Lennox International Inc (LII) 2007 Q3 法說會逐字稿

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  • Operator

  • Good morning, ladies and gentlemen.

  • Thank you so much for standing by, and welcome to the Lennox International third quarter 2007 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.

  • Instructions will be given at that time.

  • As a reminder, this call is being recorded.

  • I would now like to turn the conference over to Ms.

  • Karen Fugate, Vice President of Investor Relations.

  • Please, go ahead.

  • - VP, Investor Relations

  • Thank you, Michael.

  • Good morning.

  • Thank you for joining us for this review of Lennox International's financial performance for the third quarter of 2007.

  • I'm here today with Todd Bluedorn, our CEO, and Sue Carter, our CFO.

  • Todd will review highlights for the quarter, and Sue will take you through the company's financial performance.

  • In the earnings release we issued this morning, we have included the necessary reconciliations and the financial metrix that will be discussed to generally accepted accounting principle measures.

  • You can find a direct link to the webcast of today's conference call on our corporate website at www.lennoxinternational.com.

  • We'll archive the webcast on that site and make it available for replay.

  • I would also like to remind everyone that in the course of this call, to give you a better understand of our operations, we would 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 recent 10-K filing 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 possibility that a decline in new construction activity will depress the demand for products and services.

  • These risks and uncertainties could cause our actual results to differ materially from those we express to you today.

  • I will now turn the call over to Todd Bluedorn.

  • - CEO

  • Thanks, Karen.

  • Good morning, everyone.

  • We had another busy quarter and executed on several key initiatives.

  • I'll talk more about that in a moment, but first, I would like to cover our financial performance.

  • Our results are strong, led by operational discipline across the company.

  • We are pleased to end the quarter with robust cash flow and double-digit earnings growth, reflecting strong performance and execution.

  • Similar to last quarter, three of our four business segments had both strong top and bottom-line growth.

  • And despite weak housing market and soft replacement market, our residential business delivered solid year-over-year growth.

  • Total company revenue grew 1% to reach $1.03 billion.

  • Revenue growth was hindered by a 9% decline in the residential business but offset by double-digit growth in commercial and refrigeration as well as favorable FX.

  • We made headway in reducing cost across the company through discretionary spending, manufacturing and SGA, which, on a percentage of sales, was down 80 basis points.

  • As we head in to 2008, we will continue our focus on cost-reduction opportunities.

  • Before I move on, I would like to briefly comment on the landscape of the North America HVAC market.

  • The well-publicized softness in the residential market continued in the third quarter, and recent market data implies new house starts will likely end the year down in the mid to high 20s.

  • The replacement market also remains soft primarily due to unseasonable weather and the overall economic environment.

  • On the commercial side, the latest economic data suggest there is headwind in retail construction, and this is having an impact on some of our major national account customers, leading to deliveries being pushed out to 2008.

  • That being said, our backlog and order book remains solid, and we are realizing pricing and share gains.

  • Despite the headwinds in the market, our businesses continue to show operational and cost discipline, as demonstrated by our results.

  • We will closely monitor these market trends and aggressively reduce costs across the company.

  • With one quarter remaining in the year, we are maintaining our full-year GAAP earnings per share guidance of $2.40 to $2.50, albeit, the impact from the weak housing market will likely put us at the low end of the range.

  • We now expect full-year revenue growth of 1 to 2%, versus our previous guidance of 2 to 4%.

  • Before I hand it over to Sue, I'm going to cover a couple of recently announced initiatives.

  • First, we made progress in rationalizing our manufacturing facilities.

  • In early September, we announced plans to close our Hearth Products operations in Lynwood, California, and consolidate Manufacturing operations in Union City, Tennessee.

  • We expect annual pretax cost reductions of over $2 million starting next April.

  • Most recently, we announced plans to close Refrigeration operations in Danville, Illinois and consolidate these functions in other facilities.

  • We expect annual pretax cost reductions of over $6 million, beginning in 2009.

  • Although these decisions are difficult, they are necessary to improve our competitiveness.

  • And lastly, we began execution on the stock repurchase plan we announced last quarter.

  • As of September 30th, we completed 21% of the $500 million plan.

  • I'm confident we will complete this plan by third quarter of 2008.

