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Lennox International, Inc. (NYSE:LII)

Q3 2009 Earnings Call

October 21, 2009 10:30 am ET

Executives

Steve Harrison – Vice President of Investor Relations

Todd M. Bluedorn – Chief Executive Officer & Director

Robert W. Hau – Chief Financial Officer & Executive Vice President

Analysts

Jeffrey Hammond – KeyBanc Capital Markets

Stephen Tusa – JP Morgan

Robert Wertheimer – Morgan Stanley

Keith Hughes – SunTrust Robinson Humphrey

Glenn Wortman – Sidoti & Company

Operator

Welcome to the Lennox International Q3 2009 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.

Steve Harrison

Thank you for joining us for this review of Lennox International’s financial performance for the third quarter of 2009. I’m here today with Todd Bluedorn, CEO and Bob Hau, CFO. Todd will review key points on the quarter and Bob will take you through the earnings financial performance. In the earnings release we issued this morning we have included the necessary reconciliation to the financial metrics that will be discussed to GAAP measures. You can find a direct link to the webcast of today’s conference call on our corporate website at www.LennoxInternational.com. We will archive the webcast on that site and make it available for replay.

I would like to remind everyone that in the course of this call, to give you a better understanding of our operations we will be making certain forward-looking statements. These 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 publically 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.

Before I turn the call over to Todd I would like to announce the date of our annual investment community meeting will be held the morning of December 16th in New York. Please mark your calendars. Invitations and more details will follow. The event will also be webcast. Now, let me turn the call over to CEO Todd Bluedorn.

Todd M. Bluedorn

Before I begin I’d like to introduce Bob Hau who is our new CFO here at Lennox. Bob joins us this month after 22 years at Allied Signal and Honeywell, most recently as CFO for Honeywell’s $13 billion revenue aerospace group. Bob is off to a great start and we’re very happy to have him here.

Robert W. Hau

I’m glad to be here and I’m looking forward to working with Todd and the rest of the leadership team here at Lennox. I also look forward to working with you in the investment community and I’ll have a chance to meet many of you in person during upcoming road shows and conferences as well as the analyst day in December.

Todd M. Bluedorn

Let’s turn to the third quarter and look at our operational and financial results. End markets remain difficult in the third quarter as expected but strong execution enabled Lennox to generate a record $118 million in free cash flow, up 18% from a year ago. For the first nine months of the year, free cash flow is up more than 75%. Gross margins increased for the second straight quarter up 170 basis points year-over-year in the third quarter to 29.8%. Gross margin improvement was driven by lower component costs from our global sourcing initiative, savings from manufacturing rationalization and lower commodity costs. The cost reduction actions we have taken over the last year are providing clear benefits and additional restructuring activities are underway as end market conditions remain challenging.

Let’s talk about the residential market. Looking at AHRI data for North America residential, unit shipments in the third quarter were down 9% year-over-year compared to a 13% decline in the second quarter. In replacement business we estimate year-over-year decline in the mid single digits for the industry in the third quarter. Cool weather in July was offset by a relatively warm August and September. Consumers remain cautious in this economic environment.

On the new construction side, the year-over-year rate declines have continued to slow. The National Association of Home Builders estimated single family housing starts to be down 20% year-over-year in the third quarter compared to the 37% year-over-year decline in the second quarter. On a seasonally adjusted basis, single family housing starts are up six out of the last seven months. While we are optimistic that residential new construction has bottomed, we remain cautious due to the expiration at the end of November of the government tax credit up to $8,000 for new home buyers.

In commercial, AHRI industry data for North America commercial unitary market shows unit shipments down 30% year-over-year in the third quarter. We saw similar dynamics in the European HVAC market. In refrigeration we saw the rate of decline in refrigeration slow driven by recovery in [inaudible] Asia and some stabilization in the North American market.

Looking at our financial results in this market environment, overall revenue was $750 million down 20% in constant currency and down 22% in actual currency. Adjusted earnings per share from continuing operations was $0.72 compared to $1.10 in the record third quarter a year ago. On a GAAP basis earnings per share from continuing operations was $0.59 versus $0.96 in the third quarter last year.

