Lennox International Inc. — Q1 2020 Form 10-Q Summary
Business context and reporting period
Lennox International Inc. operates three HVACR segments: Residential Heating & Cooling, Commercial Heating & Cooling, and Refrigeration. This unaudited Form 10-Q covers the three months ended March 31, 2020, compared with the three months ended March 31, 2019. Results were materially affected by the COVID-19 pandemic, including supply-chain disruption, employee absenteeism, factory inefficiencies, and temporary facility suspensions.
Financial performance and key metrics
| Metric | Q1 2020 | Q1 2019 | Change |
|---|---|---|---|
| Net sales | $723.8 million | $790.3 million | Down 8.4% |
| Gross profit | $165.7 million | $201.6 million | Down 17.8% |
| Gross margin | 22.9% | 25.5% | Down 260 bps |
| Operating income | $36.4 million | $94.7 million | Down 61.6% |
| Operating margin | 5.0% | 12.0% | Down 700 bps |
| Income from continuing operations | $12.5 million | $69.4 million | Down 82.0% |
| Net income | $12.9 million | $69.3 million | Down 81.4% |
| Diluted EPS from continuing operations | $0.32 | $1.73 | Down $1.41 |
| Cash used in operating activities | $98.8 million | $141.0 million | Improved by $42.2 million |
Cost of goods sold declined to $558.1 million but increased to 77.1% of sales from 74.5%. SG&A declined to $131.1 million and represented 18.1% of sales versus 18.4% in the prior year. The effective tax rate increased to 52.8% from 16.4%, primarily because of an $8 million valuation allowance on certain foreign deferred tax assets related to COVID-19 effects.
At March 31, 2020, cash and cash equivalents were $39.1 million, short-term investments were $3.7 million, and total debt was $1.442 billion, including $252.3 million of current maturities and $1.190 billion of long-term debt. Available borrowing capacity under the domestic credit facility was $312.1 million, while the asset securitization program had no remaining availability based on eligible receivables. The company reported compliance with its debt covenants and maintained investment-grade ratings.
Segment results and material changes
| Segment | Q1 2020 sales | Year-over-year sales | Q1 2020 profit | Year-over-year profit |
|---|---|---|---|---|
| Residential Heating & Cooling | $442.1 million | Down 5.0% | $32.5 million | Down $54.2 million |
| Commercial Heating & Cooling | $178.4 million | Up 2.9% | $18.7 million | Up $3.6 million |
| Refrigeration | $103.3 million | Down 31.8% | $0.7 million | Down $7.7 million |
- Approximately half of the consolidated sales decline was attributed to the 2019 divestiture of Kysor Warren; the divestiture reduced Refrigeration sales by approximately 23%.
- Consolidated gross margin declined because of lower volumes, factory inefficiencies, and higher other product costs. These pressures were partly offset by lower commodity costs, lower tariffs, and sourcing and engineering savings.
- Residential segment profit included approximately $40 million of nonrecurring Marshalltown tornado insurance proceeds recognized in Q1 2019.
- Q1 2019 included a $8.5 million loss on the sale of Kysor Warren, $39.5 million of insurance proceeds for lost profits, and a $6.9 million net gain related to the Marshalltown tornado. These items did not recur in the same manner in Q1 2020.
- Cash used in operating activities improved year over year because of the timing of working-capital payments, although the business continued to use cash seasonally. Capital expenditures were $24.7 million versus $37.2 million in Q1 2019.
- The company repurchased $100 million of common stock under an accelerated share repurchase agreement and paid $29.7 million in dividends. Stockholders’ deficit increased to $318.3 million from $170.2 million at year-end 2019.
Guidance, outlook, risks, and unusual items
- Management estimated that the North America unitary HVAC and refrigeration market could decline approximately 20% in 2020 because of the pandemic.
- 2020 revenue guidance was revised to a decline of 11% to 17%, compared with prior guidance for growth of 4% to 8%.
- Expected 2020 diluted EPS from continuing operations was $7.07 to $8.07.
- Management projected approximately $460 million of 2020 operating cash flow and reduced planned capital expenditures from $153 million to $120 million.
- The company planned approximately $115 million of SG&A savings for the balance of 2020. It expected approximately $10 million of pretax second-quarter charges for severance, benefits, and facility exit costs.
- Quarterly dividend plans were unchanged at $0.77 per share. Planned second-quarter share repurchases were placed on hold, with later repurchases subject to review.
- COVID-19 may materially adversely affect operations, financial position, and cash flows through additional supply-chain disruption, absenteeism, facility closures, weaker demand, and uncertain recovery timing.
- Other risks include commodity-price volatility, foreign exchange movements, variable-rate debt, warranty obligations, litigation including asbestos-related claims, environmental liabilities, and potential debt cross-default provisions.
- The company adopted the expected-credit-loss standard in 2020, recording a $1.3 million reduction to retained earnings. It also reported $9.6 million of net unrealized cash-flow-hedge losses in accumulated other comprehensive loss, with $7.7 million expected to be reclassified into earnings within 12 months assuming market prices remain constant.
Important facts for investors to verify
- Whether the revised 2020 revenue and EPS guidance remains achievable as COVID-19 impacts demand, production, and supply chains.
- Actual availability under the domestic credit facility and asset securitization program, as well as compliance with leverage and interest-coverage covenants.
- The pace and sustainability of planned SG&A savings and the approximately $10 million of anticipated second-quarter restructuring-related charges.
- Working-capital trends, inventory levels, operating cash flow, and the ability to fund dividends while share repurchases are paused or resumed.
- Potential further impairment or valuation-allowance charges on foreign deferred tax assets and the resulting effective tax rate.
- Exposure to hedge losses, commodity prices, foreign exchange, warranty claims, litigation, and environmental remediation.
- The filing’s COVID-19 market assumptions and the comparability of year-over-year results given the 2019 Kysor Warren divestiture and Marshalltown insurance recoveries.