Steve Harrison - VP, IR Todd Bluedorn - Chairman and CEO Joe Reitmeier - CFO.

Jeff Hammond - KeyBanc Capital Markets Tim Wojs - Robert W.

Baird Steve Tusa - JP Morgan Ryan Merkel - William Blair Robert Barry - Susquehanna Financial Group Julian Mitchell - Credit Suisse Rich Kwas - Wells Fargo Securities Jeff Sprague - Vertical Research Partners Nigel Coe - Morgan Stanley Walter Liptak - Seaport Global Joshua Pokrzywinski - Buckingham Research Shannon O'Callaghan - UBS Robert McCarthy - Stifel Nicolaus Gautam Khanna - Cowen and Company.

Ladies and gentlemen, thank you for standing by. Welcome to the Lennox International Second Quarter 2016 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, sir..

Good morning. Thank you for joining us for this review of Lennox International's Financial Performance for the Second Quarter of 2016. I'm here today with Chairman and CEO, Todd Bluedorn; and CFO, Joe Reitmeier. Todd will review key points for the quarter and Joe will take you through the company's financial performance and outlook.

To give everyone time to ask questions during the Q&A, please limit yourself to a couple of questions or follow-ups and re-queue for any additional questions. In the earnings release we issued this morning, we have included the necessary reconciliation of the non-GAAP financial measures that will be discussed to GAAP measures.

You can find a direct link to the webcast to today's conference call on our website at www.lennoxinternational.com. We will archive the webcast on that site 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 publicly available filings with the SEC.

The company 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..

Thanks, Steve. Good morning, everyone, and thanks for joining us. Lennox International realized strong margin expansion and profit growth across all three of our businesses in the second quarter to set new record highs for the company.

On a GAAP basis, operating income rose 23% to a record 161 million, and operating margin expanded 260 basis points to a record 15.8%. The total segment profit rose 20% to a record 161 million, as total segment margin expanded 230 basis points to a record 15.8% in the said quarter.

Revenue was up 3%, negatively impacted by the cooler start to the summer in which April and May cooling degree days were down nearly 20% from last year. Weather turned warmer in June and has remained warmer so far in July for a good start to the third quarter.

GAAP EPS from continuing operations is up 41% in the second quarter to a record $2.52, adjusted EPS from continuing operations was up 38% in the quarter to a record $2.53. Now residential business in the second quarter, we set new records for sales, margin and profit.

Segment profit was up 16% on 4% revenue growth, segment margin rose 220 basis points to a record 20.2%. On the operations front, we continue to see a smooth regulatory transition from 13 to 14 SEER minimum efficiency in the south and southwest regions of the United States.

And 14 SEER pricing has been in line with what we expected in our financial guidance. The regulatory transition was complete at the end of June, since no more 13 SEER air conditioners can be sold or installed in the south and southwest.

Our overall residential mix was impacted by channel mix, as residential new construction and national account business grew faster than replacement business. Residential new construction revenue was up low double-digits again this quarter, compared to a mid-single digit growth in the replacement business.

Regarding distribution expansion, we opened five new Lennox parts plus stores in the second quarter to total 193 stores. We are on track to open 27 new stores and end the year at 213 stores.

These stores have been enabling us to win new dealer contract to Lennox and gain market share, as well as provide a high level of equipment parts availability to new and existing dealers in the market. Turning to our commercial business, revenue was flat compared to the strong prior year quarter, in which we were up 10% at constant currency.

Commercial margin and profit set record highs, segment profit rose 10% as commercial margin expanded a 170 basis points to 18.7%. In North America, commercial equipment revenue was flat at constant currency. Non-national account revenue was up low single digits and national account revenue was down low single digits.

We continue to see strong wins for new national account customers with 10 more wins in the second quarter to bring the total to 20 already this year. On the service side, national account service revenue was up low-single digits and Europe commercial HVAC equipment revenue was relatively flat.

In refrigeration, revenue was up 6% at constant currency in the second quarter. From a regional perspective of constant currency, North America was up mid-single digits, Australia was up low-single digits, Europe was up mid-teens, South America was down high single digits and Asia was up more than 30%.

Refrigeration profit rose 60% on the prior quarter, as segment margin expanded 390 basis points to 11.1%. For the year in refrigeration, we now expect segment margin to be up about 200 basis points versus our previous guidance to be up a 100 basis points.

Overall for 2016 our underlying market expectations for the year remained consistent despite some head-winded time some weather in the first half. We are reiterating revenue growth guidance on a reported basis, with foreign exchange now expected to be neutral and a raising guidance for EPS from continuing operations.

We have recently raised the dividend, completed our previous 200 million stock share repurchase program, and today announced new $100 million stock repurchase program for the second half of the year.

We are excited about the second half and continue to expect another record year with strong margin expansion and profit [Technical Difficulty] were set from the prior quarter. Segment profit margin was a record 20.2% up 220 basis points.

Segment profit was impacted by higher volume and lower material costs with partial offsets from unfavorable foreign exchange and investments in SG&A and distribution expansion. Now turning to our commercial heating and cooling business; commercial revenue was $253 million in the second quarter that was flat compared to the second quarter a year ago.

