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Operator
Thank you for standing by and welcome to the Lennox International fourth quarter and full year 2006 earnings conference call. [OPERATOR INSTRUCTIONS]. I would not like to turn the call over to Mr. Bill Moltner, Vice President of Investor Relations. Please go ahead.
- VP, IR
Thank you Mary, good morning. Thank you for joining us this morning for the this review of Lennox International financial performance for the fourth quarter full year of 2006 . In a moment our CEO Bob Schjerven, will highlight some of LII's key accomplishments and comment on management's outlook for 2007. Sue Carter, our CFO will then take you through our financial performance by business segment as well as address some key income statement balance sheet items. In the earnings release we issued this morning, we included the necessary reconciliation of the financial metrics that Bob and Sue will discuss to generally accepted accounting principle measures. We will wrap up today's call ending customary with a Q&A session. You can find a link to the webcast of today's conference call on our corporate web site at www.LennoxInternational.com. And this web cast will be archived and available for replay.
Before I turn the call over to Bob, I would also like it 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 a decline on new construction activity that could depress the demand for our products and services. These risks and uncertainties could cause our actual results to differ materially from those that we express to you today. With that, I would now like to turn the call over to Bob Schjerven.
- CEO & Director
Good morning. 2006 was another record breaking year for Lennox international. We set new record for sales, net income and earnings per share marking LII's financial performance in 2006 as the best in our company's 112 year history. Our total company sales for the year increased 9% to a record $3.7 billion. With all of our business segments achieving growth. Foreign exchange contributed a little bit less than 1percentage point to the top line. Our reported net income was $166 million or $2.26 per diluted share. Adjusting for these nonoperating items that are reconciled in our earnings release our adjusted income from continuing operations for full year 2006 was $160 million or $2.18 per share. This represents a very solid 19% increase over the $1.83 per share earned from continuing ops in 2005.
We generated cash from operations of $200 million and invested $74 million in capital expenditures providing full year free cash flow of $126 million. We invested in improving our core operations notably through the consolidation of operations of our Armstrong and Ducane brands in South Carolina which is expected to provide $12 million in annual cost savings beginning this year. An expansion of our Stuttgart, Arkansas commercial heating and cooling plan to support the continued growth of this business. Our solid cash flow has also allowed us to return cash to our shareholders. In 2006 we used $156 million to buyback almost 6 million shares of LII stock and we returned an additional $31 million to shareholders in the form of dividends. Plus, in December our board of directors voted to increase our quarterly dividend by 18%. Our balance sheet continues to be in terrific shape and we finished the year with a very comfortable total debt to cap ratio of 12%.
Yet, the year was not without challenges making us particularly pleased with the results that we did deliver. Commodity prices continued at historically high levels. The downturn in housing starts and unfavorable heating season weather, depressed demand for home comfort systems. The transition to the new 13 SEER energy efficiency standard for residential air conditioning, presented manufacturing and logistics challenges as it related pre-buy activity made year over year comparisons particularly difficult in the back half of the year. Our businesses met these challenges head on and they performed very well. While we predicted difficult year over year, comparisons in the fourth quarter demand in the residential market was more depressed than we had anticipated.
Certainly unseasonably warm winter weather and the accentuated decline in new construction were factors. Lennox international total revenue in the fourth quarter declined 1% or 2% in constant currency to $862 million. Fourth quarter reported net income was $41 million, or $0.58 per share. Adjusting for nonoperating items income from continuing operations was $33 million or $0.46 per share. This compares with $34 million which also equated to $0.46 per share in the prior year's very strong fourth quarter. The impact of the 13 SEER pre buy on a quarterly comparisons cannot be overstated. And as a point of comparison in the fourth quarter of 2004 our adjusted income from continuing ops was $0.29 per share. Now, 2006 was indeed a successful year. Our accomplishments went beyond our financial results. Let me briefly recap a few highlights. Lennox international was ranked number one among HVAC manufacturers satisfying the needs of our customers in the first ever JD power subcontractor satisfaction study.
