Lennox International Inc. Form 10-Q Summary
Reporting period: Three and nine months ended September 30, 2014. The company operates in Residential Heating & Cooling, Commercial Heating & Cooling, and Refrigeration. Results are seasonal and affected by weather, construction, replacement demand, commodity prices, foreign exchange, and economic conditions.
Financial performance
| Metric | Q3 2014 | Q3 2013 | 9M 2014 | 9M 2013 |
|---|---|---|---|---|
| Net sales | $898.4 million | $868.0 million | $2,554.6 million | $2,449.5 million |
| Gross profit | $247.1 million | $237.4 million | $677.9 million | $653.4 million |
| Gross margin | 27.5% | 27.4% | 26.5% | 26.7% |
| Operational income from continuing operations | $106.6 million | $103.8 million | $259.6 million | $234.1 million |
| Operational margin | 11.9% | 12.0% | 10.2% | 9.6% |
| Income from continuing operations | $67.5 million | $65.8 million | $162.0 million | $145.9 million |
| Net income | $67.4 million | $64.3 million | $161.2 million | $136.6 million |
| Diluted EPS from continuing operations | $1.38 | $1.30 | $3.27 | $2.87 |
- Third-quarter sales increased 3.5%, driven by approximately 3% higher volume and 1% favorable price and mix.
- Nine-month sales increased 4.3%, with volume up 4%, partly offset by approximately 1% unfavorable foreign currency effects.
- Q3 gross margin improved 10 basis points, primarily from lower material costs and volume. Nine-month gross margin declined 20 basis points because of foreign exchange, unfavorable price and mix, distribution investments, and higher other product costs.
- The effective tax rate was 34.2% in the third quarter and 34.8% for the first nine months, compared with 34.2% and 34.7%, respectively, in the comparable periods.
- Cash dividends declared were $0.30 per share in Q3 and $0.84 per share for the first nine months, compared with $0.24 and $0.68 in the prior-year periods.
Segment results
| Segment | Q3 sales | Q3 profit | Q3 profit margin | 9M sales | 9M profit |
|---|---|---|---|---|---|
| Residential Heating & Cooling | $462.6 million, up 6.6% | $69.4 million, up 21.8% | 15.0% | $1,332.5 million, up 8.8% | $178.8 million, up 24.4% |
| Commercial Heating & Cooling | $241.6 million, up 1.0% | $42.2 million, up 7.7% | 17.5% | $655.6 million, up 3.8% | $91.3 million, up 7.7% |
| Refrigeration | $194.2 million, down 0.4% | $16.5 million, down 31.0% | 8.5% | $566.5 million, down 4.5% | $42.3 million, down 36.4% |
Residential performance benefited from industry growth, market-share gains, volume, material savings, and favorable pricing. Commercial results benefited from North American service volumes and material savings, partly offset by VRF market-entry and distribution costs. Refrigeration was pressured by weaker North American supermarket and Australian wholesale activity, unfavorable mix, foreign exchange, growth investments, and the repeal of Australia’s carbon tax.
Cash flow, liquidity, and debt
- Cash provided by operating activities was $23.5 million for the first nine months, down from $65.0 million in 2013. The decline reflected seasonal working-capital needs and higher income-tax payments, partly offset by higher earnings.
- Capital expenditures were $59.9 million, compared with $41.0 million, mainly for Residential Heating & Cooling capacity, enterprise systems, and distribution infrastructure. Management expected approximately $90 million of capital expenditures for full-year 2014.
- Cash and cash equivalents were $48.1 million at September 30, compared with $38.0 million at December 31, 2013. Approximately $31.5 million was held outside the United States.
- Total debt was $596.0 million, compared with $400.4 million at year-end 2013. Debt-to-total-capital increased to 54.3% from 45.2%.
- Debt included $220.0 million under the asset securitization program, $149.0 million under the domestic revolving credit facility, $200.0 million of senior unsecured notes, and other obligations.
- The $650.0 million revolving facility had $473.8 million available after borrowings and standby letters of credit. The asset securitization program was fully utilized at $220.0 million.
- The company stated that cash, expected operating cash flow, and available borrowings were sufficient for foreseeable operating needs, capital expenditures, contractual obligations, dividends, and share repurchases. The company was in compliance with debt covenants.
Material changes and unusual items
- Share repurchases totaled $100.3 million under authorized plans during the first nine months, plus $12.3 million of employee tax-withholding-related repurchases. Approximately $145.9 million remained available under the existing authorization at September 30.
- Restructuring charges were $1.3 million for the first nine months, compared with $3.2 million in 2013. Total expected charges under ongoing programs were approximately $10.1 million.
- Losses and other expenses included legal contingency charges, asbestos-related litigation, environmental liabilities, foreign exchange effects, and commodity-derivative losses. The company recorded $3.5 million for the first nine months versus $2.8 million in 2013.
- Product warranty liabilities increased to $86.1 million from $81.6 million at year-end. Accrued liabilities for identified product-quality issues were $4.1 million and could increase as additional information becomes available.
- The annual goodwill impairment testing date was changed from March 31 to December 31. Management recorded no impairment but noted that the revised timing may result in impairment charges being identified in the fourth quarter.
- Discontinued operations generated a loss of $0.8 million for the first nine months, compared with a $9.3 million loss in 2013. The related businesses had previously been sold.
- On October 17, 2014, the board authorized an additional $700.0 million for share repurchases. On October 20, the company announced a planned $450.0 million accelerated share repurchase program and entered into a short-term facility allowing borrowings of up to $250.0 million, due March 31, 2015, subject to conditions.
Outlook, risks, and contingencies
- Management expected North American supermarket refrigeration activity to improve in the fourth quarter based on national-account business won during 2014.
- Management expected the repeal of Australia’s carbon tax to negatively affect the profitability of the Australian refrigerant business for the remainder of 2014.
- Key operating risks include weather-driven seasonality, construction and replacement demand, commodity prices, foreign exchange, interest rates, customer financing, economic conditions, and the execution of distribution and growth investments.
- The company uses commodity futures and foreign-currency forwards but was not currently hedged against interest-rate risk. Commodity hedge losses of approximately $2.5 million were expected to be reclassified into earnings within the next 12 months, assuming commodity prices remained constant.
- The company faces product-quality, warranty, asbestos-related, environmental, legal, and class-action claims. Management did not expect these matters to have a material adverse effect, but the evaporator-coil corrosion class action had an uncertain and not reasonably estimable outcome.
- The company was under examination for U.S. federal income taxes for 2013 and 2014 and remained subject to examinations by other tax authorities.
- Management reported no material changes to previously disclosed risk factors, and disclosure controls and procedures were effective as of September 30, 2014.
Facts investors should verify
- Whether Refrigeration profitability stabilizes after the Australian carbon-tax repeal and weakness in North American supermarket markets.
- Whether the planned $450.0 million accelerated share repurchase increases leverage without constraining investment or liquidity.
- Progress toward the $90 million 2014 capital-expenditure plan and the effect of distribution and manufacturing investments on margins.
- Fourth-quarter goodwill impairment testing results following the change in testing date.
- Cash conversion and working-capital trends, particularly receivables and inventories, which rose materially during the seasonal period.
- Developments in the evaporator-coil class action, product-quality claims, asbestos litigation, environmental matters, and tax examinations.
- The eventual impact and transition method selected for the new revenue-recognition standard effective January 1, 2017.