Feb 2, 2012
Executives
Steve Harrison – VP, IR Todd Bluedorn – CEO Bob Hau – CFO
Analysts
Jeffrey Hammond – KeyBanc Capital Markets Adam Samuelson – Goldman Sachs Josh Pokrzywinski – MKM Partners Robert Barry – UBS Adam Samuelson – Goldman Sachs Stephen Tusa – JPMorgan Nigel Coe - Morgan Stanley Keith Hughes – SunTrust Robinson Humphrey
Operator
Ladies and gentlemen, thank you for standing by. Welcome to the Lennox International Q4 2011 Earnings Conference Call.
At the request of your host, all lines are in a listen-only mode. There will be a question-and-answer session at the end of the presentation.
As a reminder, this conference is being recorded. I’d now like to turn the conference over to Steve Harrison, Vice President of Investor Relations.
Please go ahead.
Steve Harrison
Good morning. Thank you for joining us for this review of Lennox International’s financial performance for the fourth quarter and full year 2011.
I’m here today with Todd Bluedorn, CEO, and Bob Hau, CFO. Todd will review the key points for the quarter and year, and Bob will take you through the company’s financial performance.
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 corporate website at www.lennoxinternational.com.
We will archive the webcast on that site and make it available for replay. I would like to remind everyone that in the course of this call to give you a better understanding of our operations, we will be making certain forward-looking statements.
These statements are subject to numerous risks and uncertainties that could cause actual results to differ materially from such statements. For information concerning these risks and uncertainties, see Lennox International’s publicly available filings with the SEC.
Lennox disclaims any intention or obligation to update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise. Now, let me turn to call over to CEO Todd Bluedorn.
Todd Bluedorn
Thanks Steve. Good morning and thank you for joining us.
Let me touch on several key points and Bob will take you through the financial details for the quarter and the year. 2011 marked the second consecutive year of growth in unit shipments in North America for the HVAC industry but a significant mix down and fewer system sales in the residential market.
Commodity headwinds running ahead of pricing increases, and the fragile customer macro-economic environment weighed on overall financial results for the year. We aggressively reduced the company’s cost structure further in 2011, while still continuing to make transformational investments as we position the company for improved growth and profitability in challenging markets.
We continued to ramp up our Mexico manufacturing facility, source more components from Asia, and engineered our costs to reduce our product platforms, moved further into material substitution, including aluminum for copper, and leveraged R&D resources with our new India technology center, to mention a few examples. We also focused on driving shareholder value with the disciplined use of free cash flow for dividends, share repurchases and acquisitions, while maintaining a strong balance sheet.
For the company overall in 2011, revenue was up 7%. Excluding the impact of the Kysor/Warren acquisition, revenue was flat at actual currency and down 2% at constant currency.
Our residential equipment and service businesses faced a tough year-over-year comparison to 2011. The residential market was down in dollar value from a significantly lower mix of business without the $1500 U.S.
tax credit for high efficiency equipment in place and with the re-emergence of minimum efficiency condensing units based on the old R-22 refrigerant. Both of these developments contributed to a decline in furnace shipments and fewer complete HVAC system sales.
Consequently, our residential revenue was down 5% and service experts revenue was down 10%. Segment margins for the year were down 370 basis points in residential to 5.26% and down 300 basis points in service experts to slightly above breakeven.
In our commercial and refrigeration businesses, we had a strong year. At constant currency, commercial revenue was up 10% and refrigeration revenue was 5% on an organic basis adjusted for Kysor/Warren and the strategic exit of the third party coil business in Australia.
Commercial margin increased 20 basis points to 11.4%. Refrigeration margin , excluding the impact of the Kysor/Warren acquisition and the first year of ownership, was up 170 basis points to 12.8%.
For the year, adjusted EPS from continuing operations was down 15% and GAAP EPS was down 21%. Turning to the fourth quarter.
Company revenue was down 1%. Excluding Kysor/Warren, the revenue was down 7% with a neutral currency impact.
Total segment profit margin was 5.5%, down 90 basis points. Adjusted EPS was down 7% in the fourth quarter versus a year ago.
Our GAAP EPS was down 37%. GAAP EPS was impacted by $9.5 million charge for asset and goodwill impairment in our Hearth business.
Hearth is a business within our residential segment that is highly tied to new construction. With single family homes starts at the lowest on record in 2011 and the business in a loss position, we had impairments in the fourth quarter.
