2140 Lake Park Blvd.
Richardson, Texas 75080

 

April 17, 2007

 

Dear Stockholders:

 

It is my pleasure to invite you to the 2007 Annual Meeting of Stockholders of Lennox International Inc. The meeting will be held at 9:00 a.m., local time, on Thursday, May 17, 2007, at the University of Texas at Dallas School of Management, southeast corner of Drive A and University Parkway, Richardson, Texas 75083.

 

The accompanying Notice of Annual Meeting of Stockholders and Proxy Statement describe the items of business that will be discussed and voted upon during the meeting. It is important that you vote your shares whether or not you plan to attend the meeting. To be sure your vote is counted, we urge you to carefully review the Proxy Statement and to vote your choices as soon as possible. You have a choice of voting over the Internet, by telephone or by returning the enclosed Proxy Card by mail. You may also vote in person at the meeting. Please refer to the instructions in the enclosed materials. If you attend the meeting and wish to vote in person, the ballot you submit at the meeting will supersede your proxy.

 

I look forward to seeing you at the Annual Meeting of Stockholders. On behalf of management and our Board of Directors, I want to thank you for your continued support and confidence in 2007.

 

Sincerely,

 

Richard L. Thompson

Chairman of the Board

2140 Lake Park Blvd.
Richardson, Texas 75080

 

April 17, 2007

 

 

Notice of Annual Meeting of Stockholders

 

To Be Held On May 17, 2007

 

 

To Our Stockholders:

 

Notice is hereby given that the 2007 Annual Meeting of Stockholders of Lennox International Inc. will be held on Thursday, May 17, 2007 at 9:00 a.m., local time, at the University of Texas at Dallas School of Management, southeast corner of Drive A and University Parkway, Richardson, Texas 75083 to:

 

 

A Proxy Statement, Proxy Card, Annual Report to Stockholders and Annual Report on Form 10-K for the fiscal year ended December 31, 2006 accompany this Notice.

 

The Board of Directors has determined that our stockholders of record at the close of business on March 26, 2007 are entitled to notice of, and to vote at, the Annual Meeting of Stockholders.

 

By Order of the Board of Directors,

 

William F. Stoll, Jr.

Corporate Secretary

 

Your Vote is Important

 

 

 

 

PROXY STATEMENT

 

TABLE OF CONTENTS

 

 

Meeting Date and Location

 

The 2007 Annual Meeting of Stockholders will be held on May 17, 2007 at 9:00 a.m., local time, at the University of Texas at Dallas School of Management, southeast corner of Drive A and University Parkway, Richardson, Texas 75083. We began mailing this Proxy Statement and the accompanying Notice of Annual Meeting of Stockholders, Proxy Card, Annual Report to Stockholders and Annual Report on Form 10-K to our stockholders on or about April 17, 2007 for the purpose of soliciting proxies on behalf of our Board of Directors.

 

Meeting Agenda

 

At the meeting, you will be asked to elect five Class III directors to hold office for a three-year term expiring at the 2010 Annual Meeting of Stockholders, approve the issuance of shares of our common stock pursuant to an Agreement and Plan of Reorganization with A.O.C. Corporation and to transact any other business that is properly brought before the meeting.

 

Record Versus Beneficial Ownership of Shares

 

If your shares are registered directly in your name with our transfer agent, Mellon Investor Services LLC, you are considered, with respect to those shares, the “stockholder of record.” If you are a stockholder of record, we sent our Notice of Annual Meeting of Stockholders, Proxy Statement, Proxy Card, Annual Report to Stockholders and Annual Report on Form 10-K directly to you.

 

If your shares are held in a stock brokerage account or by a bank or other holder of record, you are considered the “beneficial owner” of shares held in street name. In that case, our Notice of Annual Meeting of Stockholders, Proxy Statement, Proxy Card, Annual Report to Stockholders and Annual Report on Form 10-K have been forwarded to you by your broker, bank or other holder of record who is considered, with respect to those shares, the stockholder of record. Your broker, bank or other holder of record will also send you instructions on how to vote. If you have not heard from your broker, bank or other holder of record who holds your stock, please contact them as soon as possible.

 

Record Date and Number of Votes

 

The record date for the 2007 Annual Meeting of Stockholders is March 26, 2007. If you were a stockholder of record at the close of business on March 26, 2007, you may vote at the meeting. At the close of business on the record date, there were 68,255,616 shares of our common stock outstanding and entitled to vote and approximately 792 stockholders of record. Each stockholder is entitled to one vote per share.

 

Quorum and Vote Required

 

A quorum is required to transact business at the meeting. To achieve a quorum at the meeting, stockholders holding a majority of our outstanding shares entitled to vote must be present either in person or represented by proxy. Shares held by us in treasury will not count towards a quorum. However, abstentions and “broker non-votes” will be counted as present and entitled to vote for purposes of determining a quorum. A “broker non-vote” occurs when a bank, broker or other holder of record holding shares for a beneficial owner does not vote on a particular proposal because that holder does not have discretionary voting power for that particular item and has not received instructions from the beneficial owner. In the event a quorum is not present at the meeting, we expect the meeting will be adjourned or postponed to solicit additional proxies.

 

To be elected, nominees for director must receive a plurality of the votes cast. This means that the director nominees with the most votes are elected, regardless of whether any nominee received a majority of votes cast. An affirmative vote of the majority of the votes cast (provided that the total votes cast in respect of the proposal represent more than 50% of all of our outstanding common stock entitled to vote thereon) is

required for approval of the issuance of shares of our common stock pursuant to an Agreement and Plan of Reorganization with A.O.C. Corporation. Any other matters submitted to you at the meeting will be decided by a majority of the votes cast.

 

If you are a beneficial owner, your bank, broker or other holder of record has discretionary authority to vote your shares on the election of directors even if the bank, broker or other holder of record does not receive voting instructions from you. However, your bank, broker or other holder of record does not have authority to vote your shares to approve the issuance of shares of our common stock pursuant to an Agreement and Plan of Reorganization with A.O.C. Corporation without written instructions from you. Neither abstentions nor broker non-votes will be counted as votes cast “for” or “against” any of the proposals.

 

A representative of our transfer agent will tabulate the votes and act as inspector of election at the meeting.

 

Voting Procedures

 

To be sure your shares are represented at the Annual Meeting of Stockholders, please vote as soon as possible by using one of the following methods:

 

 

If you are the beneficial owner of shares held in a stock brokerage account or by a bank or other holder of record, you will not be able to vote by calling the phone number or accessing the Internet address provided above. The availability of telephone and Internet voting for beneficial owners will depend on the voting procedures of your broker, bank or other holder of record. These procedures differ from the procedures provided by our transfer agent for stockholders of record. Therefore, you should check the information forwarded to you by your broker, bank or other holder of record to find out which voting options are available to you.

 

If you vote by telephone or Internet and your proxy is not revoked, your shares will be voted in accordance with your voting instructions and you do not need to return your Proxy Card.

 

 

Changing Your Vote

 

You can change your vote on a proposal at any time before the meeting for any reason by revoking your proxy. Proxies may be revoked by filing a written notice of revocation, which includes a later date than the proxy date, with our Corporate Secretary at or before the meeting. Proxies may also be revoked by:

 

 

 

In each case, the later submitted vote will be recorded and the earlier vote revoked. Any written notice of a revocation of a proxy should be sent to Lennox International Inc., 2140 Lake Park Blvd., Richardson, Texas 75080, Attention: Corporate Secretary. To be effective, the revocation must be received by our Corporate Secretary before the taking of the vote at the Annual Meeting of Stockholders.

 

Other Business; Adjournments

 

We are not aware of any other business to be acted upon at the 2007 Annual Meeting of Stockholders. If, however, other matters are properly brought before the meeting, or any reconvened meeting after any adjournment or postponement thereof, the persons named in the accompanying Proxy Card will have discretion to act on those matters according to their best judgment. In the absence of a quorum, stockholders representing a majority of the votes present in person or by proxy at the meeting may adjourn the meeting.

 

Our Board of Directors currently consists of 13 members, with two vacancies. In accordance with our Bylaws, the Board is divided into three classes, with each class serving a three-year term. On July 21, 2006, John W. Norris, Jr., our former Chairman of the Board, retired from the Board. Upon Mr. Norris’ retirement, Richard L. Thompson, who previously served as Vice Chairman of the Board, succeeded Mr. Norris as Chairman. The Board has determined not to fill the position of Vice Chairman at this time. In September 2006, Robert E. Schjerven advised our company of his intention to retire from his duties as Chief Executive Officer by mid-2007. On March 19, 2007, Mr. Schjerven announced his retirement from his position as Chief Executive Officer and as a member of our Board of Directors effective April 2, 2007. We wish to express our sincere appreciation to Mr. Schjerven for his unyielding commitment to our company for over twenty years and his countless contributions to our success.

