Lennox International Inc (LII) 2003 Q1 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the Lennox International First Quarter 2003 Earnings Conference Call. (Caller instructions). I would now like to turn the conference over to Bill Moltner, Vice President of Investor Relations. Please go ahead, sir.

Thank you, [Lanette] [ph]. Good morning and thank you for joining us for this review of Lennox International's First Quarter 2003 Financial Performance. We are broadcasting today's call live on the Internet and there is a direct link to the Webcast on our corporate Web site at www.lennoxinternational.com. This call will be archived and available for replay.

On this morning's call, Bob Schjerven, our Chief Executive Officer, will comment on our Company's progress and performance in Q1 and, Rick Smith, our Chief Financial Officer, will follow with an operating performance review by business segment as well as address the income statement and balance sheet items. We'll wrap up the call with a Q&A session. In the earnings release we issued yesterday, which you will find posted on our Web site at www.lennoxinternational.com, we have included several tables providing financial detail and reconciliations of the financial metrics that Bob and Rick will discuss to U.S. Generally Accepted Accounting Principles measures.

Before I turn the call over to Bob and Rick, I am pleased to announce that Lennox International will be hosting an investment community meeting on the morning of May 22 at the Hotel Intercontinental in New York City. At this meeting, the management team will be presenting insights into our Company's businesses and discussing the strategies and initiatives we've identified to build shareholder value. If you're interested in attending this May 22 meeting or would like more information, please call me, Bill Moltner, at 972-497-6670.

Finally, I'd like to remind everyone that in the course of this call to give you a better understanding of our performance, we will be making certain forward-looking statements. These forward-looking statements are subject to risks and uncertainties, which are listed in our publicly available filings with the SEC which could cause our actual results to differ materially from those we express today.

I'll now turn the call over to Bob Schjerven.

Thank you, Bill. I, too, would like to thank you for taking the time to join us this morning. In the first quarter this year, which is typically the seasonally weakest quarter for us, our financial results improved on a year-over-year basis, continuing the trend of improved financial performance, which began in 2002. End market demand remained soft, particularly in the commercial pieces of our Heating & Cooling, Service Experts and Refrigeration Businesses. Yet, our profitability increased through improved pricing, standard distribution, attention to cost control and efficient factory performance. As has been the case throughout this prolonged economic downturn, our strong brands, quality products and services and established customer relationships have differentiated our business in an extremely competitive marketplace. Given this difficult environment, we are pleased with our start for 2003.

Now before I review our first quarter results, let me take a minute to recap some of our notable accomplishments from the first quarter of this year. Lennox International continues to strengthen its position as an innovation leader and the first quarter, we introduced 45 new products under the Lennox brand, several with industry-leading claims.

The HSX19 air conditioner, for example, is an industry leader in efficiency and quiet operations. At a 19 seasonal energy efficiency ratio, the HSX19 is up to 60 percent more efficient than other central air conditioners, and it is the first high-efficiency central air conditioner with a two-stage scroll compressor utilizing chlorine-free R410A refrigerant. According to independent test results, it would take almost 13 HSX19 units running at full speed to equal the sound level of one typical air conditioner.

We also introduced the new Dave Lennox Signature Integrated Comfort Solution, another industry first. This system delivers the ultimate in comfort by focusing on the issues most import to consumers -- indoor air quality, temperature, humidity, efficiency, quiet operation, reliability and environmental responsibility. Lennox's Signature [inaudible] Home Comfort Controller ties the whole system together, making it convenient and easy to fine tune indoor air comfort levels.

Our advanced distributive products unit launched its Healthy Solutions line of evaporator coils to address growing indoor air equality concerns. This line utilizes the unique mold and mildew-resistant [indiscernible] design. Initial acceptance of the Healthy Solutions evaporator coils by customers has been very good.

The Environmental Protections Agency selected Lennox Industries as an Energy Star Manufacturer of the Year for Lennox's outstanding contribution for making and promoting energy efficient products, it is the first time an HVAC manufacturer has been chosen for the annual EPA award. This award acknowledges our leadership position in promoting the importance of using energy more efficiently through our product offerings, consumer education, technical education and training.

Earlier this year, we announced that LII had signed an exclusive agreement with Tradewinds to manufacture a Whirlpool branded home comfort equipment. Tradewinds is the subsidiary of Watsco Inc., a leading distributor of heating, air conditioning and refrigeration products in the U.S. Last month we began production of Whirlpool air conditioners, furnaces, heat pumps, evaporator coils and air handlers, on schedule and on budget. And early response of these products has been very positive to this point. Along with financial impact on the Whirlpool business will be modest in the short-term, due to associated start-up costs, we believe the agreement offers significant long-term potential.