  • Finally, we have scheduled an analyst event in New York on December 12th, and we'll discuss our strategic focus and provide an outlook for 2008.

  • You'll hear further details in the upcoming weeks.

  • To sum up the quarter, we ended with strong results, double-digit earnings growth and robust cash flow.

  • We held our full-year GAAP guidance of $2.40 to $2.50, albeit, at the low end of the range.

  • We continued our focus on reducing cost structure and made headway in SG&A and manufacturing costs, and we actively executed on the stock repurchase program, keeping us on target for a third quarter '08 completion.

  • Now, I would like to turn the call over to Sue.

  • - CFO

  • Thank you, Todd.

  • Good morning, everyone.

  • Lennox International delivered strong earnings and cash flow for the third quarter.

  • Revenue was $1.03 billion, up 1% over prior year, with foreign exchange contributing 2% to sales growth.

  • Our adjusted net income was $65 million or earnings per share of $0.94, compared to $50 million or $0.69 earnings per share in the third quarter of 2006.

  • Adjusted net income results exclude net adjustments of $4 million, which includes $2 million from the facility closure and consolidation in the Hearth Products business, $1 million from the elimination of an executive position, and $1 million from the net change in unrealized losses and open futures contract.

  • On a GAAP basis, net income was $61 million or earnings per share of $0.88, compared to $36 million or $0.49 diluted earnings per share in the year-ago quarter.

  • Year-over-year earnings per share improvement was driven by cost reduction initiatives in SG&A and manufacturing and pricing, which more than offset commodity costs.

  • Share repurchases contributed $0.07 in GAAP EPS.

  • Cash generated from operations was $116 million, and the company invested $20 million in capital expenditures for a strong free cash flow of $96 million.

  • During the quarter, the company purchased 3,026,100 shares of LII stock, representing 21% of the $500 million share authorization.

  • And, finally, we ended the quarter with total debt as of September 30th, 2007 of $161 million, resulting in a total debt to capital ratio of 16%.

  • Now, looking closer into our Business segment results for the third quarter.

  • Our Residential Heating and Cooling business reported solid operating results despite continued weakness in new construction and softness in replacement.

  • Revenue was down by 9% to $456 million, driven by volume decline of 15%.

  • As a reminder, the Hearth Products business is disproportionately impacted due to its exposure in the residential new construction market.

  • Product mix in the Residential business was favorable by 2%, and price improved by 4%.

  • Price more than offset commodity costs and contributed to year-over-year improvement in gross margin.

  • Segment profit for the Residential business was $64 million, a margin of 14% versus $53 million, a margin of 11% in the year-ago quarter.

  • Profit grew by 19% due in part to operational efficiencies and cost-saving initiatives.

  • If you recall, last year's quarter included a lag in pricing, which did not offset higher commodity costs, and in addition, we had manufacturing and logistic inefficiencies associated with our South Carolina consolidation activity.

  • This consolidation is yielding positive returns in 2007.

  • Sales in our Commercial Heating and Cooling segment were $255 million, up 12%, with favorable foreign exchange contributing 3% to that growth.

  • We realized price of 6% and favorable product mix to our new high efficiency rooftop units of 3%.

  • Even though several large customers pushed deliveries to 2008, we made up a proportion of this volume through sales to new national accounts, leading to flat volume in the quarter.

  • Total segment profit in the commercial business increased 47% to reach $38 million, a 15% margin.

  • Year-over-year earnings growth was driven by cost savings in price, which more than offset commodity costs.

  • Our Service Experts business performed well on the top and bottom-line.

  • Sales increases $10 million or 6% to reach $184 million.

  • Segment profit was $9 million, a 21% improvement, and profit margin was 5%.

  • This performance was driven by a favorable mix shift to the higher margin Service and Replacement business and by a strong Canadian market.

  • In our Refrigeration business, revenue grew 15% to $158 million, driven by growth in our international businesses and favorable foreign exchange.

  • The 15% sales increase consisted of 5% volume growth, 4% in price, and a 6% benefit from foreign exchange.

  • Segment profit for the quarter was $18 million, for a year-over-year growth of 29%.

  • We continued to address cost-reduction initiatives and most recently announced plans to close our operations in Danville, Illinois.