Cash generation remains strong as we aggressively manage working capital levels. As a result, cash from operations was $131 million in the third quarter up 12% from a year ago. Free cash flow was $118 million up 18% from a year ago. Working capital changes year-over-year contributed $27 million to cash generation. Through this downturn and especially over the last 18 months we have taken significant steps to lower our cost structure and rationalize our business operations around the world. We are tracking with our previously announced 2009 plan to save approximately $25 million incrementally from restructuring, $20 million from lower commodity costs and another $20 million from global sourcing.

In addition we announced this year that we would save $55 million in SG&A versus our prior plans driven by a 12% salary headcount reduction in 2009 on top of the 7% reduction last year and further cuts in discretionary spending. This quarter we are announcing two new restructuring initiatives. First in our commercial business, we are cutting more than 50 positions at our manufacturing facility in Mions France and transferring of production of our rooftop products for the European market to Longvic France.

Second, in our residential business we are relocating the headquarters and operations of our Hearth business in California to Tennessee. The relocation will reduce costs and reduce operating efficiencies by positioning product development and R&D personal closer to our existing fireplace manufacturing operations in Union City Tennessee. Upon completion of these two projects in the first half of 2010 we expect annual savings of about $6 million.

Let’s look at some key points from each of our businesses for the quarter. In our residential business, the anniversary or our mid 2008 price increases has come and gone and we continue to hold on to price which was flat in Q3 with the year ago levels. Looking at our residential new construction business, sales of our Lennox brand products were flat in the third quarter versus the year ago. The down performance in the market reflects the strong position we have with national builders. Seven of the top 10 builders do business with Lennox. As the residential new construction market continues to come back, we are very well positioned.

Turning to commercial; despite the weakness in the commercial unitary market in North American and Europe, pricing remained firm and mix was up. Lennox continued to win in the market place on the strength of our energy efficient rooftop systems. We signed four new national accounts in the quarter bringing the total since the start of 2007 to 68 new national accounts.

Regarding government stimulus spending K through 12 schools continue to be a bright spot. Also, in the third quarter we started to see an increase in quoting and booking activity with federal, state and local governments and we expect this to increase in 2010. With the most energy efficient rooftop product line in the industry and a focused sales force to capture these opportunities, we are well positioned to benefit from government stimulus spending.

In our refrigeration business we continue to pick up significant market share on the strength of our high efficiency products. Our North American supermarket volume is up 20% in the first nine months of the year. We continue to benefit in supermarkets from Carrier selling its refrigeration business to Hill PHOENIX, one of our major customers earlier this year. We are also gaining significant share in supermarkets in Australia where sales were up in constant currency. In China we saw double digit growth in constant currency in the third quarter. Segment margin was up from third quarter a year ago on strong cost reductions and favorable pricing.

Finally, in Service Experts we saw the year-over-year rate of decline slow slightly in the third quarter compared to the second quarter. Although commercial services are weak the residential service and replacement side of this business appears to be showing signs of bottoming. With strong cost cutting, higher technician productivity compared to a year ago segment margins were up in this business also.

Now, let me turn it over to Bob to discuss our financial results in a bit more detail.

Robert W. Hau

Let me provide some additional comments on the business segments for the quarter starting with residential heating and cooling. In the third quarter revenue from our residential heating and cooling segment was $347 million, down 16%. Volume was down 13%, price was flat and mix was down 2% on additional residential new construction business. Currency had a 1% negative impact. Segment profit in the third quarter was $39 million compared to a profit of $55 million a year ago. Segment margin was 11.2% compared to 15.4% in the third quarter of the prior year.

Now, turning to our commercial heating and cooling business. In the third quarter revenue for the commercial business was $154 million, down 39%. Volume was down 40%, product mix was up 3% and price was flat. Currency had a -2% impact. Segment profit was $17 million compared to $14 million in the prior year quarter. Segment margin was 11.1% compared to 16% a year ago. Our European commercial HVAC revenue was down in the high 30% range and the business was essentially breakeven for the quarter. Aggressive restructuring activities continue in Europe as Todd mentioned. In North America commercial HVAC revenue was down in the high 30% range due to the overall new construction slowdown and ongoing weakness in retail.

