Lennox International Inc. — Form 10-Q Summary
Reporting period: Three and six months ended June 30, 2014. The filing covers Lennox’s Residential Heating & Cooling, Commercial Heating & Cooling, and Refrigeration segments. Results are seasonal and materially affected by weather, construction activity, replacement demand, commodity costs, foreign exchange, and customer financing conditions.
Financial performance
| Metric | Three months ended June 30 | Six months ended June 30 |
|---|---|---|
| Net sales | $960.7 million; up 5.2% | $1,656.1 million; up 4.7% |
| Gross profit | $262.6 million; 27.3% margin | $430.7 million; 26.0% margin |
| Operational income from continuing operations | $119.1 million; 12.4% margin | $153.0 million; 9.2% margin |
| Income from continuing operations | $74.6 million | $94.5 million |
| Net income | $73.9 million | $93.8 million |
| Diluted EPS from continuing operations | $1.50 | $1.90 |
| Diluted net EPS | $1.49 | $1.89 |
| Cash dividends declared per share | $0.30 | $0.54 |
- Second-quarter sales growth reflected approximately 5% higher volume and 1% favorable price and mix, partly offset by a 1% unfavorable foreign-exchange effect.
- Second-quarter gross margin declined 50 basis points, primarily because of mix, warranty accrual comparisons, foreign exchange, and investments in distribution and growth initiatives. Material cost savings and pricing were favorable offsets.
- SG&A declined to 15.5% of sales in the second quarter from 16.6% in the prior-year quarter and to 17.2% from 18.1% for the first half, primarily due to lower incentive compensation.
- The effective tax rate was 35.4% in the second quarter and 35.3% for the first half, compared with 35.2% in both prior-year periods.
Segment results
| Segment | Second-quarter sales | Second-quarter profit | Six-month sales | Six-month profit |
|---|---|---|---|---|
| Residential Heating & Cooling | $527.7 million; up 10.8% | $85.0 million; up 28.4% | $869.8 million; up 10.0% | $109.4 million; up 26.2% |
| Commercial Heating & Cooling | $241.0 million; up 5.0% | $39.0 million; up 12.7% | $414.0 million; up 5.0% | $49.2 million; up 7.7% |
| Refrigeration | $192.0 million; down 7.4% | $13.7 million; down 46.9% | $372.3 million; down 6.5% | $25.8 million; down 39.3% |
Residential performance benefited from industry growth, market-share gains, volume, material savings, and pricing. Commercial results reflected broad-based North American volume and share gains. Refrigeration was pressured by lower North American volume, weak supermarket and Australian wholesale activity, unfavorable mix, and foreign exchange.
Cash flow, liquidity, and debt
- Net cash used in operating activities was $73.4 million for the first six months, compared with $88.3 million in 2013. Seasonal working-capital investment included $168.2 million of receivables growth and $133.0 million of inventory growth.
- Capital expenditures were $41.2 million, compared with $23.4 million in the prior-year period, primarily for residential manufacturing capacity, systems and software, and distribution expansion.
- Financing activities provided $125.1 million, including net revolving-credit borrowings, while the company repurchased $50.0 million of common stock, repurchased $10.8 million for employee tax withholding, and paid $23.6 million of dividends.
- Cash and cash equivalents were $49.6 million at June 30, 2014, including $29.6 million held outside the United States. Management stated that cash, operating cash generation, and available borrowings should be sufficient for foreseeable needs.
- Total debt was $606.7 million, compared with $400.4 million at December 31, 2013. Debt-to-total-capital increased to 53.9% from 45.2%.
- Debt consisted principally of $180.0 million under the asset securitization program, $203.0 million drawn on the $650.0 million domestic revolving facility, $200.0 million of 4.90% senior unsecured notes due 2017, and capital lease obligations.
- Available future borrowings were $419.4 million under the domestic revolving facility and $22.7 million under foreign obligations; the asset securitization program was fully utilized at $180.0 million. The company was in compliance with applicable debt covenants.
Material changes, outlook, and unusual items
- Net income increased $9.6 million for the quarter and $21.5 million for the first half, while diluted EPS from continuing operations increased from $1.26 to $1.50 and from $1.57 to $1.90, respectively. Share repurchases reduced diluted weighted-average shares to 49.6 million from 50.9 million in the quarter.
- Discontinued operations generated a $0.7 million loss in the second quarter and first half of 2014, compared with a $7.8 million loss in the first half of 2013, primarily related to previously sold businesses.
- Restructuring charges were $0.2 million in the second quarter and $0.3 million for the first half, versus $2.4 million and $2.9 million, respectively, in the prior-year periods. Total expected restructuring charges for ongoing activities were approximately $9.9 million.
- The company expects 2014 capital expenditures of approximately $90 million, share repurchases of approximately $150 million, and dividend payments of $50 million to $55 million. The filing does not provide a specific revenue or earnings forecast.
- Management expected North American supermarket refrigeration activity to improve in the second half based on new national-account business, but anticipated a negative second-half profitability impact in the Australian refrigerant business following repeal of the carbon tax.
- Product warranty liabilities were $85.3 million at June 30, 2014, and accrued product-quality liabilities for a heating and cooling product line were $4.3 million. Additional product-quality charges may be incurred.
- The company faces an attempted class-action lawsuit concerning corrosion and leaks in evaporator coils. Management stated that the outcome and potential financial impact cannot reasonably be estimated.
- Commodity prices, foreign exchange, interest rates, weather, seasonal working-capital needs, and economic conditions remain material exposures. The company is not currently hedged against interest-rate risk.
- The company adopted no early application of the new revenue-recognition standard; it was evaluating the impact and had not selected a transition method as of the filing date.
Investor verification checklist
- Verify whether refrigeration weakness and Australian carbon-tax effects improved or worsened relative to management’s second-half expectations.
- Track debt reduction, revolver utilization, asset-securitization dependence, covenant compliance, and the effect of leverage on capital allocation.
- Assess whether seasonal receivables and inventory growth converted into operating cash flow in the second half.
- Review warranty and product-quality claims, including the evaporator-coil litigation and potential unrecorded exposure.
- Compare actual capital expenditures, share repurchases, dividends, and revenue or earnings performance with the disclosed 2014 capital-allocation targets.
- Monitor commodity costs, foreign-exchange movements, weather-driven demand, and the implementation impact of the new revenue-recognition standard.