UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D. C. 20549

FORM 10-Q

(MARK ONE)

þ		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2005

o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                      to                     

Commission file number 001-15149

LENNOX INTERNATIONAL INC.

Incorporated pursuant to the Laws of the State of DELAWARE

Internal Revenue Service Employer Identification No. 42-0991521

2140 LAKE PARK BLVD.
RICHARDSON, TEXAS
75080
(972-497-5000)

     Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

     Yes þ No o

     Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).
Yes þ No o

     Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

     Yes o No þ

     As of October 31, 2005, the number of shares outstanding of the registrant’s common stock, par value $.01 per share, was 70,886,720.

 

 

FORM 10-Q
For the Three Months and Nine Months Ended September 30, 2005

INDEX

		Page
Part I. Financial Information
Item 1. Financial Statements
Consolidated Balance Sheets — September 30, 2005 (Unaudited) and December 31, 2004		3
Consolidated Statements of Operations (Unaudited) — Three Months and Nine Months Ended September 30, 2005 and 2004		4
Consolidated Statements of Cash Flows (Unaudited) — Nine Months Ended September 30, 2005 and 2004		5
Notes to Consolidated Financial Statements (Unaudited)		6
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		20
Item 3. Quantitative and Qualitative Disclosures About Market Risk		32
Item 4. Controls and Procedures		32
Part II. Other Information
Item 6. Exhibits		33
Certification of Principal Executive Officer
Certification of Principal Executive Officer
Certificaton of Principal Executive Officer and Principal Financial Officer

PART I — FINANCIAL INFORMATION

Item 1. Financial Statements.

LENNOX INTERNATIONAL INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS
As of September 30, 2005 and December 31, 2004
(In millions, except share data)

		September 30,				December 31,
		2005				2004
		(unaudited)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents		$	176.2			$	60.9
Accounts and notes receivable, net			567.4				472.5
Inventories			254.0				247.2
Deferred income taxes			14.0				13.1
Other assets			50.5				45.9
Assets held for sale			0.1				5.1
Total current assets			1,062.2				844.7
PROPERTY, PLANT AND EQUIPMENT, net			244.6				234.0
GOODWILL, net			225.6				225.4
DEFERRED INCOME TAXES			85.3				82.8
OTHER ASSETS			121.4				131.7
TOTAL ASSETS		$	1,739.1			$	1,518.6
LIABILITIES AND STOCKHOLDERS’ EQUITY
CURRENT LIABILITIES:
Short-term debt		$	2.5			$	6.0
Current maturities of long-term debt			114.3				36.4
Accounts payable			312.9				237.0
Accrued expenses			311.6				286.3
Income taxes payable			41.4				14.6
Liabilities held for sale			1.1				3.7
Total current liabilities			783.8				584.0
LONG-TERM DEBT			119.3				268.1
POSTRETIREMENT BENEFITS, OTHER THAN PENSIONS			15.5				14.2
PENSIONS			106.1				105.5
OTHER LIABILITIES			80.5				73.9
Total liabilities			1,105.2				1,045.7
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS’ EQUITY:
Preferred stock, $.01 par value, 25,000,000 shares authorized, no shares issued or outstanding			—				—
Common stock, $.01 par value, 200,000,000 shares authorized, 68,313,156 shares and 66,367,987 shares issued for 2005 and 2004, respectively			0.7				0.7
Additional paid-in capital			519.2				454.1
Retained earnings			148.1				66.8
Accumulated other comprehensive income			—				0.7
Deferred compensation			—				(18.2	)
Treasury stock, at cost, 3,183,631 shares and 3,044,286 for 2005 and 2004, respectively			(34.1	)			(31.2	)
Total stockholders’ equity			633.9				472.9
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY		$	1,739.1			$	1,518.6

The accompanying notes are an integral part of these consolidated financial statements.

LENNOX INTERNATIONAL INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS
For the Three Months and Nine Months Ended September 30, 2005 and 2004
(Unaudited, in millions, except per share data)

		For the								For the
		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2005				2004				2005				2004
NET SALES		$	927.5			$	771.9			$	2,495.6			$	2,241.3
COST OF GOODS SOLD			612.1				513.5				1,664.4				1,482.0
Gross Profit			315.4				258.4				831.2				759.3
OPERATING EXPENSES:
Selling, general and administrative expense			230.2				209.1				659.4				624.5
(Gains), losses and other expenses, net			0.1				—				(8.6	)			—
Restructuring charge			0.2				—				2.4				—
Goodwill impairment			—				—				—				208.3
Operational income (loss) from continuing operations			84.9				49.3				178.0				(73.5	)
INTEREST EXPENSE, net			4.3				6.1				14.4				22.5
OTHER EXPENSE (INCOME)			3.5				(0.2	)			3.0				(0.7	)
Income (loss) from continuing operations before income taxes and cumulative effect of accounting change			77.1				43.4				160.6				(95.3	)
PROVISION FOR INCOME TAXES			28.5				15.3				59.5				18.0
Income (loss) from continuing operations before cumulative effect of accounting change			48.6				28.1				101.1				(113.3	)
CUMULATIVE EFFECT OF ACCOUNTING CHANGE, NET			(0.2	)			—				(0.2	)			—
Income (loss) from continuing operations			48.8				28.1				101.3				(113.3	)
DISCONTINUED OPERATIONS:
Loss from operations of discontinued operations			0.1				6.5				1.9				29.6
Income tax benefit			(0.1	)			(1.7	)			(0.5	)			(6.3	)
Loss on disposal of discontinued operations			—				4.7				0.1				5.3
Income tax benefit			—				(0.3	)			(0.2	)			(0.5	)
Loss from discontinued operations			—				9.2				1.3				28.1
Net income (loss)		$	48.8			$	18.9			$	100.0			$	(141.4	)
INCOME (LOSS) PER SHARE FROM CONTINUING OPERATIONS BEFORE CUMULATIVE EFFECT OF ACCOUNTING CHANGE:
Basic		$	0.77			$	0.46			$	1.63			$	(1.89	)
Diluted		$	0.68			$	0.42			$	1.45			$	(1.89	)
CUMULATIVE EFFECT OF ACCOUNTING CHANGE PER SHARE:
Basic		$	—			$	—			$	—			$	—
Diluted		$	—			$	—			$	—			$	—
INCOME (LOSS) PER SHARE FROM CONTINUING OPERATIONS:
Basic		$	0.77			$	0.46			$	1.63			$	(1.89	)
Diluted		$	0.68			$	0.42			$	1.45			$	(1.89	)
LOSS PER SHARE FROM DISCONTINUED OPERATIONS:
Basic		$	—			$	(0.15	)		$	(0.02	)		$	(0.47	)
Diluted		$	—			$	(0.13	)		$	(0.02	)		$	(0.47	)
NET INCOME (LOSS) PER SHARE:
Basic		$	0.77			$	0.31			$	1.61			$	(2.36	)
Diluted		$	0.68			$	0.29			$	1.43			$	(2.36	)
AVERAGE SHARES OUTSTANDING:
Basic			62.9				60.1				62.1				59.9
Diluted			74.2				70.3				73.1				59.9
CASH DIVIDENDS DECLARED PER SHARE:		$	0.10			$	0.095			$	0.30			$	0.285

The accompanying notes are an integral part of these consolidated financial statements.