Moving to our Service Experts business, in the third quarter revenue was $137 million, down 11%. Volume was down 10%, price and mix were flat. Currency had a -1% impact. Segment profit was $8 million compared to $5 million in the prior year quarter and segment margin was 5.7% compared to 2.9% a year ago. This is due to higher technician productivity, lower fuel cost, lower SG&A expenses and the timing of cost savings between quarters in the second half.

In our refrigeration segment, revenue in the third quarter was $134 million down 18%. Volume was down 16%, product mix was flat and price was up 1% from the third quarter a year ago. Currency had a -3% impact. In constant currency sales were down in the mid teens in North America, up in Australia and China and down significantly in other international markets. Segment profit was $17 million, flat with $17 million a year ago. Segment margin was 12.6% versus 10.3% in the prior year quarter. The 230 basis point improvement was driven by favorable pricing, lower SG&A expenses and savings from manufacturing rationalization initiatives.

Looking at restructuring charges and other items from our continuing operations in the third quarter, Lennox had net after tax charges of $8.2 million from restructuring activities and $0.8 million from unrealized gains on open futures contracts and other items. These net charges impacted our GAAP EPS from continuing operations by $0.13. In discontinued operations, the company announced plans to exit from five additional unprofitable SEI service centers in the quarter which led to a $2.9 million pre-tax charge in the quarter in discontinued operations. $2.1 million of this was from impairment. The after-tax effect was $2.7 million or $0.05 per share.

Corporate expenses were $13 million in the third quarter down 18% from $16 million a year ago due to lower compensation costs and cuts in discretionary spending. Our full year 2009 corporate expense guidance remains approximately $60 million. Overall, SG&A was down 6% in the third quarter versus the prior year driven by headcount reduction and cuts in discretionary spending.

Our cash from operations in the third quarter was $131 million, 12% better than third quarter last year. For the first nine months this year, cash from operations was $213 million, up more than 50% in the same period last year. Capital spending in the third quarter was approximately $13 million versus $16 million a year ago. We now expect 2009 capital spending to be about $65 million versus prior guidance of $75 million. Working capital balances improved on a year-over-year basis by $134 million. Our 12 month average working capital as a percent of trailing 12 month sales was 18.9% compared to 18.2% in the prior year quarter. The quarter end working capital balances as a percent of trailing 12 months sales was 17.7% compared to 17.9% in the prior year quarter.

Now, looking at liquidity; cash and short term investments were $102 million at the end of September. Our debt to EBITDA ratio was 0.9 and our total debt on the balance sheet was $201 million at the end of the quarter after paying down $119 million. Looking ahead, our long term debt to EBITDA guidance remains between one and two times and we expect it to be within that range ending 2009. We will continue with a balanced and disciplined approach with the use of our cash including investing in the business, paying competitive dividends, potential share repurchases and potential acquisitions.

Before I turn it over to Q&A I’ll briefly talk about our outlook for the remainder of 2009. Looking at the end market assumptions in residential first, the most recent NAHB estimate has North America single family housing starts down 28% for all of 2009. For the fourth quarter NAHB estimates residential new construction to be up 9% year-over-year. With seasonally adjusted single family housing starts up six of the last seven months we are more optimistic that the bottom of the residential new construction market has been reached.

Our best estimate for the replacement market is down mid single digits for the full year. There continues to be uncertainty around the replacement market and around key drivers like consumer confidence, consumer financing and of course weather is always a variable. For the residential market we expect it to decline in the low teens for all of 2009.

In commercial HVAC we continue to see very soft end markets. We now expect the North American unitary market to be down in the high 20% range for the year versus our prior expectation of down in the mid 20% range. We now expect the markets we serve in Europe to be down in the mid 30% range versus prior expectations to be down in the low 30% range. In refrigeration North America continues to be soft while international markets have weakened further excluding Australia and China. We expect China to be up in 2009.

As Todd previously discussed, we are on track with our restructuring, commodity, global sourcing and SG&A cost savings guidance for 2009. Based on results today and market conditions expected through 2009 we are narrowing our revenue and adjusted EPS guidance. We expect revenue to be down approximately 19% for the full year including two point impact from foreign exchange. We expect adjusted EPS from continuing operations to be $1.65 to $1.70 for all of 2009. Our adjusted EPS from continuing operations for the first nine months of the year is $1.19.