Our transition to 13 SEER was executed extremely well and along with a successful push into key sunbelt markets where we are under represented supported the highest market share gain we have achieved in the residential HVAC market in recent years. We introduced two leadership products for the growing indoor air quality segment responding to consumer demands for whole house solutions to common challenges such as mold, mildew, dust mites and bacteria. Lennox Humiditrol is the first fully integrated whole house de-humidification system and the Healthy Climate 16 Media Air Cleaner, is the most efficient air cleaner now available. Service Expert performance continue to improve in 2006. Service Experts, as you heard me say before is a people business. And the investment in our people continues.
We graduated another 18 candidates from our general manager's fast track program and we now have 85% of our 1400 Service Techs NATE certified. By far and away the largest such force in the industry. Consumers tell us it is important that the technicians who come into their homes are trained. We have conducted over 35,000 post sales and installation satisfaction surveys as part of Service Experts standards of excellence program. And the feedback in our efforts is very positive. Our commercial heating and cooling business added 21 new national accounts. And Lennox was named Wal-Mart's construction vendor of the year. We also completed the installation of our commercial regional distribution centers providing us with the necessary distribution footprint to take advantage of replacement market opportunities.
Our domestic refrigeration business has consistently been one of our most profitable units. It has developed an effective product development strategy and a customer intimacy program designed to insure we focus resources appropriately leading to significant share gains in the commercial refrigeration systems market in 2006. As well, we achieved notable profit improvement in Europe and we began to invest in the infrastructure needed to take advantage of the emerging market opportunities in the Asia Pacific region. Before Sue provides a closer look at segment our performance, allow me to comment on our outlook for 2007.
We expect industry unit shipments in the residential heating and cooling market will be relatively flat this year. With replacement growth entirely offset by a decline in new construction. In commercial heating and cooling, industry unit volume is expected to continue to grow. But given consideration to our heavy exposure to retail, our end markets will be relatively flat. Refrigeration demand is expected to increase modestly by a rate in the low single digits. Our guidance assumes continued price improvement and we expect LII total revenue growth to be approximately 6 to 8%. We also expect continued improvement in our company's segment profit margin by 50 basis points or more. For the full year of 2007, we estimate diluted earnings per share will be in the range of $2.50 to $2.60 representing a 15 to 19% improvement over our adjusted 2006 earnings per share of $2.18.
While it has not been our practice to provide quarterly guidance we are seeing a slow start to the year, particularly in a residential businesses compounded by what is likely the last quarter of difficult 13 SEER business comparisons. Consequently we expect Q1 earnings this year could be a bit below those of 2006. With that, let me turn the call over to Sue Carter, our Chief Financial Officer. Sue.
- CFO
Thank you Bob. Good morning. As you just heard Bob describe 2006 was a very good year for Lennox international. Let me begin by providing additional commentary on our business segments results for the fourth quarter. Keep in mind the segment profit includes gains on the future contract for copper and aluminum that settled in the quarter. Revenue in our residential heating and cooling segment decreased 11% to $394 million. Industry unit volumes for both heating and cooling equipment declined by an estimated 37% in the quarter as last year's Q4 got a tremendous boost from 13 SEER pre buy activity.
This made for an extremely difficult comparison. Segment profit decreased to $43 million from $53 million last year. Lower volume was the primary driver of the reduced earnings. On a positive note, price improvement more than offset commodities inflation in the quarter. Favorable 13 SEER product mix was offset by unfavorable mix in the balance of our product sales. Our commercial heating and cooling segment had a very good quarter with revenue advancing 17% in Q4 or 14% adjusted for foreign exchange to $190 million. Segment profit doubled from $10 million last year to $20 million this year. Sales and profitability improved in both North America and Europe, with price improvement more than offsetting material cost inflation In the quarter.
