Lennox International Inc (LII) 2008 Q1 法說會逐字稿

Ladies and gentlemen, thank you for standing by, and welcome to the Lennox International Q1 2008 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 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 our review of Lennox International's financial performance for the first quarter of 2008.

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 release we issued this morning, we have included the necessary reconciliations, the financial metrics that will be discussed to generally accepted accounting principal measures.

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

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

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

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

A list of these risks and uncertainties is included in our recent 10-K filing 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 express to you today.

I will now turn the call over to Todd Bluedorn.

Thanks, Karen.

Good morning, and thank you for joining us.

As we expected, difficult residential new construction in replacement markets challenged our first quarter results.

However, disciplined cost reductions combined with strong performance in our North America Commercial and Refrigeration businesses helped offset the headwinds.

Total Company revenue for the quarter was $767 million, 3% below prior-year.

[EBIRA] is 2%, down 40 basis points, and earnings per share on an adjusted and GAAP basis were $0.10.

Our focus on cost-containment across the enterprise remains a priority, and is reflected in a 40% reduction in our corporate expenses.

We made progress in our restructuring initiatives launched last year.

The Refrigeration facility in Danville made significant progress to date, and our refrigeration facility in New Zealand and the Hearth facility in Lynnwood were substantially completed in the first quarter.

Annual pretax cost savings associated with these closures are expected to yield $10 million annually, beginning in 2009.

We are not done on rightsizing our factory footprint, and you can expect to hear more from us in this area in the future.

Cash used in operations of $33 million is a significant improvement over prior-year usage of $75 million.

If you recall, due to the seasonal nature of our business, we consume cash in the first half of the year and generate cash in the back half.

We continue to buy back shares through our 500 million share repurchase program, and during the quarter, spent $173 million for a program to date completion of 75%.

We now anticipate we will complete the program in the second quarter of 2008, a full quarter ahead of schedule.

Our balance sheet remains strong, with debt of $402 million for a debt to EBITDA ratio of 1.2.

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

Before I turn it over to Sue, I'd like to wrap up with our thoughts on the remainder of the year.

Given the continued softness in the residential market, we are revising our full year revenue growth assumptions from 2% to 5% to flat to 2%.

By accelerating plans to increase operational efficiencies and reduce costs, we believe these volume challenges can be addressed.

We expect to meet our full year earnings expectations and reaffirm our guidance of $2.85 to $3.00 on an adjusted basis, and $2.73 to $2.88 on a GAAP basis.

Now I'll turn it over to Sue.

Thank you, Todd.

Good morning, everyone.

I'll provide some additional commentary on the business segments for the quarter, starting with residential heating and cooling.

Revenue in our residential heating and cooling business decreased 9% to $329 million, while our volume was down 15%, price was flat, and mix improved by 4%.

Sales mix to our higher efficiency premium product grew 6% or 6 points sequentially, offsetting some of the volume pressure.

Segment profit was $13 million, down $7 million with a margin of 4%.

Contributing to lower segment profit, we wrote [our] customer accounts receivable of $3 million more in the first quarter of 2008 as compared to 2007, due to weakness in the sector and overall U.S.

economy.

Although the residential new construction and replacement markets continue to soften, the business is aggressively reducing its cost structure.

Now, turning to our Commercial heating and cooling business.

Our Commercial segment results were mixed.

Revenue for the total business reached $165 million; growth of 2%.

Excluding favorable foreign currency, revenue would have declined 3%.

Segment profit was down 27% to $6 million.

For the total segment, we realized mix and price of 2% and 3%, respectively, with volume down 9%.

Our European business placed a significant drag on overall segment results.

Soft markets in southern Europe and plant infrastructure investments to support our cost reduction efforts drove segment profit down year-over-year.

Recent data points suggest orders are stabilizing in Europe.

However, our primary focus is in rightsizing the business.

In North America, the business had strong segment profit growth of approximately 30%.

Much like the residential business, our mix of sales to the higher efficiency product improved sequentially.

Orders from our retail national accounts were soft in the first quarter.

However, orders from our non-national accounts, as well as the 25 plus national accounts we signed last year, helped offset the weakness.

We now expect similar dynamics for the balance of the year.

Moving to our Service Experts business.

Sales in the first quarter were $140 million, down 3% or down 6% when adjusted for favorable foreign exchange.

Segment losses and the quarter were $8 million versus $4 million in the year-ago quarter.

Service Experts performance was impacted by lower volume from the weak residential market and higher fuel costs.

Most recently, our orders have stabilized and measures to address higher fuel and other costs have been implemented.

In our Refrigeration segment, first quarter sales grew 10% to $155 million or flat when adjusted for foreign currency.

Volume was down 1%; an offset price increase of 1%.

