 45% of Lennox cooling equipment unit sales in the fourth quarter. Clearly a significant number of our Lennox dealers who have traditionally taken a more value added sales approach shifted their emphasis to higher efficiency systems well in advance of the January 23rd deadline. The impact of the 13 SEER prebuy on the industry will work its way through the system in the first part of 2006. But we're encouraged by a solid start to the year despite unseasonably warm weather this winter.

Another success story for Lennox International in 2005 was Service Experts return to profitability. With a renewed focus on the more profitable service and replacement segments of the residential light commercial market, Service Experts took advantage of robust market demand and improved advertising and marketing programs to increase segment profit by a very solid $19 million. Service Experts' progress is meeting our expectations and we're confident that this improvement will continue.

Strong leadership at the service center level is vital to the continued improvement of Service Experts. Today we have trained 38 new general managers through our comprehensive general manager fast track program and those graduates are now making a noticeable difference in the field. Service Experts increased this emphasis on providing the best customer service in the industry with the introduction of Standards of Excellence, an approach to doing business that addresses the issues that consumers revealed were most important to them including quality, responsiveness and professional certification.

In fact, over 80% of the Company's 1200 service technicians are now certified by North American Technical Excellence, NATE program, which for Service Experts the largest network of certified technicians in the industry. The introduction of a new company logo and the service uniform further differentiated Service Experts and the markets that it serves.

Looking ahead to 2006 we see continued improvement in the demand for commercial heating, cooling and Refrigeration equipment. The residential heating and cooling market, however, is going to be a bit more of a challenge in 2006. Following unprecedented demand last year, which was driven in part by an abnormally warm summer, the industry's prices a projected slow down in residential new construction and the impact of the transition to 13 SEER.

Our guidance assumes that Lennox International's revenue growth to be in the mid single digits in each of our segments, specifically in the residential cooling market we expect that higher price points will more than offset lower unit demand. We expect full-year diluted earnings per share will be in the range of $2.00 to $2.10 which represents a 9 to 15% improvement over our adjusted 2005 performance of $1.83.

As we announced earlier this month, we expect to incur a restructuring charge of approximately $13 million after-tax as we close our facility in Bellevue, Ohio and consolidate operations for our two-step residential and heating and cooling business in South Carolina. It's important to note that in our full-year guidance we expect we will be able to offset this charge through gains and other positive non-operating items through the year.

Before Sue provides a closer look at our fourth-quarter performance, I would like to comment on the changes to our Board of Directors that we announced earlier this month. John Norris, Jr., our Chairman, has advised the Board of his plan to retire effective July 21 of this year. It's hard to believe that we were a company with a little more than $50 million in total sales when John joined Lennox in 1960. Not only has John provided Lennox International with a long history of leadership and service, but also I think it's pretty fair to say that the heating, air-conditioning and refrigeration industry is better off today because of his involvement. We're going to miss him and we wish him the very best in his retirement.

Our Board governance committee has recommended that Rich Thompson, our current Vice Chairman, succeed John as Chairman. Rich is a former group president for Caterpillar Inc. and he's been an LII Board member since 1993 and was appointed to the position of Vice Chairman early last year. Rich's experience in manufacturing and his leadership on the LII Board including serving on and chairing many important committees has been a very invaluable asset.

We also announced two other changes to our Board. David Brown advised the Board of his retirement effective the day of the 2006 LII annual shareholders meeting which is coming up April 20 of this year. And also Wally O'Dell submitted his resignation. We thank them for their contributions and we have initiated a search for candidates to replace three director positions left vacant. With that, I'll turn the call over to Sue.

Thank you, Bob. Good afternoon. As you've heard, 2005 was a terrific year for Lennox International and we ended of the year on a positive note with strong performance in the fourth quarter. Let me first give you more detail on the futures contracts accounting issue. As part of our year-end procedures and prior to our originally scheduled earnings release, we determined that our futures contracts for copper and aluminum did not qualify for hedge accounting because our documentation did not fully comply with the requirement set forth in the standards. This resulted into different types of adjustment on our Company's financial statement. Both show up in the gains, losses and other expenses line item on our P&L, but each has a different impact on our financial results.

First, an unrealized pre-tax gain of $23 million or $15 million after-tax related to open futures contracts was realized, positively impacting our full-year result by this amount. Of this $15 million $9 million or $0.12 per share represented an increase to previously reported earnings for the first nine months of 2005. The remaining $6 million was realized in the fourth quarter resulting in a positive impact of $0.08 per share.