GAAP EPS from continuing operations for 2009 is now expected to be $1.31 to $1.36 on the narrower guidance range and additional restructuring charges. Our fully diluted weighted average share count assumption is 56 to 57 million shares for the full year and our tax rate on income from continuing operations is expected to be 36% to 37% for the year. We now expect capital spending to be $65 million for 2009.

With that, let’s go to Q&A.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Jeffrey Hammond – KeyBanc Capital Markets.

Jeffrey Hammond – KeyBanc Capital Markets

Todd, you announced some additional restructuring here and if you could just walk through what you’re calling for, for incremental restructuring savings in 2010 from the actions you’ve already announced?

Todd M. Bluedorn

I think the pieces that we’ve been clear about so far Jeff for 2010 is the global sourcing initiative. We’ve talked about we think that’s a 5% savings and so somewhere between $30 to $40 incremental in material cost reduction in 2010. On the restructuring charges, I’m not sure we’ve added all that up and sort of given clear guidance on what pieces are going to be in 2010. I think the piece we announced today at least right now we’re talking about being $6 million annualized and it will be implemented during the first half of 2010. We’re together in December, we’ll layout a detailed roadmap on how all that breaks out.

Jeffrey Hammond – KeyBanc Capital Markets

Then refrigeration certainly impressive results on the bottom line and certainly a little bit better on the top. It sounds like the color that you gave that the benefits that you got on the bottom line are sustainable but I just want to ask are there any aberrations or onetime benefit that would suggest that that is not a sustainable run rate?

Todd M. Bluedorn

No. I mean, it’s the things that we talked about so there’s no one timers if that’s the question. It’s we’re winning in the market place and outperforming the market. The team has done a very good job on SG&A, we got price in the quarter and then we use words like manufacturing rationalization initiatives to a large decree that’s the closure of Danville and we talked about that being a $7 million annual run rate savings and a vast majority of those savings started to kick in, in 2009. So, it’s restructuring our footprint and taking costs out.

Jeffrey Hammond – KeyBanc Capital Markets

Finally, I appreciate the comments on national accounts and what you guys continue to accomplish there on the commercial side and I think you commented on share gains in res ne construction but can you just reconcile your results res kind of down mid teens versus AHRI down 9% and the AHRI like commercial is kind of running down 30%. You guys seem to run closer to down 40%, can you just kind of talk about share and maybe some of the moving pieces of your results versus some of the market data.

Todd M. Bluedorn

If you look at our residential segment and as you know Jeff that includes our hearth businesses, our fireplace business as well as what we call our ADP coil business and both those businesses are 70% to 80% new construction so those were down more than our core HVAC business. If you just look at our core residential HVAC business we were down 10%ish or so in volume for the quarter so very much in line with the AHRI numbers of 9%.

On the commercial business, our volume was down 40% for the quarter and that’s one the market is down 30%. The other reason we’re down more than the market is just some timing of some major national accounts and sort of in essence last year we shipped them during the second half of the year and this year we shipped a lot of the volume during the first half of the year. I think if you go back the first half of the year we significantly outperformed the market. For a full year we will outperform the market but not quite as much as we did during the first half.

Operator

Your next question comes from Stephen Tusa – JP Morgan.

Stephen Tusa – JP Morgan

Just on commercial, is there any visibility here as to the pipeline of stuff that’s going on out there?

Todd M. Bluedorn

The short answer is no. Longer answer is when we talk to our major national accounts the further out you get in the planning cycle the more optimistic they are and so you hear some confidence about 2010 when you look at the more in close business either from our national accounts or replacement business, the book and ship that you get, markets continue to be soft.

Stephen Tusa – JP Morgan

When you look at the resi business, a big mix benefit in the second quarter a negative this quarter. Can you maybe talk about the dynamics around mix in resi?