 

Upon the recommendation of the Board Governance Committee, the Board has nominated five Class III directors for re-election to our Board of Directors to hold office for a three-year term expiring at the 2010 Annual Meeting of Stockholders. Among the nominees is Todd M. Bluedorn, Mr. Schjerven’s successor as Chief Executive Officer. All other Class I and Class II directors will continue in office, in accordance with their previous election, until the expiration of the terms of their classes at the 2008 or 2009 Annual Meeting of Stockholders.

 

Biographical information for each nominee for Class III director and for each current director in the classes continuing in office is provided below.

 

If you do not wish your shares to be voted for any particular nominee, you may withhold your vote for that particular nominee. If any nominee for Class III director becomes unavailable, the persons named in the accompanying Proxy Card may vote for any alternate designated by the incumbent Board of Directors, upon the recommendation of the Board Governance Committee, or the number of directors constituting the Board may be reduced. Despite the current vacancies on the Board, you may not vote for a greater number of directors than the number nominated.

The Board has nominated the following individuals for election as Class III directors for a three-year term expiring at the 2010 Annual Meeting of Stockholders:

 

 

THE BOARD OF DIRECTORS RECOMMENDS A VOTE “FOR”
EACH OF THE ABOVE NOMINEES.

The following Class I directors’ terms will continue until the 2008 Annual Meeting of Stockholders:

 

 

The following Class II directors’ terms will continue until the 2009 Annual Meeting of Stockholders:

 

 

The following family relationships exist among certain members of our Board of Directors:

 

 

The Proposal and Background of the Transaction

 

We are seeking stockholder approval for a proposal to issue up to 2,239,589 shares of our common stock pursuant to an Agreement and Plan of Reorganization, dated March 16, 2007 (the “Reorganization Agreement”), between our company and A.O.C. Corporation (“AOC”), a copy of which is attached as Exhibit A to this Proxy Statement. We will issue these shares in exchange for 2,695,770 shares of our common stock owned by AOC, which will result in a reduction in the number of outstanding shares of our common stock by up to 456,181 shares at minimal cost to us. Consummation of the transaction is subject to the satisfaction of certain conditions, including obtaining approval by the holders of our common stock of the issuance of up to 2,239,589 shares of our common stock as described in more detail below.

 

AOC is the legal successor to the Armstrong Ohio Corporation, which was in the business of manufacturing furnaces and other heating appliances. In the late 1950s, Armstrong Ohio Corporation sold its assets and invested the cash proceeds in marketable securities. Through the years, AOC sold the marketable securities and used the proceeds to purchase the then privately held shares of our common stock from the AOC stockholders and our management when such persons desired to sell shares of our common stock for cash. AOC’s assets consist solely of 2,695,770 shares of our common stock and cash. AOC would like to collapse its structure so that its assets are owned directly by its shareholders.

 

In order to achieve this objective, Thomas W. Booth, the President of AOC and a director of our company and Vice President of Operations of Services of Service Experts Inc., one of our subsidiaries, submitted a proposal, by letter dated August 22, 2005, to Robert E. Schjerven, our Chief Executive Officer at that time. The August 22 letter proposed to undertake a restructuring of AOC (the “AOC Restructuring”), whereby AOC would transfer 2,695,770 shares of our common stock in exchange for 2,395,770 shares of our common stock. Following this transfer, AOC would liquidate and distribute the shares of our common stock to its shareholders. AOC’s proposal stated that this transaction is intended to qualify as a tax-free reorganization under Section 368(a)(1)(C) of the Internal Revenue Code of 1986, as amended, which means that no gain or loss would be recognized by the AOC shareholders when they receive shares of our common stock upon liquidation of AOC. The proposal also provided that consummation of the AOC Restructuring would be contingent upon obtaining a private letter ruling from the Internal Revenue Service that the transaction would qualify as a tax-free reorganization.

 

On September 16, 2005, Linda G. Alvarado, James J. Byrne, Janet K. Cooper, C.L. (Jerry) Henry, John E. Major, Walden W. O’Dell, Paul W. Schmidt, Terry D. Stinson and Richard L. Thompson, the disinterested members of our Board of Directors at that time, met with Mr. Schjerven, Susan K. Carter, our Chief Financial Officer, and William F. Stoll, Jr., our Chief Legal Officer, to review the proposal from AOC. The disinterested directors discussed the proposal and asked management to research certain issues and report their findings to Mr. Thompson. On October 10, 2005, Mr. Stoll met with Mr. Thompson by telephone to report management’s findings. Subsequent to that meeting, it was decided not to pursue the AOC Restructuring at that time for reasons primarily related to corporate priorities and not the merits of the transaction. On October 12, 2005, Mr. Stoll transmitted a letter to Mr. Booth, which advised AOC that we did not believe it to be in our best interests to entertain AOC’s proposal at that time.

 

On October 23, 2006, Mr. Booth submitted to Mr. Schjerven a second proposal for the AOC Restructuring that was substantially identical to the prior proposal submitted on August 22, 2005. Management of our company discussed the transaction with Mr. Thompson who authorized the commencement of preliminary discussions with AOC and the transmittal of a response to AOC. On November 17, 2006, on behalf of our disinterested directors, Mr. Stoll delivered a letter to Mr. Booth in which he stated that the consideration that AOC proposed to be paid by us in the AOC Restructuring (2,395,770 shares of our common stock) was excessive in light of the efforts required by us and the benefits to be received by AOC. Mr. Stoll’s letter proposed instead that we pay 2,223,770 shares of our common stock in the AOC Restructuring and that, in order to make the transaction “costless” to us, that AOC reimburse us for all of our out-of-pocket expenses related to the transaction. In addition, Mr. Stoll proposed that (1) as a requirement to the consummation of the AOC Restructuring, the private letter ruling from the Internal Revenue Service anticipated to be received by AOC be satisfactory to us and (2) the shares of our common stock be issued pursuant to an exemption from registration under the Securities Act of 1933.

 

On November 30, 2006, Mr. Booth responded to our proposal and suggested that we pay 2,295,770 shares of our common stock in the AOC Restructuring and that AOC would reimburse our expenses, subject to a cap. In addition, Mr. Booth’s November 30 proposal stated that if we were unwilling to register the shares of our common stock issued to AOC, then the number of shares it was willing to receive as consideration was subject to change to take into account an appropriate discount for restricted securities.

 

On December 6, 2006, Mr. Schjerven, Ms. Carter and Mr. Stoll reviewed the status of the AOC discussions with the Audit Committee of the Board of Directors (which was comprised of Mr. Henry, Ms. Cooper, Mr. Major and Mr. Schmidt at that time) and Mr. Thompson. The Audit Committee authorized

management to proceed with negotiations with AOC within certain parameters. Following the Audit Committee meeting, Mr. Stoll contacted Mr. Booth and suggested a meeting to discuss the transaction.

 

On December 13, 2006, Mr. Stoll, David Dorsett, our Vice President, Tax, and representatives from Baker Botts L.L.P., counsel to our company, met with Mr. Booth and representatives from Thompson & Knight LLP, counsel to AOC, to discuss the AOC Restructuring. Mr. Stoll again stated that the disinterested members of our Board of Directors desired to share equally the benefits of the AOC Restructuring, and the parties discussed the benefits and costs of each party to the transaction. Mr. Booth and Mr. Stoll again met on January 12, 2007 and Mr. Booth proposed that we pay 2,270,534 shares of our common stock in the AOC Restructuring. As a result of such conversations, on January 25, 2007, Mr. Stoll proposed that we pay consideration of 2,239,589 shares of our common stock in the AOC Restructuring and that AOC reimburse us for all of our expenses related to such transaction up to a maximum of $250,000, regardless of whether the transaction is consummated. Mr. Stoll also proposed that the shares of our common stock would be issued in a transaction exempt from the registration requirements of the Securities Act of 1933. Mr. Booth later advised Mr. Stoll that the proposal had been accepted by AOC’s board of directors. On February 2, 2007, AOC provided us with a draft of the Reorganization Agreement and the terms of such agreement were negotiated by our representatives and representatives of AOC over the next several weeks.

