Lennox International Inc. 2016 Q2 Form 10-Q Summary
Business context and reporting period
Lennox International Inc. operates three HVACR segments: Residential Heating & Cooling, Commercial Heating & Cooling, and Refrigeration. The filing covers the unaudited three and six months ended June 30, 2016, compared with the corresponding 2015 periods. Demand is seasonal and affected by weather, construction, economic conditions, financing availability, commodity prices, and foreign currency movements.
Financial results and key metrics
| Metric | Q2 2016 | Q2 2015 | Six months 2016 | Six months 2015 |
|---|---|---|---|---|
| Net sales | $1,019.2 million | $992.5 million | $1,734.4 million | $1,678.3 million |
| Gross profit | $315.0 million | $283.4 million | $498.6 million | $446.4 million |
| Gross margin | 30.9% | 28.6% | 28.7% | 26.6% |
| Operating income | $160.7 million | $130.9 million | $204.4 million | $158.0 million |
| Operating margin | 15.8% | 13.2% | 11.8% | 9.4% |
| Net income | $110.7 million | $81.2 million | $135.6 million | $95.1 million |
| Diluted EPS from continuing operations | $2.52 | $1.79 | $3.07 | $2.10 |
| Net cash used in operating activities | Not separately provided | Not separately provided | $(41.0) million | $(52.3) million |
Material changes versus the prior comparable period
- Q2 sales increased 2.7%, primarily from 2% higher volume and 1% from price. Six-month sales increased 3.3%, with volume up 4%, partly offset by unfavorable foreign currency effects.
- Q2 gross margin expanded 230 basis points, primarily from lower material costs and improved factory productivity. Six-month gross margin expanded 210 basis points.
- Q2 operating income increased 22.8% and net income increased approximately 36%; diluted EPS from continuing operations increased from $1.79 to $2.52.
- Residential Heating & Cooling Q2 sales rose 3.5% and segment profit rose 16.0%. Commercial sales were essentially flat, while profit rose 10.2%. Refrigeration sales rose 4.4% and profit rose 60.2%, aided by volume, lower material costs, and lower depreciation following a 2015 impairment.
- SG&A increased to $159.4 million in Q2 from $152.9 million, reflecting higher incentive compensation and investments in information technology and research and development.
- Cash used in operations improved by $11.3 million year over year, but seasonal working-capital needs remained a use of cash. Capital expenditures increased to $41.7 million from $33.0 million.
- Total debt increased to $1,075.2 million at June 30, 2016 from $741.1 million at December 31, 2015, while stockholders’ equity declined to $31.4 million from $101.6 million, primarily reflecting share repurchases and dividends.
Liquidity, debt, outlook, risks, and unusual items
- Cash and cash equivalents were $54.7 million, including $29.1 million held outside the United States. The company had $279.6 million available under its domestic credit facility after borrowings and standby letters of credit.
- The company stated that cash, operating cash generation, and available borrowing capacity should fund operations, capital expenditures, contractual obligations, repurchases, dividends, and other foreseeable needs.
- The asset securitization program had $220.0 million outstanding and no remaining availability at June 30. Effective July 5, 2016, its maximum range was increased to between $200.0 million and $325.0 million, depending on the period.
- The $200.0 million senior unsecured notes mature May 15, 2017. The company was in compliance with debt covenants at June 30, 2016. Moody’s rating was Baa3 with a stable outlook, and S&P’s rating was BBB with a stable outlook.
- Management expected 2016 capital expenditures of approximately $95 million, dividends of $65 million to $75 million, and an additional $100 million stock repurchase program. The company also planned to contribute $50 million to pension plans, funded in part by a planned tax-efficient repatriation of foreign cash.
- Management expected an annual effective tax rate of approximately 31% for 2016 and approximately 32% in subsequent years. A planned repatriation benefit produced a Q2 effective tax rate of 27.8% and a year-to-date rate of 29.1%.
- The company completed a $200 million accelerated share repurchase transaction after receiving 1.3 million shares initially; an additional 0.2 million shares were delivered after quarter end. A further $100 million repurchase plan was authorized in July 2016.
- Product warranty liabilities increased to $98.8 million from $92.3 million at year-end. A supplier quality matter had an estimated probable liability of $2.0 million to $9.4 million; $2.0 million was accrued, with the supplier reimbursing most related costs.
- Asbestos-related litigation expense was $1.9 million for the six months, versus $0.6 million in 2015. Management stated that existing litigation is not expected to have a material adverse effect, while acknowledging that outcomes remain uncertain.
- Other unusual items included lower special legal contingency charges, restructuring charges of $0.6 million year to date, environmental liabilities, contractor tax payments, and commodity-hedging effects.
- Key risks include weather-driven seasonality, commodity and foreign exchange volatility, customer and construction demand, pension obligations, leverage and refinancing needs, product warranty and quality claims, litigation, and reliance on available credit and receivables securitization.
Important facts for investors to verify
- Verify the company’s ability to refinance or repay the $200.0 million senior notes maturing in May 2017.
- Assess leverage, covenant headroom, the increased receivables-securitization capacity, and the effect of continued repurchases and dividends on liquidity.
- Evaluate whether gross-margin gains from lower materials costs and productivity are sustainable as commodity prices, pricing, mix, and foreign exchange rates change.
- Track warranty claims, the supplier quality contingency, asbestos and other litigation, and restructuring obligations.
- Confirm delivery and accounting treatment of the post-quarter-end accelerated share repurchase shares and the planned $100 million repurchase program.
- Monitor the planned $50 million pension contribution, foreign-cash repatriation, tax-rate assumptions, and the company’s stated capital-expenditure and dividend plans.