Moving forward, we are pursuing strategic alternatives for Hearth. The business, which includes fireplace, systos (ph) and ventilation equipment, is considered non-core to Lennox International.
Hearth was about 6% of residential segment revenue in 2011, or about 2.5% of total company revenue. Residential revenue was down 14% in the quarter and margin was down 480 basis points on the year-over-year mix down, especially against the tough comparison to the fourth quarter of 2010, which had a rich product mix ahead of the expiration of the $1500 high efficiency tax credit, as well as demand pull-forward ahead of our announced price increases.
Weather was also warmer in the fourth quarter, with heating degree days down 10% in November and down 21% in December compared to 2010. Service expert revenue was down 16% in the fourth quarter, and margin was down 260 basis points as the business faced the same residential dynamics.
On the commercial service side, revenue was up mid-teens and margin saw a strong growth. Turning to our commercial equipment business, revenue in the fourth quarter was 8%, and segment margin was up 230 basis points to a fourth quarter record level of 11.1%.
Revenue growth was broad-based but led by double-digit growth in national accounts. Lennox had five new national accounts in the fourth quarter, bringing the total to 20 new national accounts for 2011, the most accounts added since 2008.
In our refrigeration business for the fourth quarter, organic revenue was up 2% at constant currency. From a regional perspective, Europe, South America and China continued to see strong growth.
North America saw solid gains led by year-over-year strength at Kysor/Warren and Australia was down. Refrigeration segment margin increased 170 basis points to a fourth quarter record level of 11.7%.
Regarding Kysor/Warren, revenue grew at a high-teens rate in 2011, despite a choppy market and margins expanded in each quarter through the year as the integration and operational improvements have gone well. We remain on target for the business to be $0.12 accretive to EPS in 2012.
Now I’ll turn it over to Bob.
Bob Hau
Thank you, Todd and good morning everyone. I’ll provide some financial details and additional comments on the business segments for the quarter and full year, starting with residential heating and cooling.
In the fourth quarter, revenue from residential heating and cooling was $300 million, down 14%. Currency was neutral, volume was down 10%.
And combined price and mix were down 4% with price up 1% and mix down 5%. Let me expand on the mix for a moment.
While mix was down at the same rate as in the third quarter at 5%, the fourth quarter is compared against a rich mix of the fourth quarter of 2010 in which mix was up 6%. As Todd talked about earlier, this was due to the high efficiency products sold ahead of the expiration of the $1500 tax credit and in front of our announced price increases.
As mentioned in the third quarter earnings call this year, we were taking actions toward improving mix, encouraging more complete HVAC system sales going into the fourth quarter. These included repackaging our incentives and promotions, the dealers and consumers and filling out our line of products across the various SKUs of our new furnace platform.
We saw evidence in the fourth quarter that our actions are working both with regards to mix and in share gain. Now moving on to residential segment profit.
In the fourth quarter, profit was $14 million, down 57%. Segment profit margin was 4.8%, down 480 basis points from the fourth quarter a year ago.
Segment margin was down from lower volume and product mix as well as higher commodity costs. Partial offsets include favorable price, productivity initiatives and lower SG&A expenses.
For the full year, residential segment revenue was $1.34 billion, down 5%. Currency was neutral, volume was down 4%.
Combined price and mix were down 1% with mix down 3% and price up 2%. Segment profit was $75 million, down 43%.
Segment profit margin was 5.6%, down 370 basis points. Turning to our commercial heating and cooling business, in the fourth quarter, commercial revenue was $160 million, up 8%.
Volume was 6%, an price and mix were up 3% with currency at negative 1% impact. North American commercial HVAC revenue was up low double digits, and Europe commercial HVAC revenue was up mid single digits at constant currency.
Segment profit was $18 million, up 35%, and segment profit margin was a fourth quarter record at 11.1% and was up 230 basis points from the prior year quarter. Segment margin was up from higher volume, favorable price and mix, productivity initiatives and lower SG&A expenses with a partial offset from higher commodity costs.
For the full year, commercial revenue was $696 million, up 12%. Volume was up 7% and price and mix were up 3%.
Currency had a 2% positive impact. Segment profit was $79 million, up 15%, and segment profit margin was 11.4%, up 20 basis points.
Moving to our service experts business, in the fourth quarter, revenue was $122 million, down 16%. Volume was down 20% on warmer winter weather and a soft consumer environment.
