Lennox International Inc. — Q1 2022 Form 10-Q Summary
Business context and reporting period
Lennox International operates in residential heating and cooling, commercial heating and cooling, and refrigeration. The filing covers the unaudited 13-week quarter ended March 31, 2022, compared with the quarter ended March 31, 2021.
On March 23, 2022, the company appointed Alok Maskara as CEO effective May 9, 2022. Todd J. Teske was serving as interim CEO and chairman pending the transition.
Key financial metrics
| Metric | Q1 2022 | Q1 2021 | Change |
|---|---|---|---|
| Net sales | $1,013.4 million | $930.5 million | Up 8.9% |
| Gross profit | $268.2 million | $256.5 million | Up 4.6% |
| Gross margin | 26.5% | 27.6% | Down 110 bps |
| Operating income | $111.9 million | $114.1 million | Down 1.9% |
| Operating margin | 11.0% | 12.3% | Down 130 bps |
| Net income | $83.6 million | $84.2 million | Down $0.6 million |
| Diluted EPS | $2.29 | $2.20 | Up 4.1% |
| Cash flow from operations | $(97.9) million | $(17.5) million | More cash used |
| Capital expenditures | $25.8 million | $24.7 million | Up $1.1 million |
Revenue benefited from 9% favorable pricing and 2% favorable mix, partly offset by a 2% volume decline. Cost of goods sold rose to 73.5% of sales from 72.4%, reflecting commodity, component, freight and distribution costs, factory inefficiencies, and higher warranty costs. SG&A increased $10.0 million, but declined as a percentage of sales to 15.3% from 15.6%.
The effective tax rate was 19.9%, compared with 20.9% in the prior-year quarter. Comprehensive income was $91.2 million, including $7.6 million of other comprehensive income, primarily from cash flow hedge gains.
Segment performance
| Segment | Q1 2022 sales | Sales change | Q1 2022 profit | Profit change |
|---|---|---|---|---|
| Residential Heating & Cooling | $682.2 million | Up 12.5% | $107.6 million | Up 11.6% |
| Commercial Heating & Cooling | $187.7 million | Down 5.8% | $6.3 million | Down 77.0% |
| Refrigeration | $143.5 million | Up 14.8% | $14.1 million | Up 78.5% |
Residential performance reflected pricing and mix benefits, with flat volume. Commercial results were pressured by a 16% volume decline, higher component costs and factory inefficiencies. Refrigeration benefited from higher pricing and volume, partly offset by cost inflation and unfavorable mix.
Liquidity, debt and capital allocation
- Cash and cash equivalents were $34.3 million at March 31, 2022, compared with $31.0 million at December 31, 2021. Approximately $15 million was held outside the United States.
- Total debt was $1.611 billion, up from $1.238 billion at year-end 2021. Long-term debt included $279.0 million under the asset securitization program, $347.5 million drawn on the domestic credit facility, $31.4 million of finance lease obligations and $950.0 million of senior unsecured notes.
- The $750 million revolving credit facility had $400.5 million available, after outstanding borrowings and standby letters of credit. The asset securitization program had only $0.4 million of remaining availability based on eligible receivables at quarter-end.
- Operating cash flow was negative primarily because receivables increased $96.9 million and inventories increased $168.8 million. Financing activities provided $129.1 million, including net borrowings, and ending cash increased by $5.5 million before foreign-exchange effects.
- The company repurchased $200.0 million of common stock under an accelerated share repurchase agreement and paid $33.7 million in dividends. The ASR was completed in April 2022 for a total of 0.8 million shares.
- Management stated that cash, expected operating cash flow and available borrowing capacity should be sufficient for foreseeable operating, capital expenditure, contractual, dividend and repurchase needs.
- The debt-to-total-capital ratio was reported at 134%, compared with 128% at December 31, 2021. The company reported investment-grade ratings of Baa2 from Moody’s and BBB from S&P, both with stable outlooks.
Material changes, outlook and risks
- Sales increased, but operating income declined because cost inflation outpaced pricing benefits. Gross margin fell 110 basis points.
- Commercial Heating & Cooling was the principal area of weakness, with sales down 6% and segment profit down $21.1 million.
- Supply-chain disruption and higher employee absenteeism related to COVID-19 remained risks. The company also cited commodity, component, freight, labor, tariff, foreign-currency and weather-related risks.
- The company expects a 2022 annual effective tax rate of 18% to 20%, excluding excess tax benefits from stock-based compensation.
- Demand is seasonal and affected by weather, interest rates, financing availability, construction activity, economic conditions and consumer spending.
- Interest-rate exposure increased with higher borrowings; the company stated it was not currently hedged against interest-rate risk. Commodity and foreign-currency exposures were partly hedged through futures and forward contracts.
- Warranty liabilities increased to $143.2 million from $134.2 million at December 31, 2021. Asbestos-related litigation expense, net of expected insurance recoveries, was $1.7 million in the quarter.
- Management reported compliance with debt covenants and stated that no litigation was expected to have a material adverse effect, although outcomes remain uncertain. No material changes to previously disclosed risk factors were reported.
Investor verification points
- Verify whether pricing actions and procurement or productivity initiatives can offset continued commodity, component, freight and labor inflation.
- Monitor Commercial Heating & Cooling volume, factory utilization and segment profitability.
- Assess working-capital trends, particularly the sharp increase in inventories and receivables and the resulting negative operating cash flow.
- Review leverage, liquidity headroom and the limited remaining availability under the asset securitization program.
- Evaluate the sustainability of substantial share repurchases and dividends while debt and stockholders’ deficit remain elevated.
- Follow the CEO transition effective May 9, 2022 and any changes to strategy or financial outlook.
- Track COVID-19 disruptions, weather-driven demand, commodity prices, interest rates, foreign exchange, warranty costs and asbestos-related claims.