Lennox International Inc. — Q1 2023 Form 10-Q Summary
Business context and reporting period
Lennox International Inc. reported unaudited results for the three months ended March 31, 2023. The company operates in the heating, ventilation, air conditioning and refrigeration industry through Residential and Commercial segments. Beginning January 1, 2023, Heatcraft Worldwide Refrigeration was included in Commercial, while the European commercial HVAC and refrigeration portfolio was presented in Corporate and Other. Prior-year segment amounts were recast accordingly.
Key financial metrics
| Metric | Q1 2023 | Q1 2022 | Change |
|---|---|---|---|
| Net sales | $1,049.4 million | $1,013.4 million | +3.6% |
| Gross profit | $306.6 million | $268.2 million | +14.3% |
| Gross margin | 29.2% | 26.5% | +270 bps |
| Operating income | $139.5 million | $111.9 million | +24.7% |
| Operating margin | 13.3% | 11.0% | +230 bps |
| Net income | $98.0 million | $83.6 million | +17.2% |
| Diluted EPS | $2.75 | $2.29 | +20.1% |
| Net cash used in operating activities | $78.8 million | $97.9 million | Improved by $19.1 million |
| Capital expenditures | $35.4 million | $25.8 million | +$9.6 million |
Sales benefited from approximately 6% favorable pricing and 5% favorable product mix, partly offset by a 7% volume decline and unfavorable foreign currency effects. SG&A increased to $167.5 million from $155.3 million, primarily due to higher employee-related costs. Interest expense more than doubled to $14.2 million from $6.8 million because of higher borrowing costs.
- Residential: Sales were $681.0 million, down 0.2%; segment profit was $111.1 million, up 3.3%. Pricing and mix offset lower volume.
- Commercial: Sales were $308.7 million, up 10.4%; segment profit was $50.0 million, up 110.1%, reflecting favorable pricing, mix and commodity costs.
- Corporate and Other: Sales were $59.7 million, up 15.5%; segment loss widened to $19.4 million from $16.8 million, primarily due to higher incentive compensation and European portfolio costs.
Liquidity, debt and capital allocation
- Cash and cash equivalents were $40.4 million at March 31, 2023, compared with $52.6 million at December 31, 2022. Approximately $22 million was held outside the United States.
- Total debt was $1.668 billion, including $657.5 million classified as current and $1.010 billion classified as long term. Stockholders’ deficit was $125.9 million.
- The $750 million revolving credit facility had $388.0 million outstanding, $2.0 million committed to standby letters of credit and $360.0 million available for future borrowings. The weighted-average borrowing rate was 6.06%.
- The asset securitization program had $297.0 million outstanding and only $0.3 million of remaining availability at March 31, 2023.
- The $350 million 2023 Notes and the asset securitization program mature during 2023. Management was evaluating refinancing and other alternatives and stated that it did not expect a material impact on liquidity or results.
- Net cash provided by financing activities was $101.1 million, including net credit-facility borrowings, compared with $129.1 million in Q1 2022. The company paid $37.6 million in dividends and made approximately $2.0 million of employee tax-withholding share repurchases; it made no discretionary share repurchases.
- Management stated that cash, operating cash generation and available borrowing capacity should be sufficient for foreseeable operating, capital expenditure, contractual, dividend and potential repurchase needs.
Material changes, outlook and risks
Profitability improved despite lower unit volume, driven primarily by price and product mix. Consolidated gross margin increased 270 basis points, while the Commercial segment delivered the largest profit improvement. Higher SG&A, interest costs and Corporate and Other losses partially offset operating gains.
Management provided an expected annual effective tax rate of 19% to 21%, excluding excess tax benefits. No specific full-year revenue or earnings guidance was provided in the filing.
- Demand is seasonal and sensitive to weather, interest rates, financing availability, new construction, consumer spending and broader economic conditions.
- Steel, copper, aluminum, components, freight and tariffs expose the company to commodity and supply-chain volatility. The company uses pricing actions, operational initiatives and derivatives to mitigate these risks.
- The company was not currently hedged against interest-rate risk, and variable-rate debt increased exposure to higher borrowing costs.
- Environmental liabilities and special litigation charges were $2.4 million in Q1 2023. Management stated that existing litigation was not expected to have a material adverse effect, although outcomes remain uncertain.
- Product warranty liabilities totaled $145.3 million at March 31, 2023.
- The company reported compliance with applicable debt and securitization covenants. Its senior credit ratings were Baa2 with a stable outlook from Moody’s and BBB with a stable outlook from S&P.
- There were no material changes to the risk factors disclosed in the 2022 Form 10-K, and no material changes in internal control over financial reporting.
Important facts for investors to verify
- Progress and final terms for refinancing or replacing the $350 million 2023 Notes and the asset securitization program.
- Cash conversion and working-capital trends, particularly the $150.4 million inventory-related operating cash use in Q1.
- Whether pricing and mix gains can offset continued volume pressure, higher component costs, freight, labor and interest expense.
- Execution of the European portfolio strategic-alternatives process and the associated Corporate and Other losses.
- Compliance with the 3.50-to-1.00 total net leverage covenant and continued availability under the revolving credit facility.
- Changes in warranty, environmental and litigation exposures, as well as commodity, foreign-currency and interest-rate derivative positions.