Price and mix were up 4% on strong growth in commercial service. Currency was neutral.
Segment profit was $1 million, down 78%. Segment profit margin was 0.9%, down 260 basis points from the fourth quarter a year ago.
And results were impacted by lower volume with some offsets from productivity initiatives and lower SG&A expenses. For the full year, revenue in service experts was $529 million, down 10%.
Volume was down 13%, and price and mix were up 2%. Currency had a positive 1% impact.
Segment profit was $2 million, down 92% and segment profit margin was 0.3%, down 300 basis points. In our refrigeration segment, revenue in the fourth quarter was $189 million, up 36%.
Excluding the Kysor/Warren acquisition, volume was down 2%, and price and mix were up 2%. Currency was neutral.
From a regional perspective in constant currency, South America was up mid-20s, Europe was up mid-teens, and China was up double digits. North America was up mid-single digits and Australia was down high single digits.
Segment profit was $22 million, up 59%. Segment profit margin was a fourth quarter record 11.7%, up 170 basis points.
Results were positively impacted favorable price and mix, productivity initiatives and lower SG&A expenses. For the full year, refrigeration revenue was $805 million, up 46%.
Excluding the Kysor/Warren acquisition, refrigeration revenue was up 7%. Volume was flat and price and mix were up 2%.
Currency had a positive 5% impact. Segment profit was $78 million, up 26%.
Segment profit margin was 9.6%, down 150 basis points. Excluding the Kysor/Warren acquisition, refrigeration segment was up 170 basis points to 12.8%.
Looking at special items for the fourth quarter, the company had net after-tax charges of $9.7 million. This includes $9.5 million of asset and goodwill impairment charges for the Hearth business.
For the full year, Lennox had net after-tax special charges of $20.3 million, including $10.5 million from restructuring activities, the Hearth impairment and other items. These impacted GAAP EPS from continuing operations by $0.39.
Corporate expenses were $13 million in the fourth quarter, down 25% from the prior year quarter. For the full year, corporate expenses were $54 million, down 17% from 2010.
For 2012, our corporate expense guidance remains $65 million to $70 million. Overall SG&A was $145 million in the fourth quarter, down 16%.
For all of 2011, SG&A was $616 million, down 9%. Both periods included the SG&A taking on in the Kysor/Warren acquisition.
SG&A was down for the quarter and the year, primarily from low incentive compensation, commissions and selling expenses as well as strong discretionary spending controls. Cash from operations was $76 million for the full year versus $186 million last year.
Capital spending was $43 million in 2011 compared to $46 million in 2010, resulting in free cash flow of $33 million for the full year compared to $140 million in the prior year. Cash from operations was down for the year, primarily on lower net income, lower accrued expenses and higher working capital.
As you know, our free cash flow is very seasonal in nature. We had a historically strong second half of 2011 with $194 million of free cash flow.
The timing of our accounts receivable collection and workdown of inventory was not fast enough to offset the use of cash we had in the first half of 2011 to the degree we anticipated. You may recall we had quite an increase in inventory in the first quarter of last year as we ramped up our factories to more level-load activity in front of the summer selling season as well as positioning equipment in our company-owned distribution channel.
Given the level loading that took pace and the timing of some key accounts receivable collections, we anticipate a much better first half of free cash flow in 2012 relative to what we had in the first half of 2011. Excluding the Kysor/Warren acquisition, working capital as a percent of trailing 12-month sales for the company was 19% compared to 17% in the year ago period.
The quarter end working capital ratio was 16.2% compared to 15.5% at the end of the fourth quarter in 2010. Looking at liquidity, cash and cash equivalents were $45 million at the end of December.
Our debt to EBITDA ratio was 1.9 ending the year within our target range of 1 to 2 times. The total debt was $465 million at the end of the year, up $146 million from a year ago and down $35 million from the third quarter.
We continue to be well positioned with our balance sheet to continue executing on our strategic initiatives and returning cash to shareholders. We paid more than $36 million in dividends in 2011 and repurchased $120 million of stock, including $30 million in the fourth quarter.
We have a new $100 million stock repurchase authorization in place and $20 million remaining under the prior authorization. We are targeting $50 million of stock repurchases in 2012.
Before I turn it over to Q&A, I will briefly talk about our outlook for 2012. On one end, our market assumptions for 2012 remain the same as we discussed at the analyst day in mid-December.
We expect North American residential and commercial unitary markets to be up low single digits. And we expect Europe HVAC and refrigeration markets to be up low single digits as well.