  • As a result, we expect annual pretax savings of $6 million, beginning in 2009.

  • On October 10th, we renewed and amended our revolving credit facility for $650 million, an increase of $250 million from the existing credit facility.

  • The additional capacity provides LII flexibility for operating capital and share buyback, as the company typically uses cash in the first half of the year and generates cash in the back half of the year.

  • We believe the confidence this group of lenders has in our company is affirmation of our business objectives, and stability and the use of additional capacity will enhance the capital structure of LII while improving shareholder returns.

  • Now, turning to outlook.

  • We are maintaining our full-year GAAP guidance of $2.40 to $2.50.

  • However, the weak housing market likely will put us at the low end of this range.

  • We now expect full-year revenue growth of 1 to 2% versus our previous guidance of 2 to 4%.

  • Capital expenditures are expected to end the year in the range of $75 to $80 million.

  • That concludes our prepared remarks for today's call.

  • And at this time, Todd and I will address your questions.

  • - VP, Investor Relations

  • Michael, we're ready to take questions.

  • Operator

  • Thank you, ladies and gentlemen.

  • If you wish to ask a question, please press the star followed by the 1 on your touch-tone phone.

  • You'll hear a tune indicating you are in the queue.

  • If you did press the star followed by the 1 prior to this message, we ask that you please do so again at this time.

  • You may withdraw your question from the queue at anytime by pressing the star followed by the 2.

  • Also if you are using speaker equipment today, please lift up the handset before pressing the numbers.

  • Once again, if you would like to ask a question, please press the star followed by the 1 at this time.

  • Just one moment, please, for our first question.

  • Our first question is from the line of Curt Woodworth with JPMorgan.

  • Please, go ahead.

  • - Analyst

  • Yes.

  • Hi.

  • Good morning.

  • - CEO

  • Hi, Curt.

  • - CFO

  • Good morning, Curt.

  • - Analyst

  • I kind of understand the year-on-year improvement that you saw on the margins for the Residential business, but I would like to have a little bit more color on, sequentially, how you were able to get margins up pretty dramatically despite the fact that your revenues were about $40 million less than they were in the second quarter.

  • So, you know what I mean?

  • There appears to be a pretty significant change in the underlying profitability of that segment at 14% margin, which I think is close to a record for that business segment.

  • So, can you kind of walk through some of the moving pieces there, sequentially?

  • - CFO

  • Sure, Curt.

  • As you look at the difference between the second quarter and the third quarter and the dollars that are associated with that -- let me sort of baseline that first.

  • You are talking about a difference of, perhaps, you know, $4 million in improved margin, again, from the second quarter to the third quarter.

  • And as we look down through a P&L for the Residential business, there are a lot of things that went right for us.

  • Our expenses -- as you know, we have been focused on cost control in all of the different areas, and so as we look down through, our freight was favorable.

  • Our commissions, unfortunately, because of the volume, were favorable for us.

  • And then you get into several small-line items, whether it's advertising, whether it's our employee incentive programs, all of those were favorable on a quarter-over-quarter basis, and part of that is we just had good performance in the quarter.

  • We're watching our costs, and we have got everything baselined for the lower revenue, and so there's no one specific item.

  • It's a lot of small items that added up to very good margin performance for the business.

  • - Analyst

  • Okay.

  • And so you simply just saw an acceleration of those measures sequentially in terms of --

  • - CEO

  • Price cost.

  • - CFO

  • And well, and -- that, and as we looked at our pricing, our pricing on -- continues to be ahead of what our commodity costs are also, which contributes to that.

  • - Analyst

  • So, I mean, in terms of the sustainability of this type of cost performance and a pretty tepid demand environment, do you feel comfortable saying that that type of margin rate under this base level of sales is kind of where you'll be going forward?

  • Or do you feel like you had some what I would call temporal benefit from a beginning ahead of the cost serve this quarter on price?

  • - CFO

  • I think we got ahead of the cost curve.

  • I would say that there are some discretionary items included in that, which don't continue to repeat.

  • But, again, our focus is on those costs, and as we look forward, I don't expect everything to go in the right direction in every quarter, but certainly we're very happy with the performance that we saw.