Profitability improvement in Europe was driven by strong volume growth, lower freight cost and the absence of organizational change expenses we incurred last year. Service Experts sales declined 3% to $161 million. But segment profit increased 32% to $8 million from $6 million in the prior year's quarter. A favorable adjustment to our casualty insurance accrual and lower advertising expense drove the profit improvement. Service Experts is benefiting from an emphasis on safety programs and has seen significant reductions in both workers comp and auto claims this year. A combination of price and mix offset lower unit volume in the quarter.
In our refrigeration segment revenue rose 13% to $134 million, up 10% in constant currencies driven by strong sales growth in our international markets. Segment profit declined to $12 million from the prior year primarily due to an increase in environmental reserve accrual in South America. In our refrigeration business we were not able to realize sufficient price improvement to offset commodities inflation in the quarter. Now, let me address some key line items in our financial statements. On our income statement all future contracts relating gains or losses are recorded in the gains losses and other expense line item above the operating income line. In Q4 we reported a pretax loss of $2 million related to futures contracts for commodities. This amount consists of $14 million in pretax gains on futures contracts for copper or aluminum that settled in the fourth quarter. This amount represents the gains since the inception of the contract and material related to these contracts was received in the quarter.
The remaining $16 million pretax loss, primarily represents net unrealized losses on open future contracts that were mark to market and includes an offset for the gains reported in prior periods for contracts that settled in Q4. In the fourth quarter we renewed our hedging activity initiating new cash flow hedges for copper. As a reminder were using fixed forward contracts for aluminum and economic hedges for copper in our international locations. It is our intention to use a banding strategy that hedges these commodities as far out as 18 months with hedge coverage decreasing the further out we go. With banding strategy commodities are routinely hedged to a minimum level with incremental hedge coverage dependent on commodity price fluctuations. Fourth quarter restructuring charges of $3 million related to our consolidation activities in South Carolina were offset by a gain realized from sale of property from a previously announced restructuring project.
In the fourth quarter cash from operations was $115 million. During the quarter we invested $24 million in capital expenditures resulting in free cash flow of $91 million. Our total capital expenditures were $74 million in 2006 and we project our capital expenditures in 2007 will be approximately $80 million. This spending includes investments related to projects initiated in 2006, namely out commercial heating and cooling plant expansion and the consolidation of two step residential heating and colling operations into South Carolina, investments to support new products and several IT projects. Our working capital ratio is a percentage of trailing 12 months sales with 17.1% as we predicted a year ago this level was somewhat higher than the 16.5% at the ends of 2005, as we made a conscious decision to add inventory to insure we provide the service levels important for our customers. Corporate expense in the quarter was $1 million higher. Lower incentive compensation costs were more than offset by higher cost for group and liability insurance and other personnel costs.
Before we open the call to your questions, let me address our taxes in the quarter and changes we made in GAAP accounting. First with regard to tax. We recorded an $18 million benefit from the release of tax contingencies established in prior years and the re-valuation of deferred tax asset evaluation allowances. The benefit of this $18 million was excluded from our adjusted results. Looking ahead to 2007, we expect a normalized effective tax rate for our company will be in the range of 36 to 37%. Our results for the fourth quarter and full year 2006 reflect LII's adoption of staff accounting bulletin 108, which considers the effects of prior year misstatements when quantifying misstatements in current year financial statements.
Accordingly we reduced opening retained earnings for 2006 by $12 million to reflect understatement in warranty cost accruals caused by misstatements that occurred in prior years primarily for products no longer in production. The adoption of SAB108 also resulted in $4 million increase in net income for the second quarter of 2006, over the numbers previously reported. Adjusted quarterly financial statements for 2006 are included in the press release we sent out this morning. This SAB 108 adjustment do not affect cash flows and the impact on prior years results was concluded to be immaterial.
Finally, as Bob mentioned, we ended the year with a total debt to capitalization ratio of 12%. We achieved this level despite a $24 million reduction in equity resulting primarily from the adoption of SFAS158, which addresses employers accounting for defined pension and other post retirement plans. That concludes our prepared remarks for today's call. At this point we would be pleased to address any questions that you may have.
