Lennox International Inc. (LII) Q4 2013 Earnings Report, Transcript and Summary

Ladies and gentlemen, good morning. Thank you for standing by. Welcome to the Lennox International Fourth Quarter 2013 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to our host, Mr. 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 fourth quarter and full year 2013. I'm here today with the Chairman and CEO, Todd Bluedorn; and CFO, and Joe Reitmeier. Todd will review key points for the quarter and year and Joe will take you through the company's financial performance and outlook. Financial results in prior periods have been revised to reflect sold businesses and discontinued operations. In the earnings release we issued this morning, we have included the necessary reconciliation of the financial metrics that will be discussed to GAAP measures. You can find a direct link to the webcast of today's conference call on our website at www.lennoxinternational.com. We will archive the webcast on that site and make it available for replay. We 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. In 2013, Lennox International's strong business momentum continued. Revenue was up 8% and EBIT margin expanded 180 basis points to a record 9.4%. Adjusted EPS from continuing operations rose 37% to a record $3.70, and GAAP EPS from continuing operations rose 35% to a record $3.55. Throughout 2013, growth was led by our Residential business, followed by growth in our Commercial business, which saw a strong pickup in the second half of the year. Both businesses continue to outpace industry growth in their respective end markets. In our Residential business, revenue is up 15% at constant currency and profit increased 75%. We continue to gain share in the North America Residential HVAC market in 2013, driven by strength in both Replacement and New Construction business. In addition, we captured price and we realized improved mix for the first time since 2010. In our Commercial business, revenue was up 7% at constant currency and profit increased 19%. Commercial growth was led by strength in National Account equipment and service, as well as from our strategic expansion in the emergency replacement market. In North America, our high single digit shipment growth significantly outpaced the commercial unitary market. Our North America revenue was up double digits for the year constant currency. And in the second half of 2013, we saw improvement in our European Commercial HVAC business, including strong double-digit growth in the fourth quarter. In Refrigeration, end markets' conditions remain choppy globally in 2013 and our revenue was down 1% at constant currency. But the team had strong operational execution, expanding margins 130 basis points to a record 11.7% and driving profit up 10%. Looking ahead, we expect top line growth to pick up in the second half of 2014 on the timing of existing programs and recently won new National Account business. Turning to the fourth quarter. The company's momentum continued. Revenue was up 10% at constant currency and EBIT margin expanded 200 basis points to 8.2%. Adjusted EPS from continuing operations was $0.77, up 38% and GAAP EPS from continuing operations was 68% -- excuse me, $0.68, up 31%. In Residential, revenue was up 18% at constant currency and profit tripled from the prior year quarter. Trends remain strong in both Replacement and New Construction business. We believe cold weather in November and December was also a factor, with heating degree days up double digits in the quarter versus the fourth quarter of 2012. This likely pulled some furnace volume ahead into the fourth quarter from the first quarter this winter. In Commercial, revenue was up 13% at constant currency and profit rose 31% from the prior year quarter. Growth was strong across the board, in planned and emergency replacement and in new construction. National Account revenue growth was especially strong in the quarter, and on the new National Account front, we signed up 3 more to bring the total for the year to 18. National Account customers continue to select Lennox for our leading energy-efficient rooftops, advanced controls, outstanding distribution and delivery and customer support and service. In Refrigeration, market conditions remain challenging in the quarter. South America and Europe saw strong growth, while North America and Australia remained soft as expected. Refrigeration revenue was down 4% at constant currency, but profit rose 11% from the prior year quarter. At the Investor Community Meeting in mid December, I mentioned several strategic initiatives that we are excited about. In Residential, we are expanding our manufacturing facility in Mexico as we transfer certain furnace production there from the United States and insource sheet metal fabrication as part of our Mexico operations. We are making a USD 30 million investment in total over 2013 and '14 and are tracking to start furnace production in Mexico in the second half of 2014. By 2016, we expect USD 15 million in annualized savings from this initiative. In our residential distribution expansion, we're targeting 25 additional PartsPlus stores in 2014 to exit the year at 160. Our target for 2016 is to have at least 215 stores. In our commercial distribution expansion, we ended 2013 with 32 commercial regional and local distribution centers as planned, as well as increasingly leveraging the PartsPlus store locations. In 2010, the portion of the light commercial emergency replacement market we could cover with same-day delivery, a critical requirement for this market, was 20%. In 2014, it is 75%. This expansion and the success of our Raider rooftop systems are creating strong momentum for us in emergency replacement where we saw strong double-digit shipment growth in 2013. We are well positioned to continue to capture market share in 2014. I also mentioned at the Dealer Investment Community Meeting in December that we have partnered with Midea, the largest HVAC company in China, to launch Lennox-branded VRF commercial product in North America, leveraging Lennox company-owned distribution. It is early, but the team is coming together, and we're excited about this offering in the second half of 2014 for such a fast-growing market. 2013 was a strong year and the company is well positioned for 2014. With a solid balance sheet, a strong cash generation, we are well positioned to continue to invest in the business for growth, consider acquisitions that make sense in our core businesses and return cash to shareholders. We raised the dividend 20% in 2013, and we plan to maintain a competitive dividend that grows with earnings over time. We also repurchased $125 million of stock in 2013 and plan to repurchase $150 million in 2014. 