  • - Analyst

  • And what do you think that the magnitude of the price cost dynamic -- what kind of benefit do you think you got this quarter?

  • I mean, was that the kind of the discretionary items that you just mentioned?

  • - CFO

  • No.

  • The discretionary type of items that I was talking about were things like travel and headcount and things like that.

  • - Analyst

  • Okay.

  • - CFO

  • The price cost -- obviously, the price is cumulative, as we look at it.

  • It didn't have a significant impact on any one of the businesses, but we are continuing to outpace commodity cost increases with a combination of price and with our hedging activities.

  • - Analyst

  • Okay.

  • And maybe a question for Todd.

  • In terms of cost opportunities going forward, where do you see the most opportunities in the business?

  • I mean, it seems like, obviously, SG&A, you still have a fair amount of opportunity there.

  • You kind of made some restructuring announcements on the Hearth Products side and now on the Refrigeration side.

  • So, maybe just kind of provide a little bit more insight in terms of where you guys are really going to get aggressive going forward.

  • How should we think about cost opportunities?

  • - CEO

  • I think all of the areas you talked about, we still have opportunities in front of us, Curt.

  • On the SG&A side, we were down 100 basis points last quarter versus 2nd quarter in '06.

  • We were down 80 basis points this quarter versus last year.

  • We still have opportunities in SG&A even at the 20%-ish that we're at now.

  • And we know that.

  • We're focused on that.

  • On product costs, we have 28 factories in Lennox International with the announcements this quarter.

  • We have a path to 26 -- That's still too many.

  • And we're focused on where the right investments are to be competitive and drive down our costs.

  • We announced the assembly factory in Mexico last quarter.

  • We've broken ground on that facility.

  • We continue to move forward on our Mexico plan to get low-cost sourcing -- excuse me, low-cost assembly.

  • And then the third piece of factory -- or of product costs are low-cost sourcing of our components.

  • And we continue to make investments and grow the portion of our [spend] that we get from Eastern Europe and Asia.

  • So, I think it's opportunities across the front on cost reduction, and it's the real focus of our company.

  • - Analyst

  • Okay.

  • And one last question.

  • In terms of the buyback, you pretty much committed to spending the remaining 400 million over the next four quarters to complete the buyback, which is great.

  • But are there -- should we infer from that that acquisitions probably aren't going to be a priority over that near term, that the use of cash and capital is going to go to the buyback?

  • - CEO

  • No, I don't think I would infer that.

  • I think what I would infer is that we have absolutely committed to the stock buyback, and we will do what we said we're going to do in terms of having it done by Q3 '08.

  • I would also conclude from raising our revolver from 400 to 650 that we have powder, along with our existing balance sheet, to make other investments as the company sees fit, whether that's additional investments in our business or acquisitions that make sense.

  • And as I've said in the past, acquisitions that can make sense for us would be in the businesses where we have a strong position, which is our North America HVAC, both commercial and residential, as well as our refrigeration business, doing an industry-consolidating acquisition, or doing a geographical expansion where it makes sense for refrigeration.

  • Those are all on the table for us.

  • - Analyst

  • Okay.

  • Great.

  • Thank you.

  • - CEO

  • Thanks, Curt.

  • - CFO

  • Thank you.

  • Operator

  • Our next question is from Jeff Hammond with the KeyBanc Capital Markets.

  • Please go ahead.

  • - Analyst

  • Hi, good morning.

  • - CEO

  • Hi, Jeff.

  • How are you?

  • - Analyst

  • Doing well.

  • Hey, just wanted to get behind the guidance a little bit.

  • I know you present guidance on a GAAP basis, and it just seemed on this quarter on an operating basis that the results were much better certainly than my model.

  • And I just want to understand the moving pieces within guidance.

  • How you are thinking -- if there is a way to talk about how you are thinking about operating EPS now versus three months ago?

  • And what you are contemplating within the GAAP EPS in terms of restructuring charges now versus three months ago having announced some additional restructuring?

  • - CFO

  • Jeff, as we look at it, when we gave guidance in July and had the $2.40 to $2.50, that guidance did not include the Hearth restructuring or the announcement of the Danville facility for the year.

