Lennox International Inc. — Q2 2020 Form 10-Q Summary
Business context and reporting period
Lennox International operates three HVACR segments: Residential Heating & Cooling, Commercial Heating & Cooling, and Refrigeration. This unaudited Form 10-Q covers the three and six months ended June 30, 2020, compared with the corresponding 2019 periods. Results were materially affected by the COVID-19 pandemic, including lower demand, supply-chain disruption, employee absenteeism, temporary facility suspensions, and higher health and safety costs.
Key financial metrics
| Metric | Q2 2020 | Q2 2019 | Six months 2020 | Six months 2019 |
|---|---|---|---|---|
| Net sales | $941.3 million | $1,099.1 million | $1,665.1 million | $1,889.4 million |
| Gross profit | $275.7 million | $332.1 million | $441.4 million | $533.6 million |
| Gross margin | 29.3% | 30.2% | 26.5% | 28.2% |
| Operating income | $136.0 million | $213.8 million | $172.3 million | $308.5 million |
| Operating margin | 14.4% | 19.5% | 10.3% | 16.3% |
| Net income | $100.0 million | $110.7 million | $112.9 million | $180.0 million |
| Diluted EPS from continuing operations | $2.62 | $2.81 | $2.93 | $4.53 |
| Net cash from operating activities | Not separately provided | Not separately provided | $6.5 million | $(111.0) million |
Q2 net sales declined 14.4%, primarily from a 15% volume decrease, partly offset by 1% favorable price and mix. Gross margin decreased 90 basis points due mainly to unfavorable price and mix, factory inefficiencies, and higher warranty costs. SG&A declined $23 million to $129.5 million, but operating income fell 36.4% because of lower volumes, factory inefficiencies, COVID-19 restructuring charges, and the absence of 2019 Marshalltown tornado insurance recoveries.
For the six months, operating cash flow was $6.5 million. Investing cash flow was $(44.3) million, including $43.5 million of capital expenditures. Financing cash flow was $52.3 million, including $100.0 million of share repurchases and $59.1 million of dividends.
Liquidity, debt, and balance sheet
- Cash and cash equivalents were $44.8 million at June 30, 2020, compared with $37.3 million at December 31, 2019; $21 million was held outside the United States.
- Total debt was $1.391 billion, up from $1.171 billion at year-end 2019. Current debt maturities were $343.6 million and long-term debt was $1.047 billion.
- The domestic credit facility had $702.5 million outstanding, $440.1 million available for future borrowings, and a maturity date in August 2021. The asset securitization program had $306.0 million outstanding and no remaining availability based on eligible receivables at June 30, 2020.
- The company reported compliance with its debt covenants and maintained investment-grade ratings of Baa3 from Moody’s and BBB from S&P, each with a stable outlook.
- Total stockholders’ deficit was $228.9 million, compared with $170.2 million at December 31, 2019. The debt-to-total-capital ratio was 119.7% at June 30, 2020.
Material changes versus the prior comparable period
- Residential Heating & Cooling: Q2 sales declined 6.4% to $644.8 million and segment profit declined 17.0% to $127.3 million. Six-month sales declined 5.9% and profit declined 33.4%, reflecting lower volumes and the loss of 2019 insurance proceeds.
- Commercial Heating & Cooling: Q2 sales declined 27.9% to $188.3 million and segment profit declined 34.0% to $35.6 million, primarily from lower volumes and unfavorable mix.
- Refrigeration: Q2 sales declined 27.2% to $108.2 million and segment profit declined 53.4% to $8.9 million. Six-month sales declined 29.5%, including the effect of the 2019 Kysor Warren divestiture, and profit declined 65.1%.
- Q2 included $10.0 million of restructuring charges and $3.4 million of COVID-19-related operating costs. Six-month restructuring charges were $10.5 million.
- Q2 2019 included $26.0 million of insurance proceeds for lost profits related to the Marshalltown tornado; no comparable proceeds were recorded in 2020. Q2 2019 also included a $60.6 million pension settlement charge, which did not recur in 2020.
- The company adopted the current expected credit loss standard in 2020, recording a $1.3 million reduction to retained earnings. It also recorded an $8.0 million first-quarter valuation allowance on certain foreign deferred tax assets.
Guidance, outlook, commentary, and risks
- Management expects 2020 revenue to decline 10% to 15%, compared with prior initial guidance for 4% to 8% growth and first-quarter expectations for an 11% to 17% decline.
- Management expects 2020 diluted EPS from continuing operations of $7.31 to $8.11 and operating cash flow of approximately $460 million.
- 2020 capital expenditure guidance was reduced from $153 million to $120 million. Quarterly dividend plans remained unchanged at $0.77 per share, or more than $115 million for the year.
- The company repurchased $100 million of stock in the first quarter and placed the remaining planned 2020 repurchases on hold, subject to review later in the year.
- Management expects the North America unitary HVAC and refrigeration market to decline approximately 20% in 2020. The duration and severity of COVID-19 impacts remain uncertain.
- Key risks include further demand weakness, supply-chain disruption, factory closures, employee absenteeism, additional health and safety costs, commodity and foreign-exchange volatility, warranty and product-quality costs, litigation, environmental liabilities, and refinancing or covenant risks.
- Product warranty liabilities were $116.9 million at June 30, 2020. Management stated that pending litigation was not expected to have a material aggregate effect, while noting that outcomes remain uncertain.
Important facts for investors to verify
- Whether COVID-19 demand, supply-chain, and factory disruptions cause results to fall outside the revised revenue and EPS ranges.
- Whether the company generates approximately $460 million of 2020 operating cash flow despite the low first-half result.
- The timing and terms of extending or refinancing the domestic credit facility before its August 2021 maturity and maintaining covenant compliance.
- Whether debt-funded liquidity and the $306.0 million asset securitization balance remain manageable through seasonal working-capital needs.
- Whether gross-margin pressure from lower volumes, factory inefficiencies, warranty costs, and price/mix persists.
- Whether the company resumes share repurchases while continuing its stated dividend plans.
- The realization of foreign tax assets, the adequacy of warranty and litigation reserves, and the effect of unusual items that affected 2019 comparability.