Second, we realized pre-tax gains of $17 million related to settled futures contracts. $9 million of this amount related to the first nine months of the year and was reclassified from cost of goods sold to gains, losses and other expense. This second set of adjustments as they were reclassifications had no impact on net income. For the fourth quarter we recorded an $8 million gain on settled futures contracts in the gains, losses and other expenses line item. Under hedge accounting this amount would have been included in cost of goods sold. It is important to note, as Bob pointed out earlier, none of these hedge accounting adjustments affected the Company's cash flows and also the impact on prior year's results was not material.

Now reviewing Q4 results, LII's total revenue from continuing operations increased an impressive 17% or 18% in constant currency to $871 million. 86% of our sales came from the U.S. and Canada, our domestic market, with the remaining 14% coming from international operations. Fourth-quarter reported net income was $42 million or $0.55 per share. Adjusting for gains, losses and other expenses, excluding those gains on settled futures contracts that would have been included in cost of goods sold under hedge accounting, income was $34 million or $0.46 per share. This compares very favorably with the income from continuing operations of $20 million or $0.30 per share in the prior year's fourth quarter.

I would like to draw your attention to a reduction in our effective tax rate as a result of the utilization of tax loss carry forwards and other tax items that provided a onetime tax benefit of $4 million in Q4 adding $0.05 to the quarter's earnings per share. Looking ahead to 2006, we believe the normalized effective tax rate for our company will be 37%.

We reduced our debt by $190 million in 2005 and finished the year with a total debt of $121 million and a very comfortable total debt to capital ratio of 13%. In the fourth quarter cash from operations was $72 million, during the quarter we invested $21 million in capital expenditures resulting in free cash flow of $51 million. In 2005 we made voluntary pension contributions of $26 million. We also used $13 million to buy back 447,000 shares of LII stock at an average price of just over $28.65 and we returned $25 million back to shareholders in the form of dividends. Plus, in December our Board of Directors voted to increase our dividends by 10%.

We project our capital expenditures in 2006 will be approximately $70 million. This spend includes 13 SEER equipment carryover from 2005, the costs for warehousing in South Carolina warehouse as part of the announced consolidation program, expanse in to accommodate continued growth in our domestic commercial heating and cooling business, and IT investments for customer relations management software and the implementation of SAP in Europe.

Despite our strong top-line growth our inventory was down $5 million year-over-year. Our working capital ratio as a percent of trailing 12-month sales was 16.5%, the lowest it's ever been. While management across our organization continues to be diligent on working capital, we expect that percentage will rise modestly in 2006 as we ensure that we're providing the service levels that are important for our customers. With a planned increase in sales we expect working capital will be a net usage of cash in 2006. Our pension plans are well funded and no voluntary contributions are planned for 2006.

Corporate expense in the quarter was $5 million higher than prior year primarily due to higher incentive compensation costs and profit-sharing as our financial performance exceeded expectations and our stock price continued to appreciate as well as costs associated with the centralization of our procurement function. Benefiting from a lower total debt balance and interest earned our total interest expense of $1 million in Q4 was down $4 million from prior year.

Now taking a closer look at our business segment performance. We achieved price improvement of approximately 4% in our equipment businesses in Q4, more than offsetting headwind of approximately $12 million in year-over-year increases in the cost of steel, copper and aluminum and related components. Fourth-quarter revenue in our residential heating and cooling segment increased 33% to $443 million.

While market demand was extremely strong for cooling equipment in advance of the 13 SEER deadline, we also achieved double-digit growth in heating equipment shipments. Segment profit increased 30% to $48 million. Higher sales volume, improved pricing and favorable mix more than offset commodity cost increases, higher advertising expenses, warranty reserve adjustments and factory inefficiencies associated with the 13 SEER transition. In addition benefits of $5 million from settled futures contracts were classified as a gain in the quarter and not included in segment profit.

Our commercial heating and cooling segment revenue advanced 5% in Q4 or 7% adjusted for foreign exchange to $162 million. Segment profit declined from $13 million last year to $9 million this year. Benefits of $1 million from settled futures contracts in the quarter were classified as a gain and not included in segment profit. Sales and profitability improved in North America with higher volume and improved pricing offsetting higher costs, but our European operations incurred a loss due in part to organizational change expenses and the inability to offset cost increases through higher prices.