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 $359 million, up 18%. Volume was up 18% and price and mix combined was flat on a revenue basis, with currency being neutral. Residential profit in the fourth quarter was $36 million, up nearly 200% from the prior year quarter. Segment profit margin was 10.2%, up 620 basis points. Segment profit was positively impacted by higher volume, favorable price and mix and lower material costs. Partial offsets in the fourth quarter this year included strategic investments in distribution expansion and warranty expense related to our usual end-of-year true-up. For the full year, Residential segment revenue was nearly $1.6 billion, up 15%. Currency was neutral, volume was up 13% and price and mix combined was up 2% on a revenue basis. Segment profit was $180 million, up 75%, and segment profit margin was 11.4%, up 390 basis points. Now turning to our Commercial Heating & Cooling business. In the fourth quarter, commercial revenue was $213 million, up 13%. Volume was up 13% and price and mix combined was flat on a revenue basis. Currency was neutral. North America Commercial HVAC equipment and service revenue was up mid teens. Europe Commercial HVAC revenue was up mid teens on a reported basis and up low double digits at constant currency. Commercial segment profit in the fourth quarter was $33 million, up 31%. Segment profit margin was 15.7%, up 220 basis points from the prior year quarter. Segment profit was positively impacted by higher volume, favorable price and mix and lower material costs, with partial offsets from higher SG&A and strategic investments in distribution. For the full year, commercial revenue was $844 million, up 8%. Volume was up 7% and price and mix combined was flat on a revenue basis. Currency had a positive 1% impact. Segment profit margin was $118 million, up 19%, and segment profit margin was a record 14%, up 130 basis points. In our Refrigeration segment, revenue in the fourth quarter was $178 million, down 7%. Volume was down 3% and price and mix combined was down 1% on a revenue basis, with currency having a negative 3% impact. From a regional perspective, in constant currency, South America revenue was up high teens, Europe was up high single digits, North America was down high single digits and Australia was down low double digits. Segment profit was $24 million, up 11% from the prior year quarter and segment profit margin was a record 13.3%, up 220 basis points. Segment profit was positively impacted by favorable price and mix and lower material costs, with partial offsets from lower volume and higher SG&A. For the full year, Refrigeration revenue was $772 million, down 2%. Volume was down 2% and price and mix combined was up 1% on a revenue basis. Currency had a negative 1% impact and segment profit was $90 million, up 10%, with segment profit margin a record 11.7%, up 130 basis points. Looking at special items in the fourth quarter. The company had after-tax charges of $4.3 million net, including $3.9 million related to asbestos litigation and $1.3 million from restructuring activities. For the full year, Lennox had after-tax special charges of $7.4 million net, including $3.4 million from restructuring activities. Corporate expenses were $32 million in the fourth quarter, up from the $16 million in the prior year quarter. For the full year, corporate expenses were $88 million, up from $60 million in the prior year, primarily on higher incentive compensation. Overall, SG&A was $146 million in the fourth quarter, up from $127 million in the prior year quarter. And for fiscal 2013, SG&A was $570 million, up from $570 million (sic) [$507 million] in the prior year, primarily from higher incentive compensation and volume-related selling expenses. Cash from operations was $210 million for the full year compared to $221 million in the prior year. Capital spending was $78 million in 2013 compared to $50 million in 2012 as we began the expansion in Mexico that Todd mentioned. Including $2 million from disposal of property, plant and equipment, free cash flow was $134 million for the full year compared to $170 million in the prior year. Looking at liquidity. Cash and cash equivalents were $38 million at the end of December. Our debt-to-EBITDA ratio was 1.1x ending the year, currently at the low end of our target range of 1x to 2x. Total debt was $400 million at the end of the year. Now before I turn it over to Q&A, I'll review our outlook for 2014. One month into the year, our market assumptions for 2014 remain the same as we discussed at the Investment Community Meeting in mid December. For the industry overall, 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 Refrigeration shipments to be flat globally in 2014 for the industry. Based on these market shipment assumptions, guidance for our revenue growth remains 3% to 7% for 2014 with a neutral impact from foreign exchange. There are several puts and takes we expect for 2014 as well. Most notably, we expect about $30 million of savings in our sourcing and engineering-led cost reduction programs, with most of the benefits starting after the first quarter due to the seasonality of our businesses and the timing of program cut-ins. We expect $10 million of favorable mix in Residential in 2014 and we expect $5 million of net benefit from price and commodities, with positive $10 million from price and a negative $5 million from commodities. Corporate expense is expected to be approximately $70 million in 2014, down from the $88 million in 2013 on lower incentive compensation year-over-year. Headwinds in 2014 include our entrance into the VRF commercial market in North America, our continued expansion in residential and commercial distribution and strategic investments in resources for continued market share gain momentum. More normalized weather in the summer would also be a year-over-year headwind for us. A few other guidance points. We expect net interest expense for the year of about $16 million. Our effective tax rate is expected to be 34% to 35% on a full year basis. We are targeting $150 million in stock repurchases, and the average weighted diluted share count for the full year is expected to be approximately 49 million shares. We expect capital expenditures of $90 million as we continue to invest in the company for growth. And to wrap up, our 2014 guidance for EPS from continuing operations remains $4.20 to $4.60. And with that, let's go to Q&A.

