Lennox International Inc. 2022 Q3 Form 10-Q Summary
Business Context and Reporting Period
Lennox International Inc. operates in three HVACR segments: Residential Heating & Cooling, Commercial Heating & Cooling, and Refrigeration. This unaudited Form 10-Q covers the three and nine months ended September 30, 2022, compared with the corresponding 2021 periods.
Alok Maskara became Chief Executive Officer on May 9, 2022, succeeding Todd Bluedorn. The company identified ongoing supply-chain disruption, employee absenteeism, commodity-cost volatility, weather sensitivity, foreign-exchange movements, and interest rates as important operating factors.
Financial Performance and Key Metrics
| Metric | Q3 2022 | Q3 2021 | Change |
|---|---|---|---|
| Net sales | $1,244.9 million | $1,059.9 million | 17.5% increase |
| Gross profit | $334.2 million | $295.2 million | 13.2% increase |
| Gross margin | 26.8% | 27.9% | 110 bps decrease |
| Operating income | $185.8 million | $162.7 million | 14.2% increase |
| Operating margin | 14.9% | 15.4% | 50 bps decrease |
| Net income | $141.9 million | $126.3 million | 12.4% increase |
| Diluted EPS | $3.99 | $3.41 | 17.0% increase |
| Metric | Nine Months 2022 | Nine Months 2021 | Change |
|---|---|---|---|
| Net sales | $3,624.6 million | $3,229.3 million | 12.2% increase |
| Gross profit | $999.5 million | $934.8 million | 6.9% increase |
| Gross margin | 27.6% | 28.9% | 130 bps decrease |
| Operating income | $524.6 million | $492.7 million | 6.5% increase |
| Operating margin | 14.5% | 15.3% | 80 bps decrease |
| Net income | $402.7 million | $380.4 million | 5.9% increase |
| Diluted EPS | $11.22 | $10.10 | 11.1% increase |
- Q3 sales growth reflected 11% favorable pricing, 5% higher volume, and 2% favorable mix, partly offset by 1% unfavorable foreign currency.
- Q3 gross margin was pressured by commodity costs, component costs, LIFO and other product costs, factory inefficiencies, freight, and mix. Pricing provided a 680-basis-point offset.
- Q3 SG&A increased $13 million to $147.3 million, but declined to 11.8% of sales from 12.7%.
- Interest expense increased to $10.5 million in Q3 from $6.5 million, primarily because of higher borrowings and borrowing costs.
- The effective tax rate was 18.7% in Q3 and 18.9% for the first nine months. Management expected a 2022 annual effective tax rate of 18% to 20%.
Segment Results
| Segment | Q3 Sales | Q3 Sales Change | Q3 Profit | Q3 Profit Change |
|---|---|---|---|---|
| Residential Heating & Cooling | $835.3 million | 17.5% increase | $153.8 million | 6.8% increase |
| Commercial Heating & Cooling | $252.9 million | 19.6% increase | $29.6 million | 31.0% increase |
| Refrigeration | $156.7 million | 14.0% increase | $22.4 million | 54.5% increase |
For the first nine months, Residential sales increased 15.8% and segment profit increased 11.1%. Commercial sales declined 0.5% and profit declined 44.3%, primarily because of lower volume, supply-chain constraints, factory inefficiencies, and higher input costs. Refrigeration sales increased 14.3% and profit increased 67.6%.
Cash Flow, Balance Sheet, Debt, and Liquidity
- Operating cash flow for the first nine months was $170.1 million, down from $396.3 million in 2021, primarily because of less favorable working-capital changes.
- Accounts receivable increased to $708.4 million from $508.3 million at December 31, 2021, and inventories increased to $743.4 million from $510.9 million.
- Capital expenditures were $67.0 million, compared with $68.5 million in the prior-year period.
- Cash and cash equivalents were $40.7 million at September 30, 2022, including approximately $19 million held outside the United States.
- Total debt was $1.6045 billion, compared with $1.2378 billion at December 31, 2021. Long-term debt included $400.0 million of asset-securitization borrowings, $222.0 million under the revolving credit agreement, and $950.0 million of senior unsecured notes.
- The $750 million revolving credit facility had $526.0 million available after borrowings and letters of credit. The facility matures in July 2026, subject to extension options.
- The asset securitization program had $400.0 million outstanding and $43.3 million of remaining eligible capacity at September 30, 2022.
- Management stated that cash, operating cash generation, and available borrowing capacity were sufficient for foreseeable operating, capital, contractual, dividend, and repurchase needs.
- The company paid $142.0 million of dividends and repurchased $300.0 million of common stock during the first nine months. Approximately $546 million remained available under the repurchase authorization at September 30, 2022.
Material Changes, Outlook, Risks, and Unusual Items
- Revenue and earnings increased year over year, but gross and operating margins declined as pricing did not fully offset higher commodity, component, LIFO, freight, and manufacturing costs.
- Commercial Heating & Cooling was the principal area of weakness for the first nine months, with a substantial profit decline caused by supply constraints and operational inefficiencies.
- The asset securitization program and the $350 million 3.00% senior notes due November 2023 were approaching maturity. Management was evaluating refinancing and other alternatives and stated it did not expect a material effect on liquidity or operations.
- The company was exposed to variable-rate debt but was not currently hedged against interest-rate risk. The weighted-average borrowing rate on the credit facility rose to 4.21% from 1.38% at December 31, 2021.
- Cash-flow hedges and foreign-currency contracts generated unfavorable accumulated other comprehensive income effects. The company expected to reclassify approximately $13.6 million of derivative losses into earnings within the following 12 months, assuming market prices remained constant.
- Warranty liabilities increased to $150.2 million from $134.2 million at year-end 2021.
- Environmental liabilities and special litigation charges were $3.1 million in Q3 and $6.2 million for the first nine months. Management did not expect existing litigation to have a material adverse effect, although outcomes remained uncertain.
- COVID-19-related supply-chain disruption and absenteeism remained risks. The filing reported no material changes to the risk factors disclosed in the 2021 Form 10-K.
- No goodwill impairments were recorded, and restructuring charges were immaterial in Q3 and $1.2 million year to date.
Investor Verification Points
- Verify whether pricing actions continue to offset commodity, component, freight, LIFO, labor, and factory inefficiency pressures.
- Monitor Commercial Heating & Cooling recovery, order backlog conversion, supply-chain constraints, and segment-margin normalization.
- Review refinancing or repayment plans for the asset securitization program and the 2023 senior notes.
- Assess liquidity sensitivity to higher interest rates, working-capital requirements, inventory levels, and receivable growth.
- Track the effect of foreign-currency movements and commodity-hedge settlements on earnings and accumulated other comprehensive loss.
- Confirm future capital allocation among dividends, share repurchases, debt reduction, and manufacturing-capacity investments.