While commercial equipment demand in the U.S. and Canada continued to improve, European demand remained stagnant. We strengthened our management team and realigned our organization to a more pan-European structure to improve our performance in this challenging market.

Service Experts sales were up 8% or 7% when adjusted for currency fluctuations to $166 million. Service Experts had segment profit of $6 million in the quarter or 3.7% of sales compared with $1 million or 0.6% of sales the prior year. The improvement was driven by higher revenue and reduced SG&A expenses. Service Experts continued to get better at executing its business model and is benefiting from more effective marketing programs, a leaner cost structure and strengthened leadership at the center level.

In our refrigeration segment revenue rose 3%, up 4% in constant currency led by strong sales growth in the Americas. Domestic sales to the supermarket, restaurant and convenience store segment were particularly strong. Segment profit increased 4% to $12 million due to improved volume and pricing in the Americas and Europe. Profitability improved in all regions except Asia-Pacific where cost reduction programs did not sufficiently compensate for lower sales.

In the fourth quarter we welcomed a new general manager for this region, an important priority in a market with excellent long-term growth potential. Benefits of $2 million from settled futures contracts were classified as a gain in the quarter and not included in segment profit.

Before we wrap up let me recap the elements of our 2006 guidance. We expect revenue growth in the mid single digits in each of our segments; full-year diluted earnings per share in a range of $2.00 to $2.10 with the expectation that we will offset restructuring charges through gains and other positive non-operating items during the year; capital expenditures of approximately $70 million; and a normalized effective tax rate of 37%. That concludes the remarks we have prepared for today's call and at this point we would be pleased to address any questions that you may have.

(OPERATOR INSTRUCTIONS). Curtis Woodworth, JPMorgan.

Good afternoon. A question on the $0.46 income from adjusted operations, I just want to make sure I have this correct. Does that number include the $8 million pre-tax gain from the settled futures contracts, but it excludes the $6 million after-tax gain from the unrealized contracts?

That's correct.

So in your reported ongoing EPS for this year there was about a $0.15 benefit from the settled futures gains?

Okay.

I just want to make sure I have these numbers right.

It's about $0.20, Curt.

On the open contracts that were settled, yes.

Okay.

That's a full-year number, $0.12 in the first nine months and $0.08 was in Q4.

Okay. And then going forward, are you going to report these gains on a quarterly basis whereas -- I mean $0.20 benefit is a fairly decent number that we didn't really know about or I didn't. Going forward do you plan to tell us what these gains are every quarter or how is it going to work?

What we're going to do, Curt, is we have some folks in helping us with our hedge accounting going forward. As you can tell from the 2005 statement that we have, we've unwound all of the hedge accounting associated with any of the futures contracts that we have. Obviously it's a benefit to the Company to mitigate business or economic risk to the Company by hedging the actual commodities, in our case copper and aluminum. So it's our intent to look at the entire process and see if we can get our documentation in order to do hedge accounting going forward in the future. And if not then, you're absolutely right; what you would see is the gains and losses going through on a quarterly basis as we report the financial results.

Okay. And I was wondering, Bob, if you could just provide a little bit more color on the mid single-digit revenue growth expectation for residential HVAC this year? What does that assume in terms of unit volume? I know it seems like you're assuming unit volumes are going to be down. What are you looking for for unit volumes for [alliance] this year?

Are you talking about 2006?

Yes.

Probably the best way to talk about that is -- first of all just in general we have just a little bit of a different view of the market than I think some folks have that have put out there. And again, all of the numbers that people tend to reconcile against when you look at, for example, the [A.M. Riley] reports, those are on a unit basis. Our expectation is that for this year from a market standpoint we would expect those numbers to be down low single digits to maybe mid single digits, not the kind of number that we have seen before.

Okay. And do you assume that you will track with the market then?

Well, actually we don't, of course first of all, give guidance by segment -- but just to try to answer your question a little bit, we have executed in a marvelous fashion on the 13 SEER changeover. And we also hear and, yes, some of this is anecdotally and some of it is on the market intelligence -- that performance or that success by the entire industry may be a little bit uneven. We believe that we're very well positioned to go ahead and take advantage of that. But I guess -- I would say both with respect to unit comp and with respect to margin we're somewhat bullish on what we see.

Okay. So I guess on the margin then, is it fair to say that in your guidance of the -- your annual guidance, that assumes better margin performance in residential this year?

I guess the first question you have to do is ask better than what.