LENNOX INTERNATIONAL INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Nine Months Ended September 30, 2005 and 2004
(Unaudited, in millions)

		For the
		Nine Months Ended
		September 30,
		2005				2004
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss)		$	100.0			$	(141.4	)
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Minority interest and equity in unconsolidated affiliates			(11.7	)			(8.4	)
Non-cash impairment of long-lived assets and goodwill			—				224.7
Depreciation and amortization			28.4				32.9
Deferred income taxes			(3.6	)			(24.4	)
Loss from discontinued operations, other than non-impairments			1.3				11.7
Other (gains), losses and expenses			(2.7	)			14.0
Changes in assets and liabilities, net of effects of divestitures:
Accounts and notes receivable			(109.5	)			15.9
Inventories			(10.1	)			(68.6	)
Other current assets			(4.8	)			(4.2	)
Accounts payable			86.8				6.9
Accrued expenses			28.5				17.6
Income taxes payable and receivable			32.1				15.6
Long-term warranty, deferred income and other liabilities			26.0				3.9
Excess tax benefits related to share-based payments			(3.1	)			—
Net cash used in operating activities from discontinued operations			(3.1	)			(11.2	)
Net cash provided by operating activities			154.5				85.0
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from the disposal of property, plant and equipment			1.1				0.5
Purchases of property, plant and equipment			(42.0	)			(24.4	)
Additional investments in affiliates			—				(2.3	)
Proceeds from disposal of businesses and investments			41.8				11.5
Net cash provided by (used in) investing activities			0.9				(14.7	)
CASH FLOWS FROM FINANCING ACTIVITIES:
Short-term borrowings (repayments), net			(3.1	)			3.2
Repayments of long-term debt			(25.1	)			(45.1	)
Revolving long-term borrowings			(5.0	)			(1.0	)
Sales of common stock			17.4				11.3
Payments of deferred financing costs			(1.7	)			(0.2	)
Repurchases of common stock			(2.9	)			—
Excess tax benefits related to share-based payments			3.1				—
Cash dividends paid			(24.8	)			(22.8	)
Net cash used in financing activities			(42.1	)			(54.6	)
INCREASE IN CASH AND CASH EQUIVALENTS			113.3				15.7
EFFECT OF EXCHANGE RATES ON CASH AND CASH EQUIVALENTS			2.0				2.5
CASH AND CASH EQUIVALENTS, beginning of period			60.9				76.1
CASH AND CASH EQUIVALENTS, end of period		$	176.2			$	94.3
Supplementary disclosures of cash flow information
Cash paid during the period for:
Interest		$	11.2			$	18.2
Income taxes (net of refunds)		$	38.0			$	20.6

The accompanying notes are an integral part of these consolidated financial statements.

LENNOX INTERNATIONAL INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

1. Basis of Presentation and Other Accounting Information:

     The accompanying unaudited Consolidated Balance Sheet as of September 30, 2005, the accompanying unaudited Consolidated Statements of Operations for the three months and nine months ended September 30, 2005 and 2004 and the accompanying unaudited Consolidated Statements of Cash Flows for the nine months ended September 30, 2005 and 2004 should be read in conjunction with Lennox International Inc.’s (the “Company” or “LII”) audited consolidated financial statements and footnotes as of December 31, 2004 and 2003 and for each of the three years in the period ended December 31, 2004. The accompanying unaudited consolidated financial statements of LII have been prepared in accordance with generally accepted accounting principles for interim financial information and in accordance with the instructions to Form 10-Q and Article 10 of Regulation S-X. In the opinion of management, the accompanying consolidated financial statements contain all material adjustments, consisting principally of normal recurring adjustments, necessary for a fair presentation of the Company’s financial position, results of operations, and cash flows. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to applicable rules and regulations, although the Company believes that the disclosures herein are adequate to make the information presented not misleading. The operating results for the interim periods are not necessarily indicative of the results that may be expected for a full year.

     Certain prior-period balances in the accompanying condensed consolidated financial statements have been reclassified to conform to the current period’s presentation of financial information.

     The Company’s fiscal year ends on December 31 and the Company’s quarters are each comprised of 13 weeks. For convenience, throughout these financial statements, the 13 weeks comprising each three-month period are denoted by the last day of the respective calendar quarter.

2. Stock-Based Compensation:

     In December 2004, the Financial Accounting Standards Board (the “FASB”) issued Statement of Financial Accounting Standards No. 123R “Share-Based Payment” (SFAS No. 123R). SFAS No. 123R requires compensation cost to be measured for all outstanding unvested share-based awards at fair value for all interim and annual periods beginning after June 15, 2005. In March 2005, the SEC issued Staff Accounting Bulletin No. 107 “Share-Based Payment” (SAB No. 107), which provided further clarification on the implementation of SFAS No. 123R. On April 14, 2005, the SEC announced a deferral of the effective date of SFAS No. 123R for calendar year companies until the beginning of 2006; however, the Company elected to adopt the provisions of SFAS No. 123R early with an implementation date of July 1, 2005, as permitted by the standard. Prior to July 1, 2005, the Company accounted for stock-based awards under the intrinsic value method, which follows the recognition and measurement principles of Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees and Related Interpretations” (APB No. 25), as permitted by FASB Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation” (SFAS No. 123).

     Effective July 1, 2005, the Company adopted the fair value recognition provisions of SFAS No. 123R using the modified-prospective-transition method. Under that transition method, compensation cost recognized in the second half of 2005 includes: (a) compensation cost for all share-based payments granted prior to, but not yet vested as of July 1, 2005, based on the grant date fair value estimated in accordance with the original provisions of SFAS No. 123, and (b) compensation cost for all share-based payments granted subsequent to July 1, 2005, based on the grant-date fair value estimated in accordance with the provisions of SFAS No. 123R. In accordance with SFAS No. 123R, results for prior periods have not been restated. Compensation expense of $7.2 million was recognized for the three months ended September 30, 2005 and is included in Selling, General and Administrative Expense in the accompanying unaudited Consolidated Statement of Operations for the three months ended September 30, 2005. The cumulative effect of the change in accounting related to the adoption of SFAS No. 123R was $0.2 million of after-tax income for the three months ended September 30, 2005.

     Prior to the adoption of SFAS No. 123R, the Company presented all tax benefits of deductions resulting from the exercise of stock options as operating cash flows in the Consolidated Statements of Cash Flows. SFAS No. 123R requires the cash flows from the tax benefits of tax deductions in excess of the compensation cost recognized for

those options (excess tax benefits) to be classified as financing cash flows. The $3.1 million excess tax benefits classified as a financing cash inflow in the accompanying Consolidated Statement of Cash Flows as of September 30, 2005 would have been classified as an operating cash inflow if the Company had not adopted SFAS No. 123R.

     Had the Company used the fair value based accounting method for stock-based compensation expense described by SFAS No. 123 for the fiscal 2005 and 2004 periods prior to July 1, 2005, the Company’s diluted net income (loss) per common and equivalent share for the three months ended September 30, 2004 and the nine months ended September 30, 2005 and 2004 would have been as set forth in the table below (in millions, except per share data). As of July 1, 2005, the Company adopted SFAS No. 123R thereby eliminating pro forma disclosure for periods following such adoption. For purposes of this pro forma disclosure, the value of the options is estimated using a Black-Scholes-Merton option valuation model and amortized to expense over the options’ vesting periods.

		For the				For the
		Three Months Ended				Nine Months Ended
		September 30,				September 30,
		2004				2005				2004
Net income (loss), as reported		$	18.9			$	100.0			$	(141.4	)
Add: Reported stock based compensation expense, net of taxes			0.5				13.3				3.7
Deduct: Fair value based compensation expense, net of taxes			(1.2	)			(14.3	)			(5.8	)
Net income (loss), pro forma		$	18.2			$	99.0			$	(143.5	)
Earnings per share:
Basic, as reported		$	0.31			$	1.61			$	(2.36	)
Basic, pro forma		$	0.30			$	1.59			$	(2.40	)
Diluted, as reported		$	0.29			$	1.43			$	(2.36	)
Diluted, pro forma		$	0.28			$	1.42			$	(2.40	)

     Incentive Plan

     The Company’s Amended and Restated 1998 Incentive Plan (the “1998 Incentive Plan”) provides for various long-term incentive and retentive awards. These awards include stock options, performance shares, restricted stock awards and stock appreciation rights.

     Under the 1998 Incentive Plan, the Company is authorized to issue awards for 24,254,706 shares of common stock. As of September 30, 2005, awards for 19,145,400 shares of common stock had been granted and 3,853,749 shares had been cancelled or repurchased. Consequently, as of September 30, 2005, there were 8,963,055 shares available for future issuance.

     Stock Options

     Under the 1998 Incentive Plan, the exercise price for stock options equals the stock’s fair value on the date of grant. Options granted prior to 1998 vested on the date of grant. Options granted in 1998 and after vest over three years. Options issued prior to December 2000 expire after ten years and options issued in December 2000 and after expire after seven years.

     In addition to the options discussed above, there were 198,492 stock options outstanding as of September 30, 2005 that were issued in connection with the acquisition of Service Experts, Inc. All such options are fully vested.