Based on these assumptions, our guidance for 2012 revenue growth is 2.6% with a neutral impact from foreign exchange. As discussed at the analyst day, there are several puts and takes we expect for 2012.
We continue to expect $20 million to $25 million in material cost reductions through a combination of sourcing initiatives and engineering-led cost reductions. We expect an incremental $10 million of savings from announced restructuring projects.
We currently project $15 million of commodity headwind in 2012 but offset by price. We will see some carryover benefits this year from our 2011 price increases.
And most recently on the pricing front, we announced a 1% to 6% price increase in North American commercial that we began to push through in December. North American refrigeration has announced a price increase of 2% effective March 15.
Regarding product mix, we anticipate lower mix in the residential business to be a $15 million headwind this year. And as incentive compensation as we lowered it across the company in line with our 2012 performance targets, we expect variable SG&A to be up about $20 million.
The biggest factor overall, of course, is the macro economic uncertainty and the strength of consumers. Our 2012 guidance for adjusted EPS from continuing operations remains $2.20 to $2.60 for the full year.
The GAAP EPS range remains $2.17 to $2.57, including the impact of announced restructuring activities. As most of you know, the first quarter is by far a seasonally lightest period in the context of the full year.
In fact, we were at a loss position for the first quarter of last year and in two over the last three years. So far this quarter, we’ve seen warmer weather than last year with heating degree days down 32%, and this is having a negative impact on our residential and service experts business from January.
In commercial, while we are looking forward to continued strength with our new and existing customers in 2012, the timing of some national account businesses is expected to ramp up in the second quarter and beyond, benefitting growth after the first quarter. The final point I want to make on the first quarter is that a material cost reductions of $20 million to $25 million for 2012 is back half loaded as it will flow through the P&L more in the second half of the year.
To wrap up with a few other guidance points for 2012, we expect interest expense in 2012 to be approximately $20 million. We anticipate a full year tax rate of 33% to 34%.
Our average weighted diluted share count for the full year is expected to be approximately 51 million shares and for capital spending, we expect $55 million in 2012 as we continue to focus on transformational investments in business. With that, we will go to Q&A.
Operator
(Operator Instructions) And our first question is from Jeff Hammond – KeyBanc Capital Markets. Please go ahead.
Unidentified Analyst
Hi good morning guys. This is Brent Lindsay stepping in for Jeff.
Just on the commercial business, it seems like you are seeing some resiliency there. As you kind of look over the near term, any pockets of caution or areas that might be showing some more strengths, and then just any color on traction within the national account business.
Todd Bluedorn
We continue to see a good progress both in our commercial and our refrigeration business. As we have been saying over the last couple of quarters, order rates have abated a bit from where they were earlier in 2011 but they are still positive and we really had a really good quarter, fourth quarter.
We talked about on the call that we added new national accounts in fourth quarter up to 20 for the year. I think the additional color I would add on commercial is strengthened verticals of school, even though those markets are down.
And the final point would be what Bob mentioned in his comments is we still expect the market to be up low to mid-single digits in 2012, but the timing of some national accounts will make that more second half for the year than first half.
Unidentified Analyst
Okay, great. And then on free cash flow, it came in somewhat light versus our expectation as well as your estimate at the December analyst day.
Maybe just some of the factors supporting the shortfall there.
Bob Hau
Yeah, I think I pointed out in my comments upfront, we actually had a good second half of the year with $194 million in free cash flow. Relative to our expectations we had definitely had some timing of accounts receivable collections that drifted into January and inventory ended up the year a bit higher based on some inputs as well as lower revenue relief.
Operator
We have a question from Josh Pokrzywinski with MKM Partners. Please go ahead.
Josh Pokrzywinski – MKM Partners
Just wanted to get a little bit on the revised EPA allocation for R-22. Any impact that you are hearing from your contractor customers in the way that you are pitching dry-shift or any -- obviously formerly your expectations are unchanged.
Just trying to understand how that may color your thinking?
Todd Bluedorn
Maybe I will broaden the answer for those on the line who aren’t as quite tied into those as you are. We’ve had some movement over the last month or so both from the DOE and from EPA referenced the R-22 dry charge issue.
One is a proposal reducing the allocations of R-22 refrigerant, the amount that’s able to be produced, this has led to a spike in our 22 refrigerant pricing, almost triple in value on the street. This is a recent development.