Segment profit for the quarter was $15 million, a year-over-year improvement of 18%.

Excluding the benefit from foreign currency, profit growth would have been 13%.

Segment profit margin was 10%; a 70 basis point improvement over last year.

This profit improvement resulted from favorable international market conditions and cost reduction initiatives.

Corporate expenses improved by 40% year-over-year, driven by expense reduction and compliance activities, compensation, professional fees and overall tight budgetary controls.

On an overall basis, SG&A, when adjusted for $7 million of foreign currency, was down at 3% over prior-year.

Our cash usage in operations was $33 million; over $40 million better than Q1 of 2007.

This improvement is primarily due to a reduction in working capital levels and the timing of tax payments.

Free cash outflow was $42 million versus $85 million a year ago.

Total CapEx for Q1 was $9 million.

Our working capital as a percent of trailing 12 month sales for the Company was 18.4%, slightly higher than the 17.4% a year ago.

However, our quarter ending working capital ratio at 17% improved 50 basis points over 2007, reflecting the progress the Company has made in managing our working capital.

Inventory decreased 5% due to our adjustments to the pre-season cooling equipment build to reflect the continued declines in the residential markets.

Accounts Receivable and Accounts Payable decreased 2% and 3%, respectively.

Before I turn it over to Q&A, I'll briefly talk about our 2008 outlet.

On the residential side, we've adjusted our internal estimates down a bit further based on the latest market data.

NAHB now has North America residential new construction market down 26% for 2008.

Our best estimate for the replacement market is down mid-single digits.

Assuming the residential market is 70% replacement and 30% RNC, you get to a decline of high single digits for the total residential market.

Turning to the Commercial side, retail national account orders in the first quarter were soft, and we now expect the retail national account segment to be soft for the balance of the year.

Although we can offset much of this through other account sales efforts, we believe volume will be flat to slightly down versus our last assumption of flat to up a few points.

Given these latest assumptions, we are revising our full year revenue guidance from 2% to 5% to flat to 2%.

Our 2008 earnings estimate has not changed.

And to reiterate what Todd said earlier, we believe by accelerating plans to increase operational efficiencies and reducing costs, we can address the volume challenges.

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

(OPERATOR INSTRUCTIONS).

Jeff Hammond, KeyBanc.

Just really wanted to drill into this European issue.

I remember, I think it was last year or the year before, there were European issues.

The market started to get better or you started to fix some of the issues.

So this comes as a bit of a surprise.

Just wanted to understand what's going on there.

How quick of a fix is it?

What really needs to be done from your perspective?

Let me sort of give you a little bit more color, Jeff.

If you look on a year-over-year basis where our decrease in profitability was in Europe, about half of it on a year-over-year basis, I would say, has to do with our revenue being down almost 10% year-over-year.

And I think a large part of that was the market softened on us in first quarter -- really, the backlog going into first quarter, the orders that we took at the end of the year were soft, driven in large part to one of our largest markets, which is Spain, was down significantly.

We also had a little bit of bad debt that I put underneath that category of half of it being, I would attribute it to softer markets.

About one quarter [of the miss] on a year-over-year basis I would put under the category of one-timers -- things that won't repeat; some accounting sort of correction type things that you see in the numbers.

And then about quarter of it, which we refer to -- a little bit more than a quarter of it, we refer to on our script and earnings release, has to do with what we call infrastructure investments.

And the enterprise undertook an SAP implementation in Europe a few years ago.

We are now seeing the depreciation costs associated with that.

In many ways, our business in Europe was an accumulation of acquisitions that hadn't been integrated.

To really shrink the footprint in Europe, we needed to have an infrastructure put in place that allowed us to do that.

And I think SAP was a precondition to do that.

High level message on Europe in terms of what's in front of us -- I, like you, share the disappointment in our first quarter performance there.

What I would say is we're early in the second quarter, but the order rates in Europe appear to have stabilized.

And so we don't see the bad news that we saw earlier.

But of course, markets come and go.

More importantly, we are committed to accelerating what we have said -- we have already started in Europe but now need to accelerate, which is taking out cost and rightsizing the business.

This other half of one-time expenses and infrastructure investment, is that carryover into the remainder of the year?

The infrastructure investments will, because, again, it's depreciation off IT systems, SAP.

The one-timers we don't expect to repeat.

Okay.

And then, just a little bit -- you mentioned the Spanish exposure.

What are your bigger exposures in Europe?

Our biggest end markets in Europe are France, which is number one, Germany and Spain, I believe are our top three business markets.

And we have factories in our Commercial HVAC business, both in Spain and France and in Eastern Europe.

Okay.

And then, so moving over to guidance, it looks like you're cutting, at the mid-point, your revenue assumptions by about $60 million.

Where are you making that up?

Or have you found new cost savings?

