Lennox International Inc. — Q3 2020 Form 10-Q Summary
Business context and reporting period
Lennox International operates in three HVACR segments: Residential Heating & Cooling, Commercial Heating & Cooling, and Refrigeration. This unaudited Form 10-Q covers the three and nine months ended September 30, 2020, compared with the corresponding 2019 periods. Results reflect significant COVID-19 disruption, seasonal demand, supply-chain constraints, and manufacturing absenteeism.
Key financial metrics
| Metric | Q3 2020 | Q3 2019 | 9M 2020 | 9M 2019 |
|---|---|---|---|---|
| Net sales | $1,055.0 million | $1,032.9 million | $2,720.1 million | $2,922.2 million |
| Gross profit / margin | $323.3 million / 30.6% | $298.3 million / 28.9% | $764.8 million / 28.1% | $831.9 million / 28.5% |
| Operating income / margin | $167.1 million / 15.8% | $156.8 million / 15.2% | $339.5 million / 12.5% | $465.3 million / 15.9% |
| Income from continuing operations | $131.7 million | $114.7 million | $244.9 million | $295.0 million |
| Net income | $131.7 million | $114.7 million | $244.6 million | $294.7 million |
| Diluted EPS from continuing operations | $3.42 | $2.94 | $6.35 | $7.46 |
| Cash flow from operations | Not separately provided | Not separately provided | $446.2 million | $124.5 million |
Q3 sales increased 2.1%, operating income increased 6.6%, and net income increased 14.8%. Gross margin expanded 170 basis points, primarily from lower commodity costs, sourcing and engineering savings, lower freight, and factory productivity. For the first nine months, sales declined 6.9%, operating income declined 27.0%, and net income declined 17.0%.
Segment performance
- Residential Heating & Cooling: Q3 sales increased 13.2% to $722.0 million and segment profit increased 20.9% to $153.0 million. Nine-month sales increased 0.9%, but profit declined 14.7% due largely to the absence of 2019 tornado-related insurance proceeds and higher warranty and factory costs.
- Commercial Heating & Cooling: Q3 sales declined 17.9% to $207.9 million and profit declined 17.6% to $38.8 million. Nine-month sales declined 16.5% and profit declined 19.7%, primarily due to lower volumes.
- Refrigeration: Q3 sales declined 11.9% to $125.1 million and profit declined 34.3% to $13.0 million. Nine-month sales declined 23.8% and profit declined 52.2%, reflecting lower volumes, factory inefficiencies, and the 2019 divestiture of Kysor Warren.
Liquidity, cash flow, debt, and capital allocation
- Cash and cash equivalents were $55.0 million at September 30, 2020, compared with $37.3 million at December 31, 2019. Short-term investments were $4.1 million.
- Operating cash flow was $446.2 million for the first nine months, versus $124.5 million in 2019, primarily because of lower working-capital requirements and a $137.6 million inventory reduction.
- Capital expenditures were $55.9 million, compared with $77.0 million in the prior-year period. Management reduced its 2020 capital expenditure plan from $153 million to $100 million.
- Total debt was $1,013.6 million at September 30, 2020, compared with $1,171.2 million at year-end 2019. Debt included $950.0 million of senior unsecured notes and $34.5 million outstanding under the domestic credit facility.
- The company issued $600.0 million of senior unsecured notes in July 2020, consisting of $300.0 million due 2025 at 1.35% and $300.0 million due 2027 at 1.70%. The domestic revolving credit facility was amended to $750.0 million and extended to August 2022; $713.3 million was available at quarter-end.
- The company reported compliance with debt covenants and maintained investment-grade ratings of Baa3 from Moody’s and BBB from S&P, each with a stable outlook.
- Dividends paid were $88.6 million during the first nine months. The company repurchased $100.0 million of common stock in the first quarter and placed the remaining 2020 repurchase plan on hold. The quarterly dividend remained $0.77 per share.
Material changes, outlook, risks, and unusual items
- COVID-19: The pandemic caused supply-chain disruption, employee absenteeism, temporary facility suspensions, and additional health and safety costs. The company recorded $6.4 million of COVID-related expenses through nine months and $10.6 million of restructuring charges, primarily for severance, facility closures, and canceled activities.
- Management revised 2020 expectations to revenue down 5% to 9% year over year, compared with prior guidance for 4% to 8% growth. Diluted EPS from continuing operations was expected at $8.35 to $8.95, versus prior guidance of $11.30 to $11.90.
- Management projected approximately $525 million of 2020 operating cash flow, $65 million of SG&A savings relative to initial plans, and a 2020 effective tax rate of 19% to 20%, excluding specified tax and restructuring effects.
- The August 2020 Marshalltown, Iowa derecho caused $4.5 million of Q3 losses and $4.5 million for the first nine months. Insurance recoveries were being evaluated; the filing does not provide a clear amount of expected recovery.
- Prior-year results benefited from $85.4 million of net natural-disaster gains for the first nine months, including tornado-related insurance recoveries, and included a $60.6 million pension settlement charge and a $9.1 million Kysor Warren sale loss.
- Warranty liabilities increased to $117.4 million at September 30, 2020 from $112.8 million at December 31, 2019. The company also faces asbestos, environmental, product warranty, tax, and other litigation contingencies. Management does not currently expect these matters to have a material adverse effect, but acknowledges that outcomes are uncertain.
- The company stated that it had no material off-balance-sheet arrangements and no material change in market-risk exposure from year-end 2019.
Investor verification checklist
- Verify the sustainability of Q3 residential demand and whether commercial and refrigeration volumes recover after COVID-19 effects.
- Reconcile reported earnings with unusual items, especially prior-year tornado insurance benefits, 2020 derecho costs, restructuring, COVID-related expenses, and pension items.
- Assess liquidity and refinancing needs when the domestic credit facility matures in 2022 and senior notes mature in 2023, 2025, and 2027.
- Monitor covenant headroom, variable-rate debt exposure, commodity costs, tariffs, foreign exchange, and availability under the asset securitization program.
- Evaluate whether the revised 2020 revenue, EPS, cash-flow, SG&A savings, capital expenditure, and tax-rate guidance is achieved.
- Review developments in warranty claims, asbestos and environmental matters, derecho insurance recoveries, and COVID-19 supply-chain and operating risks.