Now, reviewing the first quarter of 2003, Lennox International's total company revenues decreased four percent to $650m for the quarter. Sales of 674 million in the same quarter last year included $46m in heat transfer revenue, most of which is now part of our joint venture with Outokumpu and is no longer reported by LII. Our top line benefited from the strengthening of the Euro, as well as the Canadian and Australian dollars. Inconstant currencies and adjusting for the loss of heat transfer revenue, total Lennox International sales were up one percent. International sales, those outside of the U.S. and Canada, generated 13 percent of total company revenues in the first quarter.

The quarterly operating income was $10.6m, up 20 percent from 8.8 million in 2002's first quarter. Last year's first quarter operating earnings included $700,000.00 in pre-tax restructuring charges associated with the close of our Toronto manufacturing facility. Operating margin was 1.6 percent, compared with 1.3 percent the prior year.

Net income for the quarter was $2.5m, in contrast to a net loss of $249m in the first quarter of last year. Last year's net loss, as you probably recall, was adversely affected by a 249 million after-tax goodwill impairment charge. Our diluted earnings per share for the first quarter were $0.04, contrasted with the loss per share of $4.38 same quarter last year. Pro forma EPS for the first quarter of 2002, adjusting for the goodwill impairment charge and $400,000.00 in after-tax restructuring charges was $0.02. Foreign exchange benefited earnings per share by a penny in the first quarter of this year.

In the first quarter we continued to strengthen our balance sheet. At March 31, 2003, our total debt of $389m was down 135 million from a year-ago level, dramatically reducing our debt to capitalization ratio to 45.1 percent from 56.3 percent a year ago.

While Rick will provide the details of our business segment performance, let me briefly comment on service experts. On the surface, our Service Experts improvement trend in the first quarter appears to have leveled-off with sales down four percent and segment operating loss widening by $1.9m. Let me put these results in perspective. Service Experts sales decline is due entirely to lower revenue in our commercial new construction business. Also, soft demand compounded what is the seasonally weakest quarter for the business. Yet year-over-year sales in Service Experts service and replacement business and residential new construction business increased slightly. Taken together, these businesses represent almost 85 percent of total segment revenue.

The decline in segment operating income is due to higher [indiscernible] expenses and lower commercial business margins. We remain confident that we have identified and are implementing the right strategies to improve the performance of this unit. Also, as you are likely aware, we have a comprehensive search underway for a new president of Service Experts and continue to expect to have new leadership in place by the end of the second quarter.

Before Rick Smith takes through segment results, allow me to comment on our outlook for the balance of 2003 and to affirm our guidance. We continue to expect the Company revenues to be relatively flat in 2003. Earnings per share, based on continued focus on cost reduction initiatives and the full-year effect of actions taken in 2002 are anticipated to the range of $1.10 to $1.20 per share. However, we see no clear signs of sustained underlying strength of the economy at this point and, with a lack of visibility on the timing of any economic recovery, we expect year-over-year improvement to be more concentrated in the back-half of the year. For the full year, we expect to generate free cash flow, approximately equal to net income.

I'll now turn the call over to Rick Smith, our Chief Financial Officer, to take you through the business segment operating results. Rick.

Thank you, Bob. I’m going to start with our Heating & Cooling business, where revenues rose seven percent to $387m in the quarter. If you adjust those revenues for fluctuations and currency exchange rates, sales were up five percent. The industry picture, the Trade Association has recently reported for the first two months of the year that industry shipments from manufacturers were up three percent, but distributor shipments declined three percent, and that indicates to us that there is some end market softness. For Lennox International, the Heating & Cooling operating income did increase in the quarter 37 percent to $21m, from 15.3 million last year, and operating margins expanded over a point.

If we take that Heating & Cooling business and look separately at the underlying segments, first Residential Heating & Cooling had very strong performance in the first quarter. Sales were up seven percent to $294m, with increases across all of our home comfort equipment brands and for our hearth products. Segment operating income for the quarter increased 41 percent to $21.8m, from 15.5 million last year. Segment operating margins expanded 170 basis points to 7.4 percent. That was driven by pricing improvements in our replacement business from the steel-related price increases we implemented in the fourth quarter of 2002. We also had a favorable mix of higher-end products and improved margins and volume combined with lower overhead costs at our hearth products operation. This improvement, however, was partially offset by margin pressure in our residential new construction business.