[Operator Instructions] Our first question today comes from the line of Jeffrey Hammond representing KeyBanc Capital Markets.

Just on the weather, you mentioned maybe some pull ahead, but obviously, the weather's been consistently cold here in the 1Q. I mean, are you hearing that from your customers or would you expect just this unfavorable weather just to support an above-average furnace season?

I think the cold weather has helped us. But I think the timing of the weather, not as similar to what it is in the summertime is, we had cold weather early, we had it hard early. And as we talked about in the script, Jeff, we -- just part of the strength we saw in November and December, why we had such, for lack of a better phrase, blowout resi numbers and the industry did was -- I think some of the furnace sales that you would normally see in the first quarter were pulled forward in the fourth [ph] quarter. So net-net, cold weather helps us, but the early hard cold weather, I think, pulled volume from first quarter into fourth quarter.

Okay. And then just in general, as you talk -- I mean, I guess, as you think of your distribution and as you talk to your kind of non-Lennox brand and independents, I mean, what's kind of the feeling from an inventory perspective or people starting to get increased confidence and hold more inventory, or are things still pretty lean?

I think things are still relatively lean as -- again, people are -- emptied their barns to a large degree on furnace inventory in fourth quarter and are sort of buying it as they need it, as we finish out with the furnace season. I think we'll really get a better sense on distributor confidence for our independent distributors as we get into February, March and we start to load up for the cooling season. I would tell you though, and I know you've been out talking to distributors and dealers, they all have short memories. And right now, everything in the short memory is good news. So they had a good cooling season, they're having a good heating season and they're pretty confident as we go into 2014.

Right. And then just finally, on Refrigeration, any signs or reasons for optimism, still pretty choppy there? And then, as you look at '14, '13 was great in terms of margin expansion on the flat revenues. Can that continue if revenues stay muted here into '14?

What we saw was Refrigeration was down 4% at constant currency in fourth quarter, and the global refrigeration market continues to be choppy. Overall, we expect it to remain fairly soft for the first half of 2014. Australia will likely be soft through the first of 2014 and we hope it will pick up a bit in the second half as there's greater clarity around the government's carbon tax law. In North America, we expect to see a pickup in supermarket business in the second half of '14 based on existing programs that we have in place in some newly won National Accounts. Europe had a strong fourth quarter and we think some of that momentum continues into '14, and South America remains strong. Specifically to the margin expansion question, I think the team did a great job on '13 on protecting margins on down revenue. I think it gets harder to do that in '14. I think we'll need some revenue to be able to expand margins in '14.

