Lennox International Inc. — Form 10-Q Summary
Business context and reporting period
This unaudited Form 10-Q covers the three and six months ended June 30, 2013. Lennox operates in three HVACR segments: Residential Heating & Cooling, Commercial Heating & Cooling, and Refrigeration. Results are seasonal and materially affected by weather, construction, replacement demand, commodity costs and economic conditions.
On March 22, 2013, Lennox sold its Service Experts business. Service Experts and the previously sold Hearth business are presented as discontinued operations, and prior-period segment information was revised accordingly.
Key financial metrics
| Metric | Q2 2013 | Q2 2012 | Six months 2013 | Six months 2012 |
|---|---|---|---|---|
| Net sales | $913.1 million | $840.4 million | $1,581.5 million | $1,454.8 million |
| Gross profit | $254.0 million | $208.1 million | $416.0 million | $349.0 million |
| Gross margin | 27.8% | 24.8% | 26.3% | 24.0% |
| Operating income from continuing operations | $102.4 million | $79.8 million | $130.3 million | $98.7 million |
| Net income | $64.3 million | $44.7 million | $72.3 million | $38.6 million |
| Diluted EPS from continuing operations | $1.26 | $0.96 | $1.57 | $1.14 |
| Cash used in operating activities | Not separately provided | Not separately provided | $(88.3) million | $(10.6) million |
Q2 sales increased 8.7%, with volume up 7% and price and mix up 2%. Gross margin improved 300 basis points, driven by favorable price and mix, commodity and non-commodity cost savings, and a $3.2 million warranty-liability reduction recorded in the second quarter; higher freight and distribution costs partially offset these benefits.
Segment performance
- Residential Heating & Cooling: Q2 sales rose 15.6% to $476.2 million and segment profit increased 57.6% to $66.2 million. Growth reflected stronger replacement and new-construction demand, favorable pricing and mix, material savings and productivity improvements.
- Commercial Heating & Cooling: Q2 sales increased 3.7% to $229.6 million and segment profit rose 4.2% to $34.6 million. North American volume gains and cost savings were partly offset by European weakness and higher operating expenses.
- Refrigeration: Q2 sales were essentially flat at $207.3 million, while segment profit increased 21.7% to $25.8 million. Profit benefited from pricing and mix and growth in the Australian wholesale refrigerant business, partly offset by weaker supermarket demand.
Material changes versus the prior comparable period
- Q2 operational income increased 28.3% to $102.4 million; first-half operational income increased 32.0% to $130.3 million.
- SG&A increased 15.8% in Q2 and 13.0% year to date, primarily due to higher incentive compensation and other employee-related costs. SG&A as a percentage of sales rose to 16.6% in Q2 and 18.1% year to date.
- Q2 net income benefited from the absence of the $4.8 million discontinued-operations loss recorded in Q2 2012. First-half discontinued-operations loss declined to $7.8 million from $20.2 million.
- Cash flow weakened substantially: operating cash use increased to $88.3 million from $10.6 million, principally because of higher receivables and inventories, timing of vendor payments and payment of prior-year incentive compensation.
- Total debt increased to $537.1 million from $386.6 million at December 31, 2012. Debt-to-total-capital increased to 54.6% from 43.8%.
- Accumulated other comprehensive loss increased to $103.1 million from $22.3 million, primarily reflecting foreign-currency translation and derivative losses.
Liquidity, debt and capital allocation
- June 30 cash and cash equivalents were $45.3 million, including $24 million held outside the United States.
- The $650 million domestic revolving credit facility had $195 million outstanding and $50 million committed to standby letters of credit; $405 million was available for future borrowings. It matures in October 2016.
- The asset securitization program had $120 million outstanding against $160 million of capacity, leaving $40 million available.
- Senior unsecured notes totaled $200 million, bear interest at 4.90% and mature May 15, 2017.
- Management stated that cash, available borrowing capacity and anticipated operating cash flow were sufficient for foreseeable needs. All reported debt and lease covenants were in compliance at June 30, 2013.
- Management expected approximately $60 million of 2013 capital expenditures, approximately $100 million of 2013 share repurchases and more than $30 million of 2013 dividend payments. The filing does not provide a specific revenue or earnings-per-share forecast.
Guidance, outlook, risks and unusual items
- Management expected seasonal working-capital needs to remain elevated in the first and second quarters and generally expected to pay down debt as peak season progressed.
- Demand remains sensitive to weather, residential and commercial construction, replacement activity, financing availability, consumer spending and economic conditions.
- Commodity prices for steel, copper and aluminum, foreign-exchange movements and variable-rate debt create market exposure. The company had commodity and currency derivatives outstanding, and expected to reclassify approximately $5.8 million of derivative losses from accumulated other comprehensive income into earnings within 12 months, assuming commodity prices remained constant.
- Product warranty liabilities were $73.7 million at June 30, 2013. The company also accrued $6.0 million for identified vendor-related product-quality issues and warned that additional charges could arise.
- Restructuring charges were $2.9 million in the first half, with approximately $23.9 million expected in total for ongoing plans.
- Patent litigation, asbestos-related claims and other lawsuits remain outstanding. Management did not expect current matters to have a material adverse effect, but noted that litigation outcomes and future asbestos claims are uncertain.
- The corporate headquarters lease was renewed through March 1, 2019. At lease end, the company may need to purchase, vacate, sell or renew the property; a third-party sale could require payment of a deficit subject to stated limits.
- Management reported effective disclosure controls and no material changes in internal control over financial reporting.
Important facts for investors to verify
- Whether operating cash flow improves as seasonal receivables and inventories convert to cash.
- The sustainability of gross-margin gains after the favorable warranty adjustment, commodity benefits and pricing actions.
- Debt paydown, revolving-credit utilization and compliance with leverage and interest-coverage covenants.
- Progress against the stated 2013 capital-expenditure, share-repurchase and dividend targets.
- Performance of the Australian refrigerant business and the effect of continued European and supermarket-market weakness.
- Future warranty, product-quality, patent and asbestos-related costs, including potential amounts not covered by insurance.
- Foreign-currency translation, derivative losses and the timing of amounts reclassified from accumulated other comprehensive income.