  • What we typically do, and I think it's good practice, is we do not include anything in our guidance until we have Board of Directors' approval to move forward, and we have an announcement.

  • So, the difference that you saw in the third quarter is we made a very concerted effort, again, looking at our costs, to cover the cost of that restructuring through operating results.

  • And we were able to achieve that in our, again, based on good performance in all of the businesses.

  • And then as I look at the fourth quarter, the big item in the fourth quarter is the Danville restructuring and a small additional charge on the Hearth products piece.

  • And those will be on a pre-tax basis about $8 million in the fourth quarter.

  • - Analyst

  • And that's incorporated in to the guidance?

  • - CFO

  • Yes, it is.

  • - Analyst

  • And you had 2 million this quarter from Hearth, is that correct?

  • - CFO

  • Yes, there was 2 million from Hearth, and then 2 million from -- of other -- there was $1 million in the executive arena.

  • And then there was the $1 million from the losses on hedging.

  • - Analyst

  • Okay.

  • So, I guess you continue to cite residential as kind of the driver of your lower end of the guidance range.

  • But I guess if you step back, it seems like your restructuring costs are 10 million higher, and you are only reducing your guidance effectively from the midpoint to the low end by $0.05, so it seems like the restructuring, which I view as one time, is more the driver than maybe the residential.

  • - CFO

  • I think it's both, because as we go through, Jeff -- and I know this is hard to see when you are trying to look at a model -- but what we're doing is we're driving the cost side of the business at the same time that we're announcing the restructuring projects.

  • And so the focus is on the balance of those two items.

  • And so to us, it's not only the restructuring piece, but it's also that focus on cost to see how much of that non-recurring that we can offset through our operating results.

  • - Analyst

  • Okay.

  • And then, couple of questions on commercial heating and cooling.

  • Can you just talk about order trends in the quarter both internationally and domestically?

  • And then, maybe just a little more color on the pushouts?

  • I mean, what's the confidence that those are pushouts versus cancellations?

  • - CEO

  • Yes.

  • Let me -- Hi, Jeff.

  • This is Todd.

  • Let me talk first about domestically on commercial HVAC.

  • The latest economic data suggest that there's headwind in retail construction, and this is having some impact on some of our major National Account customers leading to some of the deliveries to be pushed out to 2008.

  • And right now, we just believe it's a pushout, not a cancellation.

  • That being said, our back log and order book remained solid, and we're realizing pricing and share gains.

  • In fact, so far this year we've added 26 new national accounts that represent a wide diversity of market segments including restaurants, theaters, convenient stores, as well as our traditional small and large box retailer focus.

  • So, that's sort of the view on the North America commercial market.

  • Europe continues to be up over last year for us both in sales.

  • And we think we're gaining a little bit of share in Europe.

  • - Analyst

  • Okay.

  • And you are happy with the progress on the cost side in Europe?

  • - CEO

  • I'm never happy with the cost side -- certainly not in Europe.

  • I think we have put together a plan to focus on costs in Europe as we have in the rest of our company.

  • And in the succeeding quarters, we'll talk about the actions that we're taking.

  • - Analyst

  • Okay.

  • Is there a way to articulate what the order growth was in commercial in the third quarter?

  • - CEO

  • I don't have that at my fingertips, Jeff.

  • - Analyst

  • Okay.

  • Okay, that's fine.

  • And then, I guess service experts.

  • Very good second quarter, solid third quarter, but down sequentially.

  • What were the dynamics there?

  • - CFO

  • On service experts, first of all, the second quarter was just an absolutely terrific quarter for service experts.

  • I mean, the weather cooperated, everything went in the right direction.

  • And as we got into the third quarter I think we saw less of the benefit on the weather side for that business.

  • And other than that, I don't think there was anything specific that was happening in the business.

  • We think they performed quite well for the quarter, and we're very happy with that.

  • - Analyst

  • Okay.

  • And final question.

  • How are you thinking about corporate expense for the year?

  • - CFO

  • The last time that we talked about that, I said that the corporate expense would have a nine in front of it.

  • And we continue to forecast for the year that corporate expenses will be in the $90 to $95 million range versus 100 million a year ago.

  • - Analyst

  • Okay.

  • Thanks.

  • - CEO

  • Thanks, Jeff.