Our next question comes from the line of Steve Tusa with JPMorgan. Charles Stephen Tusa - JP Morgan Chase & Co, Research Division: So I just wanted to tie up some loose ends on the year. What do you think the market ultimately grew for Resi and Commercial unitary for the year now, for '13, looking back?

I'm looking to my help to the side. We think Resi -- when we look at AHRI numbers, we think unit volume was probably up 10%, 11%. And we think Commercial unitary market was probably up 2%, 3%. Charles Stephen Tusa - JP Morgan Chase & Co, Research Division: Okay. And in the fourth quarter, how much did you -- sorry, I'm not sure if you said exactly -- what do you think the Commercial unitary market grew in the fourth quarter? How much did you outperform?

I don't think we've called it out, but let me look at the public numbers I have here on me. So we think -- this is Resi?

This is Commercial.

Okay. So we think, in Commercial, the industry was probably up 7%, 8%. And we think we're -- what we called out in our call is our revenue was -- in North America was up mid teens. Charles Stephen Tusa - JP Morgan Chase & Co, Research Division: Is that 7% to 8%? I mean, maybe Commercial is a little less seasonal than Resi, maybe it's not. Is that 7% to 8% -- does that indicate anything? Do you feel -- you're obviously still guiding to low single digit volume growth next year, and the term inflection gets turned around in this business like a lot. But is that an encouraging number? Is there something unusual about the compare? Or do you feel good that Commercial is finally picking up? Is there anything on the verticals too that you'd comment on?

I think we are -- I mean, look, when we have a strong a quarter as we did in Commercial, our revenue up 13% in fourth quarter, we're absolutely encouraged. But I'm also -- have been doing this long enough, and you've been following it long enough. As a couple of big customers buy in the quarter in Commercial and you can sort of drive up the volume, there's still lots of clouds on the horizon on the U.S. economy, which we all understand, I think, increasingly over the last week or 2. And so we think calling up low single digits is sort of appropriate. The Christmas selling season, I think, was okay. And when we talked our National Accounts, they're cautiously optimistic, but we'll see how '14 plays out. In Commercial, where we're excited, quite frankly, along with National Accounts -- but there's some emergency replacement initiative we have in place, continues to gain traction, the investments we've made in distribution and the product, and we think a lot of the share growth we had in '13 was from emergency replacement. Charles Stephen Tusa - JP Morgan Chase & Co, Research Division: Right, right. Okay. On the Midea JV, can you maybe outline what you think -- where you think those types of products can go as a kind of percentage of the market going forward? I mean, is it kind of a 5-year target of it being 10% of the market, or maybe just any kind of framework around how fast you think this new VRF stuff is going to grow?

Yes, I mean, we're sort of high level. The way we think about it is the North America Commercial HVAC market, $7.5 billion, $8 billion market, about half of that is unitary, about 45% of that's applied. And we think, right now, about 5% of the total market is VRF. But it's been growing about 30% a year. We think that growth continues over the next 3, 4, 5 years. If you look in Europe and you look in Asia, out of the total commercial market, VRF is 25%, 30% of the market. I don't know if it ever gets quite that high in the U.S. for multiple reasons, but I think we could see this market of the total North America HVAC market being 20%, 25% of the market. We think most of that growth is going to come out of the traditional applied segment, and that's why we think this is a nice opportunity for us. We don't have the conflict that some of our applied competitors will have of trying to sell both products at the same time. So we think we can go after this full board, and it's going to take us -- it's going to take a while. And we think '14 is going to be an investment year. And when we think about first half of '14 and most specifically first quarter, we're going to be making investments in VRF and not quite having the revenue yet. And so that will post some headwinds for us early in first quarter in the year. But we think, on a full year basis, we'll start to get some returns from this. And over a multi-year time period, we think it's going to be good investment for us. Charles Stephen Tusa - JP Morgan Chase & Co, Research Division: And just remind me -- we're still learning about this product. Everybody is talking about it. It is a retrofit. You can retrofit existing applied installations?

