Lennox's CEO Discusses Q4 2012 Results - Earnings Call Transcript

Feb. 5.13 | About: Lennox International (LII)

Lennox International, Inc. (NYSE:LII)

Q4 2012 Results Earnings Call

February 5, 2013 9:30 AM ET

Executives

Steve Harrison - Vice President, Investor Relations

Todd Bluedorn - Chairman and CEO

Joe Reitmeier - Chief Financial Officer

Analysts

Sanjay Shrestha - Lazard Capital Markets

Keith Hughes - SunTrust

Jeff Hammond - KeyBanc Capital Market

Drew Pierson - J.P. Morgan

Rich Kwas - Wells Fargo Securities

Jane Zhao - Morgan Stanley

Rob Wertheimer - Vertical Research Partners

Glenn Wortman - Sidoti & Company

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the Lennox International Fourth Quarter 2012 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 Steve Harrison, Vice President of Investor Relations. Please go ahead.

Steve Harrison

Good morning. Thank you for joining us for this review of Lennox International’s financial performance for the fourth quarter and full year of 2012. I’m here today with Chairman and CEO, Todd Bluedorn; and CFO, Joe Reitmeier. Todd will review key points for the quarter and year, and Joe will take you through the company’s financial performance and outlook.

Financial results discussed today have been adjusted for discontinued operations related to the company’s previously announced plans to divest the Service Experts business. In the earnings release we issued this morning, we have included the necessary reconciliation for the financial metrics that will be discussed to GAAP measure.

You can find a direct link to the webcast of today’s conference call on our website at www.lennoxinternational.com. We will archive the webcast on that site and make it available for replay.

I’d like to remind everyone that in the course of this call, to give you a better understand of our operations we will be making certain forward-looking statements. These statements are subject to numerous risks and uncertainties that could cause actual results to differ materially from such statements.

For information concerning these risks and uncertainties, see Lennox International’s publicly available filings with the SEC. Lennox disclaims any intention or obligation to update or revise any forward-looking statements whether as a result of new information, future events or otherwise.

Now, let me turn the call over to Chairman and CEO, Todd Bluedorn.

Todd Bluedorn

Thanks Steve. Good morning, everyone, and thanks for joining us. 2012 was year of strong earnings growth and cash generation for the corporation. We continue to make key strategic investments position us for strong performance in 2013 and beyond.

And the uneven market conditions of 2012, the company grew revenue 5% at constant currency. Adjusted EPS from continuing operations was up 20% to $2.70. GAAP EPS from continuing operations was up 26% to $2.63.

The company’s performance in 2012 was led by our residential business, with revenue up 9% and profit up 17%. Residential margins expanded 50 basis points from year to 7.5%.

With North America residential HVAC market, shipments up 2% in 2012, we clearly gained share with strong double-digit growth for the year. We made significant gains in replacement market, while also capitalizing on recovery of the residential new construction market in 2012.

Equipment revenue from residential new construction was up nearly 30% for the year. And our commercial businesses, we had strong operational performance in the face of flat market conditions in 2012.

In refrigeration revenue was flat at constant currency with profit up 6%. Refrigeration margin expanded 80 basis points to 10.4% for the year. Commercial HVAC equipment and services, revenue was up 3% at constant currency, with profit up 14%, commercial margin was up 140 basis points to a record 12.7% for the year.

Turning to the fourth quarter, an overarching comment to make is that momentum continued with revenue growth and strong operational performance across all our businesses, while profit was impacted by higher incentive compensation as planned and previously discussed.

The higher incentive compensation stems from performance targets achieved or exceeded in 2012, compared to 2011 when incentive compensation was significantly lower. The impact was $23 million for 2012 overall and about two-thirds of that impact was in fourth quarter alone.

Company revenue was up 6% at both actual and constant currency. Adjusted EPS from continuing operations was $0.56, compared to $0.55 in the prior year quarter. GAAP EPS from continuing operation was $0.52, compared to $0.56 in the fourth quarter a year ago. Total segment margin was 6.2%, compared to a 7% in the prior year.

