Steve L. Harrison - Lennox International, Inc. Todd M. Bluedorn - Lennox International, Inc. Joseph W. Reitmeier - Lennox International, Inc..

Timothy Ronald Wojs - Robert W. Baird & Co., Inc. Charles Stephen Tusa - JPMorgan Securities LLC Julian Mitchell - Credit Suisse Securities (USA) LLC (Broker) Jeffrey Hammond - KeyBanc Capital Markets, Inc. Ryan J. Merkel - William Blair & Co. LLC Gautam Khanna - Cowen and Company, LLC Deepa B. N.

Raghavan - Wells Fargo Securities LLC Robert McCarthy - Stifel, Nicolaus & Co., Inc. Shannon O'Callaghan - UBS Securities LLC Joshua Pokrzywinski - The Buckingham Research Group, Inc. Walter Scott Liptak - Seaport Global Securities LLC Robert Barry - Susquehanna Financial Group LLLP.

Ladies and gentlemen, thank you for your patience and standing by. Welcome to the Lennox International Fourth Quarter 2016 Earnings Conference Call. Just as a reminder, this conference call is being recorded, and I would now like turn the conference over to Steve Harrison, Vice President of Investor Relations. Please go ahead..

Good morning. Thank you for joining us for this review of Lennox International's financial performance for the fourth quarter and full year 2016. I'm here today with Chairman and CEO, Todd Bluedorn; and CFO, Joe Reitmeier.

Todd will review key points for the quarter and the year, 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. In addition, all comparisons mentioned today are against the prior-year period.

You can find the direct link to the webcast of today's conference call on our website at www.lennoxinternational.com. We will archive the webcast on that site 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 risk and uncertainties that could cause actual results to differ materially from such statements. For information concerning these risk 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 thank you for joining us. Let me start with a quick review of 2016 overall and then discuss fourth quarter highlights and give some high-level thoughts on 2017.

2016 was another record year for Lennox International, with the company establishing new highs for operating margin and profit as well as for cash from operations and free cash flow. Revenue was up 5% for the year and GAAP operating income rose 41% to a record $429 million. GAAP EPS from continuing operations is up 54% to a record $6.34.

On an adjusted basis, total segment profit rose 24% to a record $470 million and total segment margin expanded 200 basis point to a new high of 12.9%. Adjusted EPS from continuing operations was up 35% to a record $6.95. Revenue, margin and profit were up in all three of our businesses in 2016.

Residential and Commercial set new records in all three measures, and Refrigeration top-line growth and margin expansion drove segment profit up 30% for the year. The company's performance in 2016 was led by our Residential business. Residential margin was up 7% and profit rose 25%. Segment margin expanded 250 basis points to 17.4% for the year.

Revenue from replacement business was up mid-single digits, and new construction was up low-double digits for the year. We drove record margins in Residential while continuing to make strategic investments for future growth and enhanced profitability.

Investments range from new products to distribution expansion to leading information technology for dealers, technicians and homeowners. In Commercial, revenue was up 4% at constant currency for the year and profit rose 14%. Segment margin expanded a 160 basis points to 16.3%.

As in Residential, our Commercial business hit new record highs even as we continued to make strategic investments in the business. In North America, equipment revenue is up mid-single digits for the year. Non-national account revenue was up high-single digits, a continued success with our initiatives in the emergency replacement market.

National account revenue was up low-single digits. Outside of retail, we saw strong revenue growth in our national account business as our diversification efforts over the last several years continued to pay off. The company continued to win in the market with 31 new national accounts in 2016, a new record for us.

On the commercial service side, Lennox national accounts service revenue was up mid-single digits. In Europe, Commercial HVAC revenue was flat at constant currency for the year. In Refrigeration for the year overall, revenue was up 2% at constant currency and profit was up 30%. Refrigeration margin expanded 210 basis points to 9.5%.

At constant currency, North America, Europe and Asia Pacific was up low-single digits for the year, and South America was up mid-single digits in a very tough end market environment. Turning to the fourth quarter, company revenue was up 8% to a new fourth quarter record of $897 million.

GAAP operating income rose 233% and GAAP EPS from continuing operations was up 276%. On an adjusted basis, the company set new fourth quarter highs for total segment profit and margin as well as EPS. Total segment profit rose 30% and total segment profit margin expanded 200 basis points to 11.7%.

Adjusted EPS from continuing operations rose 35% to $1.50. Our Residential and Commercial businesses established new fourth quarter highs for revenue, profit and margin. In Residential, fourth quarter revenue was up 10%, and profit rose 43% as segment margin expanded 400 basis points to 17.2%.

Weather was relatively warm to start the quarter in October, but the team did a great job closing the quarter strong in December as weather turned cold. Revenue from replacement business was up high-single digits in the quarter, and residential new construction revenue was up low-double digits.

Turning to Commercial in the fourth quarter, revenue was up 7%, and profit rose 11% as segment margin expanded 60 basis points to 15.9%. In North America, commercial equipment revenue was up 10%, led by low-double-digit growth in non-national account businesses.

