Lennox International Inc. — Form 10-Q Summary
Reporting period: Three and nine months ended September 30, 2021. The unaudited filing covers Lennox International’s three HVACR segments: Residential Heating & Cooling, Commercial Heating & Cooling, and Refrigeration.
Business Context and Reporting Period
Lennox manufactures and sells heating, ventilation, air conditioning and refrigeration equipment and related services primarily in the United States, Canada and Europe. Results are seasonal and influenced by weather, replacement demand, new construction, economic conditions, commodity prices, freight costs and supply-chain conditions.
Financial Performance and Key Metrics
| Metric | Q3 2021 | Q3 2020 | Change |
|---|---|---|---|
| Net sales | $1,059.9 million | $1,055.0 million | 0.5% increase |
| Gross profit | $295.2 million | $323.3 million | 8.7% decrease |
| Gross margin | 27.9% | 30.6% | Down 270 bps |
| Operating income | $162.7 million | $167.1 million | 2.6% decrease |
| Operating margin | 15.4% | 15.8% | Down 40 bps |
| Net income | $126.3 million | $131.7 million | 4.1% decrease |
| Diluted EPS from continuing operations | $3.41 | $3.42 | Decrease of $0.01 |
| Metric | 9M 2021 | 9M 2020 | Change |
|---|---|---|---|
| Net sales | $3,229.3 million | $2,720.1 million | 18.7% increase |
| Gross profit | $934.8 million | $764.8 million | 22.2% increase |
| Gross margin | 28.9% | 28.1% | Up 80 bps |
| Operating income | $492.7 million | $339.5 million | 45.1% increase |
| Operating margin | 15.3% | 12.5% | Up 280 bps |
| Net income | $380.4 million | $244.6 million | 55.6% increase |
| Diluted EPS | $10.10 | $6.34 | 59.3% increase |
Cash flow and capital allocation: Nine-month operating cash flow was $396.3 million, compared with $446.2 million in 2020. Capital expenditures were $68.5 million, primarily for manufacturing capacity, equipment, systems and software. Financing activities used $410.5 million, including $600.0 million of share repurchases and $92.8 million of dividends.
Liquidity and debt: Cash and cash equivalents were $39.4 million at September 30, 2021, compared with $123.9 million at December 31, 2020. Total debt was $1,278.2 million, including $300.6 million classified as current and $977.6 million as long-term. The company had $739.0 million of borrowing capacity available under its $750 million revolving credit facility, after outstanding borrowings and letters of credit. The asset securitization program had $290.0 million of beneficial interests transferred and $79.8 million of remaining availability. Management stated that liquidity was sufficient for foreseeable operating, capital and shareholder-return needs.
Balance sheet: Total assets were $2,123.5 million and total liabilities were $2,458.3 million at September 30, 2021. Stockholders’ deficit was $334.8 million, compared with a deficit of $17.1 million at year-end 2020, primarily reflecting share repurchases.
Material Changes Versus the Prior Comparable Period
- Q3 sales were essentially flat as favorable price and mix of 4% offset a 4% volume decline.
- Q3 gross margin declined due to higher commodity costs, freight and distribution costs, factory inefficiencies, other product costs and unfavorable mix. Price increases partially offset these pressures.
- Q3 Residential sales declined 1.5% and segment profit declined 5.9%; Commercial sales increased 1.7% while profit declined 41.8%; Refrigeration sales increased 9.8% and profit increased 11.5%.
- For the first nine months, higher volume, pricing, mix, productivity and foreign currency drove strong growth. Nine-month segment profit increased 37.5% in Residential, 2.4% in Commercial and 58.4% in Refrigeration.
- SG&A decreased $18 million in Q3 because of lower incentive compensation and employee costs, but increased $34 million year to date because of higher incentive compensation and employee-related costs.
- Restructuring charges declined to $1.6 million year to date from $10.6 million in the prior-year period, and no natural-disaster losses were recorded in 2021 versus $7.6 million in 2020.
- The company repurchased $600 million of common stock during the first nine months, compared with $100 million in the prior-year period. As of September 30, $846 million remained available under the repurchase authorizations.
- In July 2021, Lennox replaced its prior credit facility with a $750 million revolving facility maturing in July 2026, subject to extension options.
Guidance, Outlook, Risks and Unusual Items
Management expected an annual 2021 effective tax rate of approximately 20%, excluding excess tax benefits from stock-based compensation. The filing does not provide a clear full-year revenue or earnings guidance figure.
- COVID-19 continued to cause supply-chain disruptions and higher absenteeism at manufacturing and distribution locations. Future effects could be material if the pandemic worsens, persists or new variants become dominant.
- Commodity costs, tariffs, freight, factory inefficiencies and product costs pressured Q3 margins. Lennox uses price increases, cost reductions and commodity and foreign-currency hedges to mitigate these risks.
- Cash flow was pressured by working-capital investment, including a $139.5 million increase in accounts receivable and a $21.1 million increase in inventories during the first nine months.
- Asbestos-related litigation expense was $4.5 million year to date, compared with $1.9 million in 2020. Management believes outstanding claims will not have a material adverse effect, but acknowledges litigation outcomes remain uncertain.
- Total product warranty liabilities increased to $133.1 million from $119.8 million at year-end 2020. The company also reported special legal contingency and environmental liability charges.
- Variable-rate debt is exposed to interest-rate risk, and the company stated it was not currently hedged against that risk. Commodity and foreign-currency cash-flow hedges were scheduled to mature through February 2023.
- The company reported compliance with its debt covenants, including the revolving credit facility’s total net leverage ratio requirement, and maintained investment-grade ratings of Baa2 and BBB, both with stable outlooks.
- No material changes were reported to the risk factors disclosed in the 2020 Form 10-K and the prior-quarter Form 10-Q.
Important Facts for Investors to Verify
- Whether pricing actions can continue to offset commodity, freight, labor, tariff and supply-chain inflation without further volume deterioration.
- The sustainability of Q3’s lower Residential and Commercial segment profitability and the extent to which Q3 margin pressure carries into the fourth quarter.
- Liquidity after the significant share repurchase program, including the November 2021 renewal or replacement of the asset securitization program.
- Debt maturities, refinancing requirements and compliance with the 3.50-to-1.00 total net leverage covenant.
- Growth in warranty liabilities and the potential cost of product quality issues, asbestos-related litigation and environmental contingencies.
- Actual full-year revenue, earnings and tax outcomes compared with management’s stated tax-rate expectation and the filing’s forward-looking assumptions.