Lennox International Inc (LII) 2007 Q4 法說會逐字稿

Welcome to the Lennox International Q4 and full year 2007 earnings conference call.

At the request of your host, all lines are in a listen-only mode.

There will be a question-and-answer session at the end of the presentation.

As a reminder, this call is being recorded.

I would now like to turn the conference over to Karen Fugate, Vice President of Investor Relations.

Please go ahead.

Good morning.

Thank you for joining us for this review of Lennox International's financial performance for the fourth quarter and full year.

I'm here today with Todd Bluedorn, our CEO and Sue Carter, our CFO.

Todd will review highlights for the quarter and Sue will take you through the company's financial performance.

In the earnings released we issued this morning, we have included the necessary reconciliation of the financial metrics that will be discussed to generally accepted accounting principles.

You can find a direct link to the web site at today's conference call on our corporate web site at www.lennoxinternational.com.

We will archive the webcast on that site and make is available for replay.

I would also like to remind everyone that in the course of this call to give you a better understanding of operations, we will be making certain forward-looking statements.

These forward-looking statements are subject to risks and uncertainties.

The list of these risks and uncertainties is included in our recent 10-K filings with the SEC and includes the impact of higher raw material prices, our ability to implement price increases for our products and services, the impact of unfavorable weather and the possibility that a decline in new construction activity will depress the demand for our products and services.

These risks and uncertainties could cause our actual results to differ materially from those we expected to you today.

I will now turn the call over to Todd Bluedorn.

Good morning, everyone.

I will start today's call with an overview of our full year results.

Lennox International finished 2007 with strong financial performance.

In fact, three of our four businesses, commercial, service experts and refrigeration had outstanding results with EBIT growth in double digits and margin expansion.

In the face of the tough markets, our residential business took aggressive cost actions and ended the year with solid results.

Total company revenue was $3.7 billion, a growth of 1% over last year.

EBIT rise of 7.4% is up 50 basis points.

Earnings per share on an adjusted basis was $2.50, a growth of 15%.

GAAP earnings per share were $2.43, a growth of 8%.

Our focus on cost containment across the enterprise gained traction and approved point is the year-over-year improvement in corporate expenses of $13 million but this is just the beginning of our cost reduction efforts.

We still have significant opportunities in front of to us drive margin expansion, and to support growth into other segments of business.

We generated cash flow from operations of $238 million, and invested $68 million in capital assets.

Our free cash flow for the year was very strong at $170 million, a marked improvement over last year's $126 million.

We returned $282 million to or shareholders through stock buyback of $247 million, and a $35 million in the form of dividends.

Our board of directors has increased the dividend in each of the last four years resulting in a compound annual growth rate of over 10%.

We continue to buy back shares through our $500 million share repurchase program, and by year end, over 40% of the program was complete, and we remain on track for third quarter '08 completion.

Our balance sheet remains strong with the year-end debt of $208 million, for a debt to EBITDA ratio of 0.6.

We continue to have significant capacity to utilize our balance sheet strength to expand and sustain our premium position.

Now, turning to the fourth quarter results.

Revenues for total LII were $887 million, up 1%.

Earnings per share on an adjusted basis were $0.55 for year-over-year growth of 20%.

On a GAAP basis, earnings per share were $0.59, growth of 2%.

2007 was the year of unprecedented challenges into the North American residential market, but a year of solid execution for LII.

We set in motion many strategic priorities that will benefit the enterprise over the long term.

First, we broke ground on our low-cost assembly factory in Saltillo, Mexico.

This factory plays a critical role on our low-cost sourcing of manufacturing efforts, reducing our costs by over $20 million on annual run rate basis by 2010.

Manufacturing and sourcing excellence is a priority for LI.

And we have more opportunities in the pipeline.

Second, we made progress on our factory rationalization efforts.

We now have three factory closures in 2007.

Although restructuring charges are incurred in the near term, we expect close to $10 million in annual savings on our run rate basis in 2010.

We're looking across our businesses to evaluate further consolidation of our manufacturing footprint, and reduction of manufacturing overhead.