National account equipment revenue was up high-single digits, and service revenue was up mid-single digits. In Europe, Commercial HVAC revenue was up low-single digits at constant currency. In Refrigeration, revenue was flat at constant currency in the fourth quarter.

From a regional perspective, at constant currency, North America and Europe were down low-single digits, and Australia was down mid-single digits. South America was up more than 20%, and Asia was up nearly 30%. Refrigeration segment profit and margin were also flat in the fourth quarter after strong growth in the first three quarters of the year.

The parts for (07:16) Refrigeration in the fourth quarter reflects timing of national account revenue and factory loading of our Kysor/Warren business. While the fourth quarter was flat in Refrigeration, that business made nice progress in 2016, and we expect progress to continue in 2017.

We expect the North America refrigeration market to be up low-single digits this year and are targeting another 50 basis points to 100 basis points of margin expansion for our Refrigeration business in 2017.

Before I hand it over to Joe, let me take a moment to make a couple of points on issues that investors have asked a lot about with the new administration; potential tax reform and border-adjusted tax or tariffs. First, on the corporate tax rate.

Given our current 32% effective tax rate, we would be a significant beneficiary from a reduction to 15% or 20%. We estimate that every 1% reduction in the tax rate equates to approximately a $0.10 benefit to EPS for us. This would obviously be a significant near-term and long-term benefit.

With regard to a potential border-adjusted tax or tariffs, we are monitoring closely alternative proposals. I would highlight that we have flexibility with our North American residential manufacturing footprint, especially with our low-cost assembly factory in South Carolina.

To add capacity in U.S., invest in factory automation to drive productivity or continue to make additional investments in Mexico, all depending on what path makes the most economic sense.

The bottom line is, we have action plans in place depending on what policies are set to continue driving margin expansion in our Residential business and across LII.

While there are a lot of headlines day-to-day, the overall perspective is another year of strong growth and profitability for the company in 2017 and with a strong balance sheet and record cash generation, we continue to be well positioned to make investments to drive future growth, raise the dividend with earnings, and repurchase company stock with $250 million planned for 2017.

Now, I'll turn it over to Joe..

Thank you, Todd, and good morning, everyone. I'll provide some additional comments and financial details on the business segments for the quarter and full year, starting with Residential Heating & Cooling. In the fourth quarter, revenue from Residential Heating & Cooling was a fourth quarter record $476 million, up 10%.

Volume was up 9%, and price and mix combined was up 1%. Foreign exchange was neutral to revenue. Residential profit was a fourth quarter record $82 million, up 43%. Segment profit margin was a fourth quarter record 17.2%, which was up 400 basis points.

Segment profit was positively impacted by higher volume, favorable price mix, higher productivity and lower material and other product costs. Partial offsets included investments in distribution expansion, information technology and research and development. For the full year, Residential segment revenue was a record $2 billion, up 7%.

Volume was up 6% and price and mix combined was up 1%. Foreign exchange was neutral to revenue. Segment profit was a record $349 million, up 25% and segment profit margin was a record 17.4%, up 250 basis points. Turning to our Commercial Heating & Cooling business. Commercial revenue was a fourth quarter record $243 million, up 7%.

Volume was up 7% and price and mix combined was flat. Foreign exchange was neutral to revenue. North American Commercial HVAC equipment revenue was up 10%. National account services revenue was up mid-single digits. Europe Commercial HVAC revenue was flat, although up at constant currency, as Todd mentioned.

Commercial segment profit was a fourth quarter record $39 million, up 11%. Segment profit margin was a fourth quarter record 15.9% and that was up 60 basis points. Segment profit was positively impacted by higher volume, lower material costs and favorable foreign exchange.

Partial offsets included higher SG&A, investments in distribution expansion and other product costs. For the full-year Commercial revenue was a record $918 million, up 3%. Volume was up 3% and price and mix combined was up 1% and foreign exchange had a negative 1% impact on revenue. Segment profit was record $149 million, up 14%.

Segment profit margin was a record 16.3%, up 160 basis points. In our Refrigeration segment, revenue in the fourth quarter was $178 million, up 1%. Volume was up 1% and price and mix combined was down 1%, and foreign exchange had a positive 1% impact on revenue. From a regional perspective, Todd addressed revenue growth in constant currency.

On a reported basis, South America was up more than 40%, Asia was up more than 20%, Australia was flat, and North America and Europe were down low-single digits. Refrigeration segment profit was $16 million, up 1%. Segment profit margin was flat at 8.8%. Segment profit was positively impacted by lower material and other product costs.

Offsets included lower factory productivity and higher SG&A. For the full-year, Refrigeration revenue was $723 million, up 1%. Volume was up 3% and price and mix combined was down 1%. Foreign exchange had a negative 1% impact. Segment profit was $69 million, up 30%. Segment profit margin was 9.5%, up 210 basis points.

And as Todd mentioned, the fourth quarter reflects timing of national account revenue and factory loading at the Kysor/Warren business. After a strong 2016 overall for Refrigeration, we see the fourth quarter as the pause and continue to expect solid growth of 50 basis points to 100 basis points in margin expansion for that business in 2017.

