Lennox International Inc. 2016 Form 10-K Summary
Business context and reporting period
Lennox International Inc. is a global manufacturer and service provider serving the heating, ventilation, air conditioning and refrigeration markets. It operates through Residential Heating & Cooling, Commercial Heating & Cooling, and Refrigeration segments. The filing covers the fiscal year ended December 31, 2016, with quarterly information provided for the fourth quarter and full-year comparisons to 2015 and 2014.
| Segment | 2016 net sales | 2016 segment profit | Sales change vs. 2015 |
|---|---|---|---|
| Residential Heating & Cooling | $2,000.8 million | $348.8 million | +7.2% |
| Commercial Heating & Cooling | $917.9 million | $149.3 million | +3.5% |
| Refrigeration | $722.9 million | $68.9 million | +1.3% |
| Total | $3,641.6 million | $469.6 million subtotal | +5.0% |
Financial performance and key metrics
| Metric | 2016 | 2015 | Change |
|---|---|---|---|
| Net sales | $3,641.6 million | $3,467.4 million | +5.0% |
| Gross profit | $1,076.5 million | $947.4 million | +13.6% |
| Gross margin | 29.6% | 27.3% | +230 bps |
| Operating income | $429.4 million | $305.4 million | +40.6% |
| Operating margin | 11.8% | 8.8% | +300 bps |
| Income from continuing operations | $278.6 million | $187.2 million | +48.8% |
| Net income | $277.8 million | $186.6 million | +48.9% |
| Diluted EPS from continuing operations | $6.34 | $4.11 | +54.3% |
| Net cash from operating activities | $354.5 million | $331.2 million | +$23.3 million |
| Capital expenditures | $84.3 million | $69.9 million | +$14.4 million |
| Cash dividends declared per share | $1.65 | $1.38 | +19.6% |
Net sales growth was driven primarily by approximately 5% higher volume across all segments. Gross margin benefited from lower material costs and improved factory productivity, partly offset by unfavorable mix and foreign exchange, distribution investments, and higher warranty costs. SG&A increased to $621.0 million, or 17.1% of sales, from $580.5 million, or 16.7%.
Liquidity, debt and capital allocation
- Cash and cash equivalents were $50.2 million at December 31, 2016, including $32 million held outside the United States.
- Total debt was $868.2 million, compared with $741.1 million at year-end 2015. Stockholders’ equity was $38.0 million, producing a reported debt-to-total-capital ratio of 95.8%.
- The company had $609.6 million of available borrowing capacity under its domestic credit facility, after outstanding borrowings and standby letters of credit, and $200.0 million of remaining availability under the asset securitization program.
- In August 2016, the company entered into a new $900 million domestic credit facility maturing in August 2021. It issued $350 million of 3.00% senior unsecured notes due 2023 and had $200 million of 4.90% notes due May 2017.
- Operating cash flow exceeded capital expenditures by approximately $270.2 million. Financing cash outflows included $300.0 million of share repurchases and $69.0 million of dividends paid.
- The board authorized total share repurchases of $2 billion; $646 million remained available at year-end.
- Management stated that cash, operating cash flow and available borrowings were sufficient for foreseeable operating, investment, debt service, dividend and repurchase needs. The company reported compliance with its debt covenants.
Material changes versus the prior comparable period
- Residential Heating & Cooling was the principal growth and profit contributor, with segment profit increasing $70.4 million, or 25.3%.
- Commercial Heating & Cooling segment profit increased $18.9 million, or 14.5%; Refrigeration segment profit increased $16.0 million, or 30.2%.
- Operating income improved substantially because of higher sales, material-cost savings and the absence of the significant 2015 impairment charges.
- 2015 included $5.5 million of goodwill impairment and $44.5 million of asset impairment related to the North American supermarket display case business; no comparable continuing-operations impairment was recorded in 2016.
- 2016 included a $31.4 million pension settlement charge related to a lump-sum pension buyout. The company also made $53.9 million of pension contributions, including a $50 million discretionary contribution.
- The pension liability declined from $122.4 million to $89.1 million, while the company’s total debt increased by $127.1 million.
- The effective tax rate declined to 30.8% from 33.8%, primarily due to a benefit from repatriation of earnings. Management expected a future effective tax rate of approximately 32%.
- Fourth-quarter 2016 net sales were $897.3 million and net income was $40.4 million, compared with $834.1 million and $11.2 million, respectively, in fourth-quarter 2015. The 2016 fourth quarter included the $31 million pension settlement charge.
Outlook, management commentary, risks and unusual items
Management’s strategy is to expand premium-market positioning through organic growth and acquisitions while pursuing product innovation, manufacturing and sourcing efficiencies, distribution expansion, geographic growth and expense reduction. The filing does not provide quantitative 2017 revenue or earnings guidance.
- Demand is highly seasonal and weather-sensitive, with sales and segment profit generally higher in the second and third quarters. Cooler summers or warmer winters could reduce demand.
- Key operating risks include intense HVACR competition, U.S. residential and commercial construction cycles, commodity and component price volatility, supply interruptions, foreign exchange movements, international operations, labor disruptions, regulation and changing energy-efficiency and refrigerant standards.
- The company relies on estimates for extended product warranties, self-insurance, pensions, derivatives, goodwill and other contingencies. Warranty liabilities were $101.1 million at year-end 2016, compared with $92.3 million in 2015.
- Asbestos-related litigation expense increased to $6.3 million from $3.0 million. Environmental accruals were $5.6 million.
- The company self-reported an alleged $475 payment involving a Russian customs broker or official to the SEC and DOJ. The investigation was expanded to Poland and remained ongoing at filing; management did not expect a material adverse effect.
- The company reported an unfunded pension liability of $89.1 million and remains exposed to changes in discount rates, asset returns and required future contributions.
- Net sales outside the United States represented 18.5% of 2016 sales. A 10% change in foreign exchange rates was estimated to affect net income by approximately $4.0 million.
- Management and KPMG concluded that internal control over financial reporting and disclosure controls were effective as of December 31, 2016.
Most important facts for an investor to verify
- Whether the 2016 margin expansion from material-cost savings is sustainable as commodity prices, wages and freight costs change.
- How the $200 million senior-note maturity in 2017 was refinanced or repaid and whether leverage subsequently declined.
- Actual covenant headroom under the domestic credit facility and the effect of the high reported debt-to-total-capital ratio.
- Progress and potential financial exposure from the SEC/DOJ customs investigation involving Russia and Poland.
- Trends in the $101.1 million warranty liability, asbestos claims, environmental reserves and other litigation contingencies.
- Whether the company’s stated approximately 32% future tax rate and planned repurchases and dividends remain achievable.
- The impact of weather, construction activity, foreign exchange, refrigerant regulation and energy-efficiency rules on segment demand and profitability.