At constant currency, residential revenue was up 9%, commercial revenue was up 5% and refrigeration revenue was up 2%.

Residential we continue to capitalize on growth in residential new construction with equipment revenue up 30% for the fourth quarter. Replacement equipment revenue was up low single digits in the quarter.

Commercial growth was primarily driven by non-national account business, while we continue to see national account orders pushed down into 2013 due to the political and economic uncertainties in the fourth quarter. This business appears to be solidifying in the first half of 2013.

I’d also like to note that our commercial equipment business signed 29 new national accounts in 2012, tying the record year of 2007. This is an indication of national account customers continue to select Lennox for leading high energy efficiency rooftops, advanced controls, outstanding distribution and delivery, and customer, support and service.

In refrigeration for the fourth quarter, revenue growth was led by greater than 20% growth in Asia-Pacific and high single-digit growth in South America from the successes we are seeing with our growth -- growth initiatives in both these regions.

Residential and refrigeration profits were down in the fourth quarter primarily impacted by the higher incentive compensation. While residential also had some impact from lower mix and a step up in our strategic investments and distribution. Residential margins were down 200 basis points to 4%. Refrigeration margin was down 60 basis points to 11.1%.

Commercial also had an impact from higher incentive compensation but the strong operational performance of the business still drove margin up 220 basis points to a new fourth quarter record of 13.5%.

Cash generation was strong in the fourth quarter for 2012 overall. Free cash flow was $171 million for the full year or 190% of GAAP net income.

We paid $48 million in dividends in 2012 and repurchased $50 million of stock. We’re planning to repurchase $100 million of stock in 2013 and have $371 million remaining under our stock repurchase authorization.

Strong cash generation and the solid balance sheet, we are well-positioned to continue invest in the business, returning cash to shareholders and consider acquisitions that make sense in our core businesses.

Conversely, we have been divesting non-strategic businesses, we completed the sale of our Hearth business in the second quarter of 2012, and in the fourth quarter of 2012 we announced plans to sell Service Experts business and this process continues to move forward.

At the Analyst Day in mid-December, I mentioned several strategic initiatives that we are excited about for improved growth, productivity and profitability. In residential, we ramped up our production in Mexico by 30% in 2012 and we’ll continue to grow that operation in 2013.

We continue to source more components from Asia now over 45%, as well as [engineer] to cost reduce our product platforms and move further into material substitutions, including replacing copper with aluminum for example.

In 2012, we had 32 Lennox PartsPlus wholesale stores and plan to add another 28 locations this year. HVAC equipment accounts for about three quarters of the sales, up from these stores and parts and supplies accounts for the remainder. These stores have been one of the keys to our market share gains and residential outperformance in 2012.

As I mentioned earlier, we stepped up our investments in these stores in fourth quarter, impacting us in the near term. But we expect positive benefits within 12 to 18 months as each of these locations ramp up sales.

Also in residential, we continue to introduce new products in the market, ranging from entry-level all the way up to most premium products available. Most recently at International Builders Show in January, we introduced the ultimate comfort system, the most advanced and efficient air conditioning, heating and air quality system ever created led by the new XC25 Air Conditioner and the new iHarmony Zoning System.

Lennox offers a complete system that allows homeowners to achieve customized comfort and control. The XC25 is the most precise and efficient air conditioner on the market with industry-leading efficiency of 25 shear as equipped with silent comfort technology that keeps sound level to a minimum. And the XC25 cooling output can be changed in increments of just 1%, providing energy savings and comfort for the homeowner.

For the ultimate control, the new iHarmony Zoning System solves a problem of uneven or uncomfortable temperatures throughout our home and reduces homeowners energy costs. The iHarmony directs air to specific areas in the home while decreasing the airflow in others, by using motorized dampers that allow homeowners to change the temperature throughout the entire house or only in a particular area. The iHarmony Zoning System can also be configured with the icomfort Wi-Fi thermostat and controlled by an iPhone, iPad or android device, putting precise comfort at the homeowners fingertips.

In commercial, our new rooftop product called Raider to attack the emergency replacement market in North America is in production and available to customers starting this quarter. We’re very excited about this launch and the opportunities available.