  • Operator

  • All right.

  • Thank you.

  • Keith Hughes with SunTrust, please go ahead with your question.

  • - Analyst

  • Just to follow up on the pushout commercial.

  • Did you see any of that in your refrigeration business in the quarter?

  • - CEO

  • Not in a material way.

  • - Analyst

  • Okay.

  • Would that normally go hand in hand seeing one thing in one sector versus the other, or their business are so different that they normally are correlated?

  • - CEO

  • There's overlap, but if you look at the -- if you segment the business, the commercial business has a higher portion of the sales which are tied to our big box retailers or national accounts.

  • Our refrigeration business has a much higher portion of business that goes through distribution and or replacement.

  • - Analyst

  • All right.

  • Thank you.

  • - CEO

  • Thanks.

  • - CFO

  • Thanks, Keith.

  • Operator

  • Our next question is from Michael Coleman with Sterne Agee.

  • Please go ahead.

  • - Analyst

  • Good morning.

  • - CEO

  • Hi, Michael.

  • - CFO

  • Hi, Michael.

  • - Analyst

  • Just a little more detail on your residential volume.

  • If you could characterize the two-step value brand performance, maybe on compressor bearing units, and what the actual impact on volume was for the Hearth operations.

  • - CEO

  • I think maybe I characterize it this way.

  • Sue announced in her comments that we were down 15% in volume in our residential business.

  • And our Hearth business, which is much more new construction, 80% or so new construction, was down significantly more for the quarter than our HVAC business.

  • Point one.

  • Point two, if you look at the ARI information and the [GAM] information, we think the market was down around 8% or so for the third quarter.

  • We think our core HVAC business was down for the market in the quarter.

  • And in a similar way, we think we're about where the market is on a full-year basis in our residential HVAC business.

  • - Analyst

  • Okay.

  • And could you update -- In the third quarter a year ago, there was some impact from, I believe, the expansion of your residential distribution.

  • How is the the expansion of your distribution footprint?

  • How is it progressing?

  • Do you have an update for that?

  • - CFO

  • I think as we look at the distribution, we continue to work on putting new dealers in place and focusing on the Sun Belt strategy, and we continue to work on the distribution.

  • But other than that, there is no specific update.

  • - Analyst

  • Okay.

  • But in the year-ago quarter, did you incur costs for the expansion of that distribution that you were able to -- some of the year-on-year margin performance derived from that?

  • - CFO

  • It is.

  • And I think the number was sort of a mid single digit type of number for the third quarter of 2006, if I remember correctly.

  • So, that did contribute to the year-over-year performance.

  • - Analyst

  • So, is that a similar type of trajectory as you look at the next couple of quarters as you annualize the investment in your distribution system?

  • - CFO

  • You know, I don't know the answer to that.

  • I think I'd probably want to do a little more research before we do that.

  • And maybe what we can do is in December when we're together, we can talk about that in sort of the later part of the '08 and looking forward.

  • - Analyst

  • Okay.

  • Great.

  • And on the commercial side, you indicated that your new accounts had offset some pushouts from national accounts.

  • Is your mix in the commercial still reversed with the end market is 2/3 new, 1/3 replacement?

  • - CEO

  • Yes.

  • - Analyst

  • And I know you've made an investment in your distribution system for that.

  • If new construction in commercial is meaningfully slower, do you think you can offset it by taking share in residential?

  • And what is the margin differential between new and replacement on the commercial side?

  • - CEO

  • The short answer is the problem that we've had in the recent -- and I say problem in parenthesis and tongue in my cheek -- is the problem we've had on changing that mix is we're growing in share in both national accounts and in the replacement side.

  • And so, the investments we're making in our regional distribution center, the investments that we made in coming out with our [T] Series and [F] Series Rooftops, which are more cost competitive as well as a larger tonnage unit, have allowed us to grow both in replacements and investment we made in our [strategos] high efficiency unit has allowed us to grow in national accounts.

  • So, we're growing on both segments of the market.

  • Clearly, some of our major national accounts have pushed out orders.

  • We have aggressively gone -- continued aggressively gone after the replacement market and get other national accounts.

  • And that's certainly the strategy to continue going forward.

  • And I think our margin across national accounts and replacement is very similar.