     Prior to the adoption of SFAS No. 123R, and in accordance with APB No. 25, no stock-based compensation cost was reflected in net income for grants of stock options to employees because the Company grants stock options with an exercise price equal to the fair market value of the stock on the date of grant. For footnote disclosures under SFAS No. 123, the fair value of each option award was estimated on the date of grant using a Black-Scholes-Merton option valuation model that uses the assumptions noted below. Estimates of fair value are not intended to predict actual future events or the value ultimately realized by employees who receive equity awards. Subsequent events are not indicative of the reasonableness of the original estimates made by the Company . Under SFAS No. 123, the Company used historical data to estimate the expected volatility for the term of new options and the outstanding period of the option for separate groups of employees that had similar historical exercise behavior. The risk free

interest rate was based on the U. S. Treasury yield curve in effect at the time of grant. The weighted-average fair value of options granted during the nine months ended September 30, 2005 was $7.50. No stock options were granted during the three months ended September 30, 2005 and 2004, or during the nine months ended September 30, 2004. The fair value of each option granted during the nine months ended September 30, 2005 is estimated at the date of grant, with the following weighted-average assumptions: dividend yields of 2.13%; expected volatility of 40.0%; risk-free interest rate of 4.23%; and expected lives of 7 years.

     No stock options were granted after June 30, 2005 following the adoption of SFAS No. 123R. For future stock option grants, the fair value of each stock option award will be estimated using the Black-Scholes-Merton valuation model and will follow the provisions of SFAS No. 123R and SAB No. 107. The Company will use historical data and other pertinent information to estimate the expected volatility for the term of new options and the outstanding period of the option for separate groups of employees that had similar historical exercise behavior. The risk free interest rate will be based on the U.S. Treasury yield curve in effect at the time of grant.

     Prior to the adoption of SFAS No. 123R, the fair value of an option was amortized to expense in the pro forma footnote disclosure using the graded method. Upon the adoption of SFAS No. 123R, options granted prior to the date of adoption will continue to be amortized to expense using the graded method. For options granted after the date of adoption, the fair value will be amortized to expense ratably over the vesting period.

     A summary of stock option activity for the nine months ended September 30, 2005 follows (in millions, except per share data):

						Weighted- Average
						Exercise
						Price per
		Shares				Share
Outstanding at December 31, 2004			7.5			$	14.00
Granted			—			$	21.57
Exercised			(1.4	)		$	12.18
Forfeited			(0.1	)		$	15.85
Outstanding at September 30, 2005			6.0			$	14.42

     The following table summarizes information about stock options outstanding as of September 30, 2005 (in millions, except per share data and years):

Options Outstanding

Options Exercisable

Weighted-

Weighted-

Average

Weighted-

Average

Weighted-

Remaining

Average

Remaining

Average

Range of

Contractual

Exercise

Aggregate

Contractual

Exercise

Aggregate

Exercise Prices

Number

Term

Price Per

Intrinsic

Number

Life

Price Per

Intrinsic

Per Share

Outstanding

(in years)

Share

Value

Exercisable

(in years)

Share

Value

$7.28 - - $49.63

6.0

3.42

$14.42

$78.5

5.1

3.11

$14.11

$68.2

     A summary of the status of the Company’s nonvested stock options as of September 30, 2005 and changes during the nine months ended September 30, 2005 is presented below (in millions, except per share data):

						Weighted-Average
						Grant Date
		Shares				Fair Value
Nonvested stock options:
Nonvested at December 31, 2004			1.0			$	5.97
Granted			—			$	7.50
Vested			—				—
Forfeited			(0.1	)		$	5.73
Nonvested at September 30, 2005			0.9			$	5.99

     As of September 30, 2005, there was approximately $1.8 million of unrecognized compensation cost related to nonvested options. Such cost is expected to be recognized over a weighted-average period of 1.9 years. Total

compensation expense for stock options was $0.7 million for the three months ended September 30, 2005.

     The total intrinsic value of options exercised and the resulting tax deductions to realize tax benefits were as follows (in millions):

		For the								For the
		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2005				2004				2005				2004
Intrinsic Value of Options Exercised		$	7.0			$	0.4			$	14.1			$	6.4
Realized Tax Benefit from Tax Deductions		$	2.6			$	0.1			$	5.2			$	2.4

     The Company’s practice is to issue new shares of common stock to satisfy stock option exercises.

     Performance Shares

     Under the 1998 Incentive Plan, performance shares are awarded (the “Fixed Performance Awards”) to certain employees at the discretion of the Board of Directors as of the beginning of each fiscal year. Awards granted prior to 2003 vest after ten years of employment (the “Vesting Period”). Fixed Performance Awards are converted to an equal number of shares of the Company’s common stock. If pre-defined performance measures are met by the Company over a three-year period, the Vesting Period is accelerated from ten years to three years for 25% to 100% of the Fixed Performance Awards, depending on the Company’s performance. Eligible participants may also earn additional shares of the Company’s common stock. The number of additional shares can range from 0% to 100% of the awards granted, depending on the Company’s performance over a three-year period.

     Prior to the adoption of SFAS No. 123R, and in accordance with APB No. 25, compensation expense was measured based on the market price of the stock on the date of grant and recognized on a straight-line basis over the performance period. Compensation expense on the additional shares was measured by applying the market price of the Company’s stock at the end of the period to the number of additional shares that were expected to be earned. Such expense was recognized over the performance period.

     Beginning in 2003, the Company changed the vesting of Fixed Performance Awards such that the awards vest if, at the end of the performance period, at least the minimum performance level has been attained. To the extent that the award payout level attained is less than 100%, the difference between 100% and the award distributed, if any, will be forfeited. Compensation expense was measured by applying the market price of the Company’s stock at the end of the period to the number of awards expected to be earned.

     Upon the adoption of SFAS No. 123R, five of the performance share plans under the 1998 Incentive Plan were classified as liability based plans and as a result, the fair value of the outstanding shares at the end of each reporting period (under the five plans) is adjusted to the fair value of the underlying common stock and amortized to expense ratably over the vesting period until all shares are exercised, canceled or forfeited. All other performance share plans under the 1998 Incentive Plan were classified as equity based plans and the fair value of each award is the market price of the stock on the date of grant and is amortized to expense ratably over the vesting period. The stock-based compensation expense for any additional shares which may be earned is estimated on the grant date based on the market price of the stock at the date of grant. The number of shares expected to be earned will be adjusted, as necessary, to reflect the actual number of shares expected to be, and ultimately, awarded.

     The weighted-average fair value of performance share awards granted during the nine months ended September 30, 2004 was $18.57. No performance share awards were granted during the three months ended September 30, 2005 and 2004, or during the nine months ended September 30, 2005.

     A summary of the status of the Company’s nonvested performance share awards as of September 30, 2005 and changes during the nine months ended September 30, 2005 is presented below (in millions, except per share data):

						Weighted-
						Average
						Grant Date
		Shares				Fair Value
Nonvested performance share awards:
Nonvested at December 31, 2004			1.5			$	13.23
Granted			—				—
Vested			(0.6	)		$	16.23
Forfeited			(0.1	)		$	13.70
Nonvested at September 30, 2005			0.8			$	11.48

     As of September 30, 2005, there was approximately $18.4 million of total unrecognized compensation cost related to nonvested performance share awards. Such cost is expected to be recognized over a weighted-average period of 2.6 years. Total compensation expense for performance share awards was $5.1 million and $1.0 million for the three months ended September 30, 2005 and 2004, respectively, and $12.4 million and $4.7 million for the

nine months ended September 30, 2005 and 2004, respectively. The Company’s practice is to issue new shares of common stock to satisfy performance share award vestings.

     Restricted Stock Awards

     Under the 1998 Incentive Plan, restricted stock awards are issued to attract and retain key Company executives. At the end of a three-year retention period, the award will vest and be distributed to the participant provided that the participant has been an employee of the Company or one of its wholly owned subsidiaries continuously throughout the retention period. Under APB No. 25, compensation expense was measured based on the market price of the stock at date of grant and was recognized on a straight-line basis over the performance period.

     Upon the adoption of SFAS No. 123R, one of the restricted stock plans under the 1998 Incentive Plan was classified as a liability based plan and as a result, the fair value of the outstanding shares at the end of each reporting period (under this plan) is adjusted to the fair value of the underlying common stock and amortized to expense ratably over the vesting period until all shares are exercised, canceled or forfeited. All other restricted stock plans under the 1998 Incentive Plan were classified as equity based plans and the fair value of each award is the market price of the stock on the date of grant and amortized to expense ratably over the vesting period.