Yes. Charles Stephen Tusa - JP Morgan Chase & Co, Research Division: Yes, okay. How are the price increases going so far? Anything stand out there on the acceptance of the price increases?

No. I think the momentum that we saw over the last couple of years continued. We announced in our Residential and Commercial business a 2% to 5% price increase effective January 15 of this year, and we continue to expect to get price. I think we guided and said we're going to get $10 million of price this year at a minimum, and that's what we're focused on. Charles Stephen Tusa - JP Morgan Chase & Co, Research Division: Okay, okay. And then one last question, just -- you talked a lot about the seasonality -- the seasonal pull-in in the fourth quarter. So what does that mean for the first quarter? I mean, do we -- you've given us your annual growth rates. I mean, does that suggest that the first quarter kind of growth rates are below obviously those annual growth rates because you pulled some stuff forward in the fourth quarter? Like could you just give us some frame reference so we can baseline ourselves on our model?

Yes. I mean, we don't give quarterly guidance, but I'm trying as hard as I can to stay on my foot here. And while we've signaled some volume has been pulled forward, we talked about -- I talked about investments in VRF. I'd also talked about investments that we're making in the Mexico factory that won't ramp up until second half of the year. So we won't see -- we'll see a lot of the expenses first quarter and a little bit second, some second quarter, but we won't see the benefits until second half. And the $30 million of cost savings from our global sourcing, as we talked about on the December call, we think most of that is second half for the year. So yes, I -- we feel real good about 2014, but we have some headwinds in the first quarter. Charles Stephen Tusa - JP Morgan Chase & Co, Research Division: Okay. I just want to say -- we don't usually say this on conference calls, but congratulations to you. You've really done a great job there over the last several years, and it seems like a lot of these investments are paying off. And so congrats to you and best of luck in '14.

Great, thanks. Now you need to make us [ph] a buy, Steve.

Our next question will come from the line of Rich Kwas with Wells Fargo Securities.

Just a couple of questions. Commercial, the margin at 14%, you finished the year. Your target is 14% to 16% by 2016. Seems like you've outperformed that with very little -- you outperformed or increased margins pretty nicely over the last years with little construction benefit. What are the headwinds to outperforming the high end of that range in '16? Just some color around that would be helpful.

We've always talked about these 3-year targets as sort of evolving over time and we raised them in December from where they were a year ago. We continue to execute and do the things we know we can do. I don't think there's any reason we can't get to the high end of those margins. Part of it will be the mix of the business. We make lower margins in Europe, and that's just -- structurally, it's a lower -- less profitable market than we do in the U.S. And so to agree that we outgrow Europe versus North America, that could have some impact on us. But our service business has nice margins. Our equipment business, whether its National Accounts or emergency replacement, we like the margins. So I tell you, internally, our team's focused on '16, quite frankly, rather than just sort of being in the midpoint.

Okay. And then the VRF investments are obviously going to have some headwind here early on within -- for '14, but the assumption is that you're leveraging that nicely by '15, '16.

Correct.

Okay, all right. And then, Joe, could you -- what was the number for replacement growth in New Construction on the Residential side in '13 full year?

Replacement growth for New Construction?

Yes. So your -- yes, replacement was up. You were giving -- because the quarters went on, you're giving replacement numbers that were up x, and then New Construction was up x, and so I don't know if you have that for the full year?

So that's total growth rates, yes. Okay. Again, I'm being handed expert notes to my right here. We think add-on or -- this is us or the market?

This is us.

Okay. Add-on and replacement year-over-year for us, we were -- we think up we're mid teens, 15%, 16%. In Residential and New Construction, probably 300 basis points below that 12%, 13%.

Okay. And then the assumption within the guide for '13 -- or '14, is that the Resi New Construction piece, the growth is not significant as '13 and that the replacement side is still pretty good?

Yes. There's unclarity around Residential New Construction. We didn't -- I don't think I explicitly called it out in December. I think what we're saying is the market is going to be mid single digits that new construction, to your point, is probably going to -- in our guidance, is going to be a little less than it was this year and then the balance will be our add-on replacement.

We have a question from the line of Josh Pokrzywinski from MKM Partners.