Regarding special items in the fourth quarter, the company had net after-tax charges of $24.5 million with $20.5 million of that due to previously announced one-time lump sum pension buyout program to certain vested participants. For the full year, the company had net after-tax special charges totaling $27 million.

Beyond the $20.5 million pension buyout, other items included $4.1 million for asbestos-related litigation and $1.8 million in special contingency charges.

Corporate expenses were approximately $32 million in the fourth quarter and $97 million for the full year, up year-over-year primarily on investments to support the company's growth, some general wage inflation, and employee incentive compensation. Overall, SG&A was $165 million in the fourth quarter compared to $151 million in the prior quarter.

For 2016, SG&A was $621 million compared to $581 million in 2015. The company have record cash from operations for the year at $355 million, up from $331 million in the prior year. Capital expenditures were $84 million in 2016 compared to the $70 million in 2015.

Free cash flow was a record $270 million for the full year, up from $261 million in the prior year.

I would note that in 2016 the company repatriated $50 million in cash resulting from tax planning initiatives and made a discretionary pension contribution in that amount which lowered cash from operations and free cash flow as reported for the year by $50 million.

In 2016, the company also paid $69 million in dividends and repurchased $300 million of stock. Total debt was $868 million at the end of the fourth quarter, and we ended the year with a debt to EBITDA ratio of 1.6 times. Cash and cash equivalents were $50 million at the end of the year. Before I turn it over to Q&A, I'll review our outlook for 2017.

One month into the year, our underlying market assumptions for 2017 remain the same. For the overall industry, we expect North American Residential HVAC shipments to be up mid-single digits, we expect North America Commercial unitary shipments to be up low-single digits, and we expect North America Refrigeration shipments to be up low-single digits.

Based on this underlying market environment and our targets for market share gains, revenue growth guidance for Lennox International remains 3% to 7% for 2017 with a minimal impact from foreign exchange. Our guidance for EPS from continuing operations for the full year remains a range of $7.55 to $8.15.

Now let me run through the key points in our guidance assumptions and the puts and takes for 2017, which remain the same as we first, set out in mid December. We continue to expect $35 million in savings from our sourcing and engineering-led cost reduction programs.

We expect $6 million in savings from our manufacturing operations in Mexico from actions that have already been taken, and we expect Residential mix to be a $5 million benefit for the year. We continue to expect $10 million of headwind from commodities in 2017 and are targeting $20 million in price increases for the year.

We have assumed a minimal impact from foreign exchange and we'll monitor that closely as the year progresses. Just a few more other guidance points that are unchanged. Corporate expense is expected to be approximately $85 million. We still expect net interest expense for the year of about $32 million.

Our effective tax rate guidance remains approximately 32% on a full-year basis. We continue to expect the weighted average diluted share count for the full year to be between $42 million to $43 million shares which includes our plans to repurchase $250 million of stock this year.

Capital expenditures are expected to be approximately $100 million for the year, and we are targeting free cash flow of $285 million for 2017. And with that, we'll go to Q&A..

Thank you. Looks like our first question comes from the line of Tim Wojs of Baird. Your line is open..

Hi. Good morning, guys. Nice job on the quarter..

Thanks, Tim..

Good morning, Tim. Thanks..

I guess just to start, Todd, maybe you could comment a little bit on how Q1 is trending to date and then, I know, Q1 seasonally is a little bit of a weaker quarter relative to the rest of the year, but just how should we think of Q1 EPS as maybe percentage of the full year?.

On the first part of the question, we're off to a solid start in Q1.

Weather has been a bit warmer in January than it was last year, but you always, quite frankly, worry a little bit when you sort of push, or not push, but have such a strong December that maybe you pulled something from the beginning of the year, but that's not the case, off to a nice start.

But March is the most important month of the quarter with 40%, 50% of the revenue in that quarter. In terms of first quarter, I would just sort of model it similar to what we've done in history.

You're right, it's our lowest seasonal quarter, and I would just look at the last two or three years, the percentage of our profits in first quarter and those are not going to be any different in any meaningful way this year..

Okay.

And then just, maybe just a bigger-picture question, just with the 3% to 7% revenue guidance range for the year, what would be the swing factors to get to kind of the top and the bottom to those ranges?.

Weather always is a big swing factor. And so, if you remember last year, we should have started out cool and then it got warmer as the year progressed. So weather is a swing factor. And then the other is how is this for an understatement, there is macroeconomic and political uncertainty. So there is some risk there also..

Okay. Great. Well, good luck on 2017. I appreciate it..

Okay, thanks..

And our next question comes from the line of Steve Tusa with JPMorgan. Your line is open..

Hey, guys. Good morning.

On the price cost side, is there any update to kind of the price capture you guys are expecting in 2017? Maybe just give us a little bit of color around what you're seeing out there as far as the range of the increases that are out there and whether or not 2017 is kind of forced to the high end of those ranges given where commodity has gone (20:48)..

As Joe talked about and reiterated our guide that we gave in December that, right now, we're guiding that we're going to have $10 million of headwind from commodities and $20 million of price benefit.

