Lennox International Inc. — Q2 2017 Form 10-Q Summary
Business Context and Reporting Period
Lennox International operates in the HVACR industry through Residential Heating & Cooling, Commercial Heating & Cooling, and Refrigeration segments. The filing covers the three and six months ended June 30, 2017; results are unaudited and seasonal, with demand affected significantly by weather, construction, economic conditions, and replacement activity.
Key Financial Metrics
| Metric | Three Months Ended June 30 | Six Months Ended June 30 |
|---|---|---|
| Net sales | $1,102.1 million, up 8.1% | $1,895.6 million, up 9.3% |
| Gross profit / margin | $340.8 million / 30.9% | $551.8 million / 29.1% |
| Operating income / margin | $175.4 million / 15.9% | $236.2 million / 12.5% |
| Income from continuing operations | $116.4 million | $159.9 million |
| Net income | $115.5 million | $159.0 million |
| Diluted EPS from continuing operations | $2.71 | $3.70 |
| Net cash used in operating activities | Not separately provided | $(48.3) million |
| Capital expenditures | Not separately provided | $43.4 million |
| Cash and equivalents at period-end | $61.3 million |
At June 30, 2017, total debt was $1,188.9 million, including $251.3 million of short-term debt, $15.0 million of current maturities, and $922.6 million of long-term debt. The domestic credit facility had $288.1 million of available borrowing capacity after outstanding borrowings and letters of credit. Debt-to-total-capital increased to 99.1% from 95.8% at December 31, 2016.
Material Changes Versus the Prior Comparable Period
- Second-quarter sales increased $82.9 million, primarily from an 8% volume increase. Operating income increased $14.7 million, while net income increased $4.8 million.
- Six-month operating income increased $31.8 million and net income increased $23.4 million.
- Residential Heating & Cooling was the primary growth driver: second-quarter sales rose 13.8% and segment profit rose 21.2%. Six-month sales rose 12.8% and profit rose 18.7%.
- Commercial Heating & Cooling second-quarter sales increased 2.3%, but segment profit declined 5.7% due primarily to unfavorable mix and higher commodity costs. Six-month profit increased 3.4%.
- Refrigeration second-quarter sales declined 0.9% and profit was broadly flat; six-month sales increased 2.5% and profit increased 17.8%.
- Second-quarter gross margin was unchanged at 30.9%. Favorable mix, pricing, and lower material costs were offset by higher commodity costs, a product quality issue, and freight and distribution costs.
- Operating cash flow deteriorated to $(48.3) million from $(25.3) million, reflecting seasonal working-capital needs, higher receivables, and increased inventories.
- Total debt increased from $868.2 million at year-end 2016, partly reflecting $250.0 million outstanding under the asset securitization program and higher domestic credit-facility borrowings. The company repaid $200.0 million of senior notes that matured in May 2017.
- The company repurchased $175.0 million of common stock during the first six months and declared $40.0 million of dividends. A $100.0 million accelerated share repurchase initiated in April was expected to settle in the third quarter.
Guidance, Outlook, Risks, and Unusual Items
- Management expects a 2017 annual effective tax rate of approximately 32%, excluding excess tax benefits from share-based compensation. The six-month effective rate was 28% after an $8.1 million discrete tax benefit.
- Expected 2017 capital expenditures are approximately $100 million. Management believes cash, operating cash generation, and available borrowing capacity are sufficient for foreseeable operating, capital, debt, dividend, and repurchase needs.
- Management identified a defective vendor-supplied component in a Residential Heating & Cooling product line and recorded a $5.2 million second-quarter expense for estimated repair costs. The defect was isolated and corrected components were being installed.
- Probable liability for a separate supplier quality issue was estimated at $0.9 million to $9.1 million; $0.9 million was accrued, with the supplier expected to reimburse most related costs.
- The company recorded $2.4 million of asbestos-related litigation expense in the first six months and remains exposed to potentially higher future settlements or judgments if insurance coverage is insufficient.
- An SEC and Department of Justice investigation remains ongoing regarding an alleged approximately $475 payment involving Russian customs operations and possible customs-document irregularities in Russia, Poland, and Ukraine. Management does not anticipate a material adverse effect but cannot eliminate uncertainty.
- Commodity prices, foreign exchange rates, interest rates, weather, economic conditions, product quality, litigation, and seasonal working-capital requirements remain important risks. The company was not hedged against interest-rate risk at June 30, 2017.
- The company adopted ASU 2016-09 for stock-based compensation, producing discrete tax benefits of $0.7 million in the quarter and $8.1 million year to date. No material impact was expected from the forthcoming revenue-recognition standard, although disclosures would expand.
Investor Verification Checklist
- Verify the sustainability of Residential Heating & Cooling volume growth and whether commercial and refrigeration margins recover.
- Assess the effect of commodity inflation, pricing, product mix, warranty costs, and the $5.2 million product-quality charge on future margins.
- Reconcile operating cash flow with earnings and monitor receivables, inventory, and seasonal working-capital usage.
- Review debt maturities, asset-securitization availability, credit-facility covenants, cross-default provisions, and the high debt-to-capital ratio.
- Track the ongoing SEC/DOJ investigation, asbestos claims, supplier-quality liabilities, and other legal contingencies.
- Confirm completion and final share count of the April accelerated share repurchase and evaluate the impact of continued repurchases and dividends on leverage and liquidity.