Todd M. Bluedorn

Really what happened on mix in resi is our new construction business was up, at least on the script we talk about being flat year-over-year so we outperformed the market on residential new construction and we make a little bit less on residential new construction than we do on our replacement business. At the same time the growth of our business towards high efficiency, that continued in third quarter. We were about 35% of our air conditioners that we sold during the quarter were 14 [inaudible] and above. I think it’s more a reflection of our mix skewing a bit towards RNC versus replacement for the quarter.

Stephen Tusa – JP Morgan

Carrier talked about a little bit of pull forward from the refrigerant change over, anything you saw there?

Todd M. Bluedorn

No, we really didn’t see that and again I think maybe it reflects how we go to market which is as you know, for the vast majority of residential we own our distribution so sort of a pull ahead, at least as I understood their comments probably meant that they pushed out on a last buy to independent distributors R22 product. We don’t have that phenomena so [inaudible] of our distribution in fourth quarter.

Stephen Tusa – JP Morgan

Just two more kind of quick ones, when you look at those buckets restructuring, commodity costs $25/$20 this year, what were those numbers in the third quarter and what have they been year-to-date if you can just remind us?

Todd M. Bluedorn

I don’t think I’ve given that color. I think the color that I’ve given has been that restructuring was really spread through the year and that commodities given the timing of the hedges and the like was back end loaded and on the material global sourcing initiatives also back end loaded although more split between third and fourth quarter.

Stephen Tusa – JP Morgan

Are you concerned about the recent move up in commodity prices and given that you are holding price but you’re not getting additional price is that a concern for 2010?

Todd M. Bluedorn

Clearly it’s a concern when inflation comes back in the business if the markets don’t recover. So, if we wake up in a scenario where commodity costs are up and the markets are still down, I think that will create a drain on margins. I’m optimistic in a belief that says I think markets will recover if commodities are inflating and then I think maybe we’re in a position to get price in the market place. I also said this before that I think a little bit of commodity inflation is good for the industry. It reminds people that doing what we’re doing which is holding our price in the market place is probably a good response when you’re not sure what your input costs are going to do.

Stephen Tusa – JP Morgan

One last quick one, your total inventories were up in the quarter kind of unusual from seasonal perspective, anything going on there?

Todd M. Bluedorn

I think maybe there were two things going on, one was just with the fx rates of some of our international inventory and more specifically in refrigeration and how it was valued quarter-over-quarter and then the other piece which I think will be taken positively is in our residential business you’re starting to see a reloading of some inventory and I think that foreshadows our expectations of what we think the markets are going to be doing.

Stephen Tusa – JP Morgan

And that’s ahead of 2010, they’re doing that now?

Todd M. Bluedorn

That’s on behalf of fourth quarter and as we go in to 2010.

Operator

Your next question comes from Robert Wertheimer – Morgan Stanley.

Robert Wertheimer – Morgan Stanley

My question is basically on the stimulus that’s going on at the federal level is that driving a new replacement cycle at the educational institutions? In other words, is it more than offsetting potential weakness from budget tightness, is it driving your replacement cycle or is it just offsetting some of the weakness that would have been there?

Todd M. Bluedorn

I understand the question, it’s hard to tell the difference between the two quite frankly. We see that as one of the few markets that continues to hold up in the current environment and we’ve made some changes in our sales force in addition to obviously the product line that we have so we are focused on that market place. It’s hard for me to say if they didn’t have the money what they would do or not do.

Robert Wertheimer – Morgan Stanley

I guess maybe a different way of asking it and I’m not sure if you’d know this level of detail but when you go out in to the business you’re winning related to stimulus is it units that wouldn’t have normally been replace because they didn’t need to come out anyway?

Todd M. Bluedorn

I’ll talk to sales, I think quite frankly it’s probably a combination of both which is we like when we sell up the higher efficiency product and the government stimulus money does that and then I’m sure there are breakeven economics or close to breakeven economics that sort of kick in to the positive when they know that the federal government is going to be picking up the bill.

Robert Wertheimer – Morgan Stanley

Can you talk a little bit just about the timeline of that end of the business, the bidding and the quoting, whether it’s accelerating still and whether schools and educational institutions have really started to take full advantage of it?