So just on the Commercial piece, if we look at fourth quarter, can you parse out at all the strength in National Accounts versus kind of regular way business? And if you're able to identify what you think you gained on the emergency replacement side. Just trying to get a handle on -- if you look outside of the National Accounts business, maybe what's happening on an underlying basis in those light commercial markets?

Yes. We saw strength everywhere, I think, is the best way I can say it. I mean, we saw New Construction was up double digits, emergency replacement was up double digits and planned replacement and just sort of normal National Account business was up almost double digits. So I mean, it wasn't that we had a huge National Account order to skew it. We saw sort of strength across the board. And I -- we think part of that, quite frankly, was market, but we think a lot of it was our initiatives, and we think we gained share in fourth quarter.

Got you, that's helpful. And maybe this is too much granularity versus what you have in front of you, but is there any difference -- smaller product versus large or is that kind of universal?

I don't have the detail in front of me. But I've looked at the detail, and the answer is it's across the board. Again, it's not skewed towards large tonnage or small tonnage. Obviously, emergency replacement, given our product line, tends to be 5-ton product and we did well there. But then our larger National Accounts, which can be 20-, 25-ton, we did well there also.

Got you. Okay. And then just one last one for Joe, did I hear corporate expense right at $70 million?

That's correct. That's what we anticipate for 2014.

Okay. Kind of surprised that you're actually seeing incentive comp go down with the big earnings ramp again. Any chance that, to the extent that this like low-single digit outlook for Commercial turns out to be conservative, that we see an outsized ramp in that number? Or is that going to be pretty stable within a small range kind of regardless?

Yes, we think it will be pretty stable within a small range. And with respect to your comment on incentive comp, we sort of recalibrate targets, et cetera, brings it back in. So quite frankly, I hope we're sitting here next year talking about that we have higher incentive compensation once again.

Our next questions from the line of Nigel Coe with Morgan Stanley.

So just wanted -- maybe just to clarify the comments on pricing, could you just maybe talk about the industry? And what do you see in terms of price actions from your competitors? And how has the reaction been from your distribution and dealer network?

Just like we saw in '13, we're seeing sort of competitors follow/lead. We've seen price increases from York and Rheem and Trane and Carrier. And we expect Goodman/Daikin to continue to push price like they did in 2013. So I think it's all as you would expect in a market that's increasing and going up where there is a discipline like -- or consolidated competitor base like there is here in North America that you're able to see prices go up, and that's what we expect.

Helpful. And then can we just -- you mentioned that the environment for new build this year is a bit more uncertain than last year, which is understandable. How was the mix between new build and replacements look between Resi and non-Resi right now?

In Resi, it's 80% add-on and replacement and 20%, maybe 25% New Construction, depending on what number you want to pick for '14. In our Commercial businesses, it's 70% add-on and replacement, maybe 65%, and 30%, 35% New Construction.

Okay. That's a much higher mix of New Construction than I expected. I mean, how do that look in a normal cycle?

I think that's about right. I mean, I think in our Commercial businesses, given the verticals that we're in, with such a high exposure to retail, that there's a tendency to rip -- down hold [ph] retail and put in new retail. And so I think you see more New Construction maybe in those -- in some of the verticals we play than what you would if you're playing in high-rise office buildings, for example.

Okay, great. And then Todd, you seem to paints [ph] to talk about some of the headwinds in the first half of the year, and VRF come up a number of times in the Q&A so far. But can you maybe help us scale the kinds of investments you see for VRF in 2014 and how that looks sort of in the first half of the year?

So our total annual investment will be $23 million and $5 million for the year. And the second half of the year, we'll have revenue and profit offset, that first half of the year, we're making investments with no returns.

Okay. Got it, got it. And then just a couple of quick ones before I pass it on. You mentioned the debt-to-EBITDA ratio is towards the low end of your target range, I think some 1.1x gross debt-to-EBITDA. How do you about the balance sheet? I mean, obviously, you’ve returned a lot of capital to shareholders. But what would gate to the 2x? Would that be an acquisition? Or could you think about maybe raising some leverage to return more cash?

I think over the medium and long term, we should be closer to 2x than to 1x. And I think as everyone on the call understands, this is sort of the -- we're flushing cash at the end of fourth quarter and then we start spending in first quarter as we get ready for the season. So it's naturally going to head back up to some more investments in the business. But we'll watch and sort of gauge, and we've said at a minimum we're going to do $150 million of share buyback this year. We've talked about the dividend being competitive. So as we have over the last 6, 7 years, we'll get it back to shareholders if we don't do acquisitions. We want to keep some powder available. If the right acquisition came along, we certainly want to do it. But in lieu of that, we're going to give it back to shareholders.