Volume was down 1% and pricing mix combined was up 1% and foreign exchange was neutral to revenue. North America commercial HVAC equipment and service revenue was flat, while Europe commercial HVAC revenue was also flat. Commercial segment profit was a record $47 million which was up 10% from the prior quarter.

Segment profit margin was a record 18.7% and that was up 170 basis points. Segment profit was impacted by lower material cost and favorable price mix, with partial offsets from lower volume, unfavorable foreign exchange and investment to support growth in the commercial services business.

In our refrigeration segment, revenue in the second quarter was $192 million and that was up 4%. Volume was up 7% and pricing mix combined was down 1%. Foreign exchange had a negative 2% impact on revenue. From a regional perspective, Todd addressed revenue growth in constant currency.

On a reported basis, North America was up mid-single digits, Australia was down low-single digits, Europe was up mid-teens, South America was down more than 20%, and Asia was up nearly 30%. Segment profit was $21 million which was up 60% from the prior quarter. Segment profit margin was 11.1% and that was up 390 basis points.

Segment profit was impacted by higher volume, lower material costs and lower factory cost and higher productivity. Commercial offsets included unfavorable price mix and foreign exchange. Regarding special items in the second quarter, the company had net after tax charges of $300,000.

This amount included 1.4 million for restructuring and other items net and a $1.1 million special legal contingency gain. Corporate expenses were $24 million in the second quarter, compared to $22 million in the prior quarter. Overall SG&A was $159 million in the second quarter, compared to 153 million in the prior year quarter.

Net cash from operations in the second quarter was $72 million, compared to 70 million in the second quarter a year ago. Capital spending was $18 million, up from $15 million in the prior year quarter. And free cash flow was $54 million in the second quarter, compared to $55 million in the prior year quarter.

We ended the second quarter with a total debt of approximately 1.1 billion and had a debt-to-EBITDA ratio of 2.2. We paid $16 million of dividends in the second quarter and at the end of June cash and cash equivalents were $55 million.

Now to review our outlook for 2016; while the first half of the year has seen some headwind from weather at times at our markets, looking at what we expect for the full year, our unrelying market assumption ranges remain unchanged. For the overall industry, we expect North American residential HVAC shipments to be up mid-single digits.

We expect North American commercial unitary shipments to be up low single digits, and we expect North American refrigeration shipments to be up low-single digits.

We continue to expect revenue growth of 3% to 7% for LII overall this year and now we expect foreign exchange to have a mutual impact versus our prior expectations for a negative one point impact. At constant currency for 2016, revenue growth guidance is now 3% to 7% compared to prior guidance of 4% to 8%.

We are raising our guidance for GAAP EPS from continuing operations for the full year from a range of $6.26 to $6.76 to a new range of $6.45 to $6.85. We are raising guidance from a just EPS from continuing operations for the full year from a range of $6.30 to $6.80 to a new range of $6.50 to $6.90 excluding $0.05 of special items in the first half.

The higher EPS range reflects the company’s strong operational performance and outlook, as well as a lower effective tax rate. As I mentioned last quarter, we have structurally reorganized an international subsidiaries for our businesses today.

As a result, we are able to utilize foreign tax credits and other benefits that drive our effective tax rate down. Much of the benefit from the foreign tax credits come in the second quarter and these were a benefit on top of the operational outperformance in the quarter.

For the full year, we now expect a lower effective tax rate of 31% versus prior guidance of 32%. To give you more color, we expect our third quarter tax rate to be approximately 32% and our fourth quarter tax rate to be approximately 34% to get to the 31% rate on a full year basis.

Looking beyond 2016 to future years, we expect approximately a 32% effective tax rate. An additional benefit of the tax reorganization is our ability to repatriate cash generated in prior periods in a tax efficient manner.

We plan to repatriate $50 million in cash from our foreign subsidiaries and contribute the $50 million to our pension plans in 2016. The 50 million in cash was generated in prior periods that we now intend to use in 2016. As a result, we are adjusting our free cash flow target to reflect our use of the cash this year.

Our free cash flow target will now be $200 million for 2016, versus the 250 million previously provided. Let me now walk you through other drivers of our guidance and the puts and takes for 2016.

Starting with the guidance points that are changing beyond those already discussed, foreign exchange is now expected to be a $10 million headwind for the year, versus the prior guidance of $20 million headwind. We now expect $40 million benefit from sourcing and engineering led cost reduction, actions compared to prior guidance of 35 million.

And we now expect a $45 million benefit from commodities and price combined compared to $40 million benefit in the previous guidance. Within this total, we are raising the commodity savings from 25 million to 35 million and fine tuning the price benefit from 15 to 10 million.

We are also fine tuning the guidance for residential mix for a $5 million benefit to relatively flat in 2016, driven by channel mix. We have seen double-digit growth in new constructions so far this year compared to a mid-single digit growth in replacement business.

For corporate expenses, we now expect $90 million for the year compared to prior guidance of $85 million, as we continue to invest in the businesses for growth. A few guidance points that have not changed; we still expect $11 million of incremental savings this year from our second plant in Mexico.

