Lennox International Inc. — Form 10-Q Summary
Business Context and Reporting Period
Unaudited results cover the three months ended March 31, 2011, compared with the first quarter of 2010. Lennox operates four HVACR segments: Residential Heating & Cooling, Commercial Heating & Cooling, Service Experts, and Refrigeration. Results are seasonal and sensitive to weather, construction activity, consumer demand, commodity prices, freight costs, and foreign exchange rates.
Key Financial Metrics
| Metric | Q1 2011 | Q1 2010 |
|---|---|---|
| Net sales | $687.8 million | $644.1 million |
| Gross profit | $165.2 million | $174.3 million |
| Gross margin | 24.0% | 27.1% |
| Operating income (loss) | $(7.0) million | $0.5 million |
| Net loss | $(7.2) million | $(1.6) million |
| Loss per share | $(0.13) | $(0.03) |
| Cash used in operating activities | $(148.3) million | $(40.3) million |
| Capital expenditures | $8.2 million | $10.7 million |
| Cash and cash equivalents at period end | $55.2 million | $63.0 million |
At March 31, 2011, total assets were $1.900 billion, total liabilities were $1.334 billion, and stockholders’ equity was $566.4 million. Total debt was $541.6 million, compared with $319.0 million at December 31, 2010. The debt-to-total-capital ratio increased to 48.9% from 35.1% at year-end 2010.
Liquidity included $309.0 million available under the domestic revolving credit facility, $44.0 million remaining under the asset securitization arrangement, $10.9 million of committed foreign facilities, and $55.2 million of cash. The company was in compliance with all debt covenants. The revolving credit facility matures in October 2012, and the asset securitization arrangement expires in November 2011.
Material Changes Versus the Prior Comparable Period
- Sales increased 6.8%, primarily from the Kysor/Warren acquisition, favorable foreign exchange, and improved price and mix. The acquisition contributed approximately 5% of sales growth.
- Gross margin declined 310 basis points. Management attributed approximately 180 basis points of pressure to commodity costs, with additional pressure from freight and fuel surcharges.
- Operating results shifted from $0.5 million of income to a $7.0 million loss, despite lower restructuring charges of $1.2 million versus $7.2 million.
- Operating cash use increased substantially, primarily because inventory increased by $136.3 million in preparation for the peak cooling season.
- Investing cash use increased because of the $144.2 million Kysor/Warren acquisition.
- Financing cash inflows increased to $191.8 million, including $171.5 million of net revolver borrowings and $50.0 million of asset securitization borrowings.
Segment Performance
| Segment | Q1 2011 Sales | Q1 2011 Profit/(Loss) | Key Change |
|---|---|---|---|
| Residential Heating & Cooling | $272.0 million | $(1.2) million | Sales declined 4.3%; volume fell nearly 10% after demand was pulled into Q4 2010 ahead of price increases. |
| Commercial Heating & Cooling | $138.8 million | $5.9 million | Sales rose 16.0%, primarily from volume growth; profit increased $2.5 million. |
| Service Experts | $116.5 million | $(8.2) million | Sales declined 8.3% and losses widened in the seasonally weakest quarter. |
| Refrigeration | $175.1 million | $13.5 million | Sales rose 33.3%, including the Kysor/Warren acquisition; profit declined $1.4 million because of commodity and freight costs. |
Outlook, Risks, Contingencies, and Unusual Items
- Management stated that the company was well positioned entering the strongest seasonal quarters and would continue focusing on new business, innovative products, manufacturing and sourcing efficiency, and expense reduction. The filing does not provide formal full-year revenue or earnings guidance.
- Management expected 2011 capital expenditures of approximately $65 million and anticipated approximately $35 million of dividend payments. It targeted more than $100 million of share repurchases for 2011.
- The Board approved a 20% quarterly dividend increase from $0.15 to $0.18, effective with the April 2011 payment. The financial statements report dividends declared of $0.18 per share for the quarter; investors should reconcile the timing and presentation.
- Kysor/Warren was acquired on January 14, 2011 for $144.2 million. The acquisition added $43.3 million of goodwill and $33.4 million of intangible assets. No goodwill impairment was recognized.
- Restructuring charges incurred in Q1 2011 were $1.2 million, with approximately $75.2 million of total restructuring charges expected across identified plans and $5.6 million of restructuring reserves remaining at March 31, 2011.
- A product quality issue involving a 2006–2007 heating and cooling product line had $14.0 million accrued at March 31, 2011. The company had recorded $24.4 million of expense to date and warned that additional charges could occur.
- A class action lawsuit involving certain hearth products had received preliminary settlement approval, with a final approval hearing scheduled for June 2, 2011. The company had incurred $9.3 million of related expense with no additional Q1 charge.
- Commodity, interest-rate, and foreign-exchange risks remain material. The company uses commodity futures, a $100 million interest-rate swap, and foreign-currency forwards. A 10% change in commodity forward prices was estimated to change hedge fair value by approximately $1.2 million.
- Warranty liabilities were $76.3 million, and self-insurance liabilities were $64.8 million at March 31, 2011. Management stated that no current litigation was expected to materially affect financial position, but outcomes remain uncertain.
Investor Verification Checklist
- Verify whether inventory growth normalizes as the peak cooling season progresses and whether operating cash flow improves.
- Assess the sustainability of price increases and the extent to which they offset copper, aluminum, steel, freight, and fuel-cost inflation.
- Review leverage, covenant headroom, facility availability, and refinancing requirements before the asset securitization and revolving facility maturities.
- Evaluate the earnings contribution, integration progress, and cash returns from the Kysor/Warren acquisition.
- Reconcile the reported $0.18 dividend declaration with management’s description of the increase becoming effective in April 2011.
- Monitor the product quality accrual, warranty experience, and final approval and cost of the hearth-products class action settlement.