Lennox International Inc. — 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 filing covers the three months ended March 31, 2018, compared with the three months ended March 31, 2017. Results are seasonal and materially affected by weather, replacement demand, new construction, economic conditions, commodity prices, and interest rates.
Key Financial Metrics
| Metric | Q1 2018 | Q1 2017 | Change |
|---|---|---|---|
| Net sales | $834.8 million | $793.4 million | +5.2% |
| Gross profit | $223.2 million | $210.9 million | +5.8% |
| Gross margin | 26.7% | 26.6% | +10 bps |
| Operating income | $53.0 million | $60.8 million | -12.8% |
| Operating margin | 6.3% | 7.7% | -140 bps |
| Net income | $37.9 million | $43.5 million | -12.9% |
| Diluted EPS | $0.90 | $1.00 | -$0.10 |
| Cash used in operating activities | $(83.5) million | $(107.6) million | Improved by $24.1 million |
| Capital expenditures | $22.7 million | $24.9 million | Lower by $2.2 million |
Gross profit benefited from favorable pricing, lower material and other product costs, warranty improvements, and foreign currency effects, partly offset by higher freight, distribution, and commodity costs. SG&A was $155.2 million, or 18.6% of sales, compared with $152.4 million, or 19.2%, in the prior year.
The effective tax rate was 13.9%, compared with 18.5% in Q1 2017, primarily reflecting the lower U.S. federal corporate tax rate and excess tax benefits from share-based compensation. Management expects a 2018 annual effective tax rate of 22% to 24%, excluding excess tax benefits.
Segment Performance
| Segment | Q1 2018 Sales | Sales Change | Q1 2018 Profit | Profit Change |
|---|---|---|---|---|
| Residential Heating & Cooling | $453.7 million | +8.1% | $51.3 million | +20.7% |
| Commercial Heating & Cooling | $205.5 million | +5.1% | $19.5 million | +2.1% |
| Refrigeration | $175.6 million | -1.4% | $11.2 million | -20.6% |
Residential performance was driven by higher replacement-equipment and parts-and-supplies volumes, favorable pricing and mix, and cost reductions. Commercial sales increased primarily from North American equipment volume, but profit was substantially flat because of unfavorable mix and higher commodity and freight costs. Refrigeration results declined because of lower volume, unfavorable mix, factory inefficiencies, and higher commodity costs.
Liquidity, Debt, and Capital Allocation
- Cash and cash equivalents were $57.1 million at March 31, 2018, including $40.7 million held outside the United States.
- Total debt was $1.289 billion, compared with $1.004 billion at December 31, 2017. Long-term debt was $1.258 billion.
- The domestic credit facility had $705.5 million outstanding, $2.9 million committed to standby letters of credit, and $154.1 million available for future borrowings. Its weighted-average borrowing rate was 3.03%.
- The asset securitization program had $225.0 million outstanding and no remaining availability based on eligible receivables at quarter-end.
- The company had $350.0 million of senior unsecured notes outstanding, bearing interest at 3.00% and maturing in November 2023.
- The debt-to-total-capital ratio increased to 108.6% from 95.2% at December 31, 2017, reflecting negative consolidated stockholders’ equity of $(102.6) million.
- Management stated that cash, operating cash generation, and available borrowings were sufficient for foreseeable operating, capital, contractual, dividend, and repurchase needs.
- Expected 2018 capital expenditures are approximately $100 million. The company paid $21.3 million of dividends and repurchased $150 million of stock through an accelerated share repurchase agreement during the quarter; the ASR was completed in April 2018.
Material Changes, Outlook, Risks, and Unusual Items
- The company adopted ASC 606 using the modified retrospective method on January 1, 2018. The ongoing impact on net income was expected to be immaterial; Q1 net income was unchanged versus the amount that would have been reported without adoption.
- Australia, New Zealand, and Asia businesses were classified as held for sale. A $10.3 million loss was recognized in Q1, and the sale was expected to close in Q2 2018.
- In Q2 2018, the company signed an agreement to sell its South America business, subject to Brazilian antitrust approval, and expected a non-cash charge of approximately $30 million.
- Losses and other expenses increased to $7.3 million from $3.1 million, including $2.1 million of asbestos-related litigation expense, $2.5 million of divestiture costs, foreign currency losses, environmental liabilities, and derivative-related effects.
- Restructuring charges were $0.9 million in Q1, with total expected charges of approximately $21.0 million for ongoing activities.
- Operating cash flow remained negative because of seasonal working-capital requirements, including a $124.3 million inventory increase and a $44.5 million increase in receivables.
- Key exposures include weather-driven demand, commodity prices for steel, copper, and aluminum, freight costs, foreign currency, variable interest rates, litigation and environmental liabilities, pension assumptions, and execution of planned divestitures.
- Management reported compliance with debt and securitization covenants. The filing states that there were no material changes to previously disclosed risk factors.
Important Facts for Investors to Verify
- Confirm the closing and final accounting for the Australia, New Zealand, and Asia divestiture and the expected South America sale charge.
- Monitor leverage, negative stockholders’ equity, credit-facility availability, securitization capacity, interest rates, and covenant compliance.
- Assess whether Refrigeration’s volume weakness and factory inefficiencies improve in subsequent quarters.
- Evaluate the sustainability of Residential segment growth, pricing, cost reductions, and the stated 22%–24% annual tax-rate outlook.
- Reconcile cash generation with planned capital expenditures, dividends, and continued share repurchases.
- Review asbestos, environmental, warranty, tax, derivative, and other litigation contingencies for changes in exposure.