Lennox International Inc. — FY2010 Form 10-K Summary
Business context and reporting period
Lennox International Inc. is a global HVACR manufacturer and service provider operating through Residential Heating & Cooling, Commercial Heating & Cooling, Service Experts, and Refrigeration. The filing covers the fiscal year ended December 31, 2010; fourth-quarter information is included but the filing is an annual report, not a quarterly filing.
| 2010 segment | Net sales | Segment profit | Profit margin |
|---|---|---|---|
| Residential Heating & Cooling | $1,417.4 million | $132.3 million | 9.3% |
| Commercial Heating & Cooling | $620.0 million | $69.3 million | 11.2% |
| Service Experts | $590.3 million | $19.3 million | 3.3% |
| Refrigeration | $550.9 million | $61.4 million | 11.1% |
| Eliminations | $(82.2) million | $0.2 million | Not applicable |
Financial performance and liquidity
- Net sales were $3,096.4 million, up 8.7% from $2,847.5 million in 2009. Volume increased approximately 5%, price and mix contributed approximately 2%, and foreign currency contributed approximately 2%.
- Gross profit was $891.8 million, with gross margin improving to 28.8% from 27.7%. Material savings and manufacturing efficiencies were the primary drivers, partly offset by commodity, freight, and distribution costs.
- Operational income from continuing operations was $190.4 million, or 6.2% of sales, versus $109.2 million, or 3.8%, in 2009.
- Net income was $116.2 million, compared with $51.1 million in 2009. Diluted EPS from continuing operations was $2.10, versus $1.09; diluted net income EPS was $2.08.
- Operating cash flow was $185.8 million, down from $225.5 million, primarily because growth increased receivables and inventories. Capital expenditures were $45.8 million, producing operating cash flow less capital expenditures of approximately $140.0 million.
- Cash and cash equivalents were $160.0 million at year-end, plus $12.2 million of restricted cash. The company had no beneficial interests sold under its asset securitization arrangement and had $100.0 million of remaining availability under that program.
- Total debt was $319.0 million, compared with $231.5 million in 2009. Long-term debt was $317.0 million, including $100.0 million drawn on the revolving facility and $200.0 million of senior unsecured notes due 2017.
- The $650.0 million revolving facility had $480.5 million available after $100.0 million of borrowings and $69.5 million of standby letters of credit. The company was in compliance with its covenants, including maximum consolidated indebtedness to adjusted EBITDA of 3.5:1 and minimum cash flow to net interest expense of 3.0:1.
- The debt-to-total-capital ratio increased to 35.1% from 27.7%. Credit ratings were Baa3 from Moody’s and BBB- from Standard & Poor’s, each with a stable outlook.
- The company returned approximately $144.3 million through share repurchases and paid $32.4 million in cash dividends. Dividends declared per share increased to $0.60 from $0.56.
Material changes versus the prior comparable period
- All four operating segments reported higher sales and profit. Residential sales increased 9.6% and profit increased 18.4%; Commercial sales increased 4.3% and profit increased 40.6%; Service Experts sales increased 10.3% and profit increased 16.3%; Refrigeration sales increased 7.5% and profit increased 25.6%.
- SG&A increased $40.8 million, primarily from higher incentive compensation and variable selling, advertising, and promotion expenses, but declined to 22.1% of sales from 22.6%.
- Restructuring charges declined to $15.6 million from $41.5 million. The 2010 charges primarily related to Australian Refrigeration manufacturing rationalization and Service Experts administrative reorganizations.
- Interest expense increased to $12.8 million from $8.2 million because of higher debt and the issuance of the 4.90% senior notes.
- The effective tax rate declined to 33.7% from 38.8%.
- Discontinued operations generated a $0.9 million after-tax loss, versus a $10.7 million loss in 2009, as the company completed the sale of twelve Service Experts centers.
- Goodwill increased to $271.8 million from $257.4 million. Management reported no goodwill impairment at year-end.
Guidance, outlook, commentary, risks, and unusual items
- The filing does not provide a clear formal full-year 2011 earnings or revenue guidance figure. Management expects 2011 capital expenditures to rise toward levels seen in 2009 and 2008 and states that operating cash flow, available revolver capacity, and other funding sources should be sufficient for foreseeable operations and planned share repurchases.
- On January 14, 2011, Lennox acquired substantially all assets of Kysor/Warren, a refrigerated systems and display-case business, for consideration of approximately $138 million, subject to a working-capital adjustment. The company paid $145.2 million, including the purchase price adjustment.
- Demand is seasonal and weather-sensitive, with sales and segment profit generally higher in the second and third quarters. Residential and commercial construction conditions, customer financing, consumer confidence, and replacement demand remain important drivers.
- Key risks include commodity-price volatility, supply interruptions, dependence on certain suppliers and single-location facilities, competition, foreign currency and international regulatory exposure, labor disruptions, warranty and product liability claims, environmental obligations, pension funding requirements, and potential goodwill impairment.
- The company recorded a $6.8 million special legal contingency charge in 2010 and total 2010 charges of $9.3 million related to a class-action lawsuit involving certain hearth products. Preliminary settlement approval was obtained in January 2011, with final approval scheduled for June 2, 2011.
- A vendor-supplied product quality issue resulted in a $24.4 million expense in 2009; no material charge was recorded in 2010. The related accrued liability declined to $16.0 million from $21.6 million, but additional future charges remain possible.
- Other 2010 unusual items included $4.8 million of acquisition expenses relating to the subsequent Kysor/Warren transaction, a $4.1 million fourth-quarter reduction in pension cost relative to the prior year, and a $2.5 million fourth-quarter LIFO adjustment that increased gross profit.
Most important facts for investors to verify
- Reconcile reported net income and EPS with continuing operations, discontinued operations, restructuring, legal, product-quality, acquisition, pension, and derivative-related items.
- Assess whether the 2010 margin improvement from volume, productivity, and material savings can offset commodity, freight, labor, and distribution pressures.
- Review liquidity after the Kysor/Warren acquisition, share repurchases, seasonal working-capital needs, and the October 2012 revolver maturity.
- Monitor debt covenant headroom, cross-default provisions, credit ratings, and the company’s ability to refinance or repay the revolving facility.
- Evaluate the integration, earnings contribution, and purchase accounting for Kysor/Warren.
- Track the final resolution and total cost of the hearth-product class action and any additional product-quality claims.
- Review pension underfunding of $91.7 million, future contributions, warranty liabilities of $75.5 million, and goodwill of $271.8 million.
- Confirm the absence of formal 2011 financial guidance in the filing and separately review subsequent quarterly disclosures for updated outlook information.