Than what you reported in '05.

But again, '05, not just for us but for everybody, Curt, was really sort of a mixed bag because of all of the activity that went in on around 10 SEER and so forth towards the end. I'll just tell you this and maybe this will help a little bit. We have good expectations around margin preservation as we go forward and not only when you look at the fighting trend so to speak, there's a little feature product, but also when they're fully featured, we take that combination of engineering what's happening in the marketplace and success frankly in terms of pricing activity makes us feel pretty good about what we see going forward.

Okay, great. Thank you very much.

Jeff Hammond, KeyBanc Capital Markets.

Good afternoon. Sue, I was wondering if you could maybe quantify or give us a sense of in the commercial business what with respect to realignment was one time in nature. And then more broadly, Bob, if you could just talk about the magnitude of the issues you're seeing in the European commercial business and what kind of timing we should expect or are these longer-term issues, short-term fine-tuning? I know this issue kind of popped up in 2Q and then kind of went away for a quarter and is now back.

Let me try to take it -- some of the high altitude part first and probably address more the back end of your questions. First of all, Europe has been challenging for not just us but everybody. Certainly if you look over the history -- and again, we don't break out the European piece by itself, but just trying to go to your question -- if you look at what's happened in Europe the market has been rough and we felt that it was necessary and made the decision, actually it was about mid last year I think it was, that we needed to charge that organization a little bit, introduced not only new management but also how we oversee and structure it and what we did is we pulled it inside of our -- it had been sort of a stand-alone unit.

So we started in a commercial structure but we pulled it into the command and control structure for broader commercial, an individual whom you may or may not know, Harry [Viseost], the individual that runs now all of our worldwide commercial HVAC activity. Harry is the guy that took the domestic operations over a period of several years and moved it from just about no profitability to nice double-digit profitability with large market share as well -- market share gain as well.

So Our expectation is under Harry's direction and with the new leadership we put in place over in Europe and some realignment internally as well, that we're looking at a new day for these folks. But I wouldn't want to mislead you into thinking that this thing is going to become our EBIT leader for the Corporation inside of six months because the nature of these kinds of things in that kind of a market is a bit more protracted than that. But improvement we will see.

And to answer your first question, Jeff, on the changes in Europe -- there's two pieces to this and one is easier to track than some of the others. First of all there were management changes that were made in the European operations and, secondly, we also realigned some of the other organizations that went along with more of a pan-European look. And just as an example might be a sales force or something like that in their view across the organization. We believe from the numbers that we're tracking that the impact of that was less than $1 million in Q4. But that will give you an order of magnitude of what's happening.

I guess what I'm unclear with is second quarter there was seemingly an impact, certainly there was another domestic issue within there. And then third quarter you had phenomenal margin performance and then seemingly a pretty big hit in the fourth quarter and I guess Europe, from my standpoint, has been stagnant for more than a year.

How long as your memory?

What's changing quarter-to-quarter that's hitting the bottom line?

Operationally -- if you look domestically nothing really. The other thing I think, you probably picked up on this, but if I'm not mistaken the gains which normally would have been part of the cost of sales offset the gains that are associated with the hedging calculation took off also another million or so out of the fourth quarter for these folks. so when you look at the fourth quarter it's been a combination of several things that waxed them. But again, if you look at the (indiscernible) domestic piece of it and how that's been operating and continues to operate, they're doing a very good job. And of course, as you know, they're totally [inert] from the 13 SEER thing, that's just a residential only type proposition.

I guess moving over to Service Experts, very solid fourth quarter. fourth quarter and first quarter have historically been your seasonally weaker quarters. I guess as we look into first quarter, is this kind of a sustainable run rate of profitability or do you see something in fourth quarter that maybe doesn't repeat?

We see a (indiscernible) coincidentally we just came off of three days last week the annual general manager's meeting for the folks at Service Experts and so personally had a small opportunity to talk to a great many of the general managers and talk with them about what's going on in their centers and look at the programs they've got laid out for the year that's coming forward.

I have no question about sustainability. One caveat though that I guess I would just toss out, and you probably heard this from a few people, and that is January has been an interesting month for this market because we've had the hottest January ever recorded in 112 years of keeping track. And so for that reason first quarter could be a little bit challenging for anybody in that particular business.