Emergency replacement for commercial rooftops comprises about 45% of the $3 billion-unitary market in North America. This has not been an area of traditional focus for Lennox compared to our success and planned replacement in commercial new construction.

With Raider, we now have the right product to sell to contractors in the segment of the market to prioritize upfront cost. And we continue to invest in distribution to provide a high level of same-day next-day delivery that customers require for emergency replacement.

I’ll now turn it over to Joe.

Joe Reitmeier

Thank you, Todd. Good morning, everyone. I’ll provide some additional comments and financial details on the business segments for the quarter and the full year starting with residential heating and cooling.

In the fourth quarter, revenue from residential heating and cooling was $305 million, up 9%. Currency was neutral, volume was up 9% and price mix was flat on revenue. Residential profit in the fourth quarter was $12 million, down 27%. Segment profit margin was 4%, down 200 basis points from the fourth quarter a year ago.

Segment margin was negatively impacted by higher incentive compensation as planned, lower mix and a step up in strategic investments for distribution expansion that is planned to benefit us 12 to 18 months out. Segment margin was positively impacted by higher volume and lower raw material cost.

For the full year, residential segment revenue was $1.4 billion, up 9%. Currency was neutral, volume was up 11%, price was up slightly and mix was down 2%. Segment profit was $103 million, up 17%. Segment profit margin was 7.5%, up 50 basis points.

Turning to our commercial heating and cooling business. In the fourth quarter, commercial revenue was $188 million, up 4%. Currency had a negative 1% impact, volume was up 4% and price and mix were up 1%. Both North America commercial HVAC equipment and service revenue were up high single digits at constant currency.

Europe commercial HVAC revenue was down high single digits at constant currency. Commercial segment profit for the fourth quarter was $25 million, up 25%. Segment profit margin was 13.5%, up 220 basis points from the prior-year quarter. Segment margin was positively impacted by higher volume, favorable price and mix and lower material costs, with an offset from higher incentive compensation.

For the full year, commercial revenue was $785 million, up 1%. Currency had a negative 2% impact, volume was up 2% and price and mix were up 1%. Segment profit was $100 million, up 14%. Segment profit margin was 12.7%, up 140 basis points.

In our refrigeration segment, revenue for the fourth quarter was $192 million, up 2%. Currency was neutral, volume was up 1% and price and mix were up 1%. From a regional perspective in constant currency, Asia Pacific was up more than 20%, South America was up high-single digits, North America was down mid-single digits and Europe was down low-double digits.

Segment profit was $21 million, down 4% from the prior-year quarter. Segment profit margin was 11.1%, down 60 basis points. Segment margin was negatively impacted by higher incentive compensation as planned with higher offsets from higher volume, excuse me -- with offsets from higher volume, favorable price mix and lower material costs.

For the full year, refrigeration revenue was $788 million, down 2%. Currency had a negative 2% impact, volume was down 3% and price and mix were up 3%. Segment profit was $82 million, up 6%. Segment profit margin was 10.4%, up 80 basis points.

Looking at special items in the fourth quarter, the company had net after-tax charges of $2 million, including $700,000 from restructuring activities. For the full year, Lennox had net after-tax special charges of $3.6 million, including $2.7 million from restructuring activities.

Corporate expenses were $16 million in the fourth quarter, up from $14 million in the prior-year quarter. And for the full year, corporate expenses were $60 million, up from $55 million in the prior year, primarily on higher incentive compensation.

Overall, SG&A was $127 million in the fourth quarter, up from $104 million in the prior-year quarter. All of 2012, SG&A was $507 million, up from $477 million in the prior year, primarily from higher incentive compensation.

Cash from operations was $221 million for the full year, up from $76 million last year. Capital spending was $50 million in 2012 compared to $41 million in 2011, resulting in free cash flow of $171 million for the full year, up from $35 million in the prior year.

Now, looking at liquidity, cash and cash equivalents were $52 million at the end of December. Our debt-to-EBITDA ratio was 1.4 ending the year within our target range of one to two times. Total debt was $387 million at the end of the year, down $94 million from the third quarter of 2012 and down $79 million from the fourth quarter a year ago.