 

On February 20, 2007, Mr. Stoll met with the Audit Committee of our Board of Directors (comprised of Mr. Schmidt, Ms. Cooper, Mr. Henry and Mr. Major) and updated them on the status of discussions with AOC. The Audit Committee approved the AOC Restructuring on the terms described above and resolved to recommend the AOC Restructuring to our Board of Directors. On February 26, 2007, our Board of Directors met with management and discussed and reviewed the terms of the AOC Restructuring (Steven R. Booth, Thomas W. Booth, John W. Norris, III and Jeffrey D. Storey, M.D. did not participate in the meeting because of their interest in the transaction as discussed below under ‘‘—Interests of Certain Persons in the Transaction”). The disinterested directors approved the AOC Restructuring on the terms described above, authorized management to negotiate and enter into the Reorganization Agreement and directed that the issuance of up to 2,239,589 shares of our common stock in exchange for the 2,695,770 shares of our common stock owned by AOC be submitted to our stockholders for approval. On March 16, 2007, the Reorganization Agreement was executed by our company and AOC.

 

Reasons for the Transaction

 

The disinterested directors of our Board of Directors believe that it is in the best interests of our company and our stockholders to approve the issuance of up to 2,239,589 shares of our common stock in exchange for the 2,695,770 shares of our common stock owned by AOC. The disinterested directors considered a number of factors, including those set forth below, in reaching its decision to approve the transaction and to recommend its approval to our stockholders:

 

 

The Reorganization Agreement

 

On March 16, 2007, we entered into the Reorganization Agreement with AOC, which provides that we will issue 2,239,589 shares of our common stock (subject to reduction if cash is delivered in lieu of fractional shares) in exchange for 2,695,770 shares of our common stock owned by AOC. AOC’s assets consist solely of

cash and the 2,695,770 shares of our common stock. As soon as practicable following the exchange of our common stock, AOC will distribute the newly acquired shares of our common stock pro-rata to its shareholders. The liquidation and distribution will be structured so that the issuance of shares of our common stock will be exempt from registration under the Securities Act of 1933.

 

Pursuant to the Reorganization Agreement, each of our company and AOC has made various customary representations, warranties and covenants. Among other things, AOC has agreed to (1) reimburse us for all out-of-pocket expenses reasonably incurred by us up to $250,000, (2) take all commercially reasonable actions to hold a special meeting of AOC shareholders for approval of the transfer to us of the 2,695,770 shares of our common stock owned by AOC and the subsequent dissolution of AOC, and (3) recommend (subject to AOC’s board of directors’ fiduciary obligations to its shareholders) the approval of such transaction to the AOC shareholders. Among other things, we have agreed to (1) submit a proposal to our stockholders to approve the issuance of up to 2,239,589 shares of our common stock and to recommend (subject to our Board of Directors’ fiduciary obligations to our stockholders) the approval of such issuance, (2) prepare a private placement memorandum for the purpose of satisfying an exemption from registration of the issuance of up to 2,239,589 shares of our common stock and (3) submit an application to the New York Stock Exchange for the listing of the shares to be issued by us under the Reorganization Agreement. Our company and AOC have both agreed to treat the reorganization as a reorganization within the meaning of Section 368(a) of the Internal Revenue Code and to file all tax returns consistently with such treatment.

 

Consummation of the transaction is subject to the satisfaction of certain conditions, including (1) receipt of a private letter ruling from the Internal Revenue Service that the transaction would qualify as a tax-free reorganization, (2) approval for listing on the New York Stock Exchange of the shares of our common stock to be issued in the AOC Restructuring, (3) approval by the holders of at least two-thirds of the outstanding AOC stock entitled to vote thereon, (4) approval by a majority of the votes cast by our stockholders (provided that the total votes cast in respect of the proposal represent more than 50% of all of our outstanding common stock entitled to vote thereon) and (5) execution of a registration rights agreement that would provide certain piggy back registration rights to the AOC shareholders.

 

The Reorganization Agreement may be terminated and the transaction abandoned at any time prior to closing (a) by the mutual written consent of AOC and our company, (b) by AOC following any breach by us of any of our representations and warranties or covenants that is not cured within five days, (d) by us following any breach by AOC of any of its representations and warranties or covenants that is not cured within five days, (e) by either party if either the AOC shareholders or our stockholders do not approve the transaction or (f) by either party if the transaction has not been consummated by September 30, 2007.

 

Interests of Certain Persons in the Transaction

 

In considering the Board’s recommendation to approve the issuance of up to 2,239,589 shares of our common stock pursuant to the Reorganization Agreement, you should be aware that certain of our directors have certain interests with respect to the AOC Restructuring that are different from, or in addition to, the interests of our public stockholders. Our Board was aware of these interests and considered them, among other matters, in approving the issuance of shares of our common stock pursuant to the Reorganization Agreement and in recommending that our stockholders approve the same. Based on the closing price of our common stock on the New York Stock Exchange on March 26, 2007, the 2,239,589 shares of our common stock to be issued pursuant to the Reorganization Agreement are valued at approximately $83,245,523.

 

The table below lists each of such interested directors, together with any immediate family member of such director who has a similar interest (we refer to such individuals herein as the Related Persons), the basis for which such individual is a Related Person, such individual’s percentage ownership in AOC, the approximate number of shares of our common stock to be received by such individual pursuant to the Reorganization Agreement and the approximate dollar value of such shares.

 

 

 

 

There are no special benefits provided for any of the Related Persons under the Reorganization Agreement. Each Related Person’s participation in the AOC Restructuring arises out of his or her ownership of common stock of AOC and will be on the same basis as all other shareholders of AOC.

 

Reasons for Seeking Stockholder Approval

 

We are seeking stockholder approval of the issuance of shares to AOC pursuant to the Reorganization Agreement as required by paragraph 312.03(b) of the New York Stock Exchange Listed Company Manual (the “NYSE Manual”) because the issuance would result in the issuance of shares of common stock greater than one percent of our outstanding shares of common stock to AOC, an entity in which certain of our directors have a direct interest.

 

Pursuant to Section 312.03 of the NYSE Manual, an affirmative vote of the majority of the votes cast (provided that the total votes cast in respect of the proposal represent more than 50% of all of our outstanding common stock entitled to vote thereon) is required for approval of this proposal. As of February 1, 2007, Thomas W. Booth, Stephen R. Booth, John W. Norris, III and Jeffrey D. Storey, M.D., each a member of our

Board of Directors, collectively owned approximately 9% of our outstanding shares of common stock. Each of them has indicated that they currently intend to vote their shares of common stock in favor of the proposal.

 

Financial and Other Information

 

In connection with this proposal, we hereby incorporate by reference the financial statements and the notes thereto contained in our Annual Report on Form 10-K for the fiscal year ended December 31, 2006, which includes our Management’s Discussion and Analysis of Financial Condition and Results of Operations and our Quantitative and Qualitative Disclosures about Market Risk. A copy of our Annual Report on Form 10-K accompanies this Proxy Statement and is available on our website at www.lennoxinternational.com by following the links “Financials—SEC Filings.” Stockholders may also receive a free copy of all information incorporated by reference into this Proxy Statement by sending a written request to 2140 Lake Park Blvd., Richardson, Texas 75080, Attention: Investor Relations, or calling (972) 497-5000. For more information about us, please see our other reports filed with the Securities and Exchange Commission, copies of which can be found on our website at www.lennoxinternational.com or at www.sec.gov.

 

THE BOARD OF DIRECTORS RECOMMENDS A VOTE “FOR” THE APPROVAL OF THE ISSUANCE OF SHARES OF COMMON STOCK PURSUANT TO THE REORGANIZATION AGREEMENT.

 

Director Independence

 

Our Corporate Governance Guidelines require a majority of our directors to be “independent.” Pursuant to New York Stock Exchange listing standards, our Board of Directors has adopted a formal definition of “independent” for the purpose of determining whether a particular director or nominee meets the independence standards of our company and the New York Stock Exchange. In accordance with this definition, a director must be determined to have no personal, professional, familial or other relationship with our company other than as a director. The definition specifies the criteria by which the independence of our directors will be determined, including strict guidelines for directors and their immediate families with respect to past employment or affiliation with our company or our independent registered public accountants. The definition also prohibits directors from receiving any compensation from our company other than in his or her capacity as a director and from participating in any interlocking directorship where an executive officer of our company serves on the compensation committee of another company that concurrently employs the director. The full text of our definition of an independent director can be found on our website at www.lennoxinternational.com by following the links “About Us—Corporate Governance—Definition of Independent Director.”

 

Applying these standards and the independence standards of the New York Stock Exchange, the Board has determined that the following directors are independent: Linda G. Alvarado, James J. Byrne, Janet K. Cooper, C. L. (Jerry) Henry, John E. Major, Paul W. Schmidt, Terry D. Stinson and Richard L. Thompson.