In the Commercial Heating & Cooling segment, quarterly revenues rose seven percent to $93m, but were really flat when adjusted for currency. WE had a small segment operating loss -- $.7m compared with a similarly small loss -- .2 million last year, and segment operating margins were down eight-tenths -- I'm sorry, were eight-tenths, down 60 basis points from the prior year. Higher insurance and wage expenses and a shift -- a skew to lower margin parts sales in the domestic operation, combined with pricing-related margin pressure in Europe, were responsible for the decline.

Now we took several initiatives in the first quarter and, although they're not yet evident in the results, they do position us for improved performance going forward in Commercial Heating & Cooling. First, we signed 16 new national accounts in North America, including agreements with Atlanta Bread Company, Payless Shoe Source, Limited Brands, Publics, Regal Theatres, Universal Cinema, and White Castle. In the U.K., we signed a supply contracts with [Azda] [ph] the Wal-Mart-owned supermarket chain there, and we also announced the closure of our Northampton, England factory. We project that the production relocation of commercial HVAC equipment from the U.K. to the continent will be completed by the end of the second quarter, eliminating approximately 120,000 square feet of factory space and the associated overhead.

Turning to Service Experts, the revenues in this segment declined four percent -- five percent when adjusted for currency to $197m. As Bob mentioned, the drop was entirely in the commercial new construction piece of Service Experts and there was a large weather factor in the first quarter and some of our key sales are as evident in those numbers. We think a significant portion of the sales decline is represented by work that has been pushed back to later in the year. For the first quarter, the segment had an operating loss, as we said, of $4.7m. That was 2.4 percent of sales. We had a loss last year in the first quarter of $2.8m. Higher insurance expense and lower margins in that commercial business more than offset improved residential performance. We continue to get cost out in Service Experts through the consolidation of administrative functions. For example, we now have over half of our U.S. centers supported by regional accounting centers, with approximately $1.5m in savings realized.

In the Refrigeration segments, revenues in Q1 were up three percent on a reported basis to $90m. That's down four percent when adjusted for currency exchange. We have seen a significant drop in the demand for commercial refrigeration equipment applications in supermarkets cold storage, both here and abroad. We also see some softness in the domestic fast food sector. But we are confident we are maintaining our market share and our strong position with our major accounts.

For Refrigeration -- segment operating income was essentially flat at $8.3m. Strict cost control helped to offset softness on the top line. Operating margins contracted about 20 basis points to 9.2 percent, primarily due to pricing-related margin pressure in Europe.

I want to move now to some other income statement items and the balance sheets. Interest expense in the quarter fell by nine-tenths of a million to $7m, reflecting reduced debt levels. Our progress [deleveraging] [ph] the balance sheet has been significant. I think Lennox International's focus on lean techniques throughout the Company has contributed to that continued strengthening of the balance sheet, and we haven't compromised service levels, as Bob shared with you. Total debt at March 31 was $389m, a full 135 million lower than it was at the same time the previous year and the debt-to-capital ratio dropped to 45 percent from 56 percent a year ago.

Free cash flow in the quarter -- we did use $52m, due primarily to a bill in pre-cooling season inventories. That compares with $8m in free cash flow generation in last year's first quarter due to the seasonal nature of many of the Company's businesses. It's not unusual for Lennox International to use free cash flow in the first half of the year and generate free cash flow in the second half. As a reminder, our definition of free cash flow is cash from operations less capital expenditures before dividends. We also exclude the impact of assets securitization. Our total inventories at March 31 were down year-over-year $25m. That's a nine percent reduction. And, again, with the significant improvement we have seen in lowering those inventories, we've seen no erosion at all in customer service levels.

Our operational working capital, expressed as a percentage of sales on a trailing 12-months basis, has improved 270 basis points to 19.3 percent from 22 flat last year.

At the end of quarter one, the amount in that securitization program for our accounts receivable -- these do not appear on our balance sheet -- was $115m. That's down from 125 million at the same time last year. And, against the change in asset securitization being a non-operating transaction is not one we include in our free cash flow calculation.

Capital expenditures -- essentially flat at $5m, compared to the first quarter of 2002. Looking ahead, full year 2003, we're on track for capital expenditures to be in the vicinity of depreciation at approximately $45m.