We announced the 5% price increase for Lennox Commercial effective November 1, 2016 and then the 3% to 6% price increase for Lennox Residential effective January 1 and in our other businesses, similar things. Obviously, that's the big umbrella that we announced but we're very confident we're going to get to $20 million.

You know and you've seen our competitors have all done similar things. Everybody understands the increasing commodity cost and the need to go out and get price. So we're confident we're going to be able to go do that..

Yeah.

And those are higher than kind of normal type of numbers, right, than in previous years?.

I think the announcement is – we tend to announce 4%, 5%. I think getting $20 million is higher than what we did last year. But in prior years, we've gotten $40 million, $50 million in price when there's been commodity shocks..

What was the price you got in 2016, just price not mix?.

I'm turning to the team. You asked me a question I'm – we were sort of rough (22:09) – I think for Resi, we said we're going to be flat. And then overall for the corporation, we had positive price..

Okay. And on the Resi incrementals, obviously, you crushed it here in the fourth quarter.

How much of that is coming from kind of the new products that you've designed where you have done a great job of taking the cost out of those and not necessarily reinvesting all of that cost out? And is there anything about the new product kind of phasing in 2016 that was kind of unusually strong?.

I think the driver in the fourth quarter was sort of the drivers we've seen all year for our Resi business with one exception. I think we had stronger mix up in fourth quarter and so we had some nice mix tailwind for the quarter. And, again, that reflects this move towards premium products. The cost takeout we saw all year.

And again, we've been at that for a while. So it sort of didn't bunch up in fourth quarter, sort of spread throughout the year. And then we had another quarter of commodity tailwind. And obviously as we go into 2017, maybe early in the year, we'll continue to have a little bit of tailwind.

But then as we get to the second half of the year, it will start to be a headwind. But, again, just overall strong performance from the Resi team. We're able to surge on revenue and not add a whole lot of cost in overhead or factory to be able to do that, just a well-run business..

Okay. And then one last question. It seems like a lot of your peers, some of the smaller guys have kind of revamped their product lines.

Are you seeing that have any kind of impact from a share perspective, maybe a little bit tougher to eke out market share with some of the guys that had been lagging historically thinking like kind of the yorks and the reams (24:00)? Are you seeing any initial impacts from their kind of reinvestments here?.

No. I mean, the longer answer is, from the time somebody launches a new product, given the distribution buffer and sort of all the touch points you have with the dealer, it's not coming out with the iPhone and you swing huge share, number one.

Number two is, I often joke from the time something is announced at Mount Olympus from one of our competitors, to the dealers tested and get comfortable to quality and make sure it works and performs the way, it takes a while. And so, they're refreshing their product, but guess what, so are we.

Our product innovation and our HVAC businesses are over 45% of product – sales from product we launched in the last three years. So we think the gap between our product and others is increasing, not closing..

Okay. Great. Thanks a lot..

Thanks..

And our next question comes from the line of Julian Mitchell of Credit Suisse. Your line is open..

Hi. Good morning. I guess my first question really on the Commercial business. You had a very nice acceleration in Q4 versus the preceding sort of six months. You're guiding for sort of low-single-digit growth in North America Commercial unitary this year.

Maybe just give us some sense around any shifts you saw in recent months in terms of the noises from customers, the distribution channel, how do you feel about that piece of your business in the U.S.

right now?.

We feel good going into 2017. There's more of a natural chunkiness or choppiness to the business given some of the large orders from some of the large customers. But again, we had a nice second half of the year in Commercial, especially fourth quarter.

We had talked about earlier in the year some of the school business being pushed out to December and that's what we saw. But order intake and backlog remains nice and strong as we enter 2017..

Thank you. And then just my follow-up would be on Refrigeration. You emphasized a sort of a pause a couple of times in the fourth quarter.

When you're thinking about how Refrigeration plays out in 2017, do you think that sort of pause continues into the first quarter or first half, or you think we should see a fairly kind of level-loaded year in that business in terms of the revenue and margin progression that you talked about?.

I think similar to Commercial, there can be some choppiness in the business. I think I would highlight the change year-over-year from 2015 to 2016 on why "we saw the pause" was third quarter was a much larger national account quarter for us than fourth quarter was in 2016, and the opposite was true in 2015.

So as we enter first quarter, we're optimistic with what we're seeing for order rates and backlog, and we think we're going to have a nice year in Refrigeration. And again, we've guided that the market is going to be up low-single digits in North America and it can add another 50 basis points to 100 basis points to margin..

And just following up on Refrigeration, the factory loading item you talked about, any more details?.

Tied to the same point, large customer in Arkansas, the timing between third and fourth quarter last year versus this year, you're building a product and so you get lots of factory absorption and benefit from those orders. And then when it's in a different quarter the next year, you get the benefits at a different time..

Great. Thank you..

Thanks..

And our next question comes from the line of Jeff Hammond of KeyBanc. Your line is open..

Hey, good morning, guys..

Hey, Jeff..

Good morning, Jeff..