We still assume net interest of approximately $29 million for the year. The weighted average diluted share count guidance for the full year remains approximately 44 million shares. And finally, we continue to target capital expenditures at approximately $95 million for the full year. And with lets go to Q&A..

[Operator Instructions] And our first question comes from the line of Jeff Hammond from KeyBanc Capital. Please go ahead. .

Just on the raw material, it looks like you are bumping up the commodity savings. Just speak to that, what’s driving that? We’re seeing some inflation on steel and may be how should we think about that in to the second half. .

In our prior guidance we had assumed that the spot price of copper and aluminum would go up during the second half of the year and impact the part of our positions that remained unhedged. That’s not been the case so far, and so it’s good news on the copper and aluminum side.

Steel pricing we have locked down, except between now and the end of the year. Thinking about 2017, if spot prices would remain flat at this point, steel would be a pretty significant headwind for us next year partially offset by copper and aluminum.

But we have to see how commodity prices continue to develop in the second half, but if steel are up year-over-year next year, which it looks like it will be, than we will go out to the market and raise price to offset it just like we have in the past. .

On the commercial business, certainly good first quarter and then a flatter second quarter, do you think of that as lumpiness, was your emergency replacement impacted by weather? Just what are you seeing from a trend standpoint there?.

I think its predominantly lumpiness. So what we talked about in the call or on the script was our non-national account business, which is sort of all the verticals besides national account just up low-single digits.

[Emphatically], I would tell you emergency replacement which is a subset of that was up mid-single digits after being up double digits in first quarter. Weather had some impact on emergency replacement, and I think why we were only up mid-single digits rather than high or double digits.

And then our national accounts business was down low-single digits in the quarter. It’s no news that Wal-Mart is going to be down this year for many of its suppliers in the HVAC or refrigeration business. Wal-Mart aside, our backlog in national accounts is up high single digits as we go in to third quarter.

So we feel good about national account business in the second half of the year. .

Our next question comes from the line of Tim Wojs from Baird. Please go ahead..

Just on the cadence in the quarter, I know weather in April and maybe May was a little bit of a headwind.

Did it really warm up enough in June, and how you’d define the trajectory in to right here?.

I mean April, May of course we talked about and everybody can read the weather maps. It was cooler about 27 cooler than last year from degree cooling days. June warmed up nicely.

I would tell you parenthetically, even in our business where we sell direct to dealers, when you have warm weather the last seven to 10 days of a quarter that really sort of carries you in to the next quarter, because even dealers sort of have their book out on jobs or buying the equipment a little later than when you see the weather.

We used a word in the script of strong start to Q3, and I would underline that for residential. We had some weather headwinds - in the fourth quarter we had some weather headwinds in first quarter. We had a little bit weather headwind in the second quarter, but we’re coming out of the gate strong in residential for the third quarter..

And then you’ve talked in the past about higher efficiency, cooling shipments, and I think your transition kind of threw a little bit of a wench in that metric.

Is there any way to try to gauge what more minimum efficiency versus maybe ‘16 here and above?.

We need to come out with a little better metric than what we have now. What I would give you now is almost unusable which is second quarter last year compared to second quarter this year our 14 SEER and above is up 17 point, but to you point that reflects a regulatory change.

We’re going to re-calibrate this, we want to get through the summer selling season so let us get through third quarter which is part of the summer selling season and then when we get together for December analyst day, we’ll have some new metrics, and so re-calibrate people going forward on how to think about mix up. .

And then last one, the new 100 million share repurchase that’s not in guidance for the second half of the year?.

I’m not sure I understand the question, so let me restate it. The $100 million share buyback is contained in the guidance that we gave today. .

It is contained. Okay, great. .

And next question comes from the line of Steve Tusa from JP Morgan. Please go ahead. .

Just a quick question on - going back to kind of the raw materials dynamics. So is there any way to kind of frame this. You’re not going to have I guess 35 million bucks in commodity benefits this year and you used the term substantial.

If we kind of just snap the line on where these things are today, do you averse that entire 35, my guess is the term substantial, you kind of put some emphasis on that, is that at least a good starting point. .

I’ll answer directly; let me ramble so that I can spin it my way in the spirit of what’s happening in Cleveland this week. For 2016, if you listen to the detailed guidance we gave, we’re saying it’s a 45 million benefit from commodities and price, 35 from commodities and 10 million from price and we’re flat on arresting mix.

So those three items are positive 45 million. When we think about 2017, if steel stays where it’s at, we’re going to have a headwind of commodities rather than a tailwind. So yes, the 35 million goes away, but I parenthetically tell you that the price would be significantly higher than 10 and we’d also have positive mix.

So, I think the bigger question to think about isn’t are we going to have 35 million of commodity, its’ just the way we are sitting now we won’t. It’s what’s that 45 million of commodities price and mix.

And I think if you go back and check even in years where we have commodity headwinds, we are able to get significant price to help offset - a positive mix to help offset it. .

Right. I guess you’re tempering your price for this year a bit from 15 to 10. I mean does that kind of give you a bit of a pause as far as the degree - our check suggest that pricing power means pretty good for most suppliers out there. So is that just a kind of - than yesterday..