So we are still evaluating how it’s going to play out, Josh. And another proposal is that manufacturers cannot sell R-22 condensing units that were not certified prior to January 2010.
This has no impact on us because R-22 units that we sold last year and planning on selling this year were certified prior to that date. These two actions from the EPA and DOE are certainly steps in the right direction.
We don’t think they will have a big impact on 2012 given where we are now. So the guidance that we gave back in December of – that the market moving from 20% R-22 dry charge to 25% R-22 dry charge is still our perspective.
But on the longer term, this is a good movement from DOE and EPA on the loophole. More needs to be done though and we continue to work with our peers, DOE and EPA on these and related issues.
Josh Pokrzywinski – MKM Partners
And then maybe just one follow up, kind of competitively on the R-22 environment. Obviously I know you guys focus on your own business, but anything that you are seeing from competitors that suggest that there is a new approach outside of obviously trying and getting into that market a little bit more thoroughly in 2012.
That says there could be some traditional share shift, people either abandoning or de-emphasizing or maybe getting a little bit more aggressive. Just anything that you’ve noted over the past couple of months.
Todd Bluedorn
Short answer is no. The longer answer is I wouldn’t have expected this.
Our guys wouldn’t have expected to see it yet. I mean, where we will see, when it will be, when we are going into the cooling season.
And so the R-22 market is really sort of emergency replacement over the counter somebody’s unit breaks in and it’s high outside, they have to replace and that’s what they go with. And then obviously even the warm weather in January, there is not a whole lot of that going on right now.
We will see this when we get into the summer time. So the answer is we haven’t seen anything but we wouldn’t have expected to.
Josh Pokrzywinski – MKM Partners
Okay. And then just one final one, can you comment on how price yield is going over the past couple of months as well?
Obviously you’ve announced increases in yield underneath that. Any change in what you saw earlier in – versus what you saw earlier in 2011?
Todd Bluedorn
I think it’s consistent with what we said back in December that we’re going to have commodity headwind this year of about $15 million and we think we can fully offset that with price. Our residential commercial and refrigeration all took price increases and early in ’11, residential announced a second increase effective 3Q11 and commercial in 4Q11.
Actually last week our refrigeration business announced another price increase starting mid-March of this year. And residential will continue to monitor strength of the market and commodity movements.
As you know, it’s very competitive market but we all face the same commodity issues and with copper inching its way back towards $4 per pound, the industry has historically been able to capture price offset commodity headwinds.
Operator
We have a question from Robert Barry, UBS. Please go ahead.
Robert Barry – UBS
I am sorry if I missed it. Did you say what the mix was of R-22 in the fourth quarter?
Todd Bluedorn
No, we didn’t.
Robert Barry – UBS
Could you?
Todd Bluedorn
I am looking at – someone told me a 4, I am not sure. And that’s for us.
Bob Hau
4% for our residential.
Todd Bluedorn
Yes, 4% for our Lennox business and again that tied, Robert, as you know, but for other on the all, the answer that I just gave Josh, fourth quarter, first quarter are really big R-22 quarters, that’s when you get into the summer time.
Bob Hau
It was zero last year.
Robert Barry – UBS
Could you also tell us the year over how much operating profit pressure that Hearth business caused in resi?
Todd Bluedorn
Yeah, in 2011 we lost a little over $12 million on approximately $80 million of revenue. For 2012, we expect an improved conditions for the Hearth market as we think R&C is going to come back.
And by the way we’ve seen that early in the year. And we took – have taken additional aggressive cost actions to significantly narrow the loss position in 2012.
Robert Barry – UBS
Is that $12 million a loss in 2011, what was that in 2010?
Todd Bluedorn
A little over $14 million,
Robert Barry – UBS
So it actually got a little bit better year over year.
Todd Bluedorn
Correct.
Robert Barry – UBS
And then just finally, the SG&A was down a lot in the fourth quarter year over year. How much of that was just lower commissions due to the lower revenue things like that versus initiatives that you have taken?
Todd Bluedorn
The answer is it was both. I mean, people got less commissions and less bonuses given the performance of the business.
But lots of discretionary actions that we took across the board, sort of the restructuring actions that we talked about in the December meeting. And we are going to see some of that bounce back into next year as we talked it out back in December that there is going to be $20 million or so of reinflation in SG&A because of some of those things both in fourth quarter and across the year, the sort of one-time items.