Third, product innovation was at the forefront of 2007.

Our new premium commercial roof top unit , Strategos is the first of its kind in the industry.

Innovative products like our Healthy Climate air cleaner and Ozone-free indoor air quality products are the best on the residential market.

And on the refrigeration side, we introduced our internal link [EC]motors, the most energy efficient motor technology available for commercial refrigeration evaporators.

It's cutting edge products like these that differentiate LII from the competition.

And lastly, expense reductions are an area of continued focus for us.

Over the last several quarters, we have taken a bite out of the corporate expenses and lowered SG&A as a percentage of sales, but we have a long way to go before we are done.

Before I turn it over to Sue, I would like to briefly wrap up with our thoughts on 2008.

First and foremost, we reaffirm our 2008 outlook provided at the December analyst meeting.

That is adjusted earnings per share in the range of $2.85 to $3, and GAAP earnings per share in the range of $2.73 to $2.88.

We expect financial performance during the first half of the year to be softer than second half.

Primarily due to the current market conditions in residential and new store retails openings being pushed out in the commercial retail market.

We will continue our focus on the cost side of the equation and execute on our strategic priorities.

Now I will turn it over to

Thank you, Todd.

Good morning, everyone.

As you heard from Todd this morning, LII finished the year with strong financial results.

I will provide some additional commentary on the business segments for the quarter and full year, starting with residential heating and cooling.

For the fourth quarter, sales in the residential business were $354 million, down 11% from prior year, primarily driven by lower sales volume of 16%, offset by favorable price and mix of 3% and 1% respectively.

Currency was favorable by 1%.

Segment profit in the quarter was $31 million, a margin of 9%, compared to $43 million, and a margin of 11% in the year ago quarter.

Full year sales of the residential segment reached $1.7 billion, a year-over-year decline of 10%.

Sales volume was down 16%, while product mix and price improved 1% and 5% respectively.

Segment profit for the year was $174 million, a margin of 10%, compared to profit of $212 million and a margin of 11% in 2006.

As you may recall, our residential segment includes our hearth business and our ADP coil business which are disproportionately down year-over-year due to the exposure to the R and C segment.

The residential equipment business was able to maintain relatively flat segment margins for the year, due to cost reductions and pricing actions.

Before I move on, let me discuss the nonrecurring warranty gain in the fourth quarter.

We made a change to the way we fulfill our warranty obligations on the Pulse furnace, which is product produced from 1982 to 1999.

We worked with our dealer partners to focus on the customer to make an equitable change to our warranty process.

This change in our warranty policy resulted in one-time $17 million pre-tax reduction in the warranty reserve which we excluded from our adjusted results.

Now, turning to our commercial heating and cooling business.

Our commercial segment had an excellent quarter, and a record-breaking year.

Sales in the fourth quarter reached $224 million, growth of 14%, or 8% growth when adjusted for foreign exchange.

Growth was the result of favorable product mix and pricing.

Commercial segment profit in the fourth quarter grew 26% to $24 million, a margin of 11%, a 100 basis point improvement over last year.

Earnings improvement is attributed to favorable product mix and cost containment.

Commercial sales for the full year were $875 million, year-over-year improvement of 16%.

Favorable foreign exchange contributed 3% of that growth and we realized price of 5% and favorable product mix and volume of 4% each.

Total segment profit for the year increased 39% to reach $101 million.

Margin improved by approximately 200 basis points to 12%, favorable product mix shifts to our high efficiency roof top unit, profitability in Europe and cost reductions drove profitability improvement.

Moving to our service experts business, sales in the fourth quarter were $169 million, 5% growth or 2% growth when adjusted for favorable foreign exchange.

Segment profit in the quarter was $7 million, a margin of 4% versus $8 million, a margin of 5% in the year ago quarter.

2006 fourth quarter results included incremental $2 million favorable adjustment to our casualty insurance accrual.

For the full year, sales and service experts reached $681 million, year-over-year growth of 4%, or 3% when adjusted for foreign exchange.

Segment profits for the year was $25 million, a 4% margin.