But when you look at the changes, you look at the training, you look at the way these folks in each on of the centers have embraced the fundamental tools that have been important to get the kind of evenness and performance you come away with a very strong feeling that this thing is absolutely sustainable and I think it's going to produce some really good news for us as we continue to go forward. But like everyone else, we continue to support them, but also watch and see what happens.

Okay. And then on residential you mentioned the non Lennox brands being up more than double in the fourth quarter. Can you give us a sense of how the Lennox brand performance was in the quarter?

In terms of just actual units or (multiple speakers)?

Units and/or volume.

Again, before we go there what I want to do is reiterated a point that I made in the comment that I made earlier and that is those two businesses -- two-step that is versus the one-step -- do look very different in terms of what kind of product it was that they're moving out there. Primarily what you saw when you looked at the folks on the two-step side the same thing that I think the industry saw and that was a lot of product being pulled into distributors who were either trying to take care of possible interruptions that they foresaw just might happen this year and then also in some cases trying to take advantage of the lower cost base for that 10 SEER inventory that they were buying.

When you look at what happened on the Lennox side you can see that there was very good peer demand I think as well because with the one-step you don't see us stocking very much product at all in dealers and the dealers just don't do that, they buy what they need pretty much and that's the ballgame. And so again, the very high -- I think the number was something like almost 45% in terms of unit count was the high SEER product that went out the door for (indiscernible). So from that standpoint I think that there was a fundamental difference. Now if you look at the two-step piece, it was about a 48% growth on a quarter-over-quarter basis. Lennox not quite as strong, it was 34% growth in (indiscernible) units.

Okay, that's helpful. Finally on the guidance, can you give us a little more color on some of the non-operating items? Where do you see share count? Corporate expense continues to move higher, where do you see that on a full-year basis? And interest expense, obviously that dynamic has changed just given the balance sheet restructuring.

True, I like the interest expense part the best. As we look forward, in all seriousness, the Company is committed to its share repurchase program so we are going to continue to buy back shares of the Company on an open market basis. So that is certainly something that we will continue to do and operate along the lines of our strategy. In terms of the different cost items, certainly we're watching all elements of our costs and where we're going with that and certainly the pieces of that are part of the 2006 plan numbers that you're looking at.

In terms of non-operating types of items, we aren't looking at specifically identified items that we're prepared to talk to the marketplace about. But I can tell you this if it's helpful, the items that we're thinking about at Lennox are very similar to the types of items that we talked about in 2005. So the date on the sale of a business, tax projects that we're working on to take advantage of restructurings in some of our tax type of areas and things like that. So nothing that's terribly unusual or profound but just continuing to work items that will help us.

Okay, thanks.

[Sabor Bognar], Cheyenne Capital.

Good afternoon. I have two questions, please, the first on commodity hedging. You usually disclose in the Q's and the K's what quantity you have hedged in any given period. Would you mind discussing for both aluminum and copper what quantity is currently hedged?

We don't discuss -- there's a certain competitive aspect to that because it deals with consumption and so forth, so we don't drill down to that kind of detail in the published information that we release.

But it's in your 10-Q's and 10-K's.

Overall for the gross amount, yes.

So would you mind saying how much you had hedged at the end of the fourth quarter?

At the end of the fourth quarter -- we're not actually providing that detail until our 10-K is actually filed.

Okay. And the second question -- you indicated that perhaps there's more residential cooling product in the channel inventory than usual. Would you venture to guess how much more than usual is in that inventory?

A don't think I said that, but now having put that disclaimer out there, I think there probably is a bit more. Probably your best guidance would be to go look at the ARR numbers and see what you see there. I'll tell you, it's a very difficult thing to assess at this point in time and a lot of people in the industry have tried it and do come up with some different answers. I think that our feeling is, just as a general comment, with anything approaching a normal year weather wise, through the first half of the year most of that effect should be flushed out of the overall marketplace.

I see. Maybe can I ask it a little bit differently? In terms of your production schedule for residential cooling product in the first quarter, have there been any adjustments relative to the normal pattern.

We're actually running very much to plan at this point in time.

Okay, thank you.

Fritz Von Carp, Sage Asset Management.

I think I heard you say, and help me if I misunderstood this, that the margins in commercial were depressed by the accounting because instead of taking the offsetting -- the gains on your copper hedges in operations like we might think of them occurring you took them below the line. Can you break out how we could -- between the two segments (indiscernible) using copper how we could think about how -- if we were to treat your hedges as hedges how would that have changed your margins in the two segments?