 

A majority of our Board of Directors is independent, which helps ensure good corporate governance and strong internal controls. We believe we are in compliance with the corporate governance requirements of the New York Stock Exchange, the Securities and Exchange Commission and the Sarbanes-Oxley Act of 2002.

 

Board of Directors and Board Committees

 

The Board of Directors met eight times in 2006. All directors attended in excess of 75% of the total number of meetings of the Board and committees of the Board on which they served, except David V. Brown who attended 50% of the total number of meetings of the Board and committees of the Board on which he served prior to his retirement on April 20, 2006. The Board of Directors does not currently have a policy with regard to attendance of Board members at the Annual Meeting of Stockholders. Four directors attended our 2006 Annual Meeting of Stockholders.

 

The standing committees of the Board are as follows: Audit, Board Governance, Compensation and Human Resources, Acquisition, Pension and Risk Management and Public Policy. The Board has adopted charters for each of these committees which are available on our website at www.lennoxinternational.com by following the links “About Us—Corporate Governance—Committee Charters.” Stockholders may also receive a free copy of these documents by sending a written request to 2140 Lake Park Blvd., Richardson, Texas 75080, Attention: Investor Relations, or calling (972) 497-5000.

 

Audit Committee.  The Audit Committee, currently composed of Mr. Schmidt, Chairperson, Ms. Cooper, Mr. Henry and Mr. Major, met 15 times in 2006. The Audit Committee assists the Board in fulfilling its oversight responsibilities relating to the integrity of our financial statements and related systems of internal control, our compliance with legal and regulatory requirements, the independent registered public accounting firm’s qualifications, independence and performance and the performance of our internal audit function. The Audit Committee also has the direct responsibility for the appointment, compensation, retention and oversight of our independent registered public accountants. Each Audit Committee member is independent as independence for audit committee members is defined by the New York Stock Exchange and satisfies the New York Stock Exchange’s financial literacy requirements. The Board of Directors has determined that Mr. Schmidt, Chairperson of the Audit Committee, is an audit committee financial expert as defined by the Securities and Exchange Commission.

 

Board Governance Committee.  The Board Governance Committee, currently composed of Mr. Stinson, Chairperson, Mr. Henry and Mr. Schmidt, met five times in 2006. Each member of the Board Governance Committee is independent as independence for nominating committee members is defined by the New York Stock Exchange. The Board Governance Committee assists the Board by identifying individuals qualified to become Board members, developing and periodically reviewing the criteria for Board membership, making recommendations to the Board regarding the appropriate size of the Board and appointment of members to the Board’s committees and developing and recommending to the Board the Corporate Governance Guidelines and codes of conduct applicable to our company.

 

Compensation and Human Resources Committee.  The Compensation and Human Resources Committee, currently composed of Mr. Byrne, Chairperson, Ms. Alvarado, Mr. Major and Mr. Stinson, met four times in 2006. Each member of the Compensation and Human Resources Committee is independent as independence for compensation committee members is defined by the New York Stock Exchange. The Compensation and Human Resources Committee assists the Board in the discharge of its responsibilities relating to our compensation and benefits programs, oversight of our incentive plans, compensation of our directors, executive officers and other key employees and the development of executive succession and development plans.

 

The Compensation and Human Resources Committee approves all decisions relating to the compensation of our executive officers. In accordance with its charter, the committee reports to the full Board of Directors on a regular basis and seeks Board approval for certain actions. The committee forms and delegates authority to subcommittees when appropriate. For example, in 2006, the committee formed a subcommittee to assist in identifying candidates to succeed Mr. Schjerven as Chief Executive Officer of our company upon his retirement. Our Chief Executive Officer and, in some cases, other executive officers, make recommendations to the Compensation and Human Resources Committee with respect to various elements of executive and non-employee director compensation. In addition, our Chief Administrative Officer, who acts as management’s liaison to the committee, and our human resources department support the committee in the execution of its duties. Pursuant to its charter, the committee is authorized to obtain advice and assistance from internal or external legal, accounting or other advisors and to retain third-party compensation consultants. To that end, the committee has engaged Mercer Human Resource Consulting LLC as its executive compensation consultant to provide objective analysis, advice and recommendations in connection with the committee’s decision-making process. See “Executive Compensation—Compensation Discussion and Analysis” for further information regarding executive compensation decisions.

 

Acquisition Committee.  The Acquisition Committee, currently composed of Mr. Major, Chairperson, Mr. T. Booth, Mr. Byrne and Mr. Stinson, met five times in 2006. The Acquisition Committee is responsible

for evaluating and making recommendations to the Board of Directors regarding potential acquisitions and divestitures.

 

Pension and Risk Management Committee.  The Pension and Risk Management Committee, currently composed of Mr. S. Booth, Chairperson, Mr. T. Booth, Ms. Cooper, Mr. Norris, Mr. Schmidt and Dr. Storey met three times in 2006. The Pension and Risk Management Committee is responsible for overseeing the administration of our pension and profit sharing plans, overseeing matters relating to our insurance coverage, reviewing legal liability matters, environmental issues and other matters relating to safety and risk management.

 

Public Policy Committee.  The Public Policy Committee, currently composed of Mr. Norris, Chairperson, Ms. Alvarado, Mr. S. Booth, Mr. Byrne and Dr. Storey, met once in 2006. The Public Policy Committee is responsible for developing educational programs for new and continuing directors and overseeing our position on corporate social responsibilities and public issues of significance that affect our stockholders.

 

Director Nominee Criteria and Nomination Process

 

The Board of Directors is responsible for approving candidates for Board membership. The Board has delegated the screening and recruitment process to the Board Governance Committee. In this capacity, the Board Governance Committee develops and periodically reviews the criteria for Board membership, identifies new director candidates and makes recommendations to the Board regarding the appropriate size of the Board and appointment of members to the Board’s committees. Qualifications required of individuals for consideration for Board membership will vary according to the particular areas of expertise being sought as a compliment to the existing Board composition at the time of any vacancy. Appropriate criteria for Board membership include:

 

 

The Board Governance Committee typically retains a third-party search firm to assist in identifying and evaluating potential new director candidates.

 

When a vacancy occurs on the Board, the Board Governance Committee recommends to the Board a nominee to fill the vacancy. The Board Governance Committee also evaluates and recommends to the Board nominees for election to our Board of Directors at our Annual Meeting of Stockholders.

 

Stockholder Nominations for Director

 

The Board Governance Committee considers nominees for election to the Board of Directors recommended by stockholders. A stockholder wishing to nominate a candidate for election to the Board at a meeting of the stockholders is required to give written notice to our Corporate Secretary of his or her intention to make a nomination. We must receive the notice of nomination at least 60 days but no more than 90 days prior to the

Annual Meeting of Stockholders, or if we give less than 70 days notice of the Annual Meeting of Stockholders date, the notice of nomination must be received within 10 days following the date on which notice of the date of the Annual Meeting of Stockholders was mailed or such public disclosure was made to our stockholders. In the case of a special meeting of stockholders for the election of directors, we must receive the notice of nomination within 10 days following the date on which notice of such meeting is first given to stockholders. Pursuant to our Bylaws, the notice of nomination is required to contain certain information about both the nominee and the stockholder making the nomination, including information sufficient to allow the Board Governance Committee to determine if the candidate meets our criteria for Board membership. The Board Governance Committee may require that the proposed nominee furnish additional information in order to determine that person’s eligibility to serve as a director. A nomination that does not comply with the above procedure will be disregarded. Stockholder nominees whose nominations comply with the foregoing procedure and who meet the criteria described above under the heading “Director Nominee Criteria and Nomination Process” and in our Corporate Governance Guidelines, will be evaluated by the Board Governance Committee in the same manner as the Board Governance Committee’s nominees.

 

Stockholder Communications with Directors

 

Stockholders may send written communications to the Board by:

 

 

Communications addressed to the Board will be received by our Investor Relations department and reviewed by the Corporate Secretary. The Corporate Secretary will:

 

 

Interested parties may communicate with non-management directors of the Board by sending written communications to the addresses listed above to the attention of the Chairman of the Board.

 

Other Corporate Governance Policies

 

Code of Conduct and Code of Ethical Conduct.  We have adopted a Code of Conduct that applies to all of our directors, executive officers and employees. We have also adopted a Code of Ethical Conduct applicable to our senior financial and principal executive officers. Amendments to and waivers, if any, from our Codes of Conduct and Ethical Conduct will be disclosed on our website. Our Codes of Conduct and Ethical Conduct are available on our website at www.lennoxinternational.com by following the links “About Us—Corporate Governance—Code of Conduct and—Code of Conduct for Senior Financial Officers.” Stockholders may also receive a free copy of these documents by sending a written request to 2140 Lake Park Blvd., Richardson, Texas 75080, Attention: Investor Relations, or calling (972) 497-5000.