This strong performance was driven by a favorable mix shift to higher margin service and replacement business, geographic mix, and cost reduction efforts.

In our refrigeration segment, fourth quarter sales grew 17% to $158 million, or 6% when adjusted for foreign currency.

Segment profit for the quarter was $15 million, a year-over-year improvement of 27%.

Profit margin was 9%, and 80 basis point improvement over last year.

Sales from our refrigeration segment for the full year topped $608 million, up 15%.

This 15% increase consisted of 4% volume, 4% price, and a 7% benefit from foreign exchange.

Segment profit was $62 million for the year, and 18% improvement over last year.

Profit margin was 10%, a 30 basis point improvement.

LII had very strong cash results for the year.

Our cash from operations at $238 million, and free cash flow at $170 million were significant improvements over last year's results.

Our free cash flow being equal to total company net income for the year is consistent with our long-term cash conversion goals.

Our $282 million return to shareholders in the form of dividends or stock buyback was facilitated by the excellent free cash flow and balance sheet leverage.

Our working capital ratio for the trailing 12 month average in 2007 of 18.3%, an increase from our results in 2006, reflects the impact of carrying higher inventory levels anticipated through much of the year.

However, our year-end working capital ratio at 16.4%, which is roughly equal to the 2006 year-end position reflects the significant progress for the company in managing these issues through the latter part of the year.

Our total capital expenditures in 2007 were $68 million.

We project our capital expenditures in 2008, will be approximately $90 million.

These funds will be used to invest in new products, capacity and process improvement initiatives.

Before we go to Q&A, I will briefly talk about our 2008 outlook.

We don't provide outlooks by business segment, but I will update the market assumptions since we last spoke in December.

On the residential side, the North American R&C market is expected to be down a bit further than the mid we talked about in December.

The NHB data shows R&C to be down for 2008.

Estimates for replacements remain the same, down to slightly flat.

Assuming the residential market is 70% replacement and 30% R&C, you get into a decline of midsingle digits for the total residential market.

Turning to the commercial side.

As you know, a large portion of our commercial business comes from retailers, some of who have publicly pushed out new stores.

Therefore, the backlog for our commercial business remains solid and we believe that 2008 looks a lot like 2007, with markets flat to up a few points.

So, with that, let's turn to total company guidance.

For total company, we expect revenue of $3.8 billion, to $3.9 billion, growth of 2% to 5%.

Core earnings per share of $2.85 to $3 per share, growth of 14% to 20%.

GAAP earnings per share of $2.73, to $2.88, growth up 12% to 19%.

Capital expenditures of approximately $90 million and a tax rate of 36% to 37%.

And with that, let's go to Q & A.

(Operator instructions) And we'll go first to the line of Curt Woodworth with JP Morgan.

Please go ahead.

Yeah, hi, good morning.

Hi, Curt.

How are you?

Good, how are you?

Good.

You know, in terms of thinking about sort of the distribution of the growth and the earnings for 2008, you made a comment similar to what you talked about in the analyst day.

First half is probably going to be a little weaker than the second half.

And I was wondering if you could walk me through that a little bit more, in terms of how different do you think the growth rate could look first half to second half.

And given some of the economic data, you know, points to potential recession, what is the level of confidence that the markets do reaccelerate in the back half of the year?

Well, Curt, as you know, we don't provide quarterly guidance, but let me offer you a little bit of thinking on it and a lot of this you know.

Our business is clearly seasonal, with Q1 being our lowest revenue and profit quarter, followed by Q4, with Q2 and Q3 our largest quarters.

And as I mentioned, and as you just reiterated we expect the first half to be a little slower than the second half, driven in part by the new construction and residential.

A couple of numbers to give you.

The North American Home Builders data shows that the first -- at least they are predicting first half of the year will be down about 30%, and the second half of the year will be down 15%.

And part of that, quite frankly is just the comps get easier as we get to the second half of the year after what's happened in '07.

The second issue that I talked about and as you mentioned during first half of the year is some of our retail customers have pushed out some of their orders for the second half of the year.

The largest being Wal-Mart, but the balance of our commercial business, which is about 60%.