     The weighted-average fair value of restricted stock awards granted during the three months ended September 30, 2005 and 2004 was $25.16 and $16.86, respectively. The weighted-average fair value of restricted stock awards granted during the nine months ended September 30, 2005 and 2004 was $24.68 and $17.70, respectively.

     A summary of the status of the Company’s nonvested restricted stock awards as of September 30, 2005 and changes during the nine months ended September 30, 2005 is presented below (in millions, except per share data):

						Weighted-
						Average
						Grant Date
		Shares				Fair Value
Nonvested restricted stock awards:
Nonvested at December 31, 2004			0.8			$	17.80
Granted			0.1			$	25.06
Vested			—				—
Forfeited			(0.1	)		$	16.62
Nonvested at September 30, 2005			0.8			$	18.36

     As of September 30, 2005, there was approximately $7.6 million of total unrecognized compensation cost related to nonvested restricted stock awards. Such cost is expected to be recognized over a weighted-average period of 2.1 years. Total compensation expense for restricted stock awards was $1.0 million and $0.3 million for the three months ended September 30, 2005 and 2004, respectively, and $2.8 million and $1.2 million for the nine months ended September 30, 2005 and 2004, respectively.

     The total fair value of restricted stock awards vested and the resulting tax deductions to realize tax benefits were as follows (in millions):

		For the								For the
		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2005				2004				2005				2004
Fair Value of Restricted Stock Awards Vested		$	5.3			$	—			$	5.5			$	—
Realized Tax Benefits from Tax Deductions		$	2.0			$	—			$	2.0			$	—

     The Company’s practice is to issue new shares of common stock to satisfy restricted stock award vestings.

     Stock Appreciation Rights

     In 2003, the Company began awarding stock appreciation rights. Each recipient is given the “right” to receive a value equal to the future appreciation of the Company’s stock price. The value is paid in the Company’s stock. Stock appreciation rights vest in one-third increments beginning with the first anniversary date after the grant date.

     Prior to the adoption of SFAS No. 123R, compensation expense was measured by applying the increase in the market price of the Company’s stock at the end of the period to the number of awards.

     Upon the adoption of SFAS No. 123R, the compensation expense for awards granted prior to the adoption is the fair value on the date of grant, recognized over the vesting period. The fair value for these awards was determined using the same approach as that of the stock options granted. No stock appreciation rights were granted after June 30, 2005 following the adoption of SFAS No. 123R. For future stock appreciation right grants, the fair value of each stock appreciation right award will be estimated using the Black-Scholes-Merton valuation model and will follow the provisions of SFAS No. 123R and SAB No. 107. The Company will use historical data and other pertinent information to estimate the expected volatility for the term of the award and the outstanding period of the award for separate groups of employees that had similar historical exercise behavior. The risk free interest rate will be based on the U.S. Treasury yield curve in effect at the time of grant.

     The weighted-average fair value of stock appreciation rights granted during the nine months ended September 30, 2004 was $6.81. No stock appreciation rights were granted during the three months ended September 30, 2005 and 2004, or during the nine months ended September 30, 2005.

     Prior to the adoption of SFAS No. 123R, the fair value of a stock appreciation right was amortized to expense using the graded method. Upon the adoption of SFAS No. 123R, stock appreciation rights granted prior to the date of adoption will continue to be amortized to expense using the graded method. For stock appreciation rights granted after the date of adoption, the fair value will be amortized to expense ratably over the vesting period.

     A summary of stock appreciation rights activity for the nine months ended September 30, 2005 follows (in millions, except per share data):

						Weighted-
						Average
						Exercise Price
		Shares				per Share
Outstanding at December 31, 2004			1.0			$	16.82
Granted			—				—
Exercised			—			$	16.75
Forfeited			(0.1	)		$	16.76
Outstanding at September 30, 2005			0.9			$	16.83

     The following table summarizes information about stock appreciation rights outstanding as of September 30, 2005 (in millions, except per share data and years):

Stock Appreciation Rights Outstanding

Stock Appreciation Rights Exercisable

Weighted-

Weighted-

Average

Weighted-

Average

Weighted-

Remaining

Average

Remaining

Average

Range of

Contractual

Exercise

Aggregate

Contractual

Exercise

Aggregate

Exercise Prices

Number

Term

Price Per

Intrinsic

Number

Life

Price Per

Intrinsic

Per Share

Outstanding

(in years)

Share

Value

Exercisable

(in years)

Share

Value

$16.43 - $18.57

0.9

5.19

$16.83

$9.4

0.3

5.19

$16.83

$3.0

     A summary of the status of the Company’s nonvested stock appreciation rights as of September 30, 2005 and changes during the nine months ended September 30, 2005 is presented below (in millions, except per share data):

						Weighted-
						Average
						Grant Date
		Shares				Fair Value
Nonvested stock appreciation rights:
Nonvested at December 31, 2004			0.7			$	6.25
Granted			—				—
Vested			—				—
Forfeited			(0.1	)		$	6.23
Nonvested at September 30, 2005			0.6			$	6.25

     As of September 30, 2005, there was approximately $1.0 million of unrecognized compensation cost related to nonvested stock appreciation rights. Such cost is expected to be recognized over a weighted-average period of 1.3 years. Total compensation expense (income) for stock appreciation rights was $0.4 million and $(0.5) million for the three months ended September 30, 2005 and 2004, respectively, and $0.9 million and zero for the nine months ended September 30, 2005 and 2004, respectively. The Company’s practice is to issue new shares of common stock to satisfy stock appreciation rights exercises.

     3. Reportable Business Segments:

     The Company operates in four reportable business segments of the heating, ventilation, air conditioning and refrigeration (“HVACR”) markets: Residential Heating & Cooling, Commercial Heating & Cooling, Service Experts and Refrigeration. The Company’s management uses segment profit (loss) as the primary measure of profitability to evaluate operating performance and to allocate capital resources. The Company defines segment profit (loss) as a segment’s net earnings before other expense (income), interest expense, goodwill impairment, restructuring charge, (gains) losses and other expense, net and income taxes.

     Net sales and segment profit (loss) by business segment, along with a reconciliation of segment profit (loss) to net earnings (loss) for the three months and nine months ended September 30, 2005 and 2004 are shown below (in millions):

		For the								For the
		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2005				2004				2005				2004
Net Sales
Residential		$	464.9			$	362.1			$	1,242.3			$	1,087.0
Commercial			191.9				165.9				489.3				425.7
Heating & Cooling			656.8				528.0				1,731.6				1,512.7
Service Experts			171.8				151.3				475.5				457.8
Refrigeration			119.6				112.3				348.4				329.5
Eliminations			(20.7	)			(19.7	)			(59.9	)			(58.7	)
		$	927.5			$	771.9			$	2,495.6			$	2,241.3
Segment Profit (Loss)
Residential		$	67.0			$	44.8			$	153.9			$	132.5
Commercial			26.8				20.0				46.8				38.1
Heating & Cooling			93.8				64.8				200.7				170.6
Service Experts			7.9				(1.2	)			10.8				(3.2	)
Refrigeration			12.0				11.3				31.0				31.6
Corporate and other			(28.5	)			(26.5	)			(70.7	)			(64.3	)
Eliminations			—				0.9				—				0.1
Segment Profit			85.2				49.3				171.8				134.8
Reconciliation to income (loss) from continuing operations before income taxes:
(Gains), losses and other expense, net			0.1				—				(8.6	)			—
Restructuring charge			0.2				—				2.4				—
Goodwill impairment			—				—				—				208.3
Interest expense, net			4.3				6.1				14.4				22.5
Other expense (income)			3.5				(0.2	)			3.0				(0.7	)
		$	77.1			$	43.4			$	160.6			$	(95.3	)

     Total assets by business segment as of September 30, 2005 and December 31, 2004 are shown below (in millions):

		As of				As of
		September 30,				December 31,
		2005				2004
Total Assets
Residential		$	600.0			$	512.0
Commercial			268.7				244.0
Heating & Cooling			868.7				756.0
Service Experts			194.9				187.8
Refrigeration			317.9				323.9
Corporate and other			371.8				258.2
Eliminations			(14.3	)			(12.4	)
Segment Assets			1,739.0				1,513.5
Discontinued Operations (Note 9)			0.1				5.1
		$	1,739.1			$	1,518.6

4. Inventories:

     Components of inventories are as follows (in millions):

		As of				As of
		September 30,				December 31,
		2005				2004
Finished goods		$	182.7			$	174.1
Repair parts			38.3				38.5
Work in process			9.8				9.2
Raw materials			80.6				71.4
			311.4				293.2
Excess of current cost over last-in, first-out cost			(57.4	)			(46.0	)
		$	254.0			$	247.2

     LIFO (last in, first out) inventory liquidations did not have a material impact on gross margins during the three months and nine months ended September 30, 2005 and 2004.