 

Corporate Governance Guidelines.  We have adopted Corporate Governance Guidelines that are available on our website at www.lennoxinternational.com by following the links “About Us—Corporate Governance—Corporate Governance Guidelines.” Stockholders may request a free copy of our Corporate Governance Guidelines from our Investor Relations department at the address and phone number set forth above under “Code of Conduct and Code of Ethical Conduct.”

 

Executive Session Meetings.  In accordance with our Corporate Governance Guidelines, the non-management members of our Board of Directors meet regularly in executive session without the presence of management. The Chairman of the Board chairs the executive session meetings of our non-management directors.

 

Committee Authority to Retain Independent Advisors.  Each of the Audit, Compensation and Human Resources and Board Governance Committees has the authority to retain independent advisors and consultants, with all fees and expenses to be paid by our company.

 

Whistleblower Procedures.  The Audit Committee has established procedures for the handling of complaints regarding accounting, internal accounting controls or auditing matters, including procedures for confidential and anonymous submission by our employees of concerns regarding such matters.

 

Disclosure Committee.  We have established a Disclosure Committee composed of members of management to assist us in fulfilling our obligations to maintain disclosure controls and procedures and to coordinate and oversee the process of preparing the reports we file or submit to the Securities and Exchange Commission under the Securities Exchange Act of 1934.

 

No Executive Loans.  We do not extend loans to executive officers or directors and have no such loans outstanding.

 

Overview of Executive Compensation Program

 

Executive compensation is administered by the Compensation and Human Resources Committee of the Board of Directors (the “Committee”). The Committee reviews, approves, and modifies, as appropriate, our executive compensation and benefits philosophies, objectives and programs to ensure competitive, fair and consistent administration of such programs for our executive officers and other employees. The specific duties of the Committee are set forth in its charter, which was adopted by the Board of Directors.

 

The persons who served as our Chief Executive Officer and Chief Financial Officer during 2006, as well as the other individuals named in the Summary Compensation Table, are referred to as the “named executive officers” throughout this Proxy Statement. The named executive officers include Robert J. McDonough, the former Executive Vice President and President and Chief Operating Officer of our Worldwide Heating & Cooling business. When discussing information relating to the compensation of the named executive officers for fiscal 2007, such discussion does not include Mr. McDonough.

 

Oversight of Executive Compensation Program and Role of Executive Officers in Compensation Decisions

 

While the Committee approves all aspects of our executive compensation program, it reports to the full Board of Directors on a regular basis and, in accordance with the Committee’s charter, seeks approval for certain actions. The Committee coordinates with management to obtain marketplace and internal data analyses, project reports and program recommendations to assist the Committee in making executive compensation decisions. As discussed throughout this Compensation Discussion and Analysis, our Chief Executive Officer and, in some cases, other executive officers, make recommendations to the Committee with respect to various elements of executive compensation. In addition, our Chief Administrative Officer, who acts as management’s liaison to the Committee, periodically reviews our compensation philosophy and program design with our Chief Executive Officer, Chief Financial Officer and other executives throughout the year, and makes recommendations to the Committee based on such review.

 

Compensation Philosophy and Key Objectives

 

We believe our ability to execute our business strategy and achieve desired results is dependent on our employees demonstrating the behaviors needed to achieve our goals. To that end, we maintain a pay-for-performance compensation philosophy designed to attract, motivate, and retain highly talented employees by paying market-competitive base salaries, while also delivering market-competitive short-term variable pay and long-term equity incentive opportunities that are directly linked to the achievement of specific company performance measurements. Where financial results exceed performance targets, monetary rewards will reflect this performance. Where financial results are below performance targets, pay levels will reflect the below-target performance results. Individual performance is not measured in our annual short-term variable pay or long- term equity incentive programs, as we have determined to focus these annual programs on objective company performance results instead of subjective assessments of individual performance. However, individual performance, measured by achievement of individual performance objectives that may include items such as contribution toward business unit growth, implementation of business strategies or delivery of strategic business programs, is considered for base salary administration, promotional opportunities, special cash or stock awards and succession planning.

 

The strategic objectives of our executive compensation program include:

 

 

For 2006 and 2007, the Committee administered base salary for the named executive officers and other executive officers competitive with the 50^th percentile of base salaries paid in the marketplace. The Committee administered short-term variable pay and long-term equity incentive awards for the same periods competitive with the 65^th percentile of the marketplace. Total compensation mix for the named executive officers puts the greatest emphasis on long-term equity incentive compensation to support our pay-for-performance philosophy and to align the compensation levels delivered to the executive with the interests of our stockholders. While the Committee has not established a policy for allocating between cash (short-term compensation) and non-cash equity compensation (long-term compensation), the Committee has historically, and in 2006, granted a majority of total compensation to the named executive officers in the form of long-term equity incentive awards, with over 60% of the Chief Executive Officer’s compensation targeted to be paid in long-term equity incentive awards and over 50% of the other named executive officers’ compensation targeted to be paid in long-term equity. Cash compensation is generally divided between base salary and short-term variable pay awards, each targeted to align with market-competitive practices for the executive officers’ positions. In 2006, the Chief Executive Officer’s base salary and short-term variable pay target opportunity each represented approximately 50% of his total cash compensation. With slight variations, the other named executive officers’ base salary and short-term variable pay target opportunity represented approximately 60% and 40%, respectively, of total cash compensation for 2006. The Committee has approved a similar compensation mix for 2007, which allows us to continue to reward and retain executive talent while focusing their attention on our long-term future.

 

Making Executive Compensation Decisions

 

When determining executive compensation policies and programs and making decisions regarding compensation design and salary administration, the Committee, with management’s input, considers competitive marketplace practices, our business objectives and relative performance, stockholder interests, legislative and government requirements and other relevant factors. While the Committee reviews the total compensation paid to our executive officers in previous years, it does not consider the value realized from prior equity awards or an executive’s current stock holdings when making executive compensation decisions. The Committee has engaged Mercer Human Resource Consulting LLC (“Mercer”), an internationally recognized human resources consulting firm, as its executive compensation consultant to provide objective analysis, advice and recommendations in connection with the Committee’s decision-making process.

 

The Committee assesses and designs each element of compensation for market-competitiveness, in accordance with its belief that keeping each element market-competitive ensures that the overall compensation program is competitive. In doing so, the Committee evaluates the market-competitiveness of our executive compensation program annually at its September meeting by reviewing either an in-depth market study of each compensation element prepared by Mercer or Mercer’s analysis regarding general market trends. The Committee uses the information provided by Mercer to determine the appropriate level and mix of each compensation element and then, each year at its regularly scheduled December meeting, grants long-term equity incentive awards to the named executive officers and other executive officers and determines the executives’ base salary and certain elements of the short-term variable pay programs for the following year.

 

In August 2005, and in preparation for 2006 salary administration, the Committee commissioned Mercer to conduct an in-depth market study of base salary, short-term variable pay programs and long-term equity incentive programs for each executive position. The study included general industry data as well as compensation data from a group of nineteen peer companies that had been selected by management and approved by the Committee based on the following similarities:

 

 

The peer group was comprised of the following companies:

 

 

The Committee reviewed base salaries that were actually paid and targeted payout opportunities for short-term and long-term incentives in the marketplace. The 2005 market data was aged to January 1, 2006, the beginning of our 2006 performance period, using an annual market salary increase factor, and regression analysis techniques were applied to adjust the data for differences in company revenue.

 

The study confirmed that our base salary levels were competitive with the 50^th percentile in the marketplace, and our short-term variable pay target opportunities and targeted long-term equity incentive levels for executives were competitive with the 65^th percentile in the marketplace, in accordance with our targeted positioning. The study also confirmed that our long-term equity incentive vehicles were consistent with the market’s trend toward shifting away from stock options and toward restricted stock awards. Based on Mercer’s in-depth market study, the Committee reviewed the compensation elements of each named executive officer and other executive officers in relationship to the market data, assessed each individual’s performance relative to previously established objectives, considered the internal value we place on each executive position and made subjective determinations regarding each individual’s contributions before adjusting any of the executives’ compensation elements for 2006.

 

In 2006, the Committee engaged Mercer to report on general market trends in executive compensation instead of providing an in-depth market study. After reviewing the market trends and applying the same considerations described above, the Committee determined adjustments for the named executive officers’ and other executive officers’ compensation for 2007.