Because I don’t think the cost of the commodity shock of steel has rolled through the P&L yet. I have a different perspective than you do. I think to have 45 million from commodity and price in the same years is strong performance.

And so even with commodities rolling through low, we’ve been able to get pricing at the same time the Canadian FX has moved in a positive direction to us and that was one of the drivers of price that we needed for this year, but it’s good news to the P&L.

So I’m more optimistic about both the results and the future that we’re going to be able to - while commodities are going to be headwind, we’re going to be able to offset it. .

And I guess just as a math, we wanted to do our own back of the envelop, so we just take, I guess you have ceilings on steel for the year, that’s kind of the way we just take the year-end steel price as of last year just to see where it is today and that’s kind of the degree of snapback.

Can we use that in to that analysis at least as a starting point or is there some sort of catch-up or something like that? I don’t if I’m asking the question in the right way. .

No, you’re asking the question the right way. .

Is that the mechanism, is that the way it works?.

I think there will be - the way I would think about it is, there’s going to be a little bit of a lag because we’ll have some of the steel that we buy in the fourth quarter weed in to 2017, number one. Number two is, it’s tough.

We’ll give you an artificially high number if you take the starting price in ‘16 and compare it to the starting price in ‘17 in the spot market, because with the agreements we had it wasn’t tied to what the lowest price was at the start of the year. We had some a collar on it, but not at that level.

So I understand what you want to do, and you can start to ballpark it, but we’ll give clearer guidance in December when we see what steel shapes out as well as the other commodities. .

But just to be clear, there is a risk that it will be negative.

You’re not necessarily saying that today, but it will be negative?.

I think when I use headwinds that’s my way of saying it’s going to be negative. .

Okay, because you said the 35 goes away, so I was saying less of a tailwind. .

I think we’re going to pay more because it’s changed the change, right. So.

Sure..

We’re going to pay for steel next year than we did this year. .

Yeah, a 100%.

And then just one last one, how good was June for you guys in resi?.

We had a nice June, but even to underline what I said, it’s a nice June, but it got us out of the blocks quickly for July and some of the weather in June helped us as we rolled in the third quarter. .

So can we think double digit for June?.

I’m not going to answer the question; I understand what you’re --..

Our next question comes from the line of Ryan Merkel with William Blair. Please go ahead. .

First question on EBIT margin, I think for 2016, you are tracking ahead of the 12.5% target that you set out.

Can you just provide an update on your thinking there?.

We’re a seasonal business and it’s sort of hard to track exactly where we should be for you guys to track exactly where we should be. Now commodities have been more front end loaded for some of the reasons we just talked about with Steve, and so I think we had more benefit commodities first half of the year.

But if you take the midpoint of our guidance; on guidance we’ve lowered revenue slightly and we’ve raised earnings slightly. So the math is that 12.5 is going to go up some. .

And then on SG&A, you haven’t leveraged that the past two quarters.

Is this something we should expect in the second half of the year?.

I think what it reflects is, we’re cognizant on the significant investment - not significant but the important investments that we need to make in IT and our ability to serve our customers, and we don’t outline those quite as dramatically as several of our or at least one of our competitors does, but we’re making the same kind of investments and I think that’s reflected in the SG&A.

The direct answer to your question is, over the medium term which is over next couple of years, you should expect to continue to see leverage in SG&A..

And just lastly, the change in the resi mix going to flat, is that more a function of mix by channel versus the consumer appetite for higher SEER equipment. .

Yes. And it especially reflects the two things that you’ve talked about, selling to some national accounts which ware important to what we do.

But the main driver is residential new construction growing quicker than add-on a replacement and add-on replacement still a healthy mid-single digit growth rate it’s just residential new construction was up double digits. .

Our next question comes from the line of Robert Barry from Susquehanna. Please go ahead. .

I did want to just clarify more specifically what the growth rate was in the quarter for the add-on replacement component of resi?.

Mid-single digits. .

How much do you think weather cost you in the quarter in resi?.

A point or two of revenue growth..

I guess I’m just trying to square the comments you’ve historically made about whether being mostly relevant to June in the second half of June and it was not in June especially in the second half and some of the swing regions that matter like the Northeast and the upper mid-west were particularly warm.

Given mid-single and add-on replacement against what became a much easier in add-on replace suggest the cool start had a pretty significant impact. .

I think the short answer is, it had an impact, a significant impact and then I’ve said that a couple of times, but I underline it. The weather the last 10 days or so really is going to have a positive impact on third quarter rather than second quarter.

The demand was there, but what sort of happens when it gets that hot that quickly that our dealers are busy.

So if you call to get your air conditioner replaced instead of somebody saying I’ll replace it today, you’ll say I’ll be out next week, and then they delay the ordering of shipment for us for a week or 10 days until they are ready to come out and do the job. That’s what we saw at the end of second quarter.

The weather the last week or two really is helping us to get off to a strong start in July. .

Got you. So as you see it, everything else of share gain around the distribution enhancement, the pent up demand, all of that in your view is the same, its’ really just weather. .