  • There would not be a material effect on the margin of the business of a shift from one segment to another.

  • - Analyst

  • Okay.

  • Great.

  • And last question, on the refrigeration, there's been a lot of -- in the news lately -- regarding the Asian, quote, cold chain with potential of 100 billion investment, which a large segment is refrigerated trucks that you are not in.

  • But what do you see in terms of Asia and refrigeration, what are the opportunities?

  • Where is your business today?

  • And what do you think about the longer term in that business?

  • - CEO

  • I think we have -- when you think about our geographical expansion opportunities at LII, I think in many ways you can boil it down to China refrigeration.

  • Our focus in that country is on cold room storage.

  • I think the article you referred to is probably the article in the Wall Street Journal.

  • That's the segment that they talked about.

  • That's the segment that we're focused on.

  • Right now, we're investing in the market.

  • We have a factory [in country].

  • We have a sales force.

  • We have distribution.

  • We have localized product, and in the process of localizing product.

  • But as many of us know, in this emerging market of refrigeration, in China, it's still a bit of the wild, wild West, and so we're fighting with others including Asian competitors and U.S.

  • competitors to grow our market.

  • And we're committed to doing that in China.

  • It's a big opportunity for us.

  • - Analyst

  • Okay.

  • Great.

  • Thank you.

  • - CEO

  • Thanks.

  • Operator

  • Our next question is from [Craig Waysey] with [Rezona] Capital.

  • Please go ahead.

  • - Analyst

  • Hi, gentlemen.

  • A couple of questions for you about working capital.

  • I noticed that with sales up 1% year-over-year, your inventories are up over 6% and your payables are actually down.

  • It sounds like you are getting a building of older inventory on the books.

  • Is that a fair assessment?

  • - CFO

  • No.

  • Here is how I would look at the inventory picture.

  • First of all, as you go back in time, you have the transition over to the 13 [sear] product, and the 13 sear product had a higher cost point, so your inventory naturally went up in the 2006 type of period for the transition to 13 sear.

  • Then as we have gone in to 2007, we typically build inventory in the first part of the year, so sort of the first half of the year, which is why we consume cash ahead of the cooling season in each of the businesses.

  • We then consume that inventory over the remainder of the year and bring it back down to sort of more normalized levels by the end of the fourth quarter.

  • We have improved inventory from the end of the second quarter by $19 million -- kind of on a rough basis.

  • And we are going to continue to improve our inventory throughout the rest of the year.

  • - Analyst

  • But on a year-over-year basis it is 6% higher than it was last year in spite of not having the sear upgrades this year?

  • - CFO

  • Yes.

  • - Analyst

  • All right.

  • And then on the receivables, I noticed they also are growing a bit quicker than sales year-over-year again.

  • - CFO

  • Yes.

  • - Analyst

  • And yet allowance for that account is down.

  • Looking out kind of across at the banking sector, across the board rising nonperforming accounts, what are you seeing that is different that you are actually having improving credit quality with the customers that you have?

  • - CFO

  • Well, I think the people, the customers that we sell to, you know, are very good customers where we typically don't have credit type of issues.

  • And as you look at the accounts receivable, again, you have made a very good point that the allowance for doubtful accounts has not really gone up, which means that we aren't experiencing those types of problems.

  • The reason that our accounts receivable is up at the end of the third quarter is that our September sales in both our commercial business and refrigeration business were very heavy.

  • And, therefore, the receivables are still on the book at the end of September.

  • - Analyst

  • You are saying your credit quality has actually improved versus last year?

  • - CFO

  • I would say, at a minimum, it's flat to last year, and we haven't seen any deterioration.

  • - Analyst

  • Thank you.

  • Operator

  • Thank you.

  • Ladies and gentlemen, if there are any additional questions at this time, please press the star followed by one now.

  • Once again, if you are on speaker equipment, please note that you need to lift the handset prior to making that selection.

  • Star, one if you have a question at this time.

  • Curt Woodworth has a follow up.

  • Please go ahead.

  • - Analyst

  • Yes, hi.

  • Operator

  • I'm sorry.

  • - Analyst

  • Yes.