 

Components of 2006 Executive Compensation

 

In 2006, our executive compensation program included the following elements:

 

 

Base Salary

 

Base Salary for the named executive officers and other executive officers is administered within a broadband salary range to provide flexibility to reward executive development, support succession planning and aid in executive recruiting. The Committee considers market-competitive salary data, achievement of previously established performance objectives and the internal value we place on each executive position and makes subjective determinations regarding the executive’s contributions to determine each executive officer’s

base salary. Based on Mercer’s market data and the other factors listed above, in December 2005, the Committee increased the named executive officers’ base salaries by an amount ranging from 4.5% to 10% for 2006. In December 2006, the Committee increased the named executive officers’ base salaries by an amount ranging from 4.0% to 5.0% for 2007. However, as a result of Mr. Schjerven’s pending retirement, his base salary was not increased for 2007. We believe that the base salary for each named executive officer for 2006 and 2007 is competitive within the 50^th percentile of the marketplace and commensurate with the experience and performance contributions of the respective individual. The 2006 base salary for each named executive officer is included in the Summary Compensation Table in the “Salary” column.

 

Short-Term Variable Pay Programs

 

Our short-term variable pay programs are cash incentive programs designed to tie annual pay to the performance of our company and each business unit. The programs are administered under the Amended and Restated 1998 Incentive Plan of Lennox International Inc. (the “1998 Plan”), which is designed to attract and retain employees, officers, non-employee directors, consultants and other independent contractors, and to motivate the active interest of such persons in our development and financial success. We accomplish these objectives by requiring the achievement of specific company financial goals for those individuals who most directly influence performance results and rewarding those individuals when our goals are achieved. In 2006, the executive officers, including the named executive officers, participated in two short-term variable pay programs: the management short-term incentive program and the broad-based short-term incentive program, each of which are described below.

 

In the fourth quarter of each year, our Chief Executive Officer, together with our executive staff, establishes, for recommendation to the Committee, the financial metric categories and payout opportunity percentages on which our short-term variable pay programs will be based for the upcoming year. These decisions are reached after discussing our reward philosophies, market-competitive practices, business climate, the recent year’s performance results and internal operating objectives for improvement. Our Chief Executive Officer then proposes the selected financial metric categories and payout opportunity percentages to the Committee for its review and approval at its December meeting. During the first quarter of the performance year, our Chief Executive Officer, Chief Financial Officer and Chief Administrative Officer determine, for recommendation to the Committee, the appropriate performance targets for our company as a whole. Similarly, each business segment President, in conjunction with our Chief Executive Officer, Chief Financial Officer and Chief Administrative Officer, determine, for recommendation to the Committee, the appropriate performance targets for the President’s business segment’s program. Our Chief Executive Officer then proposes the performance targets to the Committee for its review and approval at its March meeting. At the end of the performance period, the results are validated, with payouts generally made in March of the following year at the discretion of the Committee and subject to its final review and approval. We believe that performance targets are generally achievable, but that performance at maximum levels is difficult to achieve. Over the past five years, we have surpassed our performance targets every year, achieving maximum or above maximum performance results in three of the past five years.

 

The targeted payout opportunities under the short-term variable pay programs are based primarily on market-competitive practices as reported by Mercer, with the target payout opportunity expressed as a percentage of base salary and threshold and maximum payout opportunities expressed as a percentage of the target award. Based on Mercer’s market data and the internal value we place on each executive position, in December 2005, the Committee determined that 2006 short-term variable pay target opportunity percentages would remain at the 2005 levels. For the 2006 performance period, the Committee approved the following financial metric categories for both short-term variable pay programs with designated performance targets for each: earnings before interest and taxes, cash flow, sales growth, working capital and net income.

 

Management Short-Term Incentive Program.  Eligibility for the management short-term incentive program is limited to the named executive officers, other executive staff members and key employees. For

2006, the Committee approved the following payout opportunity percentages for achieving threshold, target, maximum and above maximum performance:

 

 

For performance above the maximum level, each business unit recommended and the Committee approved one of the above named financial metrics to function as a multiplier of 1.0 to 1.5 of the incentive payment as determined by the other metrics, resulting in a potential payment of up to 225% of the targeted amount for above maximum performance results.

 

Each financial metric has a weight within the program, with the sum of the weights totaling 100%. While the design of the management short-term incentive program is consistent for all participants, the performance targets, financial metrics and weights allocated to each financial metric between business segments may vary. In addition, executive officers who are also Presidents of a business unit have 50% of the target based on their business unit results and 50% based on aggregate company results. For 2006, 100% of the target payout opportunity for each of Mr. Schjerven, Ms. Carter, Dr. Ashenhurst and Ms. Goodspeed was weighted 50% company net income and 50% company free cash flow with company net income used as the basis for a multiplier of up to 1.5 to reach the maximum payout of 225% of target. For Mr. Boxer, half of his target payout opportunity was weighted 50% company net income and 50% company free cash flow with company net income used as the basis for a multiplier of up to 1.5 to reach the maximum payout of 225% of target. The other half of Mr. Boxer’s payout opportunity was weighted 70% Service Experts earnings before interest and taxes and 30% Service Experts sales growth with Service Experts working capital (subject to a minimum cash flow measure) used as the basis for a multiplier of up to 1.5 to reach the maximum payout of 225% of target.

 

The Committee may, in its discretion, modify the management short-term incentive program to account for unusual events or modified business objectives that occur throughout the performance period. For example, in mid-2006, following the Board of Directors’ approval for a new business growth strategy in our Worldwide Refrigeration business, the Committee modified targets to accommodate the revised business plan.

 

In addition, the Committee, upon the recommendation of the Chief Executive Officer, may reserve 15% of each business’ final calculated payout to withhold, pay or reallocate to the participants, according to its assessment of how each business performed on an overall basis. Factors to be considered in whether to withhold or reallocate this reserve include, but are not limited to, an assessment of overall business unit performance and contribution toward our operating objectives for the year, including performance relative to other critical business objectives beyond those specifically measured in the management short-term incentive program. The Committee did not withhold or reallocate this reserve for the 2006 program.

 

In 2006, each of Mr. Schjerven, Ms. Carter, Dr. Ashenhurst and Ms. Goodspeed earned the maximum payout of 225% of target, and Mr. Boxer earned a payout of 164% of target under the management short-term incentive program. As a result of Mr. McDonough’s termination of employment, he did not earn any short-term variable pay in 2006. The payout amounts earned in 2006, which were approved by the Committee and paid in March 2007, are included in the Summary Compensation Table in the “Non-Equity Incentive Plan Compensation” column.

 

Based on Mercer’s market data, in December 2006, the Committee determined that payout opportunity percentages and financial metrics for the 2007 management short-term incentive program would remain consistent with the 2006 program, with the application of and weights assigned to each metric varying slightly from 2006.

 

Broad-Based Short-Term Incentive Program.  Participation in our broad-based short-term incentive program is extended to eligible employees across our company. For 2006, employees participated in a broad-based short-term incentive program based on performance targets established for their respective business units and the named executive officers participated in a broad-based short-term incentive program based on our company performance targets. To align the short-term variable pay program offered to employees with the named executive officers’ short- term variable pay opportunities, the performance metric for the broad-based short-term incentive program matches the profitability performance metric for the management short-term incentive program described above. For 2006, the Committee approved the following payout opportunity percentages, which apply to all participating employees, including the named executive officers: target of 2% of the employee’s current base salary, with the threshold payout equal to 50% of the targeted amount and the maximum payout equal to 250% of the targeted amount. Although the named executive officers’ payout opportunity percentages are the same as all other participants, their performance targets are higher.

 

In 2006, each of the named executive officers earned a payout of 166% of target, or 3.31% of base salary, under the broad-based short-term incentive program. As a result of Mr. McDonough’s termination of employment, he did not earn any short-term variable pay in 2006. The payout amounts earned in 2006, which were approved by the Committee and paid in March 2007, are included in the Summary Compensation Table in the “Non-Equity Incentive Plan Compensation” column.

 

Based on Mercer’s market data and the internal value we place on each executive position, in December 2006, the Committee determined that 2007 broad-based short-term incentive payout opportunity percentages would remain consistent with the 2006 program.

 

We believe that the combined targeted opportunity payout levels for both short-term variable pay programs are within market-competitive short-term incentive ranges for the named executive officers, as supported by Mercer’s findings and the internal value we place on each executive position.

 

Long-Term Equity Incentive Program

 

We have established a long-term equity incentive program to foster and enhance our long-term success for the benefit of our stockholders by offering the incentive of long-term equity rewards to those employees who have principal responsibility for our long-term profitability. The program is administered under the 1998 Plan and enables us to provide participants with a proprietary interest in our growth and performance while linking our pay programs with our desired business results. Although we do not have a policy regarding stock ownership requirements for named executive officers, we believe participation in our long-term equity incentive program sufficiently aligns the interests of the named executive officers with the interests of our stockholders.