Before I turn over to Q&A, I’ll review our outlook for 2013. One month end of the year, our market assumptions for 2013 remain the same as we discussed at the Analyst Day in mid-December. We expect the North America residential and commercial unitary markets to be up single digits.

We expect Europe HVAC and refrigeration markets to be down low-single digits for 2013. And based on these market assumptions -- market shipments assumptions, guidance for our revenue growth is 2% to 6% for 2013 with a neutral impact from foreign exchange.

As discussed at the Analyst Day, there are several puts and takes we expect for 2013. We expect about $10 million of headwind from lower mix in the residential business this year due to more 13 shear products and faster growth in residential new construction.

Corporate expense is expected to be approximately $70 million in 2013, up from $60 million in 2012. We continue to expect approximately $30 million from material costs savings through a combination of source initiative and engineering-led cost reductions, and we currently project $20 million of price and commodity mix tailwind in 2013.

We expect about two-thirds of the $30 million material costs savings to be in the second half of 2013, and about half of the $20 million of favorable price and commodities impact to be in the second half of the year.

Our 2013 guidance for EPS from continuing operations remains, $3.15 to $3.55.

To wrap up a few of the guidance points for 2013, we expect net interest expense for the year of about $18 million. We expect a tax rate of 34% to 35% for the year. Our average weighted diluted share count for the full year is expected to be approximately 49 million shares and for capital spending we expect about $60 million in 2013, as we continue to focus on transformational investments in the businesses.

And with that, let’s go to Q&A.

Question-and-Answer Session

Operator

(Operator Instructions) And our first question comes from the line of Sanjay Shrestha with Lazard Capital Markets. Please go ahead.

Sanjay Shrestha - Lazard Capital Markets

Great. Thank you. Good morning, guys. You have said pretty straight forward on a lot of things, but a few question. First on the success that you guys are having on the residential side, right. Obviously it’s a new construction mix, which I think is helping you guys, but how should we think about continuation of that top line growth for you guys and if you can also comment a bit on sort of the overall competitive dynamics as it relates to that?

Todd Bluedorn

If you look at over the last 12 months and I think in resi share you have to look over 12-month period. But I think it’s tough to look quarter-to-quarter given the timing of different distribution models. But over 12-month period, industry is up 2% and unit shipments were up double digits and its both new construction, but we are also gaining share in replacement market.

And I think that reflects the investments that we’ve made in our PartsPlus distribution model, doubling the number of locations over last three years and plans to double it again over the next three years combined with the investments that we’ve made in product. So, I think it’s both winning in new construction and that market came back very strong. But I also think we are winning in the replacement market.

Sanjay Shrestha - Lazard Capital Markets

And guys, so you do expect that market share gain dynamics to continue for you guys given what you are doing, right. So that’s what I was trying to get at more.

Todd Bluedorn

Yeah. Well, I mean, I’d answer it this way, history being a predictor of the future. The strategies that we’ve embarked upon building out distribution and investing in new products, we continue to do that. We talked a little bit where I talked a little bit on the call about some new resi product. So we are really excited about 2013.

Sanjay Shrestha - Lazard Capital Markets

Got it. One final question then for me guys. So incentive new payment is a good problem to have because I think should come better than expected. But how do we think about, has it being trued up now to a point where for the residential side of the business, the incentive comp is no longer going to be a drag to the margin in ‘13 or how should we think about that?

Todd Bluedorn

Short answer is yeah. Maybe let me, Sanjay, go a little bit and just talk about the residential margins because my guess is there is probably some questions to talk about there. So number one, we talked about on the phone call. We said there was about $23 million year-over-year on incentive comp and that simply -- quite frankly, we had a tough year in 2011 and so we didn’t pay a whole lot of incentive comp and we had a pretty good year in 2012 when we did pay it and that’s the difference.