Operator
We have a question from Adam Samuelson with Goldman Sachs. Please go ahead.
Adam Samuelson – Goldman Sachs
Yes, good morning. Gentlemen I hope you can dig a little bit more into the working capital performance, it looks the inventory at the end of the year knocked down as much as – actually up year on year in terms of the days perspective.
Any commentary you might have on what the implication is for first quarter given the weak resi selling reason and maybe your production levels in the first half and maybe some fixed cost absorption there.
Bob Hau
If you go back and look kind of how we performed in 2011, we had a pretty significant ramp up of inventory in the first half or first quarter of 2011. And as I think I pointed out in the earlier conversation, or earlier points, second half of the year we did very well from a cash standpoint, both working capital and overall which it didn’t fully offset the ramp up that we had in the first quarter of ’11.
As we go into 2012, we’re kind of at that ramp up level, we’ll still have growth in inventory and first quarter as we get ready for the summer selling season but not nearly the magnitude that we saw in first quarter of 2011 over fourth quarter of 2010.
Adam Samuelson – Goldman Sachs
It just looks –looking back at your inventory days in 4Q or basically the highest they’ve ever been, and I am just trying to understand it. Some of that presumably the change in the distribution infrastructure but I am just trying to understand the implications just given the weaker resi volume here?
Bob Hau
And I think it’s that ramp up that we had and it just didn’t bleed it all in the second half of the year, didn’t fully offset that.
Adam Samuelson – Goldman Sachs
And then switching gears, in refrigeration the organic margins, if you back out Kysor/Warren rev, about 400 basis points year on year. And maybe if you could provide a little bit more color on the drivers there and breakup some of the pieces as you do in the Ks between price mix, volume, SG&A and material costs?
Bob Hau
Are you talking about fourth quarter?
Adam Samuelson – Goldman Sachs
Yes.
Bob Hau
First off, the K will be out probably in about a week and a half or so you will have a lot of detail there. But overall for the quarter, organic refrigeration did very well, it got some nice benefits from price and mix combined.
I mentioned on the call price was up, I think 2 points overall for the quarter for that business. We continue to see very good benefits in restructuring from both SG&A and a factory standpoint.
And we see some material cost savings occurred in the fourth quarter of this year.
Adam Samuelson – Goldman Sachs
Okay. Is any of that restructuring associated with Kysor/Warren integration at all, or is that purely on the existing business?
Bob Hau
What I was just describing is existing business. Obviously we are doing some integration restructuring within Kysor/Warren also.
Operator
We have a question from Steve Tusa with JPMorgan.
Stephen Tusa – JPMorgan
You said 4% R-22, could just clarify that a little bit? Is that total – that’s like total resi business, so that includes like it was obviously a higher number in your – in kind of the value brands.
And then what did it finish out for the year as a percentage of volumes?
Todd Bluedorn
I am looking at data that’s been handed to me, Steve. What did we say at December for the full year –
Bob Hau
It’s mid-teens Steve.
Stephen Tusa – JPMorgan
Mid-teens?
Bob Hau
Yes.
Stephen Tusa – JPMorgan
And so you are kind – obviously you have margin assumptions for next year in resi. I mean, are you thinking that, that percentage goes up next year, or are you assuming it’s kind of flattish?
Todd Bluedorn
Yes, I think what we are assuming is that the industry is going to go from 20 to 25 and we will move with the industry as it moves from 20 to 25. So we are going to get our fair share of R-22 as the industry moves.
Stephen Tusa – JPMorgan
Okay, great. And then the first quarter commentary you made, I mean, obviously a pretty dramatic drop-off last year, you lost money.
Are you talking about revenues being down meaningfully? I mean, the distributors we talked to or talking about now that kind of sell-through is kind of flattish in January as you kind of move beyond these tougher comps.
I mean, how do we think about how bad or I guess, how bad that performance is going to be in the first quarter?
Bob Hau
Yeah, I don’t want to get into – give specific guidance on Q1 but as I have pointed out, clearly weather is a big issue for us, January the heating degree days down 32%, and it was 59 degrees in New York, it’s 40 up in Milwaukee, that’s continuing into February, and that’s going to have an impact. And Q1 is historically very light.
Yes, we lost quite a bit in first quarter of ’11, but we lost money in two of the last three years. So it’s not dramatic and summer selling season Q2 and Q3 are our main months.
Stephen Tusa – JPMorgan
Bob, just remind me what percentage of your business in kind of these winter months is heating versus cooling?