Operator
[OPERATOR INSTRUCTIONS]. And our first question comes from the line of Mr. Curt Woodworth from JPMorgan, please go ahead.
- Analyst
Yes, hi, good morning.
- CEO & Director
Morning, Curt.
- Analyst
Bob, can you elaborate a little bit on your margin guidance, you know, for 2007 looking up 50 basis points. If you isolate just the 12 million, pretax benefit you get from the consolidation of the two step brand that gets you roughly 30 basis points for the total company. I'm just wondering what do you see as the other drivers there, is it getting more pricing or cost savings in Europe, what are the other key components you're looking at to get there.
- CEO & Director
Curt, I guess the first thing I would say is what we're experiencing, what we're anticipating is the realization of the things that we laid out for everyone in our November session that we had in New York. We call it Investors Day. There are numerous things that are spread throughout the corporation inside each one of the business segments, as well as focus on efficiency and other nonoperating areas as well that we see coming to fruition. As you know we have for the past five years or so, focused diligently on financial stewardship of the company and construction of a strong billion sheet which gives us a lot of flexibility going forward allowing us not only to look at things organic, but also to look at funding important things inside, which we have been doing. And so probably ill advised of me to pick any one thing to the exclusion of others. Certainly there will be a combination of things going in both directions as we consider pricing activity, as well as, commodity movement, none of which any of us can really predict at this time, but we think we're well positioned to deal with all of those.
- Analyst
Okay. In terms of the organic growth outlook for the business, you commented residential would be flat. I think you said the commercial market would be flat, only exposure to retail. But within the context of some price improvement and taking market share, do you still feel like you can grow, within your targeted 6 to 8% range in both those segments for the year?
- CEO & Director
Absolutely.
- Analyst
Is it mainly a function of market share or price?
- CEO & Director
I would say it's probably more market share than price, but it would certainly be both of those, revenue dollars.
- Analyst
Okay. Last question, can you give guidance for Cap Ex as well as is corporate expense for 2007?
- CFO
Sure, Curt. The Cap Ex guidance that we gave for 2007, it would approximate $80 million, up from the $74 million this year. And the expenses contained within corporate are expected to be relatively flat for 2007.
- Analyst
Great, thank thank you much.
- CEO & Director
Thank you Curt.
Operator
[OPERATOR INSTRUCTIONS]. And our next question comes from the line of Andrew De Angelo, with Key Bank Capital Markets, please go ahead.
- Analyst
Hi, good morning.
- CEO & Director
Morning, Andrew.
- Analyst
Just on the view of guidance, I guess looking a little bit more near term, if you could talk about the inventory position that you guys have within your retail or residential operation and the two step comparison within the context of the first quarter, kind of look at modeling the residential heating and cooling business.
- CEO & Director
I'm not sure I'm going to give you the answer you're looking for specifically, but let me just first of all remind you of one thing and that the majority of what we do on residential side is the one step business where we deal directly, distribute product directly to dealers as opposed to the two step side which is more convention, going through independent distribution. Obviously, I can't speak to the latter, but certainly speaking to the former, I guess I'll tell you it's pretty much the same scenario we have had before, that is on the residential side those inventories are well under control and we have had questions on previous calls relative to inventory and so forth like that hanging about. The fact is we never had an are great deal of that as perhaps contrasting with other folks simply because of the policy we adopted going into 13 SEER. At this point in time those things are quite normal. What is of course different, when you look at inventories in terms of dollars, a couple things. You have certainly the effect of higher cost product, 13 SEER verses 10 for example. You have the additional embedded cost of the product which are significant because of the commodity it increases. And then also that same would hold true of factory inventories, raw materials and so forth. Costs are higher than they have been heretofore because of the cost of raw materials. But from a normalized perspective, I'd say that we feel pretty confident. The other inventory piece that we had commented on before was in the area of commercial heating and cooling. And that of course was a very well executed and predetermined increase in inventory as we made product more available through these regional distribution centers that we have established for our Inn roads we're making into the replacement market. There is nothing there that is in any way out of line or outside of normal.