And out of the $23 million you can sort of pro ratted it out based on revenue and we said $15 million of it was in fourth quarter alone. So if you pro rate, you can pro rate that based on revenue where half of it or so goes to the resi business. The other thing we talked about with margins on resi is we talked about the strategic investments we’ve made in PartsPlus. Back in the second half of 2011 given all the uncertainties we saw in the market, we put PartsPlus on hold until the whole second half of 2011, we only added one new store.

And in the second half of 2012, we added 17 stores and so given that it takes 12 to 18 months for these stores to ramp up, we made a big investment in second half of 2012 where we saw some of that drag in fourth quarter as these stores start to ramp up. We think it really positions us, as we are getting into the cooling season of 2013 to have all these new stores online. And if you sort of take those two elements and sort of pro ratted if you will, you see that our operating margins in resi were up about 100 basis points with those investments.

Sanjay Shrestha - Lazard Capital Markets

That’s all I had, guys. That’s great. Thank you and congratulations.

Todd Bluedorn

Thanks.

Operator

Our next question comes from the line of Keith Hughes with SunTrust. Please go ahead.

Todd Bluedorn

Keith?

Keith Hughes - SunTrust

I’m sorry. Can you hear me now?

Todd Bluedorn

Yeah.

Keith Hughes - SunTrust

Sorry about that. Your comment that equipment and residential was up 30% of Lennox Hearth, was up for the quarter.

Todd Bluedorn

If we said that, we didn’t mean to say that. I think what we said is on full-year basis residential new -- the residential new construction portion of the business was up 30%.

Keith Hughes - SunTrust

Okay. I misread a bit.

Todd Bluedorn

I wish it was up 30%.

Keith Hughes - SunTrust

I bet you did. I was about to say, what was down to some of these residential numbers. Switching over to commercial in Europe, I believe you said it was down high single digits. So, I assume that was for the quarter. What was it for the year?

Todd Bluedorn

I’m looking around the room. I think it was flattish on constant FX for the full year, but some how, I will sort of stick a number in my ear. But what, Keith, we continue to see slowness in Europe as we had in the first quarter and we were profitable last year on sort of flattish revenue. We continue to sort of take the time, and make the investments to take some cost out of the business and we are doing that as we enter first quarter.

Keith Hughes - SunTrust

That’s something that would be up for a strategic review, and now it’s been and kind of up and down for many years now.

Todd Bluedorn

We’ve shown, I think that we are not afraid to parse the portfolio, but we like our European business. We think, when you sort of combine our refrigeration business and our HVAC business in Europe, we think we’re -- if not at we are close to critical mass and I think that’s the business we continue to grow. I think we’ve got it down to cost basis where we are making mid to high single-digit losses depending on the business that we have the business that I’m talking about in Europe but we like it.

Keith Hughes - SunTrust

Okay. Final question. In your ‘13 guidance when you said us in the Analyst Day that you expect mix to be a headwind in residential for ‘13 and your high percentage of ‘13. Is that the builder impact on the business in your projections?

Todd Bluedorn

I think its two things, Keith. It’s the faster R&C growth as you suggested, but it’s also a continued pressure on the consumer and continuing the mix down on the replacement market albeit at a slower rate than we’ve seen in the last few years.

Keith Hughes - SunTrust

Why was there continued to be mix down if we are slowly coming out of the pretty horrendous downturn in the last four, five years? I would expect it to be going, at least marginally the opposite way.

Todd Bluedorn

I hope you are right then we won’t have negative $10 million of mix. But it’s -- there’s still lot of things on the horizon that affect the -- not the least of which is, there’s going to be some budget wrangling. It takes place right when we get federal budget wrangling. It takes place right when we go into the summer selling season. So my crystal ball is maybe cloudy on what consumer confidence is going to be in the U.S. as we get into the summer selling season.

Keith Hughes - SunTrust

All right. Thank you.

Todd Bluedorn

Thanks.

Operator

Thank you. Our next question comes from the line of Jeff Hammond with KeyBanc Capital Market. Please go ahead.

Jeff Hammond - KeyBanc Capital Market

Hi. Good morning, guys.

Todd Bluedorn

Hey, Jeff.

Jeff Hammond - KeyBanc Capital Market

So just to wrap up on the one-timers, so you said it looks like their incentive spending -- can you quantify what -- I’m sorry, what the investment spending was in the quarter in residential?