Okay. So just on Residential, I mean, you guys talked certainly about weather issues at your analyst meeting. I just want to get behind a little bit what really drove the strength given some of those dislocations. And really maybe if you look more broadly second half, really a nice acceleration here.

What do you really see inflecting?.

I think, as often the case, I think the market's solid and strong. New construction being up, replacement demand, I know you were at our industry trade show. When you walk around and talk to people, people feel very confident. Number two is the weather got cold. And then three is I think we're performing.

All the things that we've talked about over the years just continues to be a virtual cycle. We continue to build out PartsPlus. We tend to put the PartsPlus stores, front-end load them, and so we have them in place as we go into the second half of the year, the investment in controls, the investment in LennoxPROs, our ability to convert dealers.

When you win dealers, you win them during the dealer conversion period, which is before the summer selling season. And then it takes five, six, seven months to ramp them up. And I think that you see that in the second half of the year. But, again, I think our Resi team is performing very well..

Okay. And then just on emergency replacement, you guys have done well there and very focused. I would say the observation at these shows is more people seem to be focused there.

So are you seeing that space get any more crowded as you look into 2017?.

I think others are involved and coming out with product. I think, the thing I would underline is things that we can do – I think, we're absolutely at sort of the low-cost point, and others, I think, could get close to us or match us, but I can't imagine they can get below us given our factory in Arkansas, given the design of the product.

Two is the build-out of our PartsPlus strategy for res and our ability to serve Commercial customer same day, I think, is unique. And then third is we really increased our focus on serving that segment. Carrier has been doing it forever, but some of these other folks who are getting in some emergency replacement. They may have the product.

They may even have physical distribution, but the marketing programs and the focus of having a separate sales force for these smaller at-once emergency contractors, we've gotten better and better at it. And we said when we launched, this will be a multi-year strategy and it continues to be the case.

And I know others are in it, but we continue to win..

Great. Thanks a lot, Todd..

And our next question comes from the line of Ryan Merkel. Your line is open..

Thanks, Todd. So, first, I want to talk about incremental margins.

I know in 2017 you're targeting 30%, but should we expect stronger results in the first half versus the second half just based on comparisons? And is there any other considerations you'd have us think about?.

I think that's what I would do, I mean just given the commodity profile that all of us can model when you think about the hedges. I think that's sort of the only thing that I would adjust for.

We – the weather is the other wild card, but that's hard to model that, so I think I would take what we've done over the last couple years, maybe pull forward a little bit during the first half of the year because of commodities..

Okay. Great. And then, secondly, on R-22 allocations going down again in 2017. I know it's not a big category for you, but was that – how are you going to offset? That is the first question.

And then, secondly, do you expect the decline in the R-22 availability to continue to push for more full replacements to R-410A next year?.

I think, we're really to the other side of that. I mean, from a regulatory point-of-view, you're not able to do dry charge units anymore, and so when – really, the R-22 equation just becomes a question of if you have an old system and you want it to limp along.

But typically – not typically, what will happen will be those systems are old enough now and the efficiency is low enough, it'd be silly if you had a catastrophic failure, compressor failure, to try and fix the compressor and then have it limp along by recharging the system. So I think, we're really to the other side of that as of mid-year 2016..

Okay. And just lastly on Wal-Mart's plans for Commercial and Refrigeration in 2017.

Any clarity there that you can provide?.

No. I mean, we continue to be a major supplier to them on the HVAC side. Lesser percentage of their business is on Refrigeration, but they're still very important customer to us, and sort of our – from their lips to our ears is in our full-year guidance.

I think, they continue to sort of rethink as they go along maybe what they're going to do, but – so their best guess is what our best guess is, and they're an important customer, and we'll see how it plays out..

Okay. Thank you..

Thanks..

And our next question comes from the line of Gautam Khanna with Cowen & Company. Your line is open..

Yes. Thanks. Good morning..

Hey, Gautam..

Following up on the last question with the Wal-Mart ex the Refrigeration, is there anything structural lead up that prevents Kysor Warren to get into the segment average Refrigeration margin? And if I recall, it finally broke even, right, in Q3 or Q4? So maybe (33:52)?.

Yeah. I mean we've obviously had trouble with this business; we took a write-down last year. Clearly on the right direction. Major driver of our 200-plus basis point improvement in Refrigeration. It can clearly be – our overall margin in Refrigeration is 9%, 10%.

It can clearly get to that level when you look at what Hill PHOENIX which is part of Dover has done, and in prior years, what Hussmann has done. So we're focused on that and think we're doing all the right things around cost reduction and focus on material cost reduction, as well as innovative product, alternative refrigerant systems.

So we're confident we're doing all the right things to drive the profitability of the business..

Is it in the black now and how dependent is it just on customer mix, i.e., you already go along in the restructuring and the product rationalization.

Is it now just a function of you need your big customers to buy the stuff that you want them to buy and not somebody will commoditize products?.

Without being too glib, I mean, I've never run a business where the customer mix wasn't the important thing. And so, Kysor Warren, just like all our other businesses, we got to get customers, we got to have profitable customers and we're moving in that direction and we're focused on that..

