Lennox International Inc. — 2013 Q3 Form 10-Q Summary
Business context and reporting period
The filing covers the 13-week quarter and nine months ended September 30, 2013. Lennox operates in three HVACR segments: Residential Heating & Cooling, Commercial Heating & Cooling, and Refrigeration. Results are seasonal and affected by weather, construction, replacement demand, economic conditions, commodity costs, and foreign exchange.
Service Experts was sold on March 22, 2013, and is presented as discontinued operations. Prior periods were reclassified for comparability.
Financial performance and key metrics
| Metric | Q3 2013 | Q3 2012 | Change |
|---|---|---|---|
| Net sales | $868.0 million | $809.7 million | +7.2% |
| Gross profit | $237.4 million | $204.9 million | +15.9% |
| Gross margin | 27.4% | 25.3% | +210 bps |
| Operational income from continuing operations | $103.8 million | $80.9 million | +28.3% |
| Income from continuing operations | $65.8 million | $49.7 million | +32.5% |
| Net income | $64.3 million | $29.4 million | +118.4% |
| Diluted EPS from continuing operations | $1.30 | $0.97 | +34.0% |
| Diluted net EPS | $1.27 | $0.57 | +122.8% |
| Metric | Nine months 2013 | Nine months 2012 | Change |
|---|---|---|---|
| Net sales | $2,449.5 million | $2,264.5 million | +8.2% |
| Gross profit | $653.4 million | $553.9 million | +18.0% |
| Gross margin | 26.7% | 24.5% | +220 bps |
| Operational income from continuing operations | $234.1 million | $179.6 million | +30.3% |
| Income from continuing operations | $145.9 million | $108.5 million | +34.5% |
| Net income | $136.6 million | $68.0 million | +100.9% |
| Diluted EPS from continuing operations | $2.87 | $2.11 | +36.0% |
- Q3 sales benefited from approximately 6% volume growth and 2% favorable price and mix, partly offset by a 1% unfavorable foreign-exchange impact.
- Q3 SG&A increased to $136.9 million from $125.9 million, primarily due to higher incentive compensation; SG&A increased to 15.8% of sales from 15.5%.
- The Q3 effective tax rate was 34.2%, compared with 35.0% in the prior-year quarter. The nine-month effective tax rate was 34.7% in both periods.
- Nine-month operating cash flow was $65.0 million versus $64.4 million. Capital expenditures were $41.0 million versus $28.0 million.
- Cash and cash equivalents were $37.8 million at September 30, 2013, compared with $51.8 million at December 31, 2012.
Segment results
| Segment | Q3 sales | Q3 sales change | Q3 profit | Q3 profit change |
|---|---|---|---|---|
| Residential Heating & Cooling | $433.9 million | +12.3% | $57.0 million | +$19.3 million |
| Commercial Heating & Cooling | $239.1 million | +8.8% | $39.2 million | +$6.7 million |
| Refrigeration | $195.0 million | -4.3% | $23.9 million | -$1.2 million |
Residential performance was driven by replacement and new-construction demand, favorable price and mix, and material cost savings. Commercial benefited from higher North American volume and material savings, despite European weakness. Refrigeration was affected by lower volume, foreign exchange, supermarket customer weakness, and soft European and Australian markets.
Debt, liquidity, and capital allocation
- Total debt was $434.9 million at September 30, 2013, up from $386.6 million at December 31, 2012. Short-term debt increased to $167.9 million from $34.9 million, primarily reflecting $160.0 million of asset securitization borrowings.
- The $650.0 million domestic revolving credit facility had $49.5 million drawn, $33.5 million committed to standby letters of credit, and $567.0 million available for future borrowings. It matures in October 2016.
- The company had $200.0 million of 4.90% senior unsecured notes due May 2017.
- Debt-to-total-capital increased to 47.4% from 43.7% at year-end 2012. Management stated that senior credit ratings remained investment grade and that all debt covenants were satisfied.
- Management believes cash, available borrowing capacity, and future operating cash flow are sufficient for operations, planned capital expenditures, contractual obligations, dividends, and share repurchases.
- Management expected approximately $60 million of 2013 capital expenditures, approximately $125 million of 2013 share repurchases, and more than $30 million of dividends. Nine-month share repurchases totaled $66.0 million, with $305.2 million remaining authorized.
Material changes, outlook, risks, and unusual items
- Profitability improved substantially because of volume growth, favorable pricing and mix, commodity and non-commodity cost savings, and continued cost management. Higher freight, distribution, SG&A, and incentive compensation partially offset these benefits.
- Discontinued-operations losses declined to $1.5 million in Q3 2013 from $20.3 million in Q3 2012 and to $9.3 million for nine months from $40.5 million. The prior-year quarter included a $21 million goodwill impairment associated with Service Experts.
- The company recorded $3.2 million of restructuring charges during the first nine months, with total expected restructuring costs of approximately $24.5 million. Significant ongoing projects were substantially completed as of September 30, 2013.
- Nine-month losses and other expenses included a $1.0 million special legal contingency charge related to patent litigation. Management stated that pending litigation is not expected to have a material adverse effect, while noting that outcomes remain uncertain.
- Product warranty liabilities were $75.7 million, and accrued product-quality liabilities were $5.9 million. Additional charges could arise if actual claims or costs exceed estimates.
- Asbestos-related claims, product liability, vendor-supplied component issues, commodity prices, foreign exchange, weather, European weakness, Australian market conditions, and seasonal working-capital needs remain relevant risks.
- The filing does not provide formal full-year earnings guidance. Management commentary indicates continued investment in manufacturing capacity, distribution, systems, cost savings, dividends, and share repurchases.
- The company entered into a renewed corporate headquarters operating lease through March 1, 2019. At lease end, it may be required to purchase, sell, vacate, or renew the property; a third-party sale shortfall could require a payment capped at 86% of the lease balance.
Important facts for investors to verify
- Whether residential and commercial demand and favorable pricing/mix persist after the strong 2013 improvement.
- The sustainability of refrigeration performance, particularly in Europe, Australia, and among supermarket customers.
- Working-capital conversion and cash generation, given the large increases in receivables and inventories.
- Debt levels, asset-securitization availability, covenant compliance, and the impact of seasonal borrowing needs.
- Future warranty, product-quality, asbestos, and patent-litigation costs relative to recorded accruals.
- The effect of share repurchases and dividends on leverage, liquidity, and future per-share results.
- Foreign-exchange and commodity-price movements, including the effectiveness and future earnings impact of hedging activities.