Yeah, I don’t. The short answer is, yes. Long answer is, we feel the sentiment of the consumer are still positive. We talk to our dealers, they are still very happy, they are extraordinarily busy right now as they have been for the last six weeks or so, and there’s lots of moving signals because of timing of things last year.

But I think its steady as she goes on residential revenue, and I think I wish you’ve asked the question, it was a point or two on resi revenue and that helps answer the question. I think its weather and our team is confident it’s the weather and that’s the issue and we’re off to a strong start in Q3 in resi. .

Maybe just a quick one on commercial; Todd, you made some very positive comments late in the quarter on the strength in the Commercial business particularly in planned replacement even in retail.

And then it came in flat, I know you had a tough comp, I don't know if you just want to perhaps add some additional color there, maybe you were referring more to the margin performance?.

I think when I talk publicly or even privately about the commercial business of second quarter national accounts, I always try to carve out Wal-Mart.

And I’ve always said, people understand what’s going on with Wal-Mart given some public comments by our competitors and we’re seeing the same thing, and what I mentioned in the script is that Wal-Mart aside our backlog is up high single digits in national accounts, and our non-national accounts business was up low single digits for the quarter..

Got you, and where is the mix benefit coming from? Because you said emergency was up more.

Is it the service business?.

Service was a big piece of it. And even within our non-national account business we’re seeing a mix up to higher efficiency equipment. .

And our next question comes from the line of Julian Mitchell from Credit Suisse. Please go ahead. .

Yes I just wanted to switch to refrigeration a second. I mean if you look at that business, very, very good margin performance yet again. I think it sort of the fourth quarter consecutive quarter where you’ve had a very good margin expansion year-over-year.

But comps on margins start to get a little bit tougher in the second half on the other hand, maybe price mix stops being ahead wind at some point. So if you could just give some color on how you see refrigeration margins playing out from here. .

I’ll just underline something that you said, which is, by our records fifth straight quarter of margin expansion in refrigeration and the drivers are things that you would want them to be, volume, lower material cost, improved factory productivity are all driving the margin expansion.

But I think the point you made is right, we saw a ramp up in volume in second half of the year last year with some of the Wal-Mart business, we’re now going to lap that, so the comps’ going to be a bit more challenging.

All that being said though, we’ve said that we expect refrigeration margins to be up 200 basis points this year from our prior guidance of 100 basis points. I think with that end point you can sort of back in to margin second half of the year. .

How about price mix impact?.

We continue to look to mix up in our business. And part of the issue that drives mix and refrigeration is across the different businesses and some of our - one of our best businesses are not our display case business in North America, but our core refrigeration business in North America.

And it’s strong and its had strong growth rates year-to-date and we expect that second half of the year and I think that will help the mix of the business..

And then back to commercial, just around the non-national account business. It sounds as if it is sort of purely lumpiness there was no particular slowdown in any kind of vertical or end market that you saw.

Maybe give any update on sort of specific end markets how the order intake is moving?.

It’s up low single digits non-national accounts. I think the one vertical that we’ve seen some softness year-over-year and we’ve had a really big year last year with some [K312], so that slowed down a little bit and I think that’s the end market and not our share of it for lots of different reasons.

But other verticals light industrial, small office building, you local dentist office, all those verticals sort of remain - they’re not on fire but up lower single digits. .

Next we have Rich Kwas from Wells Fargo. Please go ahead. .

So, Todd, I know you don't give quarterly guidance, but just wanted to - as we think about Q3 here, you are going against a pretty tough comp in resi?.

Yeah..

From volume standpoint. So in the context of the comp you just went through in commercial here this past quarter.

It would seem obviously, you should better than what you did in commercials past quarter in residential here in Q3, but there’s any way to think about that, anything you would point out?.

I agree there’s a tougher comp that - I said five times we are off to a strong start in res, I don’t know how many more times I can stay on my foot. .

And then as you look at next year with incrementals; with the headwind on the commodity side, how do we think about it as it relates to your normal 30% incremental margin, and you have been trending well above that with some of the commodity savings.

I know you have sourcing in there and whatnot, but do we think of this kind of from a lumpiness standpoint, where it could trend below that until pricing really sticks or is there any thoughts on that as we think about looking out into next year?.

If I would model, I would take where we’re going to end the year, take a look at the three year target that we gave last year and then you have two years ago sort of lay out, and I would lay those out and assume over a three year period. Maybe on a little less revenue, we still get to the Ross location.

So we’re still going to have nice drop through the book, we’ve underlined it, everyone understands us.

We have a 100% drop through this quarter, that’s not normal and that’s not something you do all the time, that’s what you do when you have commodity tailwind and you’re getting price and you’re doing Mexico, and you’re doing everything else we’re doing, that normalizes overtime, but 30% is still the incremental margin I would use for the out years. .

And then lastly from me with regards to further restructuring that could occur, there's more on the table potentially on the residential side, correct?.

I’ve broaden the question and the answer to say, we continue to look at ways to lower our cost structure both on the factory side and non-factory side, point one.

Point two is, I’ve said over and over again we’re not done in Mexico and we think that’s a great facility and we have two factories there and we continue to think through what’s the right play to continue to leverage our volume in Mexico. .