Bob Hau
I don’t have that data by quarter. That’s actually –
Stephen Tusa – JPMorgan
Well then just for the year, how much is heating versus cooling?
Bob Hau
About 45% heating for the year.
Operator
We have a question from Nigel Coe with Morgan Stanley. Please go ahead.
Nigel Coe - Morgan Stanley
Just want to dig into the inventory, you mentioned it didn’t hit much of the ramp up as you expected. But I think we’ve kind of (indiscernible) in terms of the first half, obviously you haven’t got a raised production as much as you normally would have because you have inventories on hand.
But I am just wondering what does that do to your first half margins within resi? Do we see bit more pressure on that just because of the fixed cost issues?
Todd Bluedorn
I think it was anticipated in the guidance. I mean, we knew we had a big ramp up last year and first quarter and we aren’t going to do it this year.
And then given broadly speaking, our cost of goods sold is 80% material, 10% direct labor, 10% fixed overhead, we’re going to adjust the direct labor based on the volumes. So the absorption factor isn’t the same as other sort of fixed cost industries.
So, I mean, there will be come but we anticipated them and sort of baked it in toward that.
Nigel Coe - Morgan Stanley
And then on the -- obviously the price increases, how that’s going to play out but I mean we more -- drive a bit more replacement versus -- sorry -- drive more repair versus replacement?
Todd Bluedorn
I think it depends how far it gets inflated right? And so right now there is a compressor replacement and sort of the lowest cost option, the option we want to drive into is a complete system replacement with 410A.
And then in between there is the dry charge. And the dry charge right now is sort of close enough to the replacement in value that it sort of an easy sell to replace the unit rather than repair the compressor.
If it gets inflated enough, then all of a sudden we are talking to people about the distance from an R-22 dry charge to 410A system, it gives close enough that we can make that sale. And again, when you are doing an R-22 – excuse me, when you are doing a compressor replacement, if R-22 refrigerant has tripled or more in price, you are still going to have to recharge the system when you do put it in the compressor , you are still going to have to add free-on, and more importantly the consumer is going to be exposed to that over time.
So I thin k it’s all goodness for the industry because we think both for the consumer and for the industry, the 410A was the transition that needs to take place. I don’t know how much impact that’s going to have on this year but over the next few years, I think it’s moving in the right direction.
Nigel Coe - Morgan Stanley
You are talking about low to mid singles on the commercial HVAC in 2012. You’re putting through 2% to 6% price increase, which implies that your volume assumptions are fairly flat.
Is that correct? And secondly, this flat volume for 2012 are little bit too conservative?
Todd Bluedorn
When I talk about low single digits, I am talking about the industry and I am talking about unit volume. And so we don’t give revenue – we didn’t give revenue guidance for our commercial segment for next year.
We just gave sort of color on the industry.
Nigel Coe - Morgan Stanley
I see. So the actual revenue should be a bit more than that?
Todd Bluedorn
If we are holding gained share and the industry is up single digits, we will do better than that in revenue.
Nigel Coe - Morgan Stanley
Okay. And then one final clarification.
The $15 million R-22 headwinds, is that revenue headwind, not an EBIT headwinds?
Todd Bluedorn
It’s an EBIT headwind.
Operator
We have a question from Keith Hughes with SunTrust Bank. Please go ahead.
Unidentified Analyst
This is GD in for Keith. Most of our questions have been answered.
But just want to clarify on the goodwill asset impairment charges. Were those all related to the Hearth business?
Todd Bluedorn
Yes.
Operator
(Operator Instructions) And our next question comes from Stephen Tusa with JPMorgan. Please go ahead.
Stephen Tusa – JPMorgan
Sorry, just had a couple of follow-ups. The first one was on R-22, obviously everybody had kind of a step-down in profitability as the mix changed.
I guess, what you are saying is that, is that normalized now, so kind of on a like-for-like basis, that R-22 goes from 20% to 25% of the industry as opposed to whatever it was zero to 15%. Do you feel like you’ve kind of weathered the majority of that storm?
Sorry, what was the $15 million R-22 headwind? I must have missed that.
Todd Bluedorn
Thanks for giving me the chance to clarify. The movement of the industry going to 20% to 25% R-22, and our moving with the industry is going to lead to a negative mix impact that we talked about in December of $15 million on our EBIT.
Stephen Tusa – JPMorgan
Okay. $15 million, that’s baked into your numbers.
