Lennox International Inc. — Form 10-Q Summary
Business context and reporting period
Lennox International Inc. operates in three HVACR segments: Residential Heating & Cooling, Commercial Heating & Cooling, and Refrigeration. This unaudited filing covers the three and six months ended June 30, 2015, compared with the corresponding 2014 periods. Demand is seasonal and affected by weather, construction, economic conditions, commodity prices and foreign currency movements.
Financial performance and position
| Metric | Q2 2015 | Q2 2014 | Six months 2015 | Six months 2014 |
|---|---|---|---|---|
| Net sales | $992.5 million | $960.7 million | $1,678.3 million | $1,656.1 million |
| Gross profit | $283.4 million | $262.6 million | $446.4 million | $430.7 million |
| Gross margin | 28.6% | 27.3% | 26.6% | 26.0% |
| Operational income | $130.9 million | $119.1 million | $158.0 million | $153.0 million |
| Net income | $81.2 million | $73.9 million | $95.1 million | $93.8 million |
| Diluted EPS from continuing operations | $1.79 | $1.50 | $2.10 | $1.90 |
| Cash used in operating activities | Not separately provided | Not separately provided | $(52.3) million | $(73.4) million |
Second-quarter sales increased 3.3%, while operational income increased 9.9% and net income increased approximately 10%. The gross margin expanded 130 basis points, primarily from lower material costs. SG&A increased to $152.9 million but declined to 15.4% of sales from 15.5%.
For the first six months, sales increased 1.3%, gross margin improved 60 basis points, and operational income increased 3.3%. The effective tax rate declined to 34.5% in the second quarter and 34.4% year to date, from 35.4% and 35.3%, respectively.
- Residential Heating & Cooling: Q2 sales rose 5.2% to $555.1 million and segment profit rose 17.5% to $99.9 million. Year-to-date sales increased 5.5% and profit increased 19.9%.
- Commercial Heating & Cooling: Q2 sales rose 5.2% to $253.6 million and profit rose 10.3% to $43.0 million. Year-to-date sales were essentially flat and profit increased 3.0%.
- Refrigeration: Q2 sales declined 4.3% to $183.8 million and profit declined 2.9% to $13.3 million. Year-to-date sales declined 6.8% and profit declined 33.3% to $17.2 million.
Cash and cash equivalents were $47.5 million at June 30, 2015, compared with $37.5 million at December 31, 2014. Operating cash flow was negative because of seasonal working-capital investment, including increases in receivables and inventories. Capital expenditures were $33.0 million year to date, compared with $41.2 million in the prior-year period.
Total debt was $1.056 billion at June 30, 2015, up from $925.6 million at year-end 2014. Debt consisted primarily of $220.0 million under the asset securitization program, $613.0 million outstanding under the domestic credit facility, $200.0 million of senior unsecured notes, and capital lease obligations. The company reported $289.8 million of additional borrowing capacity under the domestic credit facility and was in compliance with its debt covenants.
Material changes versus the prior comparable period
- Lower material costs were the principal driver of consolidated margin expansion and improved segment profitability.
- Foreign currency movements reduced sales and profits, particularly in Commercial Heating & Cooling and Refrigeration.
- Refrigeration performance weakened year to date because of unfavorable currency, the repeal of the Australian carbon tax levy, unfavorable mix and lower Australian refrigerant profitability.
- Losses and other expenses increased to $3.3 million in Q2 and $8.9 million year to date, from gains of $1.0 million and expenses of $1.4 million, respectively, in the comparable periods. The increase included legal contingencies, contractor tax charges, foreign exchange losses and other items.
- Restructuring charges increased to $1.8 million in Q2 and $2.1 million year to date, primarily related to Australian Refrigeration operations. Total expected charges for ongoing restructuring activities were $13.1 million.
- Interest expense increased to $6.4 million in Q2 and $12.2 million year to date, primarily because of higher average borrowings and borrowing rates.
- Weighted-average shares declined materially because of prior share repurchases, supporting the increase in diluted EPS.
Outlook, risks, contingencies and unusual items
Management stated that cash, expected operating cash generation and available borrowings should be sufficient for operations, planned capital expenditures, contractual obligations, share repurchases and dividends in the foreseeable future. Expected 2015 capital expenditures were approximately $80 million, and targeted 2015 dividend payments were $55 million to $60 million. Completion of the $450 million accelerated share repurchase program was expected in the second half of 2015.
Key risks include seasonal and weather-sensitive demand, economic and construction conditions, commodity-price volatility, foreign currency exposure, variable-rate debt, customer and supplier matters, product warranty costs, litigation, and covenant or cross-default provisions. Management identified a probable supplier-quality liability range of $1.7 million to $5.0 million and accrued $1.7 million; a related supplier receivable of $2.3 million was recorded.
The company recorded a $2.4 million liability for a tentatively settled class action concerning potential evaporator-coil corrosion. It also recorded a $1.6 million reserve for underpaid contractor taxes at a non-U.S. subsidiary and reversed $1.2 million of an excess vendor-quality contingency reserve. Management does not expect these matters to have a material adverse effect, although outcomes remain uncertain.
Product warranty liabilities totaled $89.9 million at June 30, 2015. The company had $3.4 million, net of tax, of cash-flow-hedge losses in accumulated other comprehensive loss and expected to reclassify approximately $3.2 million into earnings within the following 12 months, assuming commodity prices remained constant.
No material changes to previously disclosed risk factors were reported. Management reported effective disclosure controls and no material changes to internal control over financial reporting.
Important facts for investors to verify
- Whether seasonal working-capital use reverses as the year progresses and supports debt reduction.
- The sustainability of margin gains from lower material costs and the effect of future commodity prices.
- Refrigeration segment recovery, including foreign currency, Australian operations and product mix.
- Progress and final cost of restructuring activities and the accelerated share repurchase program.
- Compliance with leverage and interest-coverage covenants, including the impact of total debt of $1.056 billion.
- Final resolution and potential additional exposure from the evaporator-coil class action, supplier-quality matters, asbestos-related claims and contractor-tax reserve.
- Effects of foreign currency movements, variable interest rates and the company’s negative Moody’s outlook.
- The eventual impact and transition method for the revenue-recognition standard effective January 1, 2018.