 

In 2006, our long-term equity incentive program consisted of three stock vehicles: performance share program (“PSP”) awards, restricted stock awards and stock appreciation rights. Stock appreciation rights and PSP awards are performance based (with performance based on stock price and the achievement of financial objectives, respectively), which incentivize contribution to growth and support our pay-for-performance philosophy. Restricted stock awards, which require continued employment to vest, support our critical retention efforts to ensure continuity of management for the successful execution of business strategies and for succession planning.

 

The Committee determines the grant date for all long-term equity incentive awards. The Committee generally grants awards on an annual basis at its regularly scheduled December meeting although, upon the Chief Executive Officer’s recommendation, awards may be granted on the last business day of any fiscal quarter in special circumstances. The Committee does not coordinate the grant date for any award with the release of material non-public information. We value shares underlying long-term equity incentive awards at fair market value, which we define as the average of the high and low sales prices of our common stock on the New York Stock Exchange on the date of the grant. We employ the average to mitigate the effects of large fluctuations in the price of our common stock on the date of grant.

 

When determining appropriate award sizes and values, the Committee considers competitive market practices, as reported by Mercer, the number of shares available under the 1998 Plan and the financial impact on our company. Basing award sizes on delivered value enables the Committee to grant competitive awards, regardless of fluctuations in the price of our common stock. Once the Committee has determined the appropriate delivered value, the total amount is allocated among the three stock vehicles, as described below. Award size for each named executive officer is based on the executive’s position with our company with no consideration given to individual performance or the executive’s current stock holdings. In addition, once an executive officer announces that his or her retirement is imminent, the Committee generally does not grant additional long-term equity incentive awards to that individual.

 

For 2006, delivered value was allocated among PSP awards, restricted stock awards and stock appreciation rights as follows:

 

PSP Awards.  To maintain our strong focus on performance, 50% of the delivered value for the 2006 long-term equity incentive program was in the form of PSP awards. PSP awards are made on a contingent basis in December of each year for a three-year performance period beginning the following January 1. The Committee, based on our Chief Executive Officer’s recommendation, establishes minimum, target and maximum performance standard levels, with a corresponding payout opportunity ranging from 50% to 200% of the targeted payout. The Committee determines the measurement criteria annually and, in doing so, considers the financial metrics selected for the short-term variable pay programs to ensure the most critical financial measurements are represented throughout our various incentive programs. For PSP awards made in 2006, the financial metric used to determine whether the target performance standards have been achieved is return on invested capital, as an average over the three-year period, with the lowest year weighted at 20% and the remaining two years weighted at 40% each, in order to mitigate the impact of anomalously low performance in any one year during the three-year performance period. The Committee determined the return on invested capital performance targets based on their assessment of desired return relative to the cost of capital. At the end of the three-year performance period, the earned share awards are calculated by applying the performance standards for such period to the contingent PSP award. Assuming continued employment, if, at the end of the performance period, at least the minimum performance level has been attained, shares underlying the PSP award vest and, to the extent earned, are distributed in the form of company common stock. To the extent the PSP award payout level attained is less than 100%, the difference between 100% and the earned award is forfeited. In 2006, the named executive officers earned the maximum payout of 200% of target for PSP awards granted in 2003, the value of which is included in the Option Exercises and Stock Vested Table under the “Stock Awards — Value Realized on Vesting” column. The estimated payout amounts for the 2006 PSP awards, which will vest in December 2009, are included in the Grants of Plan Based Awards Table in the “Estimated Future Payouts Under Equity Incentive Plan Awards” column.

 

Restricted Stock Awards.  To support our retention objective and leadership continuity, 30% of the delivered value for the 2006 long-term equity incentive program was in the form of restricted stock awards. Restricted stock awards vest three years following the date of grant, provided that the recipient remains employed by our company. The number of shares underlying restricted stock awards granted to the named executive officers in 2006 is included in the Grants of Plan Based Awards Table in the “All Other Stock Awards: Number of Shares of Stock or Units” column.

 

Stock Appreciation Rights.  To incentivize participants to grow our business and deliver increased share value to our stockholders, 20% of the delivered value for the 2006 long-term equity incentive program was in the form of stock appreciation rights. Stock appreciation rights vest in one-third increments on each anniversary of the date of grant. The exercise price is based on the average of the high and low sales prices of our common stock on the New York Stock Exchange on the date of the grant. Upon the exercise of vested stock appreciation rights, the increase, if any, between the fair market value of our common stock on the date of grant and the fair market value on the date the right is exercised is paid in company common stock. Stock appreciation rights granted in 2006 expire seven years from the date of grant. The number of stock appreciation rights granted to our named executive officers in 2006 is included in the Grants of Plan Based Awards Table in the “All Other Option Awards: Number of Securities Underlying Options” column.

 

As a result of Mr. Schjerven’s pending retirement, Mr. Schjerven was not awarded any long-term equity incentive awards in 2006.

 

Perquisites and Other Compensation

 

We believe reasonable perquisites should be provided to our executive officers as a competitive practice and in order to attract and retain top executive talent. On a periodic basis, the Committee reviews our perquisite program for executives against market-competitive information provided by Mercer to monitor prevalence in the marketplace and to maintain market-competitiveness. In 2006, we provided the following perquisites to our named executive officers:

 

 

The named executive officers also participate in our employee charitable contributions matching program, pursuant to which we match the executives’ charitable contributions by up to $1,000 per year.

 

Benefits

 

We provide our named executive officers and employees with comprehensive and competitive benefits programs. Programs ranging from pensions, profit sharing plans, and 401(k) plans, to medical, dental and life insurance provide a wealth of benefits to employees and retirees. All programs are reviewed by management for competitiveness and administered, in most cases, by an administrative committee that is comprised of members from our human resources and finance departments. Various consultants, including Mercer, Benefits Partners Inc. and Watson Wyatt Worldwide, Inc., provide input and recommendations regarding the types and levels of benefit programs we offer.

 

Qualified Retirement Plans

 

Our named executive officers participate in three tax-qualified retirement plans: the Consolidated Pension Plan, a traditional defined benefit pension plan, the Profit Sharing Retirement Plan, a defined contribution profit sharing plan, and the Lennox International Inc. 401(k) Plan, a defined contribution 401(k) plan. Our named executive officers participate in these plans on the same terms as other eligible employees.

 

Consolidated Pension Plan.  We recognize the need for our named executive officers and other employees to be able to count on a predictable source of retirement income. The Consolidated Pension Plan (formerly known as the Pension Plan for Salaried Employees) provides participants with valuable benefits that are competitive in the marketplace. This plan is commonly referred to as a “floor offset benefit arrangement.” Under a “floor offset benefit arrangement,” a target benefit is established based on a participant’s service and compensation that is offset (provided) by the calculated value of the participant’s defined contribution profit sharing account. By setting a target that our company-paid retirement income should reach, the Consolidated Pension Plan acts as a safety net by assuring that the participant will receive at least the target level benefit, even if the value of the participant’s company-paid profit sharing account under the Profit Sharing Retirement Plan falls short of the target.

 

Profit Sharing Retirement Plan.  When we are successful in reaching our financial objectives, our Profit Sharing Retirement Plan allows participants to share in the rewards. Each year, we contribute a portion of our profits to the plan, with an upper limit set by the Board of Directors. No contributions are required from participants. The total profit sharing available for the year is divided among eligible participants based on

eligible compensation. Participants with compensation over the Social Security wage base receive an additional contribution due to the limit on Social Security benefits. Contributions are invested in a portfolio comprised of both long-term and short-term investment grade bonds and a portfolio of U.S. and international stocks.

 

401(k) Plan.  We believe it is important for employees to save a portion of their income for retirement. To allow participants to meet their retirement goals and save on a tax-favored basis, we offer a 401(k) plan to our employees. The plan allows for deferrals of between 1% and 75% of a participant’s pre-tax earnings subject to annual dollar limits set by the Internal Revenue Service. In addition, participants age 50 or over are allowed to make additional elective deferrals as pre-tax “catch-up” contributions. Our 401(k) Plan provides for various investment options ranging from conservative to aggressive. Although we provide for employer matches in some of our 401(k) arrangements, the provisions that govern the 401(k) Plan in which the named executive officers participate does not provide for employer matching contributions to any participants.