Todd Bluedorn
Correct. And as we talked about that back in December, that’s in our guidance, that’s ‘old news’.
Stephen Tusa – JPMorgan
And then the other question just on kind of how you manage your inventories. Looking at kind of fourth quarter levels relative to the history and just seasonally speaking, how much of your kind of cooling season, do you usually have in inventory in December?
How do we think about kind of the seasonal dynamics about you build inventory, i.e. how relevant is your inventory level at kind of year end as a determinant of kind of what you are going to do entering the cooling season?
Todd Bluedorn
The inventory that we have in January – I’d step back. Bob talked about it, and the way I think about it is, is last year compared to prior years we sort of changed our flow of how we produce the inventory, that we started earlier in the year, in the first quarter and sort of ramped up early both in refrigeration by the way and then residential, to sort of more level-load our factories.
And then as we went through the summer season, we then bleeded off and we wanted to end the year at certain level. And what happened was the markets, especially in resi were softer maybe than what we thought.
And so therefore we didn’t bleed it all, all quite off. Now I think what you are leading to is, it’s really quite frankly a question of timing now.
As we go into first quarter now, we aren’t going to have the ramp up in inventory that we had last year because we came into the year with the inventory. So it will bleed some of it off but more importantly we are just not going to build at the same levels that we did last year in first quarter because we have the inventory already.
Stephen Tusa – JPMorgan
Right, in the first quarter?
Todd Bluedorn
Correct.
Stephen Tusa – JPMorgan
So entering the cooling season, it’s not like you are going to be coming in there with a ton of product which is when you make all of your money anyway?
Todd Bluedorn
Correct.
Stephen Tusa – JPMorgan
One more question sorry, on the commercial dynamics. Have you see any kind of change in appetite?
As far as customer behavior, obviously you had a good year this year. Do you feel like they are still little bit of kind of pent-up replacement and then how is that market kind of transitioning as we make it through kind of year or two of growth there?
Todd Bluedorn
It continues to struggle (ph) long, Steve. I mean it’s not sort of 20% growth rates that we saw in first quarter last year.
But the backlog, the order rates remained strong, and I think the thing that I am encouraged by is how broad it is. It’s national accounts and planned replacement but it’s also increasingly the one demand that we have been focused on, it’s verticals schools, and so I think it’s a broad segment of the market that we think continues to understand and have cash to make investments to lower their operating costs to buy our high energy efficiency equipment.
Stephen Tusa – JPMorgan
Right, and then just I have one more last question. Just to make sure I understand what you are saying around demand destruction and price increases at residential.
Just to make sure I understand this correctly. What you are basically saying is that it’s not necessarily 2% to 3%, 4% price increase on equipment that’s only 50% of the contractor costs that – that kind of destroys demand in resi is really when you have that installation cost that goes from 1500 for the compressor repair, 3000 for the R-22 to 6000 to 7000 for like the full 410A, is that the right way to think about it?
Obviously 1% to 5% price increase on equipment cost, that’s only half the installation is kind of peanuts in the end.
Todd Bluedorn
I apologize if I said anything implied that. No, you are exactly right.
I mean, what the consumer sees is the install cost and/or install price and part of that is big – half of that’s labor, half of that order of magnitude equipment. And so that gives us pricing power as an industry and we have seen that we have been able to do that.
The dynamic we have here is that’s complicated as our R-22 dry charge gives a consumer all-in price point that has mixed us down as an industry.
Operator
We have a question from Adam Samuelson with Goldman Sachs. Please go ahead.
Adam Samuelson – Goldman Sachs
Just one quick follow up. The $15 million headwind from R-22 in 2012.
What was the number in 2011 all-in for the year?
Todd Bluedorn
$30 million.
Operator
At this time, I will turn the conference back to Mr. Todd Bluedorn.
Todd Bluedorn
Thanks operator. A few points to leave you with.
For 2012, commercial and refrigeration markets continue to look solid, and we have announced price increases that are being enacted in these markets. We expect improved market conditions in residential this year with low single digit shipment growth and less mixed headwind than what we saw in 2011.
We will continue to drive our strategic initiatives across the company for improved revenue and profit growth in 2012 and continue to focus on driving productivity across our business globally. Thank you for joining us.
Good day.
Operator
Ladies and gentlemen, that does conclude your conference for today. Thank you for your participation and for using AT&T executive teleconference.
You may now disconnect.