Our contract to customers remain optimistic for all of 2008.

Their backlog looks strong and they are signaling that to us.

Given the growth that we had in international beings business and 29 new accounts that we captured in 2007, in part with our Strategos unit, we feel confident on the balance of our commercial business.

So, really to me, the big softness during first half of the year has to do with the residential market.

I think our confirmation of guidance for full year sort of reflects that.

Okay.

Great.

Thank you.

And then in terms of the, you know, the gross margins for the company, you know, a lot of significant improvement on SG&A and gross margin this year, and into the fourth quarter results, despite, you know, very weak residential volumes was really impressive.

I'm just thinking about in terms of '08 and in terms of getting this annualized benefit of all the cost actions you took in 2007, you know, it seems like it would be pretty fair to assume that gross margins, you know, under flattish volume scenarios should be up year-over-year in 2008.

Short answer is yes.

The longer answer would be to talk about the guidance that I gave in December and I talked about how we are going to end the year at 7.4 EBIT rise, which we did.

And I talk about a 2010 target of 10%.

We obviously need to be on that line in 2008.

We are clearly focused on margin expansion or 2008.

On both the growth and the SG&A benefit line?

Correct.

Yes.

Okay.

Last question in terms of the leverage, even with the buyback, are going to be only about, you know, one turn debt to EBITDA.

You know, how high would you be willing to go and,, do you see any acquisition opportunities that would even foster that?

Let me answer the first question and then I will get to the second question.

As we talked about in December, as you suggest, we are going to end up one debt to EBITDA as we go into 2008.

When we look at where we think makes sense for a company of our size, and debt rating, and competitive field, we think two-ish is sort of a reasonable place for us to be.

And then -- so if we are going to end at one and two is just the place to be, then we look at where else can we go.

As you suggest, it's either investments organically in the business.

It's acquisitions that could make sense or in lieu of that, to give money back to the shareholders.

In terms of acquisition, I don't -- none of us talk about individual candidates, but this is clearly an industry that lends itself to consolidation.

I think we're in a strong position to do that, given a market leading position, and our strong balance sheet.

The businesses that make sense to us are the businesses that we have strength in, which is our North American residential business, our North American commercial business, our refrigeration businesses can make sense and as I talked about in December, we like commercial service quite a bit.

And so growing that business through acquisition could also make sense.

Great.

And would you characterize the pipeline in terms of the opportunities as better than it was last year or given the market conditions to buy back the priority near term in completing that?

As you know, acquisitions are often a long dance and I think at any given time, the pipeline or at least the conversations around the pipeline need to be full and that's what we are focusing on.

Great.

Thanks a lot.

Next we go to Jeffrey Hammond with KeyBanc Capital Markets.

Hi, how are you?

Fine, how are you.

Todd, I just wanted to go back.

It seems like you lowered your new construction assumptions.

It seems like you lowered the commercial at least slightly from a market perspective.

If the revenue guidance is unchanged, has that meant you picked that up with share or, you know, your bias is maybe towards the lower end or maybe just a little more color there?

I think you are probably fair on the back end of your statement which is probably biased towards the lower end right now.

And also, I mean, my inclination is to fund the revenue guidance.

Let's get a quarter under our belt.

First quarter the lowest quarter and second and third quarters are really the big drivers.

I think that's the short answer.

Okay.

It looks like you drew down inventory substantially in the quarter.

Can you speak to the impact, you know, that had on absorption and just maybe characterize how you feel about your inventories and inventories in the channel?

On the inventories on the channel, as you know, given that the vast majority of our business is one step.

We are typically not concerned about that in the same way that our competitors are [who are having it] on every two steps.

And as demand goes, our sales will fluctuate very quickly with that.

In terms of the inventory draw down, yes, that was good news as we generated cash with that.

And we had absorption impacts but overall, we were able to a large degree offset those with cost reductions in the factory, to help protect our margins.

Short answer is , we had inventory go down.

We had some absorption.

We offset it to large degree with cost

Great.

You talked about restructuring benefits into 2009, 2010.

