Lennox International Inc. — Form 10-Q Summary
Business context and reporting period
Lennox International operates four HVACR segments: Residential Heating & Cooling, Commercial Heating & Cooling, Service Experts, and Refrigeration. The filing covers the three and nine months ended September 30, 2011, compared with the respective 2010 periods. Results are seasonal and sensitive to weather, consumer spending, construction, financing availability, commodity costs, and foreign exchange.
Financial performance and position
| Metric | Q3 2011 | Q3 2010 | Change |
|---|
| Net sales | $923.0 million | $818.2 million | +12.8% |
| Gross profit | $231.1 million | $232.8 million | -0.7% |
| Gross margin | 25.0% | 28.5% | -350 bps |
| Operating income | $54.5 million | $66.6 million | -18.2% |
| Net income | $33.8 million | $41.8 million | -19.1% |
| Diluted EPS from continuing operations | $0.64 | $0.76 | Declined |
| Metric | Nine months 2011 | Nine months 2010 | Change |
|---|
| Net sales | $2,547.7 million | $2,334.4 million | +9.1% |
| Gross profit | $643.8 million | $671.8 million | -4.2% |
| Gross margin | 25.3% | 28.8% | -350 bps |
| Operating income | $120.0 million | $146.4 million | -18.0% |
| Net income | $71.6 million | $88.5 million | -19.1% |
| Diluted EPS from continuing operations | $1.33 | $1.59 | Declined |
- Nine-month operating cash flow was negative $2.2 million, versus positive $43.6 million in 2010. Investing cash flow was negative $161.7 million, including $147.7 million of business acquisitions and $27.1 million of capital expenditures.
- Cash and cash equivalents were $57.9 million at September 30, 2011, down from $160.0 million at December 31, 2010.
- Total debt was $499.6 million, compared with $319.0 million at year-end 2010. Debt-to-total-capital increased to 50.0% from 35.1%.
- The $650 million revolving facility had $278.5 million outstanding, $80.0 million committed to standby letters of credit, and $291.5 million available for future borrowings. The company reported compliance with all debt covenants.
- Share repurchases and dividends returned $116.8 million to shareholders during the first nine months. The quarterly dividend increased from $0.15 to $0.18 per share.
Material changes versus the prior comparable period
- Sales growth was led by the Kysor/Warren acquisition, which contributed approximately 9% of third-quarter growth and 7% of nine-month growth, plus favorable currency effects. Excluding the acquisition and currency, third-quarter sales grew 2%, while nine-month sales were approximately flat.
- Residential Heating & Cooling profit declined 26.2% in the third quarter and 38.3% year to date, driven by weaker consumer demand, reduced high-efficiency tax credits, unfavorable product mix, and commodity costs.
- Commercial Heating & Cooling sales and profit increased 13.0% and 15.3%, respectively, in the third quarter. Refrigeration sales increased 59.1% and profit increased 18.5%, substantially reflecting Kysor/Warren and currency effects.
- Service Experts sales declined 4.1% in the third quarter and 8.8% year to date; year-to-date segment profit fell from $14.2 million to $0.4 million.
- Gross margin compression reflected higher raw-material and component costs, freight and distribution costs, unfavorable mix, and the lower-margin Kysor/Warren business. Commodity costs reduced third-quarter gross margin by approximately 160 basis points and nine-month margin by approximately 180 basis points.
- Third-quarter restructuring charges increased to $10.8 million from $4.7 million, primarily from terminating the corporate airplane lease, closing the aviation department, and reorganizing support functions. Nine-month restructuring charges were $14.4 million versus $15.0 million.
Guidance, outlook, commentary, risks and unusual items
- Management expected 2011 capital expenditures of approximately $45 million to $50 million and targeted approximately $120 million of share repurchases. Expected 2011 dividend payments were approximately $35 million.
- Management stated that available borrowing capacity, cash, and anticipated cash from operations were expected to fund operations, capital expenditures, repurchases, dividends, and other foreseeable needs.
- The company is exposed to commodity-price volatility for steel, copper, and aluminum; its hedging program had approximately $8.8 million of commodity hedge losses expected to be reclassified into earnings over the following 12 months.
- A $100 million interest-rate swap partially hedged variable-rate debt; approximately $1.4 million of related losses were expected to be reclassified into earnings over the following 12 months.
- A product quality issue involving a 2006–2007 heating and cooling product line had an accrued liability of $10.1 million at September 30, 2011. Management stated that additional future charges were possible.
- Product warranty liabilities totaled $71.3 million, and self-insurance liabilities totaled $67.6 million. Management did not expect pending litigation to materially affect financial position, but acknowledged that litigation outcomes could affect individual periods.
- The class-action litigation concerning certain hearth products was settled and dismissed on June 10, 2011, with no significant additional expense expected.
- On October 21, 2011, after quarter-end, the revolving credit facility was amended and extended from October 2012 to October 2016. Capacity remained $650 million, with substantially similar interest terms and covenants, while certain covenants were liberalized.
- The asset securitization arrangement, with up to $100 million of availability, was scheduled to expire on November 18, 2011; management expected to amend, renew, or replace it.
- Senior credit ratings were Baa3 and BBB-, each with a stable outlook. Management identified no material changes to the risk factors disclosed in the 2010 Form 10-K.
Most important facts for investors to verify
- Whether commodity, freight, and component costs continue to pressure gross margins and whether pricing actions offset those costs.
- The sustainability and quality of organic growth after separating Kysor/Warren acquisition and foreign-exchange effects.
- Service Experts’ recovery from sharply lower sales and profitability, and Residential Heating & Cooling demand following reduced tax incentives.
- Operating cash-flow conversion, inventory and receivables management, and the ability to reduce debt after the acquisition.
- Renewal or replacement of the $100 million asset securitization arrangement and compliance with revolving-credit covenants.
- Future costs related to the product quality issue, warranty claims, self-insurance, restructuring plans, and other contingencies.
- Whether planned capital expenditures, dividends, and share repurchases remain appropriate given the higher leverage and negative year-to-date operating cash flow.