Okay. And then last one, $0.40 spread for the balance of the year that was narrowed a bit, but not as much as you've done in the past.

Anything to think about there?.

I say this and sound arrogant, and I don’t quite mean to, but $0.40 on a $3 guide is different than $0.40 on a $6.70 guide. So while it’s still $0.40, I think as a percentage it’s even tighter that it’s been in the past. .

Our next question comes from the line of Jeff Sprague from Vertical Research. Please go ahead. .

Just a couple things to clean up, a lot of ground covered here.

Just on 14 SEER, Todd as you said, it's kind of case closed, but just wondering if it is totally case closed from an industry standpoint, from your vantage point? In other words, do you see people stuck with inventory in the South that they are moving north, did you have any yourself Just the state of the channels, from your vantage point?.

Really haven’t seen any behavior by others, so I won’t directly respond to that. Our guys been doing the field, I don’t know right now.

But we had a little bit de-minimus to our results and we have already accounted for it and are in the process of moving it North, and we always knew that we wanted to have the last Board and the last shot fired in the war, so we didn’t want to run out and so we made sure that we have enough and we had a little bit left and are in the process of moving it.

.

And then I'm just wondering on the pension perhaps for Joe, by my math just this move in interest rates created $40 million - $50 million headwind in your funded status. So it looks like you’re plugging that hole this year.

Would you see the need for further pension contributions into ‘17 and ‘18, if rates stay this low?.

Good question first of all, second, I want to go back and talk about the tax benefits that we derived it, afforded us the opportunity to have access to about $50 million in cash that we looked at various places where we thought we could most effectively utilize that cash with its (inaudible) plans. To your point, the discount rate has moved down.

With this pension contribution it enables us to once again raise our funding levels, with the expectation over time that discount rates will increase and when they do and it will continue to afford us the opportunity to further de-risk the pension plans. .

The direct answer to your question Jeff is, we’re not sure, we have to see how asset returns come in as well as where the discount rate ends the year at. But we thought the 50 million was the prudent use of cash that we got from that changed our tax policy. .

Yes. I'm just wondering, it does make sense, obviously; I get it. Are you flirting with getting snagged in mandatory requirements or anything? Are you - basically the contribution keeps you in front of that. .

No. This was purely voluntary and when you look at our strong cash flow supported by strong earnings, we are confident that this is an opportunity like I said that will force the opportunity to continue to de-risk the plans going forward.

Once again, this is a voluntary contribution that we’re making to sort of get a little ahead of it as you mentioned. .

Next we have Nigel Coe from Morgan Stanley. Go ahead. .

Just a couple of quick cleanups here from me; so you did a good job of managing inventories this quarter, Todd. But one of your competitors did allude to the possibility of excess inventories entering June and therefore maybe some potential but weak in through pricing.

Did you see any of that from competitors?.

No, and I assume you’re referring to UTX and to extension [Watsco]. My guess is the warm weather helped our concerns..

Okay.

And then was the weather impact mainly within the Northeast or was it broadened, and in particular, did you see any impact of shale in Texas?.

Well, it’s a question about Texas, do we see any what?.

I just was wondering if the oil CapEx declines had an impact on consumer demand in Texas?.

The weather was wise. Where it was warmest was, I think we were historically stronger, which is in the central part of the country, central northwest and then also in the west coast especially California. On the specific question of Texas no, we haven’t seen impact to our demand.

Even in places like Houston in the woodlands there are still lots of housing going in for Exxon Mobile’s move to the suburbs and so even with at the low oil prices we continue to do fine in Texas. .

Okay, and then just one more on the buyback, would you hope to get the $100 million done by year-end?.

Yes. .

And next we have Walter Liptak from Seaport Global. Go ahead. .

I've just got a couple of cleanups, too. You mentioned with the commodities headwind that's coming, that you’d be potentially raising prices for next year.

I wonder on that, what's your expectation that you’d be able to neutralize the commodity cost headwind, or do you think you can get a benefit in 2017?.

No, we’re going to have to see how it all sticks out. I think I would look to the past as a predictor of the future, and so in past years when commodities were up moderately, we were able offset and then some with price and mix.

And steel is what’s gone up emphatically without being political artificially because of tariffs rulings and the tariff on imports. The underlying economy internationally still remains in such a way that copper and aluminum I think are still going to be, at least where they stand now are going to be benefits to us next year.

We have benefits for two other commodities, headwind from one, all combined it’s going to be a net headwind where it stands now and we’re going to focus on getting price and mix to offset it and then some, but we’ll have to see how the final map shakes out. .

Okay, that sounds fair. With this commodity situation for next year seems to be very well telegraphed by you guys, by the industry, I think everybody knows it.

Any thoughts or any conversations with customers about pre-buying ahead of any price increase for next year?.

You mean our customers?.

Yes..

No. Typically given that we sell, we own our own company distribution we’re selling large part to dealers, they just don’t carry enough inventory to have a meaningful impact. And on the commercial side amongst the replacement obviously not the case, but even on planned replacement they have schedules.

There might be a little bit of pull forward at the end of the year with a significant price increase looming if we announce or when we announce something in fourth quarter. But I don’t think it’d be material to the results. .

