Lennox International Inc. — Q1 2013 Form 10-Q Summary
Business Context and Reporting Period
Lennox International Inc. reported results for the 13 weeks ended March 31, 2013. The company operates in three HVACR segments: Residential Heating & Cooling, Commercial Heating & Cooling, and Refrigeration. Results are seasonal and affected by weather, construction, replacement demand, consumer spending, commodity prices, and foreign exchange.
Service Experts was sold on March 22, 2013, and is presented as discontinued operations. Prior-period segment and financial information was revised where applicable.
Key Financial Metrics
| Metric | Q1 2013 | Q1 2012 | Change |
|---|---|---|---|
| Net sales | $668.4 million | $614.4 million | +8.8% |
| Gross profit / margin | $162.0 million / 24.2% | $140.9 million / 22.9% | Margin +130 bps |
| Operational income from continuing operations | $27.9 million | $18.9 million | +47.6% |
| Income from continuing operations | $15.8 million | $9.3 million | +69.9% |
| Net income (loss) | $8.0 million | $(6.1) million | Improved |
| Diluted EPS from continuing operations | $0.31 | $0.18 | +$0.13 |
| Diluted net EPS | $0.16 | $(0.12) | Improved |
| Cash used in operating activities | $(137.3) million | $(34.3) million | Greater use of cash |
| Capital expenditures | $12.1 million | $6.6 million | Higher investment |
Gross margin benefited from favorable price and mix, material-cost savings, and higher volume, partly offset by higher freight and distribution costs. SG&A increased to $135.6 million from $123.2 million, primarily because of higher incentive compensation.
Segment Performance
| Segment | Q1 2013 Sales | Sales Change | Q1 2013 Profit | Profit Change |
|---|---|---|---|---|
| Residential Heating & Cooling | $314.5 million | +15.4% | $20.5 million | +$9.5 million |
| Commercial Heating & Cooling | $163.0 million | +4.0% | $11.1 million | +$2.8 million |
| Refrigeration | $190.9 million | +3.1% | $16.7 million | +$2.5 million |
Residential performance was driven by new-construction and replacement demand. Commercial results benefited from national-account volume and favorable price and mix. Refrigeration benefited from Australian wholesale refrigerant operations, including lower-cost inventory purchases and related investments, while some supermarket customers reduced order rates.
Cash Flow, Debt, and Liquidity
- Cash and cash equivalents were $34.9 million at March 31, 2013, compared with $51.8 million at December 31, 2012; approximately $21 million was held outside the United States.
- Operating cash usage reflected seasonal inventory builds, higher receivables, incentive-compensation payments, and annual volume rebates. Inventories increased to $464.3 million from $374.8 million, and receivables increased to $407.0 million from $373.4 million.
- Total debt was $516.4 million, up from $386.6 million at year-end. The debt-to-total-capital ratio increased to 53.3% from 43.8%.
- The $650 million domestic revolving credit facility had $274.0 million outstanding, $49.9 million committed to standby letters of credit, and $326.1 million available for future borrowings. The $160 million asset securitization program had $20.0 million outstanding and $140.0 million available.
- The company stated that cash, available borrowing capacity, and expected operating cash flow were sufficient for foreseeable operating, capital, dividend, and repurchase needs. It expected approximately $60 million of 2013 capital expenditures.
- Management targeted approximately $100 million of 2013 share repurchases and more than $30 million of dividend payments. No shares were repurchased under the announced plans during the quarter.
Material Changes and Unusual Items
- Service Experts was sold for $10.4 million in cash proceeds, including a $3.8 million working-capital adjustment expected in the second quarter. The transaction generated a $1.7 million gain, but the business recorded a $15.1 million pre-tax operating loss through the sale date, including $2.3 million of retention and severance costs.
- Discontinued operations generated a $7.8 million after-tax loss in Q1 2013 versus a $15.4 million loss in Q1 2012. The prior period also included the Hearth business and a $6.3 million asset write-down.
- Comprehensive loss was $41.3 million, primarily because $41.1 million of foreign-currency translation gains were reclassified into discontinued-operations earnings upon the Service Experts sale, along with other currency, derivative, and securities losses.
- Restructuring charges declined to $0.5 million from $2.6 million. Approximately $0.6 million of additional costs remained expected for the regional distribution-network project.
- First-quarter 2013 included a $0.6 million net asbestos-related charge, a $0.2 million patent-litigation contingency charge, and $0.2 million of special product-quality adjustments.
- Product warranty liabilities were $73.8 million, and accrued non-warranty product-quality issues were $6.1 million. Additional charges may arise as information develops.
Guidance, Outlook, and Risks
Management did not provide a specific full-year revenue or earnings forecast in the filing. Management expected seasonal working-capital needs to remain elevated into the peak cooling season and stated that the company typically pays down debt as the season progresses. Management also cited continued focus on commodity hedging, pricing, manufacturing, sourcing, engineering, and distribution initiatives.
- Demand is sensitive to weather, construction activity, financing availability, employment, consumer confidence, and replacement cycles.
- Steel, copper, and aluminum price volatility may affect margins despite hedging, pricing actions, and cost controls.
- Product warranty, product-quality, product-liability, asbestos, patent, and other litigation exposures could result in future costs. Management did not expect current matters to materially affect financial condition, but outcomes remain uncertain.
- Debt agreements, the asset securitization program, and the renewed headquarters lease contain financial covenants and cross-default provisions. The company reported compliance as of March 31, 2013.
- The company was no longer hedged against benchmark interest-rate risk after its interest-rate swap expired in October 2012, leaving variable-rate debt exposed to rate movements.
Facts Investors Should Verify
- Whether the substantial first-quarter operating cash outflow reverses as seasonal inventory converts to sales and receivables are collected.
- Debt reduction, leverage, covenant compliance, and revolver availability through the summer peak season.
- The sustainability of margin gains from pricing, mix, commodity costs, and Australian refrigerant operations.
- Final proceeds and working-capital adjustment from the Service Experts divestiture and any remaining separation costs.
- Potential changes to warranty, product-quality, asbestos, patent-litigation, and other contingent liabilities.
- Execution of the stated 2013 capital-expenditure, dividend, and share-repurchase plans.