Okay, great. And then final question on -- just want to dig a bit deeper on the Refrigeration margins. Obviously, to expand operating income with down revenues is not easy. But what are we seeing there? Are we seeing the benefits from low raw materials? Did we see a little bit of benefit from the warranty true-up towards the end of the year? I mean, how did you spend margin so well in that business?

I think we continue, as we have the last couple of years, an aggressive focus on material cost reduction. For the size of their business, they sort of overdelivered on material cost reduction within our corporation. We had some commodity tailwind. And we also did a nice job in our Australia business. We've talked about -- in our Australia business, we've sort of grown our refrigerant segment of the marketplace and had some low cost refrigerant that we were able to sell into the marketplace. And so we did a nice job in Australia to help drive margins.

Our next question comes from the line of Walter Liptak with GHS.

Wanted to ask sort of a general question on the guidance for 2014, the range. It's a pretty large. I wonder if you could just give us some color on how you're viewing the high end of the range versus the low-end? [indiscernible]

Yes. Thanks, Walter. I think I heard the question. You broke up on the call. So I think the question was the guidance range and spread in the guidance range. I think the variable is going to be the marketplace. I think our visibility to execute on our initiatives is pretty clear and reasonably tight. I think the variable is going to be do what the market does. And I think when you look at our revenue guidance and our earnings guidance, they're sort of roughly tied together. If we get to the high end of the revenue, we'll drive the high end of the EPS growth.

Okay. And then, just a follow-up. I think you already answered this. But in your -- when you were talking about the outlook, you talked about -- you commented more normalized weather, it's a headwind. I just want to make sure that, that was referring to the achievement in the first quarter that pulled into the fourth?

The -- again, I'll restate your question in case others couldn't hear it. As -- in the script, Joe -- I think it was Joe who talked about and maybe even me talked about normalized weather as a headwind in 2014. We actually weren't talking about first quarter. I did a lot of other things to talk about first quarter. The normalized weather Joe's talking about is the summer selling season. That '13, although cooler than it was in 2012 from a weather point of view, was still historically a very high year. And so if we get back to more normalized summer weather in 2014, that would create a year-over-year headwind for us in the cooling season. And so -- but again, that's encompassed by the guidance that we gave in December and reiterated today that a normal summer creates some headwind.

The next question comes from the line of Glenn Wortman with Sidoti. Glenn Wortman - Sidoti & Company, LLC: Yes. Just on the commercial market [indiscernible] some of your end market assumptions are accurate, and then just give [indiscernible] in distribution thereafter do you expect [indiscernible] margins to be up in '14?

Glenn, it's not your fault, but it's breaking up. I think your question was -- I couldn't tell what your question was. Maybe take one more shot at it? Glenn Wortman - Sidoti & Company, LLC: Just first of all, [indiscernible] directionally, just given your market [indiscernible] investments you're making in distribution, do you expect the second part to be up in '14 [indiscernible]

Yes. The question, I'll repeat for other, is, given the investments we're making in '14 in Commercial, do we still expect segment margins to be up? And the answer is yes. I mean, even with the investments I talked about in VRF, even with the markets being up low single digits, we think, given the productivity initiatives we have in place and the continued investments we have and premium product and the mix-up effect, that we can continue to drive margin expansion in 2014 in Commercial. Glenn Wortman - Sidoti & Company, LLC: Okay. And second, if you could share what you are hearing [ph] from your National Account customers on planned replacement for '14.

Again, the question, for those who couldn't hear it, was what are we hearing from our National Account customers on planned replacement in 2014? The answer is cautious optimism. I mean, the Christmas selling season was okay. It wasn't great. And when we talked to large of our -- large National Accounts, they're cautiously optimistic. And again -- so the business is getting booked, and we're putting it into our plans. But the way it works at National Accounts is they give you the signal, they give you the signal, and as long as the economy continues to roll, then they take the shipments. If the economy gets off-track, they slow things down. But as we stand right now, National Accounts are sending us positive signals.