Todd M. Bluedorn

The school market is very seasonal in nature obviously which is the business is done in the summer time so you have lots of dialog and conversations with folks but then you actually do the work during a reasonably narrow period of the year. I think the bidding activity continues to bubble along in that market and more interest activity but I don’t see any spikes.

Operator

Your next question comes from Keith Hughes – SunTrust Robinson Humphrey.

Keith Hughes – SunTrust Robinson Humphrey

As you were talking about residential you quoted some NAHB predictions. Do you believe that the fourth quarter will see the industry up year-over-year in residential HVAC?

Todd M. Bluedorn

For the overall residential HVAC?

Keith Hughes – SunTrust Robinson Humphrey

Yes.

Todd M. Bluedorn

I don’t think so. I think if you take our math of up 9% I think is what we quoted on NAHB and then we said down mid single digits on replacement, I think if you take the weighted average the market is still down.

Keith Hughes – SunTrust Robinson Humphrey

Within residential you had talked about the Lennox brand being flat –

Todd M. Bluedorn

[Inaudible]

Keith Hughes – SunTrust Robinson Humphrey

Second question, if you look within the hearth business and the non Lennox branded, are they performing substantially worse than that?

Todd M. Bluedorn

Yes because the way to think about them at least as a proxy is what housing is doing year-over-year and so even though sequentially we’re seeing good moves, third quarter was still down 20% plus in new housing and first half of the year was down 50%. That’s sort of the way I would think about those businesses.

Operator

Your next question comes from Glenn Wortman – Sidoti & Company.

Glenn Wortman – Sidoti & Company

Given the restructurings and cost initiatives you guys have been making do you guys have any revised figures on some of the margin goals for your various businesses over the longer term or in a more ideal operating environment?

Todd M. Bluedorn

Yes and we’ll clean that up when we’re together in December. The answer is we do and we’re working through it and directionally it is what you are suggesting which is the last time I talked about this last December we said 10% EBIT [inaudible] at a $4 billion revenue level and given all the work we’ve done getting a 10% is going to be at a lower revenue level and we’ll sort of clean all that up and give guidance in December for on a long term basis.

Glenn Wortman – Sidoti & Company

It did sound like you have some tough comparisons maybe on the replacement side of the business, if I’m mistaken please correct me. Can you just give us what the number was year-over-year?

Todd M. Bluedorn

I think it was less tough comparisons on replacement. I think the tough comparisons was the timing of national account deliveries, that several of our major national accounts just the timing of when they wanted the deliveries, and we knew this coming in to the year, was different this year than last year. Last year was skewed towards the second half of the year, this year was skewed towards the first half of the year so if you look at some of those customers the comps become more difficult and some of them were some of our largest customers.

Operator

Your next question comes from Jeffrey Hammond – KeyBanc Capital Markets.

Jeffrey Hammond – KeyBanc Capital Markets

Just a couple clean up items here, I think you’re affirming your corporate expense spend of $60 million which would imply $18 million in the fourth quarter. Is there something sizeable that comes in the fourth quarter or is there some downside risk to there? And then, the same on cap ex I think $65 million cap ex would imply a $30 million cap ex quarter in 4Q.

Robert W. Hau

First on the cap ex, if you recall on the second quarter call we had back in July we talked about $75 million because we had released quite a few projects and the timing of getting those projects done in house has slid a little bit in to the fourth quarter and actually a little bit in to next year so we took our guidance down about $10 million but we do believe the $65 million given what we have in the pipeline right now. And, the first part of your question?

Jeffrey Hammond – KeyBanc Capital Markets

Corporate expense?

Todd M. Bluedorn

The answer on corporate expense Jeff is in the fourth quarter there is that sort of catch all for accruals and sort of true ups for the end of the year. That’s our best guess of where we think the numbers are going to be. If your question is do we think there’s downside risk there, I don’t think so. I think we’re going to be reasonably close to that number.

Jeffrey Hammond – KeyBanc Capital Markets

It looks like in Service Experts you closed some additional branches, underperforming branches, is that process still ongoing or are you kind of getting through that analysis of those sites that maybe don’t make sense in the portfolio?