And is it in the black now?.

I mean, not in low seasonal quarters, but we're making money in Kysor Warren..

Last question just on M&A, can you talk a little bit about what you're seeing, if anything, in the pipeline and what types of assets might interest you?.

No, we're very selective, and I think we have this luxury that we can continue to expand margins in our businesses that we own, and we play in end markets that are growing low- to mid-single digits, and we can grow revenue like we did this year in the last four, five years of 5% to 6% a year. Our focus on M&A hasn't changed.

If we could consolidate the North America unitary HVAC market, we would love to do it, but it's only a handful of assets, and someone will have to decide they wanted to get out. We – for the right business, we'd do something in Europe. We have an improving team there.

And if we could grow our business in Europe through acquisitions, we might want to do something. And then the third one would be in commercial service. We've done some deals over the years, but organically we're growing. So, again, we'd be very selective there..

Thanks, Todd..

Thanks..

And our next question comes from the line of Rich Kwas of Wells Fargo. Your line is open..

Good morning. This is Deepa Raghavan for Rich Kwas. I have a question on Refrigeration trend. One of your competitors called out some mix headwinds, some pricing there too. Not all translates to you. We understand that, but trying to get a sense for the confidence you have in getting 50 bps to 100 bps margin expansion potential.

How much of that is internal initiatives versus how much of that is macro-dependent?.

I think, it's a little bit of both. I mean, our competitors, I'm sure, you probably talk – I assume you're talking about Hill PHOENIX. It's – I mean, that's a display case business that's maybe 20%, 25% of our Refrigeration business.

We do a lot of other things, cold room storage, international business, convenience stores, and those businesses continue to grow and margin expand, and we have the right customers.

So, again, from an overall perspective, it's obviously a combination of both the self-help and customers, but we feel pretty good about the margin expansion in Refrigeration. We said at least 200 basis points this year, and we did 210 basis points..

Okay. Residential revenue is pretty strong in Q4. Just given weather was not favorable early part and obviously – just curious, was demand more December weighted or did you experience any election-related pause or was it an even quarter? Any color on trends within Q4 would be helpful..

It was driven by the cold weather second half, November and December. I don't think the election had any impact at all. I think we just – it got cold, and the dealers were waiting for it to get cold, and it got cold, and we sold product..

Okay. My last one.

Any updates to your outlooks post your Analyst Day? Anything you're seeing on quoting activities on the non-Residential side or Residential or any verticals that you think picked up pace or anything that slowed since your Analyst Day?.

No. I think, it's steady as she goes. I mean, Joe reiterated all the financial guidance points. It's just – it's early in the year. As we get into the season, we'll find out more, but as we talk to our customers, and we're getting ready to start dealer meetings, people feel very confident as we go into 2017..

All right. Thank you very much..

Thanks..

And the next question comes from the line of Robert McCarthy of Stifel. Your line is open..

Good morning, everyone. Congratulations on the solid quarter..

Thanks, Robert..

Thanks..

Yeah. Two questions. I guess, one, I think, Steve spoke to it, but is there anything, particularly in the quarter, you mentioned the mix, I mean, obviously, they could compare.

But anything else that you would just kind of cite in terms of incremental market share gains or anything for the strength across the board in terms of the revenues?.

No. I mean, it's sort of what I said. In our Residential business, and we heard some of our other competitors announce, I think, we gained share in fourth quarter. That's certain. In Commercial, I think, we probably gained share. And again, it reflects all the good things we're doing in the business. There is no silver bullet to our strategy.

It's three or four things we've talked about over a multi-year period that we continue to do to innovate, to build out distribution, and to focus on our channel partners. And we had nice momentum in fourth quarter as we did in the full year..

Yeah. And I know you love talking about the Internet of Things and pie-in-the-sky technology investments.

Now that being said, maybe you could talk about the investments you are making in distribution that are kind of technology or productivity related, and do you think this is going to continue to be just kind of a strong market share driver over the next couple years? Anything to add there would be helpful..

Not to be Sean Spicer, but just for the record, I don't like to talk about Internet of Things and pie-in-the-sky investments. What I'd like to talk about is in investments that we're investing to allow for ease with our dealer contractors.

And you were at our December Analyst Day and saw what we're doing with LennoxPROs to do prognostics and diagnostics and training. And that's just part of our business now. And we have a strong team on the IT side, and the engineering side, and in our sales and marketing side.

So that's a big part of the investment and how we will continue to gain share going forward..

Drive safe..

Thanks..

And the next question comes from the line of Shannon O'Callaghan with UBS. Your line is open..

Good morning, guys..

Hey, Shannon..

Hey. Todd, just relative to the scenario planning and ability to flex or pivot depending on tax law changes. I mean how fast could you do that? What's the capacity in South Carolina? How difficult is it to maneuver? Maybe just a little bit more color on what it would take..

We've been very purposeful even before sort of all this happened to make sure we had a balance between U.S. and Mexico just given risks, prior risks in that concern about Mexico. If you look at hours worked for our equipment business for Residential, a little under a quarter of our business comes out of South Carolina today.