5. Shipping and Handling:

     Shipping and handling costs related to post-production activities are included as part of Selling, General and Administrative Expense in the accompanying Consolidated Statements of Operations in the following amounts (in millions):

	For the								For the
	Three Months Ended								Nine Months Ended
	September 30,								September 30,
	2005		2004						2005				2004
	$42.6		$	35.4					$	115.2			$	104.2

6. Warranties:

     The changes in the carrying amount of the Company’s total warranty liabilities for the nine months ended September 30, 2005 are as follows (in millions):

Total warranty liability at December 31, 2004		$	71.0
Payments made in 2005			(20.7	)
Changes resulting from issuance of new warranties			21.4
Changes in estimates associated with pre-existing warranties			3.9
Total warranty liability at September 30, 2005		$	75.6

     The change in warranty liability that resulted from changes in estimates of warranties issued prior to 2005 was primarily due to revaluing warranty reserves based on higher material input costs and increased labor allowances on the Company’s CompleteHeat® product line, which was discontinued in the second quarter of 2004.

7. Cash, Lines of Credit and Financing Arrangements:

     The Company has bank lines of credit aggregating $431.8 million, of which $2.5 million was borrowed and outstanding and $91.8 million was committed to standby letters of credit at September 30, 2005. Of the remaining $337.5 million, the entire amount was available for future borrowings after consideration of covenant limitations. Included in the lines of credit are several regional facilities and a multi-currency facility governed by agreements between the Company and a syndicate of banks. In July 2005, the Company amended and restated its revolving credit facility to, among other things, increase the borrowing capacity from $225 million to $400 million and extend the maturity date from September 2006 to July 2010. The facility contains certain financial covenants and bears interest at a rate equal to, at the Company’s option, either (a) the greater of the bank’s prime rate or the federal funds rate plus 0.5%, or (b) the London Interbank Offered Rate plus a margin equal to 0.475% to 1.20%, depending upon the ratio of total funded debt-to-adjusted earnings before interest, taxes, depreciation and amortization (“Adjusted EBITDA”), as defined in the facility. The Company pays a facility fee, depending upon the ratio of total funded debt to Adjusted EBITDA, equal to 0.15% to 0.30% of the capacity. The facility includes restrictive covenants that limit the Company’s ability to incur additional indebtedness, encumber its assets, sell its assets and make certain payments, including amounts for share repurchases and dividends. The Company’s facility and promissory notes are secured by the stock of the Company’s major subsidiaries. The facility requires that LII annually and quarterly

deliver financial statements, as well as compliance certificates, to the banks within specified time periods. LII believes that cash flow from operations, as well as available borrowings under its revolving credit facility, will be sufficient to fund its operations for the foreseeable future.

     The Company has included in Cash and Cash Equivalents in the accompanying unaudited Consolidated Balance Sheet as of September 30, 2005, $32.4 million of restricted cash primarily related to routine lockbox collections and letters of credit issued with respect to the operations of its captive insurance subsidiary, which expire on December 30, 2005.

     On September 7, 2005, the Company called for redemption all of its outstanding 6.25% convertible subordinated notes due 2009 (“Convertible Notes”) on October 7, 2005. The redemption price was 103.571% of the principal amount. As of September 7, 2005, there was $143.75 million aggregate principal amount of Convertible Notes outstanding, which could be converted into the Company’s common stock at a rate of 55.2868 shares of common stock per $1,000 principal amount of Convertible Notes at any time before the close of business on the business day prior to the redemption date. As of September 30, 2005, holders of approximately $40.7 million in Convertible Notes converted them into approximately 2.2 million shares of common stock. As of October 6, 2005, all of the holders of the Convertible Notes had converted the Convertible Notes into an aggregate of approximately 7.9 million shares of common stock. As a result, the $103.05 million in Convertible Notes outstanding as of September 30, 2005 is included in Current Maturities of Long-Term Debt in the accompanying unaudited Consolidated Balance Sheet as of September 30, 2005.

8. Accounts and Notes Receivable:

     Accounts and Notes Receivable are shown in the accompanying Consolidated Balance Sheets, net of allowance for doubtful accounts of $19.9 million and $18.5 million as of September 30, 2005 and December 31, 2004, respectively. In addition, approximately $307.5 million of accounts receivable, as reported in the accompanying unaudited Consolidated Balance Sheet as of September 30, 2005, represent retained interests in securitized receivables that have restricted disposition rights per the terms of the asset securitization agreement and may not be available to satisfy obligations to creditors. The Company has no significant concentration of credit risk within its accounts and notes receivable.

9. Divestitures:

     Outokumpu Joint Venture Sale

     On June 7, 2005, the Company completed the sale of its 45% interest in its heat transfer joint venture to Outokumpu Copper Products OY of Finland (Outokumpu) for $39.3 million and the Company recorded a pre-tax gain of $9.3 million which is included in (Gains), Losses and Other Expenses, Net in the accompanying Consolidated Statements of Operations. In connection with the sale, the Company entered into an agreement with Outokumpu related to joint remediation of certain existing environmental matters. In conjunction with the new agreement, the Company updated its estimate of its portion of the on-going remediation costs and recorded expenses of $2.2 million for the nine months ended September 30, 2005.

     Service Experts

     In the first fiscal quarter of 2004, the Company’s Board of Directors approved a turnaround plan designed to improve the performance of its Service Experts business segment. The plan realigns Service Experts’ dealer service centers to focus on service and replacement opportunities in the residential and light commercial markets. The Company identified approximately 130 centers, whose primary business is residential and light commercial service and replacement, to comprise the ongoing Service Experts business segment. As of December 31, 2004, the Company had divested the remaining 48 centers. The operating results of the 48 centers that are no longer a part of Service Experts are classified as a Discontinued Operation in the accompanying Consolidated Statements of Operations. The related assets and liabilities for these centers are classified as Assets Held for Sale and Liabilities Held For Sale in the accompanying Consolidated Balance Sheets.

     A summary of net trade sales, pre-tax operating results and pre-tax loss on disposal of assets for the three months and nine months ended September 30, 2005 and 2004, and the major classes of assets and liabilities presented as held for sale at September 30, 2005 and December 31, 2004, are detailed below (in millions):

		Discontinued								Discontinued
		Operations for the								Operations for the
		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2005				2004				2005				2004
Net trade sales		$	—			$	51.0			$	0.2			$	191.0
Pre-tax loss operating results		$	(0.1	)		$	(6.5	)		$	(1.9	)		$	(29.6	)
Pre-tax loss on disposal of centers		$	—			$	(4.7	)		$	(0.1	)		$	(5.3	)

		September 30, 2005				December 31, 2004
Current assets		$	0.1			$	5.1
Non-current assets			—				—
Total assets		$	0.1			$	5.1
Current liabilities		$	1.1			$	3.7

     The following table details the Company’s pre-tax loss from discontinued operations for the three months and nine months ended September 30, 2005 and 2004, and the cumulative amount incurred through September 30, 2005 (in millions):

										Cumulative
		Three Months				Three Months				Incurred
		Ended				Ended				through
		September 30,				September 30,				September 30,
		2005				2004				2005
Goodwill impairment		$	—			$	—			$	14.8
Impairment of property, plant and equipment			—				—				3.1
Operating loss			—				4.7				14.9
Other divestiture costs			0.1				1.8				8.0
Subtotal			0.1				6.5				40.8
Loss on disposal of centers			—				4.7				15.0
Total loss from discontinued operations		$	0.1			$	11.2			$	55.8

		Nine Months				Nine Months
		Ended				Ended
		September 30,				September 30,
		2005				2004
Goodwill impairment		$	—			$	13.3
Impairment of property, plant and equipment			—				3.1
Operating loss			—				10.2
Other divestiture costs			1.9				3.0
Subtotal			1.9				29.6
Loss on disposal of centers			0.1				5.3
Total loss from discontinued operations		$	2.0			$	34.9

     The income tax benefit on discontinued operations was $0.1 million and $2.0 million for the three months ended September 30, 2005 and September 30, 2004, respectively. The income tax benefit on discontinued operations was $0.7 million and $6.8 million for the nine months ended September 30, 2005 and 2004, respectively. The income tax benefit on discontinued operations for the nine months ended September 30, 2004 of $6.8 million includes a $1.5 million tax benefit related to goodwill impairment. Through September 30, 2005, proceeds from the sale of these centers totaled $25.9 million.

