Lennox International Inc. 2011 Form 10-K Summary
Business context and reporting period
Lennox International Inc. is a global HVACR provider operating through Residential Heating & Cooling, Commercial Heating & Cooling, Service Experts, and Refrigeration. This Form 10-K covers the fiscal year ended December 31, 2011; fourth-quarter information is included in the annual results. Sales and profitability are seasonal, generally strongest in the second and third quarters.
Financial performance and key metrics
| Metric | 2011 | 2010 | Change |
|---|---|---|---|
| Net sales | $3,303.6 million | $3,096.4 million | +7.0% |
| Gross profit / margin | $833.6 million / 25.2% | $891.8 million / 28.8% | Margin down 360 bps |
| Operational income from continuing operations | $147.7 million / 4.5% of sales | $190.4 million / 6.2% | Down $42.7 million |
| Net income | $88.3 million / 2.7% of sales | $116.2 million / 3.8% | Down $27.9 million |
| Diluted EPS from continuing operations | $1.65 | $2.10 | Down $0.45 |
| Cash flow from operating activities | $76.2 million | $185.8 million | Down $109.6 million |
| Capital expenditures | $43.2 million | $45.8 million | Down $2.6 million |
| Total debt at year-end | $465.1 million | $319.0 million | Up $146.1 million |
| Cash and cash equivalents | $45.0 million | $160.0 million | Down $115.0 million |
Gross margin deterioration reflected higher commodity costs, freight and distribution costs, and the lower-margin Kysor/Warren acquisition. SG&A declined to 20.0% of sales from 22.1%, primarily because of lower incentive compensation and cost controls.
Segment results and material changes
| Segment | 2011 sales | 2011 profit | Change versus 2010 |
|---|---|---|---|
| Residential Heating & Cooling | $1,341.0 million | $75.1 million | Sales down 5.4%; profit down 43.2% |
| Commercial Heating & Cooling | $696.0 million | $79.4 million | Sales up 12.3%; profit up 14.6% |
| Service Experts | $528.6 million | $1.5 million | Sales down 10.5%; profit down 92.2% |
| Refrigeration | $805.2 million | $77.5 million | Sales up 46.2%; profit up 26.2% |
- Reported sales growth was driven substantially by the January 2011 acquisition of Kysor/Warren, favorable foreign exchange, and strength in Commercial Heating & Cooling and Refrigeration. Excluding Kysor/Warren and foreign exchange, sales declined 2%.
- Residential and Service Experts were pressured by reduced government tax credits, consumer weakness, lower-efficiency component replacements instead of full-system replacements, and weaker residential installation volumes.
- Kysor/Warren was acquired for $143.3 million and added refrigerated systems and supermarket display cases to the Refrigeration segment. The acquisition contributed approximately $147.7 million of cash outflows, including related amounts.
- The Company recorded $16.0 million of restructuring charges, $7.0 million of asset impairments, and $7.6 million of goodwill impairment in 2011. The goodwill impairment eliminated all goodwill associated with the Hearth reporting unit.
- Fourth-quarter 2011 net sales were $755.8 million, gross profit was $189.7 million, net income was $16.7 million, and diluted EPS was $0.32. Fourth-quarter results included the asset and goodwill impairment charges.
Liquidity, debt, cash flow, and capital allocation
- Operating cash flow fell to $76.2 million, reflecting lower earnings, unfavorable working-capital movements, payments of accrued litigation-related expenses, and lower incentive compensation accruals.
- At December 31, 2011, the Company had $243.0 million outstanding under its domestic revolving credit facility, $200.0 million of senior unsecured notes, $16.6 million of capital lease obligations, and $4.7 million of short-term debt.
- The amended revolving facility provides $650.0 million of capacity, with $328.5 million available for future borrowings after outstanding borrowings and standby letters of credit. The receivables securitization facility had $150.0 million of available capacity and no beneficial interests sold at year-end.
- The debt-to-total-capital ratio increased to 49.9% from 35.1%. The Company was in compliance with its debt covenants at year-end, including a maximum consolidated indebtedness-to-adjusted-EBITDA ratio of 3.5 to 1.0 and a minimum cash-flow-to-net-interest-expense ratio of 3.0 to 1.0.
- The Company paid approximately $36.5 million in cash dividends and repurchased approximately 3.2 million shares for $119.7 million under its repurchase plan. The quarterly dividend increased from $0.15 to $0.18 per share during 2011.
Outlook, risks, contingencies, and unusual items
- Management expected approximately $55 million of 2012 capital expenditures, approximately $15 million of U.S. defined-benefit pension contributions, and approximately $50 million of share repurchases.
- Management stated that cash on hand, available borrowing capacity, and expected operating cash flow were sufficient for operations, planned capital expenditures, contractual obligations, dividends, and anticipated share repurchases.
- Key risks include weather-driven demand, U.S. residential and commercial construction conditions, commodity and component price volatility, supply interruptions, competitive pricing, warranty and product liability exposure, labor disruptions, foreign exchange, regulatory changes affecting energy efficiency and refrigerants, litigation, goodwill impairment, and pension funding requirements.
- The Company was pursuing strategic alternatives for the Hearth business because of prolonged weakness and uncertainty in residential new construction. No clear transaction outcome was provided in the filing.
- A class-action lawsuit involving certain hearth products concluded in June 2011. Management did not expect significant additional expense; substantially all accrued costs had been paid.
- Total contractual obligations were $657.5 million, including $460.4 million of long-term debt obligations, $169.2 million of operating leases, $21.9 million of purchase obligations, and $6.0 million of uncertain tax positions.
- Warranty liabilities totaled $72.2 million at year-end. Management noted that future warranty costs, product quality claims, litigation, and environmental remediation estimates could change.
Most important facts for investors to verify
- Whether margin recovery can offset commodity, freight, and distribution pressures.
- The sustainability and profitability of the Kysor/Warren acquisition and broader Refrigeration growth.
- Residential and Service Experts volume trends, particularly the mix between full-system and component replacements.
- Available liquidity after considering seasonal working-capital needs, standby letters of credit, debt maturities, dividends, repurchases, and pension contributions.
- Compliance with debt covenants and the effect of increased leverage and lower year-end cash.
- The outcome of strategic alternatives for Hearth and the potential for additional impairment charges.
- Changes in warranty, pension, environmental, tax, litigation, and commodity-hedging liabilities.