Taking all the actions together, to date, do you get any material benefit in '08, and is that, you know, incorporated in the guidance?

No material benefit in '08.

Really, '09 is when we start to kick it in.

In fact, I don't have the exact map in front of me.

I think it's neutral to a slight head wind on some of the period expenses that we will be having in our face end of 2008.

So, it's really an 2009, 2010 benefit on the factory with consolidation.

And some of the restructuring that we done on head count that you see on the corporate expense line, obviously.

We will see those benefits in 2008.

Okay.

And then just final question, back to the acquisition discussion.

Maybe just ask it a little bit different way.

As you came in April, it seems like you were very focused internally on cost improvements and restructuring actions.

I just want to get a better sense of how the balance is shifting or not shifting, you know internally versus externally.

Are you more focused externally now than you were, you know, six, nine months ago?

I guess the way I think about it is given the market conditions that we face, there's no way me or anyone else in this organization have taken our eye off the internal focus on restructuring, margin expansion, and cost reduction.

We can't afford to.

So, we have not in anyway lessened the focus that we had on that when I first walked in the door, where zero down on that.

At the same time, we understand as I talked about in December, the future of this company is about growth.

And so we are focused at the same time on new product development.

And then the third piece is industry consolidation and so we are starting and has started trying to fill the pipeline with candidates where that can make sense.

I don't want to convey that in some way, we have taken our high off the cost ball, because we haven't.

Okay.

Great.

Thanks.

All right.

Thank you.

[ Operator instructions ] and we'll go now to the line of Michael Coleman with Sterne Agee.

Please go ahead.

Hey, good morning.

Hi, Michael, how are you?

Doing well.

You picked up three points of price on your residential business in the fourth quarter, and if I go back, I think you picked up maybe high single digits in the fourth quarter of '06, which was on top of price gains in the fourth quarter of '05.

You look out, given the volume issues and the new residential construction and so forth, do you see at some point where you are not going to get price, you know, at least in the coming year?

I think the way I would answer it is we have been very disciplined on offsetting the commodity increases in our business with price increases.

And the volatility of the commodities will really drive what we think we can get on price in the market place.

So in the current market, as commodities go up, I think we will be able to capture more price and we will strive to do that.

Okay.

And you seem to have at least this year captured more price on the commercial side of the business than residential.

Are you finding it, you know, not necessarily easier, but are you finding the commercial end market more receptive to price increases?

I think short supply and demand indicates that the market in commercial is strong, third and fourth year of a strong market, certainly supports price as we announced a 5% -- excuse me, 8 to 5% increase in prices on our commercial product line December 1st of 2007.

So, we recently announced the price increase on commercial and continue to push price in the market place.

Okay.

And have you taken action on residential?

We have not announced a recent price increase in residential.

But as you know, that's a dealer to dealer business where we push pricing as we go.

In any given market, we are fighting everyday for price but haven't had a recent price announcement.

Okay.

In terms of the commercial -- the description of commercial potential push outs in the first half, relative to your comments in December, have you seen an acceleration in the kind of push outs or the commercial deterioration in the last -- since mid-December?

No.

That's a good question.

The answer is no.

In terms of the guidance that I gave in December, it's really consistent with my view there on the commercial market which is the things I knew about retail pushing out we knew in December and talked about it.

The same comments I gave on the broader 60% of our business, which is non-retail, the contractors remain optimistic and talk optimistic about the backlog.

Okay.

Great.

Thank you.

Thanks.

Thank you.

(Operator instructions)

Okay.

I would like to wrap up then.

A couple of comments in closing.

LII had strong results despite a very tough market with outstanding performance in three of the four businesses.

Strategic initiative set in motion ensure LII is well positioned to expand its premium position and reduce costs across the enterprise.

2008 is about execution, and though the markets remain tough we reaffirm the financial outlook we laid out in December, and remain optimistic about this market and our position in it.

Thank you all for your time.

Thanks.

Ladies and gentlemen, that does conclude our conference for today.

Thank you for your participation and for using AT&T executive teleconference service.

You may now disconnect.