 

Nonqualified Retirement Plans

 

The named executive officers also participate in two nonqualified retirement plans: the Supplemental Retirement Plan, a defined benefit plan, and the Profit Sharing Restoration Plan, a defined contribution plan. Nonqualified plans are generally not subject to the Employee Retirement Income Security Act (ERISA) and are designed to cover key executives. Participation in our nonqualified plans is limited to key executives who are defined as certain participants that were “grandfathered” in 2000, our Chief Executive Officer and any executive officer who reports to the Chief Executive Officer. The Supplemental Retirement Plan and the Profit Sharing Restoration Plan are unfunded liabilities of our company.

 

Because eligible compensation is limited by the Internal Revenue Service under tax-qualified plans, our nonqualified plans do not provide the same percentage of retirement income to those participants whose compensation exceeds the prescribed limits compared to those participants whose compensation falls below the limits. Further, many key executives are hired late in their career and may not reach maximum benefits under our tax-qualified plans prior to retirement. Therefore, our nonqualified plans are designed to supplement the benefits payable under our tax-qualified plans, which may be limited due to compensation limitations imposed by the Internal Revenue Service.

 

Supplemental Retirement Plan.  Compared to the Consolidated Pension Plan, the Supplemental Retirement Plan allows for a faster accrual of benefits and considers twice the percentage of final average pay in the computation of the target benefit. Unlike the Consolidated Pension Plan, profit sharing balances are not projected to retirement, thus allowing for a lower offsetting profit sharing benefit. A participant must have at least five years of vesting service to be eligible for benefits. As such, all of the named executive officers are eligible for benefits under the Supplemental Retirement Plan except for Ms. Carter who currently has less than five years of vesting service. The plan provides for unreduced benefits at age 62, if 10 years of service has been reached prior to separation (unreduced at age 60 if the Rule of 80 (credited service and age equal 80) has been met and the participant retires from employment). Otherwise, benefits are payable at the normal retirement age of 65. Any benefits provided under the Supplemental Retirement Plan are reduced by the benefits payable under the Consolidated Pension Plan.

 

The Supplemental Retirement Plan allows for a deferred vested benefit upon a participant’s separation of employment after the completion of five years of service, but prior to a participant’s early retirement date. Deferred vested retirement benefit payments commence at the same time that deferred vested retirement benefit payments commence under the qualified Consolidated Pension Plan with reductions applying for early commencement in certain situations.

 

Profit Sharing Restoration Plan.  Our Profit Sharing Restoration Plan permits accruals that otherwise could not occur under our Profit Sharing Plan because of Internal Revenue Service limitations on compensation. Earnings are allocated at the same market rate as the Profit Sharing Retirement Plan. Distributions may occur at separation of employment and can be paid in the form of a lump sum, or equal annual installments over either a five or ten-year period.

 

Other Benefits

 

Our named executive officers participate in our medical and dental insurance and short-term and long-term disability plans on the same terms as other employees.

 

Our named executive officers also participate in a company sponsored life insurance plan that provides for minimum coverage of $1 million for executive officers and $3 million for our Chief Executive Officer. We pay the premium, including the incremental portion above the basic life insurance of 1.5 times annual base salary provided to salaried employees, as we believe that it is important that these executives have competitive life insurance with a minimum coverage level. Further, in 2006, Mr. Schjerven and Dr. Ashenhurst were provided additional compensation subject to a grandfathered agreement allowing for payment of premiums for Executive Life and Long-Term Disability programs that were terminated in 1992. These payments, which are not subject to adjustments for any increase or decrease in future premiums, will continue to be paid as long as the individuals are employed by our company; provided, however, that we reserve the right to modify or terminate these payments at any time for any reason.

 

Other Awards or Arrangements

 

As a competitive practice and to attract and/or retain executive officers and other key employees, we may, from time to time, provide special cash or stock awards in the form of retention bonuses, sign on/employment bonuses, or special recognition “lightning bonuses” for outstanding and extraordinary performance. We may also provide a separate monthly stipend for an extended assignment generally outside the duties of an executive’s core position. For example, Dr. Ashenhurst received a monthly stipend for performing an interim role as President and Chief Operating Officer of our Worldwide Refrigeration business, in addition to his Chief Administrative Officer duties. In addition, for succession planning purposes and to incentivize Dr. Ashenhurst to remain employed by our company until he is eligible to retire in July 2008, we granted Dr. Ashenhurst a restricted stock award for 20,000 shares of common in October 2006, which will vest on July 20, 2008 if he remains employed with our company throughout the vesting period. Details regarding Dr. Ashenhurst’s special stipend and restricted stock award are included in the Summary Compensation Table under the “All Other Compensation” column (see footnote 5 to the Summary Compensation Table) and the Grants of Plan-Based Awards Table, respectively. All special cash awards, stock awards, stipends and other compensation arrangements relating to our executive officers, including the named executive officers, are approved by the Committee.

 

Employment Agreements and Change of Control Employment Agreements

 

We have entered into employment agreements and change of control employment agreements with each named executive officer. Employment agreements are executed to secure the future services of the named executive officers critical to our success and for financial and business planning. Our change of control employment agreements are intended to assure that, in the event of a change of control or potential change of control, we will have the continued services of the named executive officer and that the named executive officer will be provided with continued compensation and benefits. These agreements are discussed in detail under “Potential Payments Upon Termination or Change of Control.”

 

Tax and Accounting Implications

 

Section 162(m) Compliance

 

Section 162(m) of the Internal Revenue Code limits a company’s ability to deduct compensation paid in excess of $1 million to the Chief Executive Officer and the other four highest paid executives, unless the compensation meets certain stockholder-approved performance requirements. It is our intent to make awards that qualify as deductible compensation under Section 162(m) of the Internal Revenue Code whenever possible. However, where granting awards is consistent with our strategic business goals, the Committee reserves the right to make awards that are non-deductible. Accordingly, for fiscal 2006, the amount of non-performance based compensation in excess of $1 million for the Chief Executive Officer and the other named executive officers (other than Mr. McDonough) was not deductible for federal income tax purposes.

 

Nonqualified Deferred Compensation

 

On October 22, 2004, the American Jobs Creation Act of 2004 was signed into law, adding Section 409A to the Internal Revenue Code and changing the tax rules applicable to nonqualified deferred compensation arrangements. Section 409A requires that “deferred compensation” either comply with certain deferral election and payment rules or be subject to a 20% additional tax and, in some circumstances, imposes penalties and interest on the person who is to receive the deferred compensation. We have considered the implications of Section 409A and intend to operate our nonqualified deferred compensation arrangements in a manner that complies with Section 409A.

 

Accounting for Stock-Based Awards

 

We accounted for stock-based awards granted or modified during fiscal year 2006, including stock options, stock appreciation rights, restricted stock awards and PSP awards, in accordance with the requirements of Statement of Financial Accounting Standards No. 123R “Share-Based Payment” (“SFAS No. 123R”).

 

Compensation and Human Resources Committee Report

 

The Compensation and Human Resources Committee has reviewed and discussed the foregoing Compensation Discussion and Analysis with management. Based on our review and discussions with management, we have recommended to the Board that the Compensation Discussion and Analysis be included in this Proxy Statement.

 

Submitted by the Compensation and Human Resources Committee of the Board of Directors:

 

 

Notwithstanding anything to the contrary set forth in any of our previous filings under the Securities Act of 1933 or the Securities Exchange Act of 1934 that incorporate future filings, including this Proxy Statement, in whole or in part, the foregoing Compensation and Human Resources Committee Report shall not be incorporated by reference into any such filings.

 

The Securities and Exchange Commission recently adopted enhanced executive compensation disclosure requirements for public companies. As a result, the following disclosure regarding the compensation of our executive officers and directors will be somewhat different in content and format from previous years.

 

Summary Compensation Table for 2006

 

The following table provides information regarding total compensation earned in 2006 by the named executive officers, which include our Chief Executive Officer, our Chief Financial Officer, our three other most highly compensated executive officers and, in accordance with the Securities and Exchange Commission’s rules, Robert J. McDonough, the former Executive Vice President and President and Chief Operating Officer of our Worldwide Heating and Cooling business.

 

 

 

 

 

 

The values attributable to each “perquisite” and item of “other compensation” listed above are calculated as follows:

 

 

 

 

In addition to the perquisites and other compensation listed above:

 

 

Grants of Plan-Based Awards in 2006

 

The following table provides information regarding short-term cash incentive awards granted under our short-term variable pay programs and PSP awards, restricted stock awards and stock appreciation rights granted under the 1998 Plan to the named executive officers in 2006.

 

 

 

 

Outstanding Equity Awards at December 31, 2006

 

The following table provides information regarding all outstanding equity awards held by the named executive officers as of December 31, 2006.