10. Earnings per Share:

     Basic earnings per share are computed by dividing net income by the weighted-average number of common shares outstanding during the period. Diluted earnings per share are computed by dividing net income, adjusted for the interest expense and amortization of deferred financing costs associated with the Company’s Convertible Notes, by the sum of the weighted-average number of shares and the number of equivalent shares assumed outstanding, if dilutive, under the Company’s stock-based compensation plans and Convertible Notes. Emerging Issues Task Force Issue 04-8, “The Effect of Contingently Convertible Debt on Diluted Earnings per Share” requires that contingently convertible debt securities with a market price trigger be included in diluted earnings per share, if they are dilutive,

regardless of whether the market price trigger has been met. As of September 30, 2005, the number of shares attributable to Convertible Notes was 5,699,890. As of September 30, 2005, the Company had 65,129,525 shares outstanding and 3,183,631 shares held as treasury shares. Diluted earnings per share are computed as follows (in millions, except per share data):

		For the								For the
		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2005				2004				2005				2004
Net income (loss)		$	48.8			$	18.9			$	100.0			$	(141.4	)
Add: after-tax interest expense and amortization of deferred financing costs on Convertible Notes			1.5				1.6				4.6				—
Net income (loss) as adjusted		$	50.3			$	20.5			$	104.6			$	(141.4	)
Weighted-average shares outstanding			62.9				60.1				62.1				59.9
Effect of diluted securities attributable to stock options and performance share awards			3.7				2.3				3.2				—
Effect of diluted securities attributable to Convertible Notes			7.6				7.9				7.8				—
Weighted-average shares outstanding, as adjusted			74.2				70.3				73.1				59.9
Diluted earnings (loss) per share		$	0.68			$	0.29			$	1.43			$	(2.36	)

     Additionally, options to purchase 140,959 shares of common stock at prices ranging from $24.90 to $49.63 per share and 1,266,959 shares of common stock at prices ranging from $17.00 to $49.63 per share were outstanding for the periods ended September 30, 2005 and 2004, respectively, but were not included in the diluted earnings per share calculation because the assumed exercise of such options would have been anti-dilutive. Similarly, for the nine months ended September 30, 2004, all potentially dilutive securities, including 7,947,478 shares attributable to Convertible Notes, were excluded because their effects were anti-dilutive for that period.

11. Comprehensive Income (Loss):

     Comprehensive income (loss) is computed as follows (in millions):

		For the								For the
		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2005				2004				2005				2004
Net income (loss)		$	48.8			$	18.9			$	100.0			$	(141.4	)
Foreign currency translation adjustments			17.6				9.9				(4.2	)			0.1
Cash flow hedges			6.1				2.1				2.4				1.7
Minimum pension liability			(0.2	)			(0.5	)			1.1				(0.3	)
Unrealized gain on investments			—				(0.6	)			—				(1.9	)
Total comprehensive income (loss)		$	72.3			$	29.8			$	99.3			$	(141.8	)

12. Goodwill:

     The Company evaluates the impairment of goodwill under the guidance of Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets” (“SFAS No. 142”) for each of its reporting units. As a result of the annual impairment tests required by SFAS No. 142, the Company recorded an impairment charge in the first quarter of 2004 associated with its Service Experts segment. This impairment charge reflected the segment’s performance below management’s expectations and management’s decision to divest of 48 centers that no longer matched the realigned Service Experts business model. See Note 9 — Divestitures. The impairment test requires a two-step process. The first step compares the fair value of the units with goodwill against their aggregate carrying values, including goodwill. The Company estimated the fair value of its Service Experts segment using the income method of valuation, which includes the use of estimated discounted cash flows. Based on the comparison, the carrying value of Service Experts exceeded its fair value. Accordingly, the Company performed the second step of the test, comparing the implied fair value of Service Experts goodwill with the carrying amount of that goodwill. Based on this assessment, the Company recorded a non-cash impairment charge of $208.3 million ($185.1 million, net of tax), which is included as a component of operating income in the accompanying Consolidated Statements of Operations. The Company also recognized a $13.3 million ($11.8 million, net of tax) goodwill impairment charge arising from goodwill allocated to centers held for sale. This amount is included as a part of loss from discontinued operations in the accompanying Consolidated Statements of Operations. During the first quarter of 2005, the Company performed its annual goodwill impairment test and determined that no further impairment charge was required.

     The changes in the carrying amount of goodwill related to continuing operations for the nine months ended September 30, 2005, in total and by segment, are as follows (in millions):

		Balance												Balance
		December 31,				Goodwill				Foreign Currency				September 30,
Segment		2004				Impairment				Translation & Other				2005
Residential		$	26.1			$	—			$	—			$	26.1
Commercial			30.7				—				(2.2	)			28.5
Heating & Cooling			56.8				—				(2.2	)			54.6
Service Experts			95.7				—				2.6				98.3
Refrigeration			72.9				—				(0.2	)			72.7
Total		$	225.4			$	—			$	0.2			$	225.6

13. Pension and Postretirement Benefit Plan:

     Effective December 31, 2003, the Company adopted Statement of Financial Accounting Standards No. 132 (revised 2003), “Employers’ Disclosures about Pensions and Other Postretirement Benefits.” This standard requires the disclosure of the components of net periodic benefit cost recognized during interim periods. The 2005 pension benefit information provided in the table below includes the Company’s foreign operations; however, the 2004 information does not include the periodic pension benefit costs for the foreign operations of $1.2 million for the 2004 fiscal year.

Three months ended September 30		Pension Benefits								Other Benefits
(in millions)		2005				2004				2005				2004
Service cost		$	1.8			$	1.7			$	0.3			$	0.3
Interest cost			3.6				3.1				0.4				0.5
Expected return on plan assets			(3.7	)			(3.5	)			—				—
Amortization of prior service cost			0.2				0.2				(0.1	)			(0.1	)
Amortization of net loss			0.9				0.5				0.2				0.2
Net periodic benefit cost		$	2.8			$	2.0			$	0.8			$	0.9

Nine months ended September 30		Pension Benefits								Other Benefits
(in millions)		2005				2004				2005				2004
Service cost		$	5.3			$	4.7			$	0.9			$	0.8
Interest cost			10.2				9.1				1.2				1.3
Expected return on plan assets			(10.5	)			(10.1	)			—				—
Amortization of prior service cost			0.8				0.8				(0.4	)			(0.3	)
Amortization of net loss			2.5				1.7				0.8				0.6
Net periodic benefit cost		$	8.3			$	6.2			$	2.5			$	2.4

     In the third quarter of 2005, the Company made $5.5 million in contributions to its pension plans, which included $4.8 million of voluntary pension contributions. The total contributions made in 2005 to the pension plans through the third quarter of 2005 were $7.0 million. As of September 30, 2005, the Company expects fourth quarter 2005 minimum contributions to its pension plans to be $0.7 million. The Company will continue to evaluate additional voluntary pension contributions through the end of 2005.

     In December 2003, the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (“the Act”) was signed into law. The Act introduces a prescription drug benefit under Medicare (Medicare Part D) as well as a federal subsidy to sponsors of retiree health care benefit plans that provide a benefit that is at least actuarially equivalent to Medicare Part D. In January 2004, Financial Accounting Standards Board Staff Position No. FAS 106-1, “Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003” (“SFAS No. 106”) was issued which permits a sponsor of a postretirement health care plan that provides a prescription drug benefit to make a one-time election to defer accounting for the effects of the Act. The Company has elected not to reflect the changes in the Act as the effects of the Act are not a significant event that calls for remeasurement under SFAS No. 106. Therefore, the accumulated postretirement benefit obligation and net postretirement benefit costs in the accompanying consolidated financial statements and above disclosure do not reflect the effects of the Act on the Company’s plans.

