Lennox International Inc. — Form 10-Q Summary
Reporting period: Three and nine months ended September 30, 2019. The interim financial statements are unaudited. Lennox operates in Residential Heating & Cooling, Commercial Heating & Cooling, and Refrigeration.
Financial performance and position
| Metric | Q3 2019 | Q3 2018 | 9M 2019 | 9M 2018 |
|---|---|---|---|---|
| Net sales | $1,032.9 million | $1,030.2 million | $2,922.2 million | $3,040.4 million |
| Gross profit | $298.3 million | $301.9 million | $831.9 million | $886.6 million |
| Gross margin | 28.9% | 29.3% | 28.5% | 29.2% |
| Operating income | $156.8 million | $145.2 million | $465.3 million | $393.3 million |
| Net income | $114.7 million | $108.0 million | $294.7 million | $283.4 million |
| Diluted EPS | $2.94 | $2.65 | $7.46 | $6.86 |
| Operating cash flow | Not provided | Not provided | $124.5 million | $231.3 million |
- Q3 operating margin was 15.2%, compared with 14.1% in the prior-year quarter. Nine-month operating margin was 15.9%, compared with 12.9%.
- Q3 Residential Heating & Cooling sales increased 7.2% to $637.6 million and segment profit increased 11.9% to $126.5 million. Commercial sales increased 6.9% to $253.3 million, while segment profit increased 5.1% to $47.1 million.
- Q3 Refrigeration sales declined 28.5% to $142.0 million and segment profit declined 20.5% to $19.8 million, primarily because of divestitures.
- At September 30, 2019, cash and cash equivalents were $46.1 million, short-term investments were $2.4 million, and total debt was $1,451.1 million. Stockholders’ deficit was $277.3 million.
- Capital expenditures were $77.0 million in the first nine months, principally for Marshalltown reconstruction and investments in equipment, systems, and software.
Material changes versus comparable periods
- Q3 sales were essentially flat because higher volume and favorable price/mix were offset by divestiture-related revenue losses. Nine-month sales decreased 3.9%, primarily from divestitures and unfavorable foreign exchange.
- Gross margin declined 40 basis points in Q3 and 70 basis points year to date. Management cited lower factory efficiency, higher freight and distribution costs, commodity and tariff costs, and other product costs.
- Operating income benefited from Marshalltown tornado insurance proceeds, including $8.0 million of Q3 proceeds allocated to lost profits and $73.8 million of lost-profit proceeds year to date. Net gain from insurance recoveries was $7.1 million in Q3 and $85.4 million year to date.
- Results included $6.1 million of Q3 restructuring charges and $6.5 million year to date, primarily for resource and product-portfolio realignment.
- The company recorded a $60.6 million pension settlement charge in the second quarter following the transfer of $100.0 million of pension assets and $105.6 million of obligations to a group annuity contract.
- Q3 interest expense increased to $12.5 million from $10.3 million, and nine-month interest expense increased to $36.5 million from $28.5 million, primarily because of higher average borrowings.
- Lennox repurchased $400.0 million of common stock and paid $80.9 million of dividends during the first nine months, compared with $350.2 million and $68.2 million, respectively, in the prior-year period.
Liquidity, debt, outlook, and risks
- Operating cash flow declined to $124.5 million from $231.3 million, reflecting seasonal working-capital needs and timing of payments. Receivables and inventories increased by $178.2 million and $107.0 million, respectively, during the first nine months.
- The amended domestic credit facility consisted of a $1.0 billion revolving facility and a $190.0 million term loan. Borrowings were $708.0 million, with $449.5 million available after outstanding borrowings and standby letters of credit.
- Asset securitization borrowings were $365.5 million, leaving $14.5 million of remaining availability under the program at September 30. The program was scheduled to expire in November 2019, and management intended to renew it.
- Management stated that cash, expected operating cash flow, and available borrowing capacity should be sufficient for operations, capital expenditures, contractual obligations, dividends, and potential share repurchases. Planned 2019 capital expenditures were approximately $100 million, excluding insured Marshalltown repairs.
- Management expected a 2019 effective tax rate of 22% to 23%, excluding excess tax benefits. The filing does not provide a consolidated revenue or earnings-per-share outlook.
- Management expected 2019 Marshalltown insurance proceeds of $94 million for lost profits and $154 million for reconstruction and other losses, with cumulative expected proceeds of $121 million and $251 million, respectively.
- On October 15, 2019, Lennox announced another pension annuity transaction involving $75.0 million of assets and $77.9 million of obligations. The company expected a $38.5 million non-cash pretax pension settlement loss in Q4 2019.
- Key risks include weather-driven seasonality, economic and construction conditions, commodity and tariff volatility, foreign exchange exposure, interest-rate exposure, execution of the Marshalltown reconstruction, product warranties and quality matters, asbestos and other litigation, environmental liabilities, and substantial leverage. Management reported compliance with debt covenants and no material change in previously disclosed risk factors.
Important facts for investors to verify
- Whether insurance proceeds and the Marshalltown reconstruction materially affect recurring earnings, cash flow, and 2020 results.
- The renewal terms and ongoing availability of the asset securitization program after its November 2019 expiration.
- Debt reduction, covenant headroom, refinancing requirements, and the effect of continued share repurchases on leverage and stockholders’ deficit.
- The Q4 2019 pension settlement charge and the remaining funded status and obligations of the pension plans.
- Whether Residential and Commercial growth can offset the revenue and profit reductions from divestitures in Refrigeration.
- Actual commodity, tariff, freight, factory-efficiency, warranty, and foreign-exchange impacts on future margins.