Lennox International Inc. — Q1 2015 Form 10-Q Summary
Business context and reporting period
Lennox International operates in three HVACR segments: Residential Heating & Cooling, Commercial Heating & Cooling, and Refrigeration. The report covers the 13 weeks ended March 31, 2015, compared with the same period in 2014. Results are seasonal and affected by weather, construction activity, economic conditions, foreign exchange, and commodity prices.
Key financial metrics
| Metric | Q1 2015 | Q1 2014 | Change |
|---|---|---|---|
| Net sales | $685.8 million | $695.4 million | Down 1.4% |
| Gross profit | $163.0 million | $168.1 million | Down 3.0% |
| Gross margin | 23.8% | 24.2% | Down 40 bps |
| Operational income from continuing operations | $27.0 million | $33.9 million | Down 20.4% |
| Income from continuing operations | $14.0 million | $19.9 million | Down 29.6% |
| Net income | $13.9 million | $19.9 million | Down 30.2% |
| Diluted EPS from continuing operations | $0.31 | $0.40 | Down $0.09 |
| Net cash used in operating activities | $122.2 million | $125.0 million | Improved $2.8 million |
| Capital expenditures | $18.0 million | $17.3 million | Increased $0.7 million |
SG&A was $133.4 million, or 19.5% of sales, versus $135.6 million, or 19.5%, in the prior-year quarter. The effective tax rate was 34.3%, compared with 35.0%. Interest expense increased to $5.7 million from $3.3 million due to higher average borrowings.
At March 31, 2015, cash and cash equivalents were $36.7 million. Total debt was $1.086 billion, including $185.3 million of short-term debt and $900.5 million of current maturities and long-term debt. The company had $239.3 million available under its domestic credit facility and $258.7 million of total stated debt capacity available, including foreign facilities. Stockholders’ equity was negative $16.2 million, compared with positive $9.0 million at December 31, 2014.
Material changes versus the prior comparable period
- Sales declined primarily from a 3% unfavorable foreign-exchange impact, partially offset by 2% volume growth and improved price and mix.
- Residential Heating & Cooling sales increased 6% to $362.5 million, while segment profit increased 28% to $31.2 million, aided by volume growth and material cost savings.
- Commercial Heating & Cooling sales decreased 8% to $159.9 million and segment profit decreased 25% to $7.7 million, primarily from National Account timing, foreign exchange, distribution investments, and VRF start-up costs.
- Refrigeration sales decreased 9% to $163.4 million and segment profit decreased 67% to $4.0 million, reflecting foreign exchange, the Australian carbon levy repeal, unfavorable mix, lower Australian refrigerant profitability, and factory investments.
- Gross margin declined despite $2.4 million of margin benefit from lower material costs. Offsetting factors included unfavorable mix and price, lower Australian refrigerant pricing, distribution investments, and higher product costs.
- Losses and other expenses increased to $5.6 million from $2.4 million, including $3.4 million of special legal contingency charges and $0.7 million of environmental liabilities.
- Foreign currency translation losses contributed to a $25.2 million decline in other comprehensive income and reduced accumulated other comprehensive loss to negative $178.7 million.
- Total debt increased from $925.6 million at year-end 2014 to $1.086 billion, while debt-to-total-capital increased from 99.0% to 101.5%.
- The company repurchased 191,979 shares for $20.5 million to satisfy employee tax-withholding obligations. Approximately $395.9 million remained authorized under share repurchase plans, after consideration of a $450 million accelerated share repurchase program.
Guidance, outlook, risks, and unusual items
- Management expected 2015 capital expenditures of approximately $85 million and dividend payments of $55 million to $60 million. The filing does not provide explicit full-year revenue or earnings guidance.
- Management stated that cash, expected operating cash flow, and available borrowings should be sufficient for operations, capital expenditures, contractual obligations, dividends, and share repurchases in the foreseeable future.
- Working capital requirements are seasonally higher in the first and second quarters. Q1 operating cash usage was driven principally by increases in receivables and inventories.
- The company had $180.0 million outstanding under its asset securitization program, with no remaining availability at March 31, 2015. The program was scheduled to renew in November 2015.
- The domestic credit facility matures in November 2019; its $300 million term loan requires quarterly principal repayments of $7.5 million beginning June 30, 2015. The company reported compliance with all debt covenants.
- Credit ratings were Baa3 with a negative outlook from Moody’s and BBB with a stable outlook from S&P.
- Material contingencies included a $2.2 million accrual for a supplier quality issue, offset by a corresponding receivable, a $2.4 million accrual for tentative settlement terms in an evaporator-coil class action, asbestos-related litigation expense of $0.1 million, and environmental remediation liabilities.
- Product warranty liabilities totaled $86.6 million at March 31, 2015. Management stated that litigation was not expected to have a material adverse effect, although outcomes remain uncertain.
- Commodity prices, foreign exchange, weather, refrigerant pricing, customer demand, construction activity, and the timing of National Account shipments were identified as important operating risks.
- The company was not currently hedged against interest-rate risk. Commodity futures and foreign-currency forwards were used to manage portions of commodity and currency exposure.
- Management reported no material changes to the risk factors disclosed in the 2014 Form 10-K and concluded that disclosure controls and procedures were effective.
Most important facts for investors to verify
- Whether residential momentum offsets continued weakness in Commercial Heating & Cooling and Refrigeration.
- The effect of foreign-exchange movements, Australian refrigerant pricing, and the Australian carbon levy repeal on subsequent quarters.
- Inventory and receivables growth, seasonal working-capital needs, and the company’s ability to generate positive operating cash flow.
- Debt reduction, term-loan repayments, asset-securitization renewal, covenant headroom, and credit-rating developments.
- The ultimate cost and timing of the evaporator-coil settlement, supplier quality issue, environmental liabilities, and other legal contingencies.
- Execution of the $85 million capital-expenditure plan, the accelerated share repurchase settlement, and planned dividend payments.