  • In terms of looking at the restructuring cost of the business, I think there was 2 million kind of net 3Q, 4 million in the third quarter, and then you are talk about an 8 million charge next quarter.

  • So, in an [aggregate], that's about $14 million or roughly, I think, $0.12 a share.

  • And then you are saying you going to get a $2 million net cost benefit next year from the Hearth restructuring.

  • So, call that $0.02 a share.

  • Todd, in your mind, is the way you are kind of looking at the operating run rate EPS capability of this company would really -- let's say you come in at 245 or 240 and then really add $0.14 on top of that for onetime restructuring and then the Hearth benefit?

  • So, to me it looks like on an operating basis, with the way you repositioned the company, your base level of earnings, obviously, you may have more restructuring next year, and let's not take that in to account, but really it's closer to 2 -- 255, 260 for the company.

  • That's basically the math, right?

  • - CEO

  • I understand how you did the math.

  • I'm not going to give guidance for '08, I know that's what you are trying to walk me to.

  • - Analyst

  • No.

  • No.

  • That's not what I'm trying to get to at all.

  • I'm just trying to figure out where you are for the year, taking out these onetime items.

  • What your run rate on an operating basis is.

  • - CEO

  • I think the math you did is correct and is a short answer.

  • - Analyst

  • Yes.

  • - CEO

  • And I think we have done a good job year to date on driving the core business to fund our restructuring, and that's obviously conceptually what we would like to do going forward.

  • - Analyst

  • And do you anticipate changing guidance to be, to give guidance on an operating level, which is really how I think the market looks at it?

  • Because it -- kind of to Jeff's point earlier -- it is a little confusing to try to basically take some of these changes in your onetime items, and that's kind of what's part of what is driving your guidance on a GAAP basis and then figuring out really on an operating level where the company is.

  • You know, I think it would be helpful if you could provide operating guidance as well.

  • My $0.02.

  • - CEO

  • And as we roll into the December meeting in Manhattan, let us continue to work on the best way to communicate.

  • Fundamentally, we like to drive it around sort of the bottom line bottom line, and make sure that operationally, we do the things to make sure the bottom line bottom line is where we need it to be.

  • And while the pro forma guidance, I think, is helpful in some ways, and in other ways it allows you to take offline bad news in onetime items.

  • And that's a bit of a slippery slope, so, cautiously, we're trying to drive down a path of the bottoms line is the bottom line.

  • - Analyst

  • I agree with that, and I think when we you have moderate restructuring costs and you are able to offset that and other areas of the business that's fine.

  • But the other companies if there were to be a more severe big-number restructuring, again, people try to get at an operating number for kind of the underlying profitability of the business.

  • So, just something to think about.

  • And then the last question is what share count should we use for the fourth quarter given the buyback activity?

  • - CFO

  • What did you use for the third quarter so I can make sure we're doing apples to apples?

  • - Analyst

  • Well -- what you reported, yes.

  • Maybe what was the run rate at the end of the quarter?

  • Where did you finish at, and then we can make assumptions.

  • - CFO

  • 69,764 was the number at the end of the third quarter.

  • And then I would take that down by about 3 million shares for the fourth quarter.

  • - Analyst

  • Okay so like 66-6.

  • - CFO

  • 66-2.

  • Somewhere in there.

  • - Analyst

  • Okay.

  • Thank you.

  • Operator

  • All right thank you this concludes our question-and-answer session.

  • Management please continue with any closing comments.

  • - CEO

  • Thanks, operator.

  • Thank you, all.

  • Before we hang up, let me conclude with a summary I made at the end of my opening comments.

  • We ended with strong results, double-digit earnings growth and robust cash flow.

  • We held our full-year GAAP guidance of $2.40 to $2.50 albeit at the low end of the range.

  • We continued to focus on reducing our cost structure and made headway in SG&A and manufacturing costs, and we actively executed on the stock repurchase program, keeping us on target for the third quarter '08 completion.

  • Thanks, everyone and I look forward to talking with you at our analysts event on December 12th in New York.

  • Thanks.

  • Operator

  • All right, thank you.

  • Ladies and gentlemen, that does conclude our conference for today.

  • We thank you for participation and for using AT&T executive teleconference.

  • You may now disconnect.

  • Have a very pleasant rest of your day.