Fritz, this is Bill Moltner. $5 million for residential heating and cooling in fourth quarter and $1 million in commercial heating and cooling and 2 million in refrigeration. There's actually three equipment businesses that were impacted.

Sorry, right. And that's on the fourth quarter. So I would add that amount back to the gross profit and say that's what it would have been had the hedge accounting been --?

Had we used hedge accounting, that’s correct, it would have appeared as part of our segment profit.

Okay. Thank you, sir.

Michael Coleman, [Stern McGee & Leech].

Good afternoon. Looking at the facility and you've also got in the discussion of your CapEx for next year expansion of facility. And I'm looking at on a net basis what's happening to your residential cooling capacity with the various things that are going on in your facilities?

Well, there's really no -- if you look at it more broadly and try to factor out the new products (indiscernible) the other, there is going to be certainly no diminishment of capacity on that side. In fact it will be enhanced I'm sure with changes in the production line and so forth themselves as you go ahead and execute that kind of a plan.

Okay. Second, in terms of your comments regarding the industry and the unitary shipments, is it --.

Hello?

(OPERATOR INSTRUCTIONS). Curtis Woodward, JPMorgan.

Just a question on some of the offsets you expect to see relative to the $13 million after-tax charge to I guess consolidate the two-step business, what would those benefits be?

As we went through the list of items what my comments were is that those items, while there was nothing specific that we were discussing in and of itself, that they were similar to the types of activities that were in the non-operating items for 2005, so the gains on the sales of businesses, the tax items, things like that. So true non-operating projects that we were working on.

Would they include hedging gains?

Well, I guess that's a question that depends on whether the Company feels that it can qualify for hedge accounting beginning in 2006 for new contracts. And again, that's something that we are exploring. We want to make sure that the benefit of doing hedge accounting is worth the cost of actually doing hedge accounting because it's very, very complicated and it's a very big process.

So if the Company moves forward with hedge accounting -- and we'll actually talk to you about this at the end of the first quarter with some of our results -- then we would go back to having the types of activities in the financials that you saw previous to these adjustments. If not, then yes, you would see some of the gains and losses but that's not the piece that we're referring to as we talked about that.

Okay, that's what I was wondering. Thank you.

Okay, good.

Michael Coleman, Stern McGee & Leech.

I guess I should ask my question a little quicker, I got cut off.

I didn't know what happened, you were gone all at once, Michael.

If I heard you correctly your capacity and cooling equipment, you have a plant closure and an expansion of another -- really isn't changing going forward, did I --?

Yes, it's shifting. For example, first of all, you have an overall diminishment in square feet because of the closure in the Bellevue plant, an older facility. And then -- so then you have that transition. Also you have a shift of warehousing activity that's going to South Carolina as well and then the actual activity we talked about in South Carolina with respect to warehousing. That's why I said it's sort of a flux. Again, the change was not done primarily to add a great deal of instant capacity, but anytime you make a change and look at productivity as well as perhaps more current methodologies with respect to line layout and so forth. That's why my comments was as it was -- I suspect we gain a certain increment of additional capacity as a result of those shifts. But again, those are the parts that are moving.

Okay. And regarding the 13 SEER changeover, how do you view that in terms of marketshare, your marketshare and the outlook for taking share or maintaining share in the next year?

We're not giving any projections in terms of what we think the share change is going to be, but I'll go back to what I said before and that is just given from all that we can glean in terms of market intelligence and then reflecting on our own preparedness, we feel that from a marketshare perspective this year should be a good year for us in residential.

Could you give us a feeling for how strong the domestic commercial was in terms of the volume improvement year-over-year in the fourth quarter?

I think we can (indiscernible) just a bit. Just hang on just one second here (indiscernible).

On the domestic on a year-over-year basis they were up about 5%, a mid single digits kind of number.

Sir, did that answer your question?

-- your potential for an acquisition you've got a very strong balance sheet now, what areas you might be looking and how large of an acquisition you might be able to make?

First of all you were cut off on this end, so we only got the last little bit of your question. Would you mind starting from the top again?

Your balance sheet is in a great position and you have the ability to do an acquisition if that's what you wanted. Could you talk about what areas you might be looking at and how large of an acquisition you might be able to make?

