Lennox International Inc. — 2012 Q2 Form 10-Q Summary
Business context and reporting period
Unaudited results cover the three and six months ended June 30, 2012. Lennox operates four HVACR segments: Residential Heating & Cooling, Commercial Heating & Cooling, Service Experts, and Refrigeration. Results are seasonal and influenced by weather, economic conditions, construction activity, financing availability, commodity prices, and foreign exchange rates.
Financial performance and key metrics
| Metric | Q2 2012 | Q2 2011 | Six months 2012 | Six months 2011 |
|---|---|---|---|---|
| Net sales | $933.8 million | $914.1 million | $1,618.0 million | $1,583.5 million |
| Gross profit | $248.7 million | $244.2 million | $414.8 million | $408.5 million |
| Gross margin | 26.6% | 26.7% | 25.6% | 25.8% |
| Operational income | $77.8 million | $74.2 million | $81.7 million | $72.9 million |
| Operational margin | 8.3% | 8.1% | 5.0% | 4.6% |
| Income from continuing operations | $48.2 million | $46.1 million | $47.7 million | $42.6 million |
| Net income | $44.7 million | $45.0 million | $38.6 million | $37.8 million |
| Diluted EPS from continuing operations | $0.93 | $0.85 | $0.93 | $0.78 |
| Diluted net EPS | $0.87 | $0.83 | $0.75 | $0.69 |
- Q2 sales increased 2.2%; management reported a 4% increase excluding foreign exchange. Sales volume increased 5%, while price and mix declined 1% and foreign exchange reduced sales by approximately 2%.
- Q2 operational income increased 4.9%, driven by higher volume and non-commodity material cost savings, partly offset by less favorable warranty adjustments.
- Six-month sales increased 2.2%, or approximately 4% excluding foreign exchange. Six-month operational income increased 12.1%.
- Income tax expense was $25.2 million in Q2 and $24.9 million for the first six months. Effective tax rates were approximately 34.3% in both periods.
- Cash dividends declared were $0.18 per share in Q2 and $0.36 per share for the first half.
Segment trends
- Residential Heating & Cooling: Q2 sales increased 10.6% to $411.9 million and profit increased 19.3% to $42.0 million. Six-month sales increased 9.4% to $684.5 million and profit increased 33.8% to $53.0 million, primarily from higher volume.
- Commercial Heating & Cooling: Q2 sales increased 1.2% to $200.7 million and profit increased 11.1% to $30.1 million. Excluding a 4% foreign exchange headwind, sales increased 5%.
- Service Experts: Q2 sales declined 8.5% to $133.1 million and profit declined 37.5% to $2.0 million. Six-month sales declined 10.4% to $234.7 million, and the segment reported a $9.5 million loss versus a $5.0 million loss in 2011.
- Refrigeration: Q2 sales declined 4.8% to $207.1 million, primarily due to foreign exchange, while profit was essentially flat at $21.3 million. Six-month sales were essentially flat and profit increased slightly to $35.5 million.
Cash flow, balance sheet, debt and liquidity
- Cash used in operating activities was $10.6 million for the first six months of 2012, compared with $142.4 million used in the prior-year period. The improvement primarily reflected better working capital performance and higher accrued incentive compensation.
- Cash used in investing activities was $9.5 million, including $16.8 million of capital expenditures and $7.2 million of net proceeds from the Hearth business sale.
- Cash provided by financing activities was $44.3 million. Cash increased by $24.2 million to $69.1 million at June 30, 2012.
- Total debt was $528.9 million, up from $465.1 million at December 31, 2011, largely reflecting seasonal inventory financing. Long-term debt was $514.2 million, including $297.5 million outstanding under the domestic revolving credit facility and $200.0 million of senior unsecured notes.
- The $650 million revolving facility had $294.0 million available for future borrowings, excluding $58.5 million of standby letters of credit. The asset securitization program had $150.0 million available and no beneficial interests sold at quarter-end.
- The debt-to-total-capital ratio increased to 51.8% from 49.9% at year-end. The company stated that cash, available borrowing capacity, and expected operating cash flow were sufficient for foreseeable operating, capital, contractual, dividend, and repurchase needs.
- All debt and lease financial covenants were satisfied at June 30, 2012. The revolving facility matures in October 2016, and the $200.0 million senior unsecured notes mature in May 2017 at a fixed 4.90% interest rate.
Material changes, outlook and unusual items
- The Hearth business was sold on April 24, 2012 for $7.2 million of net proceeds, subject to a working capital adjustment. It was reported as discontinued operations and generated a $3.8 million loss on sale.
- Discontinued operations produced a $3.5 million after-tax loss in Q2 and a $9.1 million after-tax loss for the first half. The losses included a $6.3 million pension settlement charge, a $6.3 million asset write-down recorded in the first quarter, the loss on sale, and a $3.5 million foreign currency translation gain.
- Restructuring charges were $0.6 million in Q2 and $3.7 million year-to-date. Total expected restructuring charges were $66.8 million, with $65.2 million incurred through June 30.
- The company recorded $0.7 million of expense in Q2 for product quality issues involving vendor-supplied materials, including a refrigerant issue. Accrued product quality liabilities were $6.5 million at June 30, and management noted that additional charges may arise.
- Product warranty liabilities were $71.9 million at June 30. Management completed its annual second-quarter warranty reassessment and reduced the warranty liability by $0.4 million.
- Management expected approximately $55 million of 2012 capital expenditures, approximately $36 million of 2012 dividend payments, and planned a minimum of $50 million of 2012 share repurchases. Management also stated that debt is typically paid down as peak seasonal demand passes.
- Commodity, interest-rate, and foreign currency risks remain material. A $100 million interest-rate swap expires October 12, 2012. A 10% change in exchange rates was estimated to affect net income by approximately $1.2 million.
- Management identified weather, economic conditions, commodity costs, foreign exchange, product quality, warranty claims, regulatory changes, environmental standards, and changes in tax incentives as key risks. No material changes to previously disclosed litigation risks were reported.
Most important facts for investors to verify
- Whether the Service Experts sales decline and year-to-date losses improve, particularly in residential service operations.
- Whether Residential Heating & Cooling volume growth and pricing can offset commodity, warranty, and price/mix pressures.
- The timing and magnitude of additional product quality, warranty, restructuring, and pension-related charges.
- Seasonal working capital needs, debt paydown after the cooling season, and continued compliance with leverage and interest-coverage covenants.
- Execution against the stated 2012 capital expenditure, dividend, and share-repurchase plans.
- The financial effects of foreign exchange and commodity-price movements, including the expiration of the interest-rate swap.