Todd M. Bluedorn

I think we’re closer to the end than the beginning. I think the other thing obviously that’s going to help us is the markets appear to have bottomed or are close to the bottom and will recover in 2010 and so I think that helps. But, I wouldn’t expect a whole lot more of that, if any.

Jeffrey Hammond – KeyBanc Capital Markets

Then just finally, if we take commodity costs as they stand today copper, steel, aluminum, do you think commodities are kind of neutral next year, a headwind, tailwind?

Todd M. Bluedorn

You’re going to try and get guidance out of me for 2010. I think the thing that you can start to model a little bit on your own is we talk about how we’re hedged 50% on copper 12 months out and I think the actual number is we’re close to 40% hedged copper right now. I think the actual number 38% for 2010. So, you can start to figure what that means and when the hedges went in and make your own assumptions, the spot price on copper today is $2.85 or whatever it is today.

I think the way to think about steel is we buy it at a discount to what the CRU pricing is which is an industry standard and we buy it pricing a quarter in arrears if you will so whatever the CRU was during the prior quarter then we get a discount that we’ve negotiated off that depending on our different grades of steel. I think you can start to lay out what’s happening with steel, what has happened with steel, what you think will happen with steel, how you lay copper in and draw some conclusions. I spent a lot of words and didn’t answer your questions.

Jeffrey Hammond – KeyBanc Capital Markets

I guess final question, you mentioned I think being below your net debt to EBITDA target of one to two but you thought by year end you’d kind of be back within that band so maybe just walk me through priorities on cash flow? I’m assuming you’ll generate a nice chunk in the fourth quarter?

Todd M. Bluedorn

Well, I think it continues to be the things that we’ve talked about which is investing in the business and we talked a little bit about how we saw from second to third quarter residential inventory go up which is unusual for the business which indicates the business is starting to grow or we think it is going to grow and so inventories are starting to be reinflated. I think we’ll see some of that. Then, as always the focus on investment in the business on the cap ex side and then finally giving money back to the shareholders. As you know, we have an open authorization on the share buyback and Bob used his word and parsed the phrase correctly which is we’ll opportunistically do share buy backs as it makes sense.

Operator

Your next question comes from Stephen Tusa – JP Morgan.

Stephen Tusa – JP Morgan

Just a follow up on the resi side, at what point do you think we will start to see the distributors behavior next year or the end market channel begin to fill up a little bit more to get an idea of how consumers are feeling on HVAC versus next year? I mean do you think we’ll have to wait until May like we did this year or do you think people are going to look out and project a little bit better demand and start to stock a little bit earlier? What are your guys in the channel telling you?

Todd M. Bluedorn

Again Steve we’re a little bit different than the others which is we own our distributors. So, I think the numbers I gave you on inventory indicate where we’re placing our bets a little bit on what we think the resi markets are going to do. But, at the end of the day though we don’t realize a sale until we sell it to a dealer and a dealer doesn’t buy it until, in most cases, until he sells it to a end use customer or consumer. So, I think you really don’t know what the residential market is going to do until you get to the May/June time period.

Stephen Tusa – JP Morgan

Then Robert maybe you can just talk about your initial impressions and what you’re most excited about there, what your plans are to improve things at Lennox?

Robert W. Hau

I’m in the middle of week three here and impressions are good. Lots of due diligence coming in and I though highly of what I was walking in to when I did walk in the door and those assumptions have been proven out. It’s a great company, terrific cost control over the last 12 to 18 months in very difficult markets and I’m looking forward to those markets starting to come back.

Operator

There are no further questions, if you have any closing comments?

Todd M. Bluedorn

End markets remain difficult in the third quarter but cash generation remains strong. While the commercial market continues to look soft, the rate of decline in the residential and refrigeration markets has been slowing. While we continue to realize the benefits from our previously announced cost savings initiatives, additional restructuring initiatives are underway for further savings. We continue to focus on strong execution through this downturn and continue to position the company for strong earnings leverage as end markets recover. I want to thank everyone for their interest in joining us on the call. Thanks.

Operator

Ladies and gentlemen that does conclude your conference for today. Thank you very much for your participation and for using the AT&T Executive Teleconference. You may now disconnect.

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Source: Lennox International, Inc. Q3 2009 Earnings Call Transcript
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