Todd Bluedorn

On distribution?

Jeff Hammond - KeyBanc Capital Market

Yeah. In the order of magnitude a couple million.

Jeff Hammond - KeyBanc Capital Market

Couple million. Okay. So incrementals were kind of more normal if you strip out that in the incentive comp?

Todd Bluedorn

When I do the math, if you do the incentive comp sort of take half-ish of the $15 million and a couple million or so for the investment distribution, margins are up order of magnitude of 100 basis points in resi, which is more in line with what you would expect.

Jeff Hammond - KeyBanc Capital Market

Okay. Okay. Perfect. And then, can you give me an early read out on what you’re seeing in terms of price actions that you’ve taken?

Todd Bluedorn

Well, we announced -- the Carrier announced, the Trane announced the price increase, Goodmen announced the price increase, Nordyne had announced the price increase and so far so good. I mean, as we all know, everyone in the industry announces an umbrella price increase.

You will get the full amount you announce, but it looks like so far that we’re sort of a -- maybe back to a normalized industry where people announced a price increase at the beginning of the year before we go into the season and we make it stick. We’ll know more as we get into the summer but so far, so good.

Jeff Hammond - KeyBanc Capital Market

Okay. And then anything in the order trends in commercial or what you are seeing in residential for Q and into 1Q kind of shade your view at all on ‘13 growth rates, or kind of how you frame the guidance, it’s not unchanged but…?

Todd Bluedorn

No. I mean, as you know first quarter is always our seasonally lightest period. But the quarters after that will start with some colder weather in January versus last year. But up to half of our shipments can take place in March and so it’s early. And we also, as we talked about some of the guidance that we expect two thirds of the $30 million material costs savings to be in the second half.

So some of the cost savings have pushed out, but from a market viewpoint so far, so good. And as we talked about in the script, we’ve seen the commercial markets stabilized a bit which is good news. And again that may change as we get in the some of the more -- the additional budget wrangling at the end of the quarter but so far so good on commercials.

Jeff Hammond - KeyBanc Capital Market

And your comment, the commercial stabilizing, is that functionally that some of the national account push outs are abating?

Todd Bluedorn

Yeah.

Jeff Hammond - KeyBanc Capital Market

Okay. Thanks, guys.

Todd Bluedorn

Thanks.

Operator

Thank you. Our next question comes from the line of Steve Tusa with J.P. Morgan. Please go ahead/

Drew Pierson - J.P. Morgan

Hi. Good morning. It’s Drew on for Steve. Just hoping I could get an update on refrigeration. I wasn’t sure if it’s maybe doable but of the similar margin walk to there, and then just kind of give an update on what’s going on with the Kysor/Warren integration and then any other kind of margin details for the 4Q?

Todd Bluedorn

I think the margin details for our refrigeration business is driven by the incentive comp and so they are about a quarter of our business. And so, I think you can pro rata out the incentive comp to them by about the same amount. Operationally, they had a solid quarter again.

Kysor/Warren, we continued to be on track on the cost side of the business. The revenue side has been a bit soft as grocery has in 2012, so it tightened up about halfway through the year not only for us but with all of our competitors. But KW’s a great acquisition and we think we’ve done a really good job integrating it and we have some big plans in ‘13 and beyond for KW.

Drew Pierson - J.P. Morgan

That’s helpful. And then back to resi, maybe just give color on the Allied versus Lennox split and then maybe what you saw from independent distribution channel, their stocking behavior? I know there has been some kind of diversions in the timing of price increases. So maybe give that split and some color?

Todd Bluedorn

Yeah. It’s hard for me to figure out. When competitors do things or don’t do things and so those having independent distribution, what they are doing in terms of loading the channel I guess is a correct phrase to use. So, I guess I don’t have a whole lot of cap color to add there.

On the Allied-Lennox comment, we continue to make investments in both those business and continue to win in both those businesses. And so you we had solid quarters in both our Lennox and Allied businesses.

Drew Pierson - J.P. Morgan

With similar levels of growth?