14. Investments in Affiliates:

     For its investments in joint ventures, the Company records its equity in the earnings of the joint ventures as a component of Selling, General and Administrative Expense in the accompanying Consolidated Statements of Operations. The Company recorded $11.9 million and $9.0 million of equity in earnings of its affiliates for the nine months ended September 30, 2005 and 2004, respectively.

     The Company owns a 20% common stock ownership interest in Kulthorn Kirby Public Company Limited, a Thailand company engaged in the manufacture of compressors for refrigeration applications. The Company previously accounted for its investment in Kulthorn Kirby Public Company Limited as a marketable equity security investment. In October 2004, the Company purchased an additional 1.3% common stock interest for $1.5 million. The Company has adjusted prior years’ information to reflect the change to equity accounting. The change increased earnings of affiliates by $0.1 million and $1.4 million for the three months and the nine months ended September 30, 2004, respectively.

     The carrying amount of investments in affiliates as of September 30, 2005 and December 31, 2004 was $44.6 million and $63.0 million, respectively, and is included in long-term Other Assets in the accompanying Consolidated Balance Sheets. The decrease in the investment in affiliates from December 31, 2004 to September 30, 2005 was primarily due to the sale of the Company’s 45% interest in its heat transfer joint venture to Outokumpu Copper Products OY of Finland. See Note 9 - Divestitures.

15. Contingencies:

     The Company is involved in various claims and lawsuits incidental to its business. In addition, the Company and its subsidiary Heatcraft Inc. have been named in four lawsuits in connection with its former heat transfer operations. The lawsuits allege personal injury resulting from alleged emissions of trichloroethylene, dichloroethylene and vinyl chloride and other unspecified emissions from the South Plant in Grenada, Mississippi, previously owned by Heatcraft Inc. It is not possible to predict with certainty the outcome of these matters. Based on present knowledge, management believes that it is unlikely that resolution of these matters will result in a material liability for the Company; however, the Company anticipates the future legal fees in defense of these matters could be significant. As of September 30, 2005, no accrual had been made for these matters.

16. Lennox Hearth Products — Burlington Plant Closure:

     Due to competitive cost pressures, on April 4, 2005, Lennox Hearth Products Inc., a subsidiary of the Company, commenced plans to relocate its Whitfield pellet stove and Lennox cast iron product lines from Burlington, Washington to a third party production facility in Juarez, Mexico, discontinue its existing steel wood stove line manufactured in Burlington, and close the Burlington facility. These actions were substantially complete as of September 30, 2005. In connection with the plant closure, the Company recorded pre-tax restructuring-related charges of $0.2 million and $2.4 million for the three months and nine months ended September 30, 2005, respectively, which are included in Restructuring Charge in the accompanying Consolidated Statements of Operations. As of September 30, 2005, the Company had $1.1 million in restructuring reserves related to the Burlington plant closure, which are included in Accrued Expenses in the accompanying unaudited Consolidated Balance Sheet as of September 30, 2005. The Company expects that these actions will reduce costs and enhance profitability.

17. Stock Repurchase Program:

     On September 19, 2005, LII announced its Board of Directors had authorized a stock repurchase program, pursuant to which the Company may repurchase up to ten million shares of its common stock and had terminated a prior repurchase program that was announced November 2, 1999. Purchases under the stock repurchase program will be made on an open-market basis at prevailing market prices. The timing of any repurchases will depend on market conditions, the market price of LII’s common stock and management’s assessment of the Company’s liquidity needs and investment requirements and opportunities. No time limit was set for completion of the program and there is no guarantee as to the exact number of shares that will be repurchased. Because the Company had not released earnings for the third quarter of 2005, LII had not initiated any repurchases of its common stock as of September 30, 2005.

18. Subsequent Event:

     As discussed in Note 7 – Cash, Lines of Credit and Financing Arrangements, on September 7, 2005, the Company called for redemption all of its Convertible Notes on October 7, 2005. The redemption price was 103.571% of the principal amount. As of September 7, 2005, there was $143.75 million aggregate principal amount of Convertible Notes outstanding, which could be converted into the Company’s common stock at a rate of 55.2868 shares of common stock per $1,000 principal amount of Convertible Notes at any time before the close of business on the business day prior to the redemption date. As of September 30, 2005, holders of approximately $40.7 million in Convertible Notes converted them into approximately 2.2 million shares of common stock. As of October 6,

2005, all of the holders of the Convertible Notes had converted the Convertible Notes into an aggregate of approximately 7.9 million shares of common stock. As a result, the $103.05 million in Convertible Notes outstanding as of September 30, 2005 is included in Current Maturities of Long-Term Debt in the accompanying unaudited Consolidated Balance Sheet as of September 30, 2005.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Overview

     Lennox International Inc. (“LII” or the “Company”) participates in four reportable business segments of the heating, ventilation, air conditioning and refrigeration (“HVACR”) industry. The first reportable segment is Residential Heating & Cooling, in which LII manufactures and markets a full line of heating, air conditioning and hearth products for the residential replacement and new construction markets in the United States and Canada. The second reportable segment is Commercial Heating & Cooling, in which LII manufactures and sells primarily rooftop products and related equipment for light commercial applications in the United States and primarily rooftop products, chillers and air handlers in Europe. Combined, the Residential Heating & Cooling and Commercial Heating & Cooling segments form LII’s Heating & Cooling business. The third reportable segment is Service Experts, which includes sales and installation of, and maintenance and repair services for, HVAC equipment. The fourth reportable segment is Refrigeration, in which LII manufactures and sells unit coolers, condensing units and other commercial refrigeration products.

     Improving the performance of the Service Experts business segment remains a top priority of LII’s management. In the first fiscal quarter of 2004, LII’s Board of Directors approved a turnaround plan designed to improve the performance of its Service Experts business segment. The plan realigns Service Experts’ dealer service centers to focus on service and replacement opportunities in the residential and light commercial markets. LII identified approximately 130 centers, whose primary business is residential and light commercial service and replacement, to comprise the ongoing Service Experts business segment. As of December 31, 2004, LII had divested the remaining 48 centers. The operating results of the 48 centers that are no longer a part of Service Experts are classified as a Discontinued Operation. See “Results of Operations – Three Months Ended September 30, 2005 Compared to Three Months Ended September 30, 2004 – Loss from Discontinued Operations” and “ – Nine Months Ended September 30, 2005 Compared to Nine Months Ended September 30, 2004 – Loss from Discontinued Operations” for more detail regarding Service Experts’ discontinued operations.

     Initiatives within the Service Experts business segment in 2005 include increasing focus on revenue generating activities and continuing to strengthen the leadership at Service Experts through its general manager development program. This general manager development program graduated its first class in the latter part of 2004 and its second class during the first quarter of 2005. These general managers have assumed leadership positions at dealer service centers. A third class commenced during the third quarter of 2005 and will graduate during the fourth quarter of 2005.

     During the first quarter of 2004, LII evaluated the impairment of goodwill under the guidance of Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets” (“SFAS No. 142”), and determined that the carrying value of Service Experts’ goodwill exceeded its fair value. As a result, LII recorded a pre-tax, non-cash charge of $208.3 million for the nine months ended September 30, 2004 in the Company’s Service Experts business segment. The impairment charge was driven primarily by lower than expected operating results as well as the turnaround plan discussed above. The tax benefit of this charge was $23.2 million. The $208.3 million pre-tax goodwill impairment charge is included in LII’s Loss from Continuing Operations for the nine months ended September 30, 2004, in the accompanying Consolidated Statements of Operations. Subsequent to the recognition of the $208.3 million goodwill impairment under SFAS No. 142 and as part of the realignment of service centers discussed above, LII also recognized $13.3 million in pre-tax goodwill impairment included in its $29.6 million pre-tax loss on discontinued operations under Statement of Financial Accounting Standards No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” (“SFAS No. 144”), resulting in a total pre-tax goodwill impairment charge of $221.6 million for the nine months ended September 30, 2004. During the first quarter of 2005, LII performed its annual goodwill impairment test and determined that no further goodwill impairment was necessary.

     Due to competitive cost pressures, on April 4, 2005, Lennox Hearth Products Inc., a subsidiary of the Company, commenced plans to relocate its Whitfield pellet stove and Lennox cast iron stove product lines from Burlington, Washington to a third party production facility in Juarez, Mexico, discontinue its existing steel wood stove line manufactured in Burlington and close the Burlington facility. Although these actions were substantially complete as of September 30, 2005, the Company anticipates additional expenses during the fourth quarter of 2005, which are not expected to be material. In connection with the plant closure, the Company recorded pre-tax restructuring-related charges of $2.4 million for the nine months ended September 30, 2005, which are included in Restructuring Charge in the accompanying Consolidated Statements of Operations. The tax benefit of this charge was $0.8 million.