Our next question comes from the line of Joshua Pokrzywinski from Buckingham Research. Please go ahead. .

I think we've covered a lot of ground here, so maybe just one or two follow-ups from me.

I guess, Todd, first, on the price-cost gap in resi, 2Q to 3Q should we expect 2Q to have been kind of the widest gap there, and how should we think about that sequentially?.

Well I think the drop through in all three of the businesses was strong in second quarter as commodities, I think we’re at their low point for us and so that’s what I’d expect quite frankly for all three of the businesses. As I said earlier, we’re not going to have a 100% drop through going forward. .

Okay. So, I get it and maybe a little less of a tailwind into 3Q. And back onto refrigeration, clearly some internal initiatives have started to get traction there.

How much of the impact, if any, was from some of the stronger growth in Europe, and how should we think about that as kind of new business or anything that we can point to as having legs into 2017, as comps get tougher?.

Our refrigeration business was up in Europe and our team’s done a good job there. I think the driver of the revenue growth is North America, both in our display case business with the Wal-Mart customers, but also in our non-display case business we had a really nice quarter in North America.

And then margin expansion is driven a lot of self-help on material cost.

Commodities aside, as I’ve said earlier, I guess now the 40 million that we’ve assigned as a guide to material cost reduction, higher percentage of that is in refrigeration than it’s ever been and lower factory cost as we’ve done significant improvement in productivity both in our European business and our North American business. .

So Todd, just to maybe borrow your phrase, that you will understand this question. But thinking about maybe a baseball analogy on refrigeration margins, any good CEO would say that you are still early innings and there's plenty of wood to chop still.

But do you feel like you’ve made it a significant way through some of the initiatives there, how much where is left to go, just based on what you can see in kind of the pipeline ahead of you?.

I think I’ll give you some math, we ended last year at about 7.5, 7.4 someone just put in front of me. We said 200 basis points up, so it will put us at 9.4 just for the hell of it, I would say 9.5 this year, and we set our 2018 target was 11 to 13.

So I would say sort of over our three year journey to get to 11 to 13 we took a nice chalk out of it in the first year, but we still have our ways to go to get to 11 and 13 and we have a roadmap to get there. .

A ratable roadmap from here or still front-end loaded?.

I would lay it our ratable. .

Perfect. All right, thanks, guys..

If that means linear, I think it does. .

And next we have Shannon O'Callaghan from UBS. Please go ahead. .

Hey, aside from the potential raw headwind in 2017, are you sort of glad to see this when you think 2018, 2019, et cetera? Was it getting tougher to get price with the declining raws? Is this something that has a positive side to it in your view?.

I know distribution talks that way, because they view it as just sort of a higher cost of goods sold that they pass on. I’d rather live in a world where our cost of goods sold was zero, and all we did was sell stuff.

I don’t think commodity is going up, it’s a necessarily a good thing, but the key is how do we handle and how do we react to it and I’ll sort of said pretty aggressively that we’ve been to this before and we know how to do this and we’ll go out and get price. .

And just as you think about the hedges and things like that, is there - do you have any quarterly lumpiness for this where we have to kind of think about backend-loaded year, just anything in terms of those dynamics we should be mindful of?.

Again we hedge on copper and aluminum and so I’ve said that, at least where we’re sitting out that’s going to be a net benefit.

So you’re going to have to lay out the - if you’re going to try and guess before December you’re going to have to lay-off those hedge positions overtime and then on steel we buy it based on a quarter CRU, but this year we’d been able to get some fixed pricing during the second half of the year and so that’s going to be hard to model.

I think the answer is there will be some lumpiness next year where the comps are tougher than the different parts of the year, and I think it will be broadly speaking the comps will be maybe most challenging first half of the year and get easier in the second half of the year. .

Just on refrigeration margins, you talked about the five straight quarters, et cetera, and you have some nice momentum there.

Are you ready to sort of, from an operational improvement standpoint, kind of declare a victory in terms of some of the challenges that you’ve had there or there are kind of still visible things that are far from optimal?.

I’m going to answer like I think you hope I would, which is, its continuous improvement forever in our [men]. So we had 20% margins in residential and we ain’t done there on continuous improvement and making it better, and so we ended double digits 11% in refrigeration and we’re not even close to be in down with what we need to do there.

Albeit, we’ve made some nice progress, I think we’ve gone from critical care to preventive wing of the hospital..

Our next question comes from Robert McCarthy from Stifel. Go ahead. .

The question I have is, maybe just stepping back talking a little bit about your investments in distribution, I think a comment, Todd you made at our conference about just how you've changed your kind of view about distribution and the value it can bring, and could you talk a little bit about the investments you’re making there, and how you think that's going to be helping kind of your topline and bottom line?.

I sort of reflected there and I’ve reflected publicly in the past that pay check distribution 20 years ago, distribution not dealers but distributors.

I would have said the model I’ve thought made sense was local independent, fragmented independent, because I viewed it very much as local business where as it’s all about relationships and managing boxes of inventory and making sure things flowed locally.