Todd Bluedorn

I don’t know if they are similar. I mean, I think some of the investments we’ve made in PartsPlus have really sort of -- and the exposure to new construction have sort of helped the Lennox branded business because our Allied business really doesn’t play in new construction at 30% we are seeing in the Lennox business. So Lennox grew faster than Allied.

Drew Pierson - J.P. Morgan

Okay. That’s helpful. Thanks very much.

Todd Bluedorn

Thanks.

Operator

Thank you. Our next question comes from the line of Rich Kwas with Wells Fargo Securities. Please go ahead.

Rich Kwas - Wells Fargo Securities

Hi. Good morning, everyone.

Todd Bluedorn

Hi, Rich.

Rich Kwas - Wells Fargo Securities

Question on, Todd, regarding the, what you’re seeing on the national accounts. So you said, basically here at this last quarter, sound like some of the non-national accounts were stronger, you continue see the push outs? If we think about margin flow through, if national accounts are stabilizing, there is potential improvement later in the year? Does that come through at a lower margin versus the non-national accounts? Is there any significant difference there?

Todd Bluedorn

No.

Rich Kwas - Wells Fargo Securities

Okay.

Todd Bluedorn

… is short answer, I mean, again, we sort of cost and price it and a little bit margin agnostic on the two segments.

Rich Kwas - Wells Fargo Securities

Okay. So it doesn’t matter in terms of the mix. Okay. And then on the, I know you don’t give quarterly guidance, but we think about the first quarter here, as you mentioned seasonally slowest quarter, last year had a pretty strong March on residential side nice rebound. Anything we should be considering here as we think about first quarter just for modeling purposes?

Todd Bluedorn

I think the thing I throw out both in the Q&A and call about the $30 million material cost savings being two-thirds, are those savings second half of the year. So if you laid that in your model, linearly, linear fashion I’d revisit it.

And then we talked about, I don’t know, if I said it on the call, just having the Q&A in front of me. But the $20 million pricing commodity tailwind will be split 50/50 and so if you front-end loaded some of that, I would spread it out equally throughout the year.

Rich Kwas - Wells Fargo Securities

Okay. Great. That’s all I have. Thanks so much.

Todd Bluedorn

Thanks.

Operator

Thank you. Our next question comes from the line of Nigel Coe with Morgan Stanley. Please go ahead.

Jane Zhao - Morgan Stanley

Hi. This is Jane calling in for Nigel. Joe, just a couple questions I think. First on inventory, it looks little bit of high year-over-year, is this indication of stronger like expectation for demand going forward into 1Q?

Joe Reitmeier

Not really I think I just said a timing of when we build and what we build. I think the thing I would underline with inventory and broader working capitals we had an outstanding fourth quarter and a very good year, where we are almost 200% of GAAP net income. And so, yeah, I mean, short answer is, given our guidance we think the markets are going to -- our revenue is going to be up in 2013 and we build some inventory to take care of that.

Jane Zhao - Morgan Stanley

I see. So for the inventory build, is it mainly for heating or cooling products, is it possible to get a breakdown?

Joe Reitmeier

We don’t really sort of get into that level of detail. I’m honest answer is, right now, even in the middle of the, even in fourth quarter we are building, we are selling half our loads as air conditioner, so we air conditioners on the yearly basis. So we are building both of those.

And the real ramp up for the cooling season inventory starts more in February, where we, now are starting to build, what you would have seen at the end of the year was just inventory as we are coming off of the peak of the heating season.

Jane Zhao - Morgan Stanley

Got it. That’s very helpful. And another question just on the R22 mix, I guess, R22 itself is going to be lower in ‘13 and do you expect to see some margin benefit from that in ‘13?

Joe Reitmeier

What we’ve talked about is that we think we are going to have mix headwind next year of $10 million both from faster growth in [RFP] and more ‘13 that the elimination of -- or the decrease in R22 as a percentage of our sales, we think helps drive revenue as people buy fuller systems, but there is still a pressure on margins, we think it is going to about $10 million headwind next year.

Jane Zhao - Morgan Stanley

Okay. Got it. Cool. All right. That’s it. That’s all I have. Thank you.