So it's a well-run large factory. The other thing to always think about is we build product prior to the demand. We build inventory. And so if things change, we could sort of ramp up the factory and start building inventory for the following season prior to what we normally would do and we could trade inventory load for product cost.

And then over a longer period of time, we can move production there. We have the people. We have the capabilities. We build everything we build there in terms of our Residential product line. So again, we'll see how it plays out.

I mean, what I wanted to convey in my comments is, we have action plans and I've looked at the different scenarios, whether it's moving more South Carolina as we just – as you asked and I answered or invest in factory automation both in Iowa and in South Carolina to lower our costs or continue to make investments in Mexico depending on which way the policy goes.

But almost under any scenario, we're going to continue to drive margin expansion in our Residential business and across LII..

Okay. Great. Thanks. And then just one follow-up on the cold weather into the quarter. I know a lot was kind of riding on December for the Heating business. Was that – how unusually strong was that versus a typical December? I mean, was it – relative to the last couple Decembers, was it – I know last December was notably warm.

But relative to normal, would you characterize it as extra strong?.

If you look at heating degree days, it was actually a little warmer than average, about 4% warmer than average. But it was 36% warmer than last year. So when I think about the comps going into next year, which I assume is why you're asking the question, it was sort of a normal December.

It was just so warm in 2015 that the year-over-year comp was very good..

Great. Thanks..

Thanks..

And our next question comes from the line of Josh Pokrzywinski of Buckingham Research..

Hi. Good morning, guys..

Hey, Josh..

On the most of the dealer meetings that you alluded to, Todd, how are those discussions going? Are your dealers bringing up any of their own personal, I guess, contingencies or thoughts around Mexico production? Does that factor into the equation, or is that kind of out of their orbit yet without any specifics in policy?.

Oh, they could care less, Josh. I mean, my read as we moved down to Mexico six years – five years, six years, seven years ago, and when Carrier moved to Mexico before that, I mean, dealers want a high-quality product at the right price. It could be made on the moon for all they care. And we've done that with Mexico, and they're fine.

And then our sense was UTX and Carrier took a lot of public browbeating over their announcement in Indianapolis. From everything we can tell, that had zero impact on any of their market share. I mean, the dealers sort of see through all that, and they understand it's a global economy.

Now, if we try and raise prices for Mexico by 30%, they'll knock down our door. But we would never do that..

Got you. I wouldn't recommend making anything on the moon. I think there's an atmosphere of adjusted tax being proposed. And then just a follow-up on some of the energy efficiency initiatives that get enacted on the Commercial side in 2018 I think.

What percentage of the Commercial portfolio do you think would get impacted those kind of being sold at the minimum today that would move up and be calibrated what that looks like and any signs that maybe you could get a pre-buy later this year on that basis?.

I don't think there'll be much of a pre-buy at the end of the year because Commercial, whether emergency replacement, national account sort of any scenario, people buy it when they need it, very few – because we're selling to dealers. If you're selling to independent distributors, they may carry some minimal load.

So I don't think there'll be any pre-buy. In terms of the impact, I mean we've always focused on high efficiency and we'll tweak up our entry level product to meet your requirements and we think we're well down the curve of doing that.

I mean, the art of this always is when the new minimum efficiency comes out, anyone can get there obviously, but you want to be there at the lowest cost and we are pretty good at that and we think we are and we'll be..

Got you. All right. Thanks, guys..

Thanks..

The next question from the line of Walter Liptak with Seaport Global. Your line is open..

Hi. Thanks. Good morning, guys..

Good morning, Walt..

I want to ask about the guidance on the mix, the $5 million. I think in 2016 you had kind of a great year for that SEER mix, were 14-plus SEER.

How did you end the fourth quarter? I know it's low for Cooling, but how did the SEER mix end and what's your thoughts on 2017? Is it tough comp now that we've moved up the way we have?.

We're guiding, as you suggested, $5 million on Residential mix in 2017. And we got some tailwinds second half of the year as the minimum efficiency went from 13 SEER to 14 SEER in the South. We'll get less of a tailwind, but some tailwind in the first half of the year.

But, really, the focus has been and continues to be to mix people up beyond 14 SEER or the minimum efficiency to 15 SEER, 18 SEER, 20 SEER.

We had some natural headwind this year that sort of muted the benefits in the sense of – I mean, it's good problem to have but Residential new construction, the market and our sales grew faster than the replacement market, and we tend to make – not tend, we make higher margins on replacement business.

So we think we're doing all the right things to continue drive mix up and 2017 should be another good year..

Great. And in Refrigeration, there have been some C-store expansions that were announced. I wonder if you've factored that in. I don't think there was a change from the December Analyst Day.

How are you viewing that C-store business?.

Well, I think net-net, the guide is still the same. There's movement there, but then there's move – Walmart is a big driver of Refrigeration sales for all of us. And so some movement on convenience stores sort of gets dwarfed by what Walmart is going to do or not do certainly in the display case business.

But, again, just to underline, we continue to be confident in the market being up low-single digits. We're going to expand our margins 50 basis points to 100 basis points, and we try to wrap all that breaking news into our current guidance..