But overtime that’s significantly changed and I think it’s increasingly changing, and that’s why we’re making such significant investments in IT to support our dealer network through LennoxPROs which is our online portal.

So being able to provide information, flow of material, being able to order, being like Amazon where you can track - the dealer can track his delivery and know when it’s going to reside.

Have an online portal where they can order like you’ve seen Amazon where you buy the unit and the parts and it reminds you if you’re missing anything and what you need.

You’d be able to have technician training online, you’ll be able to have spare parts availability when they arrive at home and on our Dave Lennox signature series where you have the iComfort to be able to do prognostics and diagnostics so that dealer technician arrives at the home knowing exactly what’s wrong before he gets there.

That’s all value added that we can provide.

And I think overtime as this value added becomes more and more differentiator, those who have, who own the distribution or control national distribution will have big advantages because they’re going to be able to leverage that spend over a broader and broader sales volume and that’s where we think we’re at. .

I'll leave it there..

And next we have a question from the line of Gautam Khanna from Cowen and Company. Please go ahead. .

I wanted to get your sense Todd, of where you think we are in the resi replacement cycle? If you can just calibrate us again, given the housing kind of boom of it was now 10 to 12 years ago.

Do you expect to see another bow wave, another increase in resi replacement as we move forward, and if so, when would you expect it?.

We’re still very bullish on the resi replacement market, and we’ve more broadly on the resi market we think there’s mid single digit growth for next three to five year, and I think there are three drivers.

One is, the pent up demand we think still exists, so we think all that volume from say ‘08 to 2011-2012 where people were repairing rather than replacing, we still think those units are breaking for the second time and we’re seeing a bow wave of that pent up demand.

Some of the sell side analysts have painted as much as a full year of air conditioning volume was created over that 4-5 year time period and we think at the end of this summer we’ll probably be two-thirds the way through that so there’s still a chunk of that left.

Second is, simplistically stated as your question applied, the new housing bubble becomes our replacement bubble. So a unit lasts 12 to 15 years or so. So all those homes that were put in early in mid-2000 are now coming in to the replacement cycle.

And then the third is, and we’ve seen it for a couple of years now, but we think it continues as single family starts which is a driver of our new construction business, we think continues to grow and never gets back to the peak at least I hope it doesn’t for a lot of reasons in my professional career.

But still has ways to go to get to the normal take up rate and we’re seeing double digit growth in that end market again this year. So, I think there is three drivers of the resi demand over the next three to five years growing as a multiple GDP. .

That's very helpful. And I was wondering if you could update us on any change to the M&A environment? I know you've announced the buyback. I presume that means it's still not as robust an opportunity set. But maybe you can opine on what you are seeing and what you might expect to see over the next couple years..

Yeah, we’re pretty selective about what we’re going to do.

So I’m not sure I’m a broad or I’m an indicator of the broad M&A market, where we would want to do a deal first and foremost is consolidate the North America HVAC business that’s a handful of property, somebody would have to decide so and then we might do something in Europe if that made sense and we could get it at the right price to expand the strengthening business in Europe that we have.

And the share buyback just reflects, I think more positively the strong cash flow we have in the business, the strong quarter that we have and what we think remains in front of us for the balance of the year. .

And last question, just looking out a year I was hoping you could just opine on what you think happens to SEER 14 pricing? It’s matched your expectations so far, but do you expect that that's going to be a bigger headwind next year? Any comments on that would be helpful..

I can’t get the tenses right. I don’t know if I want to say it has shook out or it has shaken out, but it’s done all the shooking and shaking it’s going to do I think.

So we think we’re at where we’re at on 14 SEER pricing that folks have sold out their inventories and its stabilized about where we thought it would which was somewhere between the old 14 SEER pricing and the old 13 SEER pricing and I think we avoided a big problem, and we always thought that’s how it shake out and that’s how it has. .

Last one for Joe, perhaps you can just frame for us how large steel is as an input overall relative to your COGS, I had it at under 5%? Is that in the ballpark?.

Actually I think it’s a little bit more than that. .

I think about it as - I’ll give you the pieces of the math because I haven’t done the sort of gold math lately. It’s about 70% or so of our cost of goods sold is material, and then if you take that material and blow it back up about 35% to 40% of that 70% is raw copper, steel and aluminum and still is the largest of the three. .

Our last question comes from the line of Steve Tusa with JP Morgan. Please go ahead. .

Just two very quick follow-ups; how much is that commods number, that commodity benefit this year, been so far for the first half? I know it is 35?.

It’s about 25 or so..

25 million of that 35? Yes, okay.

And then did you have any down months in resi?.

Say that one more time. .

Did you have any down months in resi? Down sales months in resi?.

I’m pausing. I don’t think so. I think we’re up year-over-year every quarter or every month. Maybe in April we may have been slightly down, but really I don’t remember. .

Thanks a lot guys. .

Few points to leave you with. The company set new record highs for margin and profit in the second quarter and we remain focused on driving performance. We’re raising EPS guidance for 2016 and initiating a new $100 million stock repurchase program for the second half.

The third quarter is off to a good start for all three of our businesses, and we continue to expect another record year with strong margin expansion and profit growth. Thanks everyone for joining us today. .

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