TWST: We'd like to begin with a brief historical sketch of the company and a picture of the things you are doing at the present time.
Mr. Bluedorn: Lennox is 113 years old, and was started in Marshalltown, Iowa. There was an inventor by the name of Dave Lennox who started the company and then sold it to the Norris family. It was a privately owned company until 1999 and then listed on the New York Stock Exchange as LII. Today, Lennox is an international company with nearly $4 billion in revenue. That's the high level overview of Lennox International.
We are a premium heating, ventilation, air-conditioning, and refrigeration business. About half of our revenue is from North America residential consumers, which is how most people know of Lennox — as either their air-conditioning in their backyard or the furnace in their basement. About a quarter of our sales are commercial HVAC products, which are products on the roofs of customers like Wal-Mart and Target and Kohl's, big box retailers across the country. About 15% of our business is refrigeration, which is the inside cooling equipment for what you see in your local grocery store or in cold storage warehouses. And then our fourth business segment is what we call Service Experts, which are local dealers and contractors who support residential and commercial customers by maintaining and installing HVAC equipment.
TWST: What is the competitive landscape like?
Mr. Bluedorn: It depends on the industry segment we play in. But to a large degree, the major competitors are companies like Trane, which is now part of Ingersoll-Rand; Carrier, which is part of United Technologies; York, which is part of Johnson Controls; and Goodman, which is held by private investors here in the US. Those are our major competitors, both in the commercial and residential marketplace.
TWST: Do you feel that you have distinct advantages over them?
Mr. Bluedorn: I think we do. When I think how we are positioned in the marketplace, we are positioned on the premium end and Carrier and Trane are there along with us. I think we have some distinct advantages. Normal distribution is a two-step distribution process. There are distributors that then sell to thousands of dealer customers across the country. For our Lennox brand, we own our own distribution, so we sell directly to our dealer customers, which we think gives us advantage on the premium end. We also think we are very innovative on product.
A leading consumer magazine recently rated our Healthy Climate® air cleaner as the number one professionally installed, whole-home filtration system. We just recently launched a rooftop unit called Strategos™, the most efficient rooftop unit in the industry. At the same time, we have lots of opportunities going forward to reduce our costs and be more competitive on the cost side. Over the last 18 months, we have either announced or completed the closure of four factories worth $20 million of additional savings. We announced and have actually completed a 300,000 square foot factory in Mexico, and we will be ramping up full production in September of this year. We have communicated that this move to Mexico is going to save us $20 million in costs annually in 2010. So we are both proud of our heritage and the advantage it gives us in distribution. Beyond this, we have intensified our focus on factory and overhead costs, and that is helping drive our profitability and margin expansion.
TWST: Is there anything else on opportunities and strategies?
Mr. Bluedorn: The additional opportunity I would talk about is some geographic expansion. We have about 85% of our businesses in North America. Our largest single opportunity for geographic expansion is in China, specifically in terms of refrigeration. We have a factory in Wuxi, China, which is outside Shanghai. Our sales this year, while still relatively small to the company overall, have almost tripled in China over the last year. We have recently announced expansion of our factory in Wuxi, and almost doubled the size of our production there. There is a lot of breathless forecasting about how the refrigeration market is going to grow in China. The segment we are playing in is called cold storage. Some industry experts expect this business will grow tenfold over the next 10 years. That's a segment we like because customers value the technology we bring. We are well positioned for the growth in China and are excited by that. The other area we are focused on is overhead and expense controls. Again, facing difficult markets here in the US, we have reduced our salary headcount by 6% over the last year. We have taken down our corporate expenses from $85 million last year to around $65 million this year. Our strategy encompasses product innovation, distribution excellence, geographical expansion, factory footprint and costs, and reducing our overhead expenses.
TWST: What about possible challenges or problems?
Mr. Bluedorn: I think the biggest challenges we face in this industry are now happening in the marketplace. Residential new construction, which accounts for about 30% of the residential HVAC market, is down 60% from where it was at a peak in 2005. Even the residential replacement market, which has tended to be recession-proof, was down mid-single digits last year. It looks like it's going to be down mid-single digits this year as the economy and consumer confidence drag it down. Again, the initiatives I talked about earlier, specifically reducing our product cost and our overhead, is how we are responding to these pressures in the marketplace.
TWST: What would be the two or three best reasons for the long-term investor to take a close look at Lennox International?
Mr. Bluedorn: I would sum it up this way: we are in an industry that has strong fundamentals, an industry that allows you to use technology insertion to differentiate the product in a meaningful way to consumers. What I am saying is, customers understand and are willing to pay for things like energy efficiency, and so that's a good industry structure. One point is the solid industry structure.
The second point is, many of our end-use markets are at or near the bottom of a cycle — residential new construction, residential replacement and the retail segment, all which have downturned over the last year. And yet even in this very difficult market, we have managed to take out cost and focus on productivity. We've been able to sustain and expand our margins. As those markets come back, we expect the cost we've taken out will allow us to continue to expand the margins and really have a take-off in the business. So, one is good industry structure. Two, we have done a lot of good work on positioning ourselves for the market rebound. And then third, there are the things we are traditionally good at: innovation, product differentiation and our distribution. As the markets continue to value energy efficiency and environmental sustainability and controls, we think we are very well positioned to take advantage of that macro turn.