Okay. All right. Great. Thank you..

And the next question comes from the line of Robert Barry of Susquehanna. Your line is open..

Hey, guys. Good morning..

Hey, Robert..

Hey. I think at the Analyst Day, you adjusted the guide and I think it implied 4Q was maybe $0.06 or $0.08 lower from where it came in.

So just curious was better than you expected, was it really just the weather?.

It was. It's sort of that simple..

Got you.

And can you quantify how much you think the weather helped the Resi growth?.

I'm not sure I put – I think we overshot the consensus revenue number by about $10 million and we overshot by $0.05 or so on EPS. To be consistent, I would tie that to weather..

Got you. Any impact either in Resi? Sorry..

Again, to repeat what I said to the earlier question I think it was cooler than we thought it would be given how warm it had been early. But again, the whole quarter was really just sort of an average coolness for winter. So as we go into 2017 I think the comps will still be fine..

Got you. Got you.

Any impact from maybe some buying ahead of these price hikes either in Resi or in Commercial?.

No. I don't think so. I mean, again, we have a price increase every year January 1. So you sort of have the year-over-year window..

Yeah..

There is a pull forward that happened last year too. The other point is what I mentioned earlier is January started off nice. Solid, I guess, is the word I would use. And you get concerned, maybe you pulled something for it, but I don't think that is the case. I think they just needed the product to meet demand when it got really cold..

Got you.

The Refrigeration factory loading, how much did that weigh on the margin in the quarter?.

I understand the question, I'm not going to answer it directly. I think I would do this – I'd answer it this way as there was no surprises to us. We guided 200 basis points for the whole year and even in mid-December we said 200 basis points. We knew how fourth quarter was going to shake out and had built that into our plans..

Got you. Maybe just lastly, a strategic question. Todd, I think you mentioned earlier, productivity or vitality is tracking in the 40s, maybe even near 50%. I see the benefits of that but it does also imply some fairly rapid obsolescence.

Might there be an opportunity to moderate that investment just given the high level now and still have a very competitive offering?.

high sufficiency, lowest noise, best reliability, best control systems. And when you go into a town, you want to convert the premium dealers you need to be able to say that. We have industry-leading claims. That's a big part of our strategy, and if R&D was 10%, I might have a different answer. But I don't think the leverage is there.

I think the difference between 1.5 point and 2 points of R&D is well worth the market share gains that we're getting that are being driven by the product innovation..

And also, I'll add to that, Robert, that I think part of that vitality is also tied to lower cost products that we're continuing to use to enhance profitability..

That's a good point..

I see. Fair enough. Great. Thanks, guys. Congrats on another solid quarter. Take care..

It looks as if our last question is a follow-up from the line of Steve Tusa of JPMorgan. Your line is open..

Yeah. Todd, just one more question for you. I usually have a pretty reasonable view of what's going on out there and I guess, we're all looking for a little bit of direction.

And I don't expect a precise answer to this question, but obviously, you guys are kind of a bit in, I wouldn't say the crosshairs, but in the middle of this big debate around taxes, et cetera, et cetera.

I mean, what are the – what do you think and what are the experts telling you on kind of the likelihood of this actually getting through in the end? I mean, what's kind of your high level view on the ability for them to kind of execute this in Washington?.

The honest answer is I have no idea. I think the more constructive answer is I've gotten to the point, professional and personally, that I'm not going to listen; I'm going to react what's done.

And from a business point of view, I've sort of implied it in my comments or maybe even explicitly said we've scenario planned about every option we can think of. And all those options turn out to increase profitability for us. The flexibility of our manufacturing, ability to build inventory, the fact that we have low cost in South Carolina.

I mean, you sort of lay it all out, what will happen will happen and we're a small flea in this overall environment. The administration or the government is going to do what it's going to do and then we'll adjust accordingly, and we have a path. We're going to continue to drive profitability and make money regardless of the scenario..

Have your experts and consultants and whoever else is running around for you, any kind of – what's your view on timing of any of this and on any related news?.

Again, I don't want to bash our experts, but maybe they read the same paper as I do. Same experts said we'd be talking about President Clinton. So I'm not sure what all that means. So, again, I try not to sort of try and read tea leaves that I know I can't read. We're ready for any scenario and we're going to be prepared..

Okay. Great. I just respect your opinion and so, I just wanted to see if there is maybe something that will differentiate what you were thinking..

I can make up an answer trying to impress you, but I don't know. We don't know..

All right. I'll follow your Twitter feed, your Twitter handle there closely in the coming months. Maybe something will come out of that. All right. Thanks. Thanks a lot, guys..

I keep following that. Well, go and check, I will post it on Facegram (55:22). To wrap up, the fourth quarter is a strong finish to a record year and we have seen momentum continue into the first quarter of the new year. Overall, we expect strong growth in margin expansion in 2017 and another year of record profit and cash generation.

Thank you again for joining us..

And ladies and gentlemen, that does conclude the conference for this morning. We do thank you very much for your participation and for using our executive teleconference service. You may now disconnect..