And, lastly, our effective tax rate for the quarter was 39 percent, and that's a rate we expect to be able to sustain throughout the year 2003.

At this point, Bob and I would be pleased to address any questions you might have.

(Caller instructions). And our first question is from the line of Kit Case of Southwest Securities. Please go ahead.

Hi, good morning. I've got a few questions here. Bob, can you give us an update on how April is going?

Well, at this point, when you look at the order entry rate, I'd say that we feel pretty good on the residential side, based on what we see. Of course, the weather is going to be the deciding factor, as is always the case in residential. As far as commercial business is concerned, we have seen some slight, and I underline the word "slight" strengthening and order entry rate and interest on the commercial side. But as we stated at the beginning of the monologue here, the commercial sector and both on all refrigeration commercial, also the commercial pieces on Service Expert, are still pretty shaky and the market itself is naturally down a fair amount.

Well, what do you think will -- commercial's weak for everybody. What gives you any hope that commercial new construction can tick back up this year? Or do you anticipate any flattening out or strengthening for the year?

First of all, there're a couple of pieces in our corporation that enter -- well, certainly both in the commercial business little bit tougher so let me talk about them separately, if I might. As far as the commercial HVAC equipment is concerned, we've seen certainly flat to up slightly market share penetration with that unit. Without question, the product features and the relationship with national accounts and the pace of which we're picking up national accounts, is helping to offset the generally down conditions of that market.

If you look at the Service Experts piece, there's a couple of different things. First of all, without question, they're seeing the same depressed condition as far as the commercial building, supermarket, all of those things are not a real rosy picture as of this moment, however, they also have found, particularly true it the Northeast coast, there was a noticeable delay in deferral of projects that look like they're still going to go forward. To the extent that we're involved in commercial new construction, that was impacted by the weather, as we all know. Some of that is definitely, I think, in the future for Q2. But as a general statement, the market conditions for Refrigeration, for commercial unitary, and the commercial piece of our SEI unit -- that is not robust as here and is certainly no strength in it -- or no sign that it's going to strengthen considerably. As I've said, we've even seen slight upticks in a couple of those areas, I think, based on our products and service, but I don't think that that's an indication that market is about to bust loose.

Do you need commercial to bump up to hit your guidance for the year?

No. First of all, as we constructed our plan, I think that we were pretty realistic and nothing that we've seen in the last three or four months have really changed our lookout for the year and that is that the year top line, across all the businesses is pretty much [indiscernible], and as we look forward for the next few quarters, we have no difficulty with the guidance that we have out there -- as I mentioned, that we're confident that we'll be there.

Okay. Your corporate overhead was up 20 percent year-over-year. Is that kind of growth going to continue and what kind of investments are you all doing in that?

Kit, this is Rick Smith. The corporate overhead number -- no, you shouldn't annualize that change. We did have an increase in effort in the quarter in some of our common programs that are funded at the corporate level that eventually get fed out into the business units. And we also did have to absorb some insurance increase in the quarter, as well, relative to first quarter 2002. That looks to be at a level now where we are at plateau. Most of our insurance programs have been now solidified for the year. We would not expect to see that rate of increase continue.

Would you expect to see the dollar amount stay the same throughout the rest of the year quarter-by-quarter?

Kit, there's a large component in there of performance-related expense as well so that the dollar amounts won't stay the same. They'll be affected by the Company's overall performance. But again, in terms of the truly fixed component of that, you're going to see that plateau and come down a little bit towards the latter part of this year -- again, as we feed some of these centrally funded programs out to the businesses.

Okay. Last question and I'll let someone else jump on. What gives you the confidence in Service Experts just that they're going to be able to come through with margin improvement this year?

This is Bob again, Kit. Don't have any doubt about that. There's a couple of this, first of all, about the first quarter. And that is that is is in fact, in a number of businesses, it is always seasonally the most down quarter [indiscernible] that you have in the year. Second thing is that the commercial businesses, while we talked about the difficulty we had in the top line of [indiscernible], I don’t see that becoming tremendously worse as we go forward so I'm not concerned about that being a continued drag on an increasing basis on the business. At the offset, which I think is the part that is most important for us because it's really in the family where we play with this particular [indiscernible] and now that the furnace and replacement side, both on commercial and residential, as well residential new construction -- the things that are driving that appear to be fairly healthy at this particular point in terms of top line. And, of course, that is a business that has a strong seasonal component to it so we're just about to cross the threshold into what will be too, I think, a lot more attractive quarters, in terms of top line revenue for those segments -- or those pieces of this segment.