Our next question comes from the line of Jim Krapfel with Morningstar.

I may have missed this, but what was your replacement versus New Construction growth in Residential in the quarter?

We're digging into the notes. I think I gave full year numbers, I'm not sure. In fourth quarter, add-on replacement was up over 20%, and Residential New Construction was up mid teens.

Okay. And second question, your mid-single digit growth in industry Residential units arguably is conservative. It seems that you're assuming the replacement market growth rate drops meaningfully. Can you provide your thoughts on that? And is that mostly a function of much of the pent-up replacement demand being released in 2013?

I mean, I think if you do the math, I think about the math this way. If you think the market's 20% Residential New Construction, and I already, on one of the answers, said we think the growth is going to be less than it was this year. So just say it's up 10%, so that means it's 2 points of growth from Residential New Construction, then that means the balance of the growth has to come from add-on or replacement. And so if add-on replacement's up 2 or 3 points on the 80% of the market, you're up to 5% total market growth. So I don't think we're saying it's going to be down even in our guidance. We're sort of seeing like...

Yes, just a slowing?

Yes. I -- and again, I hope we're wrong and I hope it's up more, but we had a great year. The market had a great year in 2013. We're sort of factoring in that's going to be a cooler summer. We're factoring in some of the overhang and some of the concerns we have on the economy.

Our final question today will come from the line of Jeffrey Hammond with KeyBanc Capital Markets.

I was just wondering if you could size your controls business. And I was wondering if you thought you might spin that out or sell it to Google.

That's a hell of a question to end the call with. I'm not going to size it and you know that. But give me -- maybe I can give a serious answer to a tongue-in-cheek question. It's not -- the obvious answer from our perspective is we're in the home comfort business in Residential and we're not in the controls business. Controls helps us drive home comfort. But I think this Nest acquisition by Google is a good thing for us and for the industry, because I think it's really raised the profile and continues to raise the profile of the importance of controls. And that's a good thing for us because we have the best controls system in the market in icomfort Wi-Fi. And anytime we're in a conversation with the homeowner about premium controls, we love that conversation, and that's a heck a lot better conversation to have than who has the lowest-priced 13 SEER. So we think it's a great thing, and we're glad it happened and it raises profile and we think it plays to our strength.

Have you spent much time looking at their technology relative to yours and others in the industry and how might that be the same or different?

Yes. We spent a lot of time looking at it. So I'm going to answer and try not to get too far in the weeds. Couple of things, they're a great marketing company and that's what you'd expect from the Apple guys. I mean, the technology is not breathtaking, but they're a very good marketing company and they've made it very simple. I think the fundamental difference between Nest and our controls is our controls are what are called communicating controls, which means we have boards on our units, the outdoor unit, the air handler, the furnace in the attic, that all communicate to our thermostat, and you can derive prognostic and diagnostics and information on the system that you can only do if you have that communicating control capability. Nest is not a communicating control. It's sort of a thermostat that's on the wall, that can send signals to the -- to each of the pieces of equipment, but doesn't read information from them. And so it can develop algorithms to control the system, but it can't react in a dynamic way with what the system's telling them. And our ability to do that allows us to be unique. It allows us to do prognostic, diagnostics, allows the dealer to install it easier, it makes it better for the consumer. I think we can learn from Nest about the former Apple guys are world-class at user interfaces, make it simple, make it easy. And I think we'll continue to make that better, although I think we're pretty good now. But this ability to communicate with our unit separates us from Nest. And again, we've always said that our applications are agnostic, that at the end of the day, we don't think Lennox is going to control the home. There's going to be somebody somewhere, whether it's Google, whether it's Apple, somebody who's going to have the home user interface for everything. And we're fine with that because again, our ability to do prognostics and diagnostics and communicate with the units, we can feed into whatever user interface the consumer wants, although I'd argue our thermostat on the walls are a pretty good one. Good. I think that's the last question, operator. So a few points to leave everybody with. 2013 was a year of strong revenue and record earnings growth. We continue to make key investments for the future. Momentum continued in the fourth quarter with 18% Residential and 13% Commercial revenue growth and significant margin expansion across our businesses. Looking ahead, the company remains strategically well positioned to capitalize on growth on our major end markets, capture additional market share and drive increased profitability through our operational initiatives in 2014. I want to thank everyone for joining us.

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