- Analyst
Great, that's helpful. And just on the commercial piece, I know you talked about the kind of normalization of the retail environment within the context of commercial H VAK, is that something that you have seen thus far or just anticipate based on discussions in the marketplace?
- CEO & Director
Well, we certainly are close to the individual plans that our retail folks have that are out there. So that's certainly perspective to a certain extent. Then the other thing that is just a fact is the very nice large share of our business, which in fact is in the national account area. So, it's a combination.
- VP, IR
Andrew, Bill Moltner here, if you look at the forecast from the, Dodge and such, you will see that it is basically consistent with that story where the retail piece of commercial is forecast to be softer than the balance.
- Analyst
Okay. But suffice to say it doesn't sound like that's something that you have seen thus far, it's more perspective in nature.
- CEO & Director
I guess it's maybe largely. I guess I wouldn't want to put my thumbs on the table for that, because I haven't got the instantaneous access that the folks in the front lines would have. But we certainly see that as being real.
- Analyst
And then just in view of 2007, what is the commodity head wind that you guys anticipate and then the offsets to that,in terms of price and the different hedging strategies that you guys are working on, if you could just maybe comment on the gross head wind with respect to the commodities and then, some of the offsets that you guys anticipate.
- VP, IR
Andrew, we are anticipating commodities to be a head wind next year, however we are anticipating that we will overcome that with price and depending on what commodities do, it's a very dynamic marketplace out there. Price is one of the tools that we have to combat it and we have a number of price increases that were instituted that will continue to provide price improvement benefit next year even if we don't take further pricing action. At this point in time when we look ahead commodities will be a head wind, but we have got the pricing in place to address it.
- Analyst
Okay. When you say a head wind is that on a net basis?
- VP, IR
That's on a gross basis.
- Analyst
Okay.
- VP, IR
The price increase address is basically our way of mitigating it.
- Analyst
Absolutely. Just lastly, could you guys maybe comment on the succession plan and the schedule therein, are you guys on track I guess? Any update there would be helpful.
- CEO & Director
Well, we have got the process in place and definitely on track. We have a committee of outside directories who are I think working very effectively on this. I am part of that committee, I can tell you that yes we are very much on plan. I'm very pleased with the progress to date.
- Analyst
Bob, I guess as you reflect on your ten year at Lennox, what are some of the things that perhaps, have been some of the bigger gains in terms of competencies built versus maybe right now as we stand some of the things that as you look out the company needs to work on, just in the context of as we kind of think about your eventual replacement, what type of person and what type of competencies they would need to bring to the table?
- CEO & Director
Will with, first of all with respect to your first question I think that the company has done admirably well on a number of fronts. The more visible would be taking a company in January of 2001, that while a lot healthy in many respects had a balance sheet that was over leveraged and whose asset base had a number of things that weren't really producing and contributing. The Management team has done an excellent job at focusing our company on things that are really the future. In the process of prosecuting those things, did what we call clear the decks. But in parallel with that, added a level of sophistication around appreciation for cash flow and stewardship of cash and cash assets that perhaps was not present before. And of course all that is not resident in the very strong management team at multiple levels in the company that is Lennox International. As we stand here today we have extremely exciting strategies some of which we shared with everyone in November, that are being executed as we speak. So I would say that on a go forward basis, it's critical that we continue to prosecutor those strategies in an aggressive manner and that we don't take our eye off the ball, in things like capital stewardship and so forth that we certainly know how to do well. We serve in many cases, markets that are mature. And our ability to execute on the things that we say in the marketplace we're going to do has been well proven. And as a result we have a slate of products that are technologically I feel the best and I think market share gains and other indications such as the JD power review, indicates all this is working well. So I would say that we have got to a company today that has every reason to be very bull'ish about and that the real task will be to continue to execute and to continue to go ahead and take each one of those businesses and move them forward, with the strategies that have been laid out.
- Analyst
Great, thanks a lot.
- CEO & Director
Thank you.