Joe Reitmeier

Welcome.

Operator

Thank you. Our next question comes from the line of Rob Wertheimer with Vertical Research Partners. Please go ahead.

Rob Wertheimer - Vertical Research Partners

Hey. Good morning.

Todd Bluedorn

Hi, Rob.

Rob Wertheimer - Vertical Research Partners

I wanted to ask just sort of bigger picture question about the competitive environment in commercial, it seems though you guys have been winning share for quite a while though and I’ve you asked before, I’m not sure, you are willing to quantify the net rooftops versus gross? But it seems though you continue to win share and I’m wondering if you are seeing any stepped up competitive response?

And then secondary question, does the Raider product help you, I apologize for forgetting at all, with national accounts or is that more or just mom and pops?

Todd Bluedorn

Let me answer second question first, it doesn’t help with national accounts although I wouldn’t quite -- I wouldn’t label it as mom and pops. I think I’ll label it as emergency replacements. So I know what you mean by mom and pops, yeah, it’s sort of local businessman, local rooftop often within intermediary and between. So what they want is the landlord is to meet your contractual obligations at the lowest landed cost.

And that products without segment of the market accounts for 45% of the total rooftop market in North America, huge segment. We have low-single digit share, mid-single digit share in that segment, big opportunity for us. And it’s about two things, it’s about having the right product which we now have with Raider which means cost but the features that people need, but nothing more and in distribution and we’ve launched the initiative, we call it ERA, emergency replacement.

And while we now have and we are in plan -- we have doubled our distribution over the last couple of years and we have plans to double it again in commercial distribution. And again it’s getting those rooftops on the ground at the right cost point is a big deal. So we think that’s a big growth opportunity for us.

Rob Wertheimer - Vertical Research Partners

And just a bigger picture, competitive response as you’re seemingly continue that, I mean, I just don’t have share numbers?

Joe Reitmeier

Yeah. Short answer is everybody pushes back and we have some very good competitors technically and distribution wise. And so they continue to go after national accounts but -- and we continue to spin the [fly ball] as quicker, quicker on innovation and we continue to hold our own.

Rob Wertheimer - Vertical Research Partners

Okay. Thanks.

Joe Reitmeier

Thanks.

Operator

(Operator Instructions) and we have a question from the line of Glenn Wortman with Sidoti & Company. Please go ahead.

Glenn Wortman - Sidoti & Company

Yeah. Good morning, everyone.

Todd Bluedorn

Hey, Glenn.

Joe Reitmeier

Hey, Glenn.

Glenn Wortman - Sidoti & Company

Yeah. I was actually going to ask about the commercial competitive position but -- as well but then, I guess, shifting over to refrigeration, can you just comment on your competitive position there and any market outperformance, if any that you expressed in 2012 and will you anticipate heading into 2013?

Todd Bluedorn

Yeah. I think across the board in refrigeration, so at the same points about the investments that we’ve made in product differentiation in our traditional HVACR business in North America, I think we probably gained same share. We’re pretty confident in our international business, most namely South America and Australia.

We had a nice year. In our Kysor/Warren business, our share was sort of flattish probably in 2012. And I think that’s an opportunity going forward for us to grow share as you know that’s a sort of a three-party race. And I think the largest competitor, Hussman people are looking for alternatives and I think that’s a big opportunity for us.

Glenn Wortman - Sidoti & Company

Yeah. Thank you.

Todd Bluedorn

Thanks.

Operator

And we have no more questions in queue at this time.

Todd Bluedorn

Okay. Thanks Operator. A few points, I want to leave everybody with. 2012 was the year of strong earnings growth and cash generation for the company. And we continue to make key strategic investments to position us for strong performance in 2013 and beyond.

Momentum continued in the fourth quarter with revenue growth and strong operational performance across all our businesses. From significant share gains and strong new construction growth in residential, the pickup in national account business and refrigeration and commercial as well as the opportunities in the emergency replacement market, we are focused on continued momentum for the company and our outperformance in 2013. I want to thank everyone for joining us today. Have a great day.

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.

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