The last thing is that we continue to drive and have had good progress on plan with moving package of changes and best practices that have been developed over the past 14 to 18 months, down into the individual operations. This process has really just begun in the first quarter, but the early results on those centers [indiscernible] implementing a [indiscernible] are noticeably up and having a very good effect. And it really is a continuation of the kind of things that we began with operations accountability management that we spoke of a year and a half or so ago.

As we look at several of the things that are critical for that business, such as the level of expertise across all the general managers, the lean structure that they have in place and the focus that we have on the service and replacement business, along with the fact that the best practices and so forth that are just now beginning to take hold, I don't have any difficult -- I know it's tough to look at the first quarter, [indiscernible] but we also have to [indiscernible] that look with the fact that the insurance change that we had made last year -- a lump of which, of course, you saw in the month of December -- the fourth quarter, that, by itself, accounts for $2m delta in the quarter-over-quarter comparison. And sort of another way you can see we that we are performing better when you take into accounts these commercial piece for performing better in their segments that are the main fairway for this business -- about 85 percent of it. So just hang in there. No alarm. We're doing good.

Alright thanks.

Thank you. And our next question is from the line of [Chris Perry] [ph] of First Dallas Securities. Please go ahead.

Hey, guys. You might have mentioned this, but can you comment on the year-over-year increase in your gross margin?

Yeah. This is Rick, Smith, Chris. Certainly the gross margin -- we mentioned some favorable pricing particularly in the residential business. Bob indicated we've got a lot great new products that are starting to flow into the pipeline. That is part of it. We also have a mix effect versus a year ago. Our heat transfer business, which is now deconsolidated in as much as we own less than 50 percent of that business, is not in this year's numbers -- it was in last year's.

Okay. Thanks.

(Caller instructions). Thank you. And our next question is a follow-up from the line of Kit Case of Southwest Securities. Please go ahead.

Yeah. One other question. For the second quarter, and I know you don't want to give quarterly guidance, but are you still expecting year-over-year growth in the second quarter, assuming that June comes in? I know it's heavily weighted towards June, but are you still expecting earnings growth in the second quarter?

Let me answer that question this way, Kit. First of all, in terms of the business plan that we have [indiscernible] with which we drives our guidance and everything that we talk about as a frame of reference, that expectation is certainly [indiscernible]. The other thing which I think everyone will appreciate, if you this industry, is that the second quarter, these months, April, May, and June, are really significant with respect to the impact that climate has. And that can make the difference in terms of it being had -- heat even with [indiscernible] pervious year. Remind everybody that last year we saw pretty good weather, in fact, a lot more normal type weather conditions that we normally would have seen.

And the other thing I would like to mention that one man's opinion, but I think is important, and that is given the bump up in degree days and the weather pattern that we saw last year in spring and early summer, it would have been my expectations that the industry increased it shipments would have been a couple percentage points or more greater than what they were based upon the kind of swings we had seen in years past when we had similar swings in weather. That's what my personal opinion is that there's still is an element of pent-up demand, particularly true on the residential side that lays out there, and, of course, I attribute all of that -- reluctance on the part of the consumer to make that investment in new systems. The question is still uncertain condition of the economy and their own individual disposable incomes.

And I know I sort of danced around -- I guess the short answer for you would have been the fact that there's really no way to predict that accurately, but we have got a lot things that are in place that are taking traction that we did last year that are certainly to improve our performance, but again, a lot of that has to be [indiscernible] the revenue impact that it has. We go to church on Sunday and pray for good weather for the second quarter, I think we'll probably come up with a nice quarter.

Alright. Thanks.

Okay.

And thank you. And at this time, Mr. Moltner, I would like to turn the conference back over to you, sir.

This is Bob Schjerven. We are really pleased at the performance improvement Lennox International began in 2002 continues through the first quarter of this year. That said, this management team is not resting. We're intensely focused on continual operating improvement -- improvement that will accelerate with economic recovery that we all hope is just around the corner. Thank you for taking the time to be with us today on our phone call. Good by.

Ladies and gentlemen, this conference will be available for replay after 1:00 pm today until April 30, 2003 at midnight. You may access the AT&T Executive Playback Service at any time by dialing 1-800-475-6701 and entering the access code 681357. International participants may dial 1-320-365-384[inaudible]. That does conclude our conference for today. Thank you for your participation and for using AT&T Executive Teleconference Service. You may now disconnect.