Operator
And our next question comes from Line of Mr. Michael Coleman with Sterne Agee. Please go ahead.
- Analyst
Thank you and good morning.
- CEO & Director
Good morning, Michael.
- Analyst
What does the price realization in the quarter on the residential side?
- CEO & Director
We will see if we can come up with something.
- Analyst
Wells unit volume.
- VP, IR
If you look at our residential volume combined with down a little more than 20% and price was up in the high single digits.
- Analyst
Okay. And you mentioned that you felt your market share had improved as a result of the actions you have taken in the key sunbelt states. What would be your estimate of residential market share today?
- VP, IR
Michael, actually there's a combination of factors that contributed to the market share growth in the sunbelt, an important contributor but also our effective execution of the 13 SEER transition contributed as well. And the market share gain is one of the most significant that we have ever seen, but we don't give specifics on exactly what that market share gain is.
- Analyst
Okay. The gain from the 13 SEER transition which may have come as a result from a stumble from a competitor, I mean would you expect to maintain that market share or is that something that would revert back it to more historical normal levels?
- CEO & Director
Well, we would certainly expect to maintain that, because if you look now certainly I think everyone's difficulties that they had during the course of 2006 and the transition, should be pretty much history. And we continue to have very strong performance with respect to the new customers, new accounts that we have picked up. And, you know, sometimes when people change they may change for one reason, then realizing the strength of the organization and backed with the excellent products that we have, remain part of the Lennox family because of that relationship and the advantages that they perhaps heretofore have not seen.
- Analyst
Okay. Great. And in November you talked about increasing distribution points, and I'm just kind of wondering where are you in the process. I think if I heard right that you're going to have something like 70 distribution points. A, is that correct and B, you know, where are you today on that?
- VP, IR
Yeah, Michael we don't have a meaningful update for you on the initiative that Doug Young talked about in terms of the new distribution strategy for our residential business it's an initiative that will be undertaken in 2007. So we look forward to reporting on it as the year progresses.
- Analyst
Okay. So my understanding is that was coinciding with your push into the sunbelt or is that separate?
- CEO & Director
They're separate, but occurring on a parallel basis.
- Analyst
Okay.
- CEO & Director
They're not co-dependent in other words.
- Analyst
Right, okay. And do you have in terms of the copper and aluminum hedges, do you have an estimate of what percent you're hedged over the next 12 months on each of those.
- CFO
Sure. We're looking at as we said we're doing a banding strategy on the hedging that looks out over the next 18 months. Because of what we're doing, we're not going to give specific guidance on the different items, but the banding strategy again, as you get closer to the month in question is at a higher rate and lower as you go out moving forward.
- Analyst
Okay. So on a blended, would you be more than 50% hedged on those comoditites over the next 12 months or would it be under 50%?
- CFO
I think the banding strategy would take you to the at least the 50% level as you look at it going out over that period. And we did have some 2007 hedges as you may have noticed in the transcript, we did have some losses as copper started to come down, we did have some 2007 hedges that were done, that are economic hedges that were done in 2006.
- Analyst
Okay. You mentioned that the first quarter, the first quarter would be down on a year over year basis. Which of the three remaining quarters given the push to the back half of the year, the concentration and earnings in the back half of the year, which of the three would represent kind of a difficult comparison?
- CEO & Director
I don't know that any of the back three. The first quarter, the quarter that we're currently in is the quarter that's the difficult one because of course if you go back 12 months you saw a lot of activity around pre-buy and around the transition. Industry revenues were high, revenues were high. Quarter to quarter comparison for the first quarter that's a difficult one. That's compounded by the fact when you look at residential new construction it is certainly down. And while everyone , the pronosdictators are predicting that we are going to see that thing fall at the end of Q2, Q3, and things start to get better, it certainly is with us at this point. The winter weather, as a lot of people know, has suddenly become very normal, but certainly up until recent weeks it has been warmer than usual. So, I talk to many people that observe the industry who are players and participants, what we see in the first quarter this year it is not as robust as it might be, but when compared to the very strong first quarter of 2006 for the reasons we just discussed, you know, it's going to be a tough comparison.