First of all, your first comment with respect to the balance sheet being in good shape, I totally concur with that. But as a matter of course, we just don't go into any detail around our acquisition plans and so forth. We never have, we just don't think that that's fruitful from a competitive standpoint. I'd like to be able to sit and talk with you about that, but we really can't at this point in time. Although I do understand where the question is coming from. And we'll probably in the course of the year try to find ways to creatively go ahead and help everyone with answers to that question.

Thank you.

Jeff Hammond, KeyBanc Capital Markets.

Good afternoon. I guess on the residential side, Bob, for some time I think to the question of what's the impact on margins from this 13 SEER, you had always kind of stated we think we can hold margins. And you continued that discussion today talking about preservations of margins. I guess from my standpoint and from the industry view pricing is holding up considerably better all be it early as we transition to 13 SEER on this new pricing. Coupled with your confidence that you're executing well the transition relative to maybe some of the competition. If you could maybe speak to that in the context of margin enhancement opportunities in '06 and going forward in general?

First of all, your comment relative to what's happened in the industry, certainly across all last year and so far this year near as we can tell the pricing discipline has been there. And I guess in order to help you with that a little bit, as I look at the design of our products and I look at what has been done from a design standpoint, as I look at what we've done as we've integrated those designs into the manufacturing environment, we've got every reason to believe that we're as effective or more effective in terms of how we're converting material into product for the consumers.

As I, again relying a little bit upon what I think has been a very necessary but heartening discipline in terms of pricing in the industry, looking at the opportunity to probably fill in some places voids at least particularly in the first half of this year that other manufacturers may well have to contend with, I think that we're probably positioned very well to go ahead and not only help ourselves marketshare wise, but also to help the margins a bit.

And again -- I think you would appreciate this, the number of parts that are moving is almost a historical record in terms of all the things that are going into the marketplace. So it really would be a little bit probably presumptive of me to go ahead and stick my neck out too much farther, so I guess I'll leave that to what I said and that was just that we're pretty bullish about what we think we're going to see both in terms of share and in terms of our ability to go ahead and maintain and possibly improve margins.

Okay. And then looking at the SG&A line, it was up slightly as a percentage of sales, and certainly in this robust environment from a demand standpoint I would have expected more leverage on that line. Can you maybe speak to why that was up or you didn't see more leverage out of that line?

You're speaking to Q4 specifically?

Yes.

Well, in Q4 as we look at our expenses, I think there's a couple of different pieces of that that you could look at. Again, our performance continued to improve throughout the fourth quarter and, again, real operating performance and taking away the hedge accounting adjustment that we've been talking about today. And so as our performance continued to settle in higher we did true up all of our accruals for our incentive program as well as our long-term incentive programs that are impacted by that. And so I would say that that's probably the biggest piece of what you're seeing. But again, I don't know that that's a -- I don't think that's a one rate phenomenon, Jeff, as we look at this. It is a matter of what was going on at the time and the impact of our stock price and other things on some of those programs.

Okay. And then I guess finally, back to the share count question. Is it your expectation that share counts continue to move higher or you hold share count flat through share repurchase? Because I noticed this quarter you had purchased a bit of stock and shares still going up on a sequential basis.

We haven't specifically said one way or the other, Jeff, as to whether we were going to attempt to hold the share count flat, but what we did say on the share repurchase is that we were going to make opportunistic purchases of shares and certainly help offset some of the dilution that has occurred, but we didn't give that specific long-term guidance and I think we want to settle back and watch that a little bit and be thoughtful about that type of guidance before we actually are specific about that.

I guess what I'm trying to understand is within your '06 guidance you have to have a share count assumption. So what would that be?

That's not something that we send out to the marketplace and there will be two pieces of that, Jeff, as you try to work your model. I'm not trying to be flip about that, but there's going to be the piece of the averages that come in from the increases in 2005 plus the addition of programs. So you should consider both pieces of that as you develop your model.

Okay, thanks a lot.

There are no further questions at this time. I would like to turn it back to Mr. Schjerven.

Today Lennox International is a different company that we were just a few years ago. Our balance sheet is strong with cash on hand providing an appropriate degree of operating flexibility. Our prospects for continued strength in cash flow generation continue to be very good. Our Company is truly at a new and very exciting point in its history. Our management team is focused on continuing the momentum.

Once again, I apologize for any inconvenience or concern our delay in earnings release may have caused anyone. The accounting for futures contract is complex and we needed to ensure that our treatment in this area was appropriate. The Lennox International team is and I am absolutely committed to transparency and providing totally accurate and reliable financial data. And that you can take to the bank. Thank you and 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.