     On June 7, 2005, the Company completed the previously announced sale of its 45% interest in its heat transfer joint venture to Outokumpu Copper Products OY of Finland (Outokumpu) for $39.3 million and the Company recorded a pre-tax gain of $9.3 million for the nine months ended September 30, 2005, which is included in (Gains), Losses and Other Expenses, Net in the accompanying Consolidated Statements of Operations. The income tax provision on this gain was $2.3 million. In connection with the sale, the Company entered into an agreement with Outokumpu related to joint remediation of certain existing environmental matters. In conjunction with the new agreement, the Company updated its estimate of its portion of the on-going remediation costs and recorded pre-tax expenses of $2.2 million for the nine months ended September 30, 2005. The income tax benefit of the remediation expenses was $0.8 million.

     On September 7, 2005, the Company called for redemption all of its outstanding 6.25% convertible subordinated notes due 2009 (“Convertible Notes”) on October 7, 2005. The redemption price was 103.571% of the principal amount, plus accrued and unpaid interest to the redemption date. As of September 7, 2005, there was $143.75 million aggregate principal amount of Convertible Notes outstanding, which could be converted into the Company’s common stock at a rate of 55.2868 shares of common stock per $1,000 principal amount of Convertible Notes at anytime before the close of business on the business day prior to the redemption date. As of September 30, 2005, holders of approximately $40.7 million in Convertible Notes converted them into approximately 2.2 million shares of common stock. As of October 6, 2005, all of the holders of the Convertible Notes had converted the Convertible Notes into an aggregate of approximately 7.9 million shares of common stock.

     On September 19, 2005, LII announced its Board of Directors had authorized a stock repurchase program, pursuant to which the Company may repurchase up to ten million shares of its common stock and had terminated a prior repurchase program that was announced November 2, 1999. Purchases under the stock repurchase program will be made on an open-market basis at prevailing market prices. The timing of any repurchases will depend on market conditions, the market price of LII’s common stock and management’s assessment of the company’s liquidity needs and investment requirements and opportunities. No time limit was set for completion of the program and there is no guarantee as to the exact number of shares that will be repurchased. Because the Company had not released earnings for the third quarter of 2005, LII had not initiated any repurchases of its common stock as of September 30, 2005.

     On October 6, 2005, Lennox Industries Inc. (“Industries”), a subsidiary of the Company, announced that it ratified a collective bargaining agreement with The International Union United Automobile, Aerospace and Agricultural Implement Workers of America (“UAW”) Local 893, Unit 11 with respect to Industries’ Marshalltown, Iowa manufacturing facility. The previous collective bargaining agreement between Industries and the UAW expired by its terms on October 31, 2004. Although the agreement expired, the employees at the Marshalltown facility continued to work under its terms. Industries’ Marshalltown facility is a major manufacturer of residential air conditioning and heating equipment.

     As permitted by the standard, LII adopted Statement of Financial Accounting Standards No. 123 (revised 2004), “Share-Based Payment” (“SFAS No. 123R”) early, using the modified-prospective-transition method as of July 1, 2005. The cumulative effect of the change in accounting principle related to the adoption of SFAS No. 123R was after-tax income of $0.2 million for the nine months ended September 30, 2005. Under the standard, companies are required to recognize compensation cost for share-based compensation issued to or purchased by employees, net of estimated forfeitures, under stock-based compensation plans using a fair-value-based method effective not later than January 1, 2006. For more information, see Note 2 — Stock-Based Compensation in the Notes to Consolidated Financial Statements.

     On April 2, 2004 the Department of Energy announced that it will enforce a 13 seasonal energy efficiency rating or “SEER” standard for residential central air conditioners. This standard, which will apply to central air conditioners manufactured after January 23, 2006, increases by 30 percent the minimum SEER standard that applies to models produced currently. Although this new standard creates several engineering, manufacturing and marketing challenges for the Company, the Company anticipates it will meet the new regulation by January 23, 2006. Air-conditioning products with ratings lower than 13 SEER manufactured prior to January 23, 2006 can continue to be sold legally after such date. It is possible that quantities of lower than 13 SEER product may remain in the distribution pipeline after January 23, 2006 and this may have an adverse effect on operating results during the 2006 cooling season. However, management is unable to predict the extent to which this may occur. The Company is also using the new standard as an opportunity to redesign its entire line of cooling products to standardize product platforms across its brands and to integrate other improvements in its products. For the nine months ended September 30, 2005, expenditures for property, plant and equipment (“Capital Spending”) of $42.0 million were driven in part by expenditures in connection with this redesign effort. The Company expects additional Capital Spending related to this redesign effort to occur in the fourth quarter of 2005 and/or early in 2006. The Company doesn’t expect any delays in Capital Spending to threaten the Company’s ability to meet the January 23, 2006 deadline. Capital Spending in 2005 is dependent upon the actual timing mentioned above and is estimated to be less than $80 million.

     LII’s customers include distributors, installing dealers, property owners, national accounts and original equipment manufacturers. LII recognizes sales revenue when products are shipped or when services are rendered. The demand for LII’s products and services is influenced by national and regional economic and demographic factors, such as interest rates, the availability of financing, regional population and employment trends, new construction, general economic conditions and consumer confidence. In addition to economic cycles, demand for LII’s products and services is seasonal and dependent on the weather. Hotter than normal summers generate strong demand for replacement air conditioning, refrigeration products and services and colder than normal winters have the same effect on heating products and services. Conversely, cooler than normal summers and warmer than normal winters depress HVACR sales and services.

     The principal components of cost of goods sold in LII’s manufacturing operations are component costs, raw materials, factory overhead, labor and estimated costs of warranty expense. In LII’s Service Experts segment, the principal components of cost of goods sold are equipment, parts and supplies and labor. The principal raw materials used in LII’s manufacturing processes are steel, copper and aluminum. Higher prices for these commodities and related components continue to present a challenge to LII. Commodity prices and related component costs in LII’s manufacturing businesses increased by approximately $54 million for the nine months ended September 30, 2005 compared to the same period in 2004. LII is mitigating the impact of higher commodity prices in 2005 through a combination of price increases, hedging programs, improved production efficiency and cost reduction initiatives. Warranty expense is estimated based on historical trends and other factors.

     LII’s fiscal year ends on December 31 and its interim fiscal quarters are each comprised of 13 weeks. For convenience, throughout this Management’s Discussion and Analysis of Financial Condition and Results of Operations, the 13-week periods comprising each fiscal quarter are denoted by the last day of the calendar quarter.

Results of Operations

     The following table sets forth, as a percentage of net sales, LII’s statements of operations data for the three months and nine months ended September 30, 2005 and 2004:

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2005				2004				2005				2004
Net sales			100.0	%			100.0	%			100.0	%			100.0	%
Cost of goods sold			66.0				66.5				66.7				66.1
Gross profit			34.0				33.5				33.3				33.9
Selling, general and administrative expense			24.8				27.1				26.4				27.9
(Gains), losses and other expenses, net			—				—				(0.3	)			—
Restructuring charge			—				—				0.1				—
Goodwill impairment			—				—				—				9.3
Operational income (loss) from continuing operations			9.2				6.4				7.1				(3.3	)
Interest expense, net			0.5				0.8				0.6				1.0
Other expense			0.4				—				0.1				—
Income (loss) from continuing operations before income taxes and cumulative effect of accounting change			8.3				5.6				6.4				(4.3	)
Provision for income taxes			3.0				2.0				2.3				0.8
Income (loss) from continuing operations before cumulative effect of accounting change			5.3				3.6				4.1				(5.1	)
Cumulative effect of accounting change, net			—				—				—				—
Income (loss) from continuing operations			5.3				3.6				4.1				(5.1	)
Discontinued operations:
Loss from operations of discontinued operations			—				0.8				0.1				1.3
Income tax benefit			—				(0.2	)			—				(0.3	)
Loss on disposal of discontinued operations			—				0.6				—				0.2
Income tax benefit			—				—				—				—
Loss from discontinued operations			—				1.2				0.1				1.2
Net income (loss)			5.3	%			2.4	%			4.0	%			(6.3	)%