- Analyst
Okay. Thanks. One last thing, you purchased 6 million shares of the 10 million authorized, what are the intentions in terms of the next year with respect to the remaining 4 million shares on that buyback ?
- CFO
Well, we will resume our share buyback program. We're going to continue to do that under the open market purchase program or the 12 B 18 program that we had done before which provides for a maximum of 25% of average daily trading volume over the previous four weeks. But we will resume that and we're looking to acquire more of those shares.
- Analyst
Okay, great. Thank you, very much.
- CEO & Director
Nice talking with you Michael.
Operator
And we have a follow up question from Mr. Curt Woodworth with JPMorgan, please go ahead.
- Analyst
Yeah, hi, thank you. Can you tell me what your commodity head wind was on a net basis for 2006, if there was one?
- VP, IR
There wasn't one.
- Analyst
There wasn't one, okay. And then in terms of the restructuring costs that you incurred for the two step division, what was the net impact of that for the year?
- CEO & Director
Good question, give us a moment.
- CFO
Yeah.
- Analyst
And I guess in the context of the 12 million in savings you expect this year is that essentially assume or a reversal of that expense and then actual savings or is that just a total gross figure from the consolidation?
- CEO & Director
The $12 million is run rate savings on an annual basis. So, we will see from an operating basis the $12 million improvement versus last year and previous years.
- CFO
Okay. So the restructuring was about $16 million of pretax in 2006.
- Analyst
Okay. And that was run through the operating number you have reported, right?
- CFO
Yes, it was.
- Analyst
Okay. And last question, for the commercial business in Europe, you talked about improved profitability there, can you give us a sense where margins stand today, maybe what a run rate level you envision for 2007?
- CEO & Director
Well, when you look at the European market, we see it's been relatively tepid, [Inaudible] those run rates in what we achieve is certainly a function of volume of where you are at.
- VP, IR
For the full year Curt, the business is profitable and so it's moved in the right direction. With initiatives that Harry Bizios just put in place there we expect the progress to continue.
- Analyst
Okay. You're saying that the margins were about break even.
- VP, IR
Right.
- Analyst
So I'm just wondering kind of maybe where you finished the year?
- VP, IR
Modestly better than that.
- Analyst
Okay. And do you think like a 5% target is reasonable for 2007 or what, what's the goal to get a handle for what you're doing there to improve the margins and what's realistic?
- CEO & Director
Definitely, still in the low single digits.
- Analyst
Okay.
- CEO & Director
One of the things when you see operation as you improve them, as you move to break even, trim line or vector that shows that gradual improvement, when you're close to break even you are still very dependent upon volume. If you tell me more about how that market is going to go, I'll give you all the answers.
- Analyst
And is it fair to say if I was to eliminate that 16 million of charges for the two step brand, that that would be a more accurate reflection of the operating margin for the residential business this year?
- CFO
No. I think what you should think about, Curt, when you think about the restructuring cost that is in the net income number, but it is below the adjusted earnings that you're looking at in the segment profit. So it's not in the segment profit. So the segment profit is already comparable.
- Analyst
Okay. So it would show up in the other income line?
- CFO
Below operating earnings, so it's net income.
- Analyst
Okay, Thank you very much.
- CEO & Director
That's a 12 million improvement is in operating income.
- CFO
Absolutely.
- Analyst
Okay. Thank you.
- CEO & Director
Okay. Great, thanks.
Operator
And we have no more questions in cue at this time. I would like to turn the conference back over to our host.
- CEO & Director
All right. Thank you Mary. Lennox International has established a positive earnings growth trend where we have identified a number of opportunities in each of those businesses that will allow us to continue to grow and build shareholder value. We expect that our 2007 earnings per share will be in the range of $2.50 to $2.60 which represents a 15 to 19% increase over the adjusted EPS earned in 2006. Thank you for your questions and taking the time to be with us this morning. Good bye.
Operator
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.