Lennox International Inc. 2019 Form 10-K Summary
Business context and reporting period
Lennox International is a global HVACR manufacturer and service provider operating through Residential Heating & Cooling, Commercial Heating & Cooling, and Refrigeration. This filing covers the fiscal year ended December 31, 2019. The company’s business is seasonal, with demand and profits generally strongest in the second and third quarters.
For fourth quarter 2019, net sales were $885.0 million, net income was $114.0 million, diluted EPS was $2.93, and gross profit was $247.8 million.
Key financial metrics
| Metric | 2019 | 2018 | Change |
|---|---|---|---|
| Net sales | $3,807.2 million | $3,883.9 million | Down 2.0% |
| Gross profit / margin | $1,079.8 million / 28.4% | $1,111.2 million / 28.6% | Margin down 20 bps |
| Operating income / margin | $656.9 million / 17.3% | $509.9 million / 13.1% | Up 28.8% |
| Net income / margin | $408.7 million / 10.7% | $359.0 million / 9.2% | Up 13.8% |
| Diluted EPS from continuing operations | $10.38 | $8.77 | Up 18.4% |
| Operating cash flow | $396.1 million | $495.5 million | Down $99.4 million |
| Capital expenditures | $105.6 million | $95.2 million | Up $10.4 million |
| Total debt | $1,171.2 million | $1,041.3 million | Up $129.9 million |
| Cash and cash equivalents | $37.3 million | $46.3 million | Down $9.0 million |
Residential Heating & Cooling sales increased 3.0% to $2,291.1 million and segment profit increased 16.3% to $464.6 million. Commercial Heating & Cooling sales increased 5.2% to $947.4 million and segment profit increased 5.0% to $165.4 million. Refrigeration sales declined 25.0% to $568.7 million and segment profit declined 10.0% to $61.3 million.
At year-end, current assets were $1,120.9 million versus current liabilities of $1,002.7 million. The balance sheet included $181.6 million of operating lease right-of-use assets and $183.7 million of operating lease liabilities recognized following adoption of ASC 842.
Material changes versus the prior comparable period
- Consolidated sales declined primarily because of the divestitures of the Australia, Asia, South America, and Kysor Warren businesses. Underlying volume increased 1%, while price and mix contributed 2%.
- Operating income benefited from higher residential and commercial sales, sourcing and engineering cost reductions, and a larger Marshalltown tornado insurance recovery.
- Gross margin declined because of higher commodity costs, freight and distribution costs, and factory inefficiencies, partially offset by pricing, mix, cost reductions, and the divestiture of lower-margin businesses.
- Operating cash flow fell because of increased working capital, including higher inventories and receivables and lower accounts payable.
- Net interest expense increased to $47.5 million from $38.3 million, reflecting higher average borrowings.
- The effective tax rate declined to 19.5% from 23.0%. Management expects a future effective tax rate of approximately 21% to 22%, excluding excess tax benefits.
- The company completed the sale of Kysor Warren on March 29, 2019, receiving $49.0 million of cash and recording a $10.6 million loss on sale.
- The company adopted ASC 842 lease accounting on January 1, 2019, materially increasing reported assets and liabilities without changing prior-period income statements.
Guidance, outlook, commentary, risks and unusual items
Management expected approximately $153 million of 2020 capital expenditures, including $53 million to complete reconstruction of the Marshalltown, Iowa facility. Management also stated that it expected to repurchase approximately $400 million of shares in 2020. At December 31, 2019, $546 million remained available under the company’s repurchase authorizations.
Liquidity was supported by $37.3 million of cash, operating cash generation, $652.1 million of available borrowing capacity under the domestic credit facility, and $35.0 million of remaining capacity under the asset securitization program. The company reported compliance with its debt covenants. The domestic credit facility required a Consolidated Indebtedness to Adjusted EBITDA ratio of no more than 3.5:1 and a Cash Flow to Interest Expense ratio of at least 3.0:1.
- The Marshalltown tornado generated cumulative insurance recoveries of $367.5 million. In 2019, the company received $243.2 million and recorded a net gain of $178.8 million after $64.4 million of related expenses. The 2019 gain included $99.2 million for lost profits and $79.6 million for property damage.
- The company recorded $99.2 million of pension settlement charges in 2019 after transferring certain pension obligations to Pacific Life through group annuity contracts.
- Restructuring charges were $10.3 million, primarily related to store closures, workforce reductions, and resource and product portfolio realignment.
- Key risks include cyclical construction demand, weather-driven seasonality, commodity and component prices, tariffs and trade policy, supply-chain concentration, foreign currency, international operations, regulatory changes affecting energy efficiency and refrigerants, product warranty and liability claims, cybersecurity, labor relations, pension funding, and litigation.
- The company identified approximately 24 Chinese suppliers and operations in China in its coronavirus-related risk discussion; the filing stated that the potential financial impact was uncertain as of the filing date.
- Product warranty liabilities were $112.8 million at year-end, and the external auditor identified evaluation of the warranty liability as a critical audit matter.
KPMG issued an unqualified opinion on the consolidated financial statements and internal control over financial reporting. Management concluded that internal controls were effective as of December 31, 2019.
Most important facts for an investor to verify
- How much of 2019 earnings and segment profit was attributable to the nonrecurring Marshalltown insurance recovery and how results perform without that benefit.
- Whether the expected 2020 capital expenditures, Marshalltown completion costs, and planned $400 million share repurchases are consistent with operating cash flow.
- The company’s debt maturities, variable-rate exposure, covenant headroom, and reliance on receivables securitization; $322.8 million of debt principal was scheduled for payment in 2020.
- Whether residential and commercial growth offsets the continuing effects of refrigeration divestitures and whether Refrigeration margins remain sustainable.
- Trends in inventory, receivables, working capital, commodity costs, freight, factory productivity, tariffs, and warranty claims.
- The ultimate financial effects of coronavirus-related supply-chain disruption, regulatory changes involving refrigerants and efficiency standards, and unresolved legal, environmental, asbestos, and pension obligations.