Is it just you had some contingency and now that some of that's come up, maybe just a little color on how to make up the lower sales.

Yes.

We obviously knew when we entered the year that we're facing uncertain markets and really a challenging time for this industry.

So we entered the year with some contingency.

And so we're recognizing that contingency.

We also have realized over the last few months that markets were softening on us.

And so we have aggressively accelerated our pace of cost reduction on discretionary spending.

And I think you see some of that in corporate expenses and you'll see that during the balance of the year.

Okay.

And then just -- you gave some good color on commercial orders.

Can you just -- is there a way to quantify your Commercial order rate in the first quarter?

And maybe within there, the differentiation between the national accounts and the other?

Yes.

On this one, I won't put exact numbers around it, but I'll give you some color, which is -- at the highest level of logic, you fragment our business into national accounts which, as you know, are large degree retail.

And then the balance of our order book, which are more general contractor type business.

What we saw was the national account, the retail business, down, which I don't think is a surprise to anybody, given what we hear -- what everyone sees is going on in the retail business.

Down, quite frankly, a little bit more or down more than we thought in December, when we first gave guidance and we talked to you.

The good news is the other part of the business, which is the contractor business, we continue to see strength in that segment of the business; in fact, was up year-over-year.

So what we see there is backlogs or contract to customers, at least as far as we can see, continue to remain solid.

And the other point I make is, while some of our major customers, people who you all know, who are in the paper every day talking about pushing out their stores, we've been able to offset that to some degree by winning in the marketplace, which is the new national accounts that we signed last year and 10 new national accounts that we signed already in first quarter of '08.

Okay.

Good color.

Thanks.

(OPERATOR INSTRUCTIONS).

Chris Sommers, Greenlight Capital.

My question was answered, thank you.

Thanks, Chris.

Hopefully, it was answered well.

David Grumhaus, Copia Capital.

A couple of questions for you.

You talked a little bit about obviously what you're seeing in housing, but can you give us a sense of what you're sort of baking in, in terms of housing starts for this year in your guidance?

Yes.

Let me just sort of restate a couple of things.

We talked about residential new construction being down 26%.

That ties to the NAHB guidance that's out.

And what they're forecasting on their most recent forecast -- and I don't have exact numbers in front of me -- but they have their housing starts under 1 million for a full year -- I think it's 980,000 -- bottoming out in second and third quarter on annualized run rates of 950,000.

Now that includes multi-family housing starts.

And then what we've baked into our guidance on the residential side that sort of reiterates some of the things Sue talked about is we're saying that we now reflect that on the R&C market, which is being down 26%.

And if you recall, back in December, when we first gave guidance, we thought it'd be mid-teens.

In February, we thought it'd be 20; now, we think 26%.

Now that under -- a 950,000 annualized start second and third quarter, which are the lowest numbers, as you all know, that we've seen since the early '70s.

On the replacement market for residential, we've seen a softening in that market.

And when we were together, many of us back in December in New York, we talked about a flattish market to slightly down.

In Sue's guidance, she talked about it now being down mid-single digits year-over-year.

And as you know, in a market where 70% is replacement, that's actually the variable that's most important as you think about the risks on the business.

And so we now see a residential market that's down high single digits, 10-ish type number, for 2008.

And that's what's reflected in our guidance.

Okay, that's helpful.

And then, a second question, just -- steel prices obviously running rampant, how you're dealing with that?

How easily it is to get past due on that, and what you're thinking about that for the rest of the year?

Yes.

And maybe I'll even broaden it to copper and aluminum --

Yes.

-- the whole commodity thing.

We're fairly well hedged on copper and aluminum.

In fact, for full year 2008, we're hedged at 65% for copper and 60% for aluminum.

So we have a pretty good hedge position there.

On steel, as we all know, what you can't hedge, we have LTAs, long-term agreements, with our suppliers through the balance of 2008.

But having said that, commodity prices, specifically steel, are seeing the kind of spikes that we saw four or five years ago.

We have been very disciplined as a company that when our cost increase go up on commodities, we pass that on the marketplace.

Right now we are -- again, we have long-term agreements on steel.

We expect our suppliers to honor them.

And so when you say long-term agreements, you mean fixed-price contracts?

Yes.

Okay.

And so you're basically locked on that through 2008?

We're locked on in 2008, but again, I'll put color around that as you can imagine, which is in the past, that hasn't always stopped the steel integrated mills from passing on price increases.

And I would restate, we've been disciplined as a company as our costs have gone up on commodities and passing it on, on price, and we'll continue to do that.

Okay.

And is that generally true of most of your competitors that they would have longer-term contracts as well?

I don't want to speak for everyone.

Okay.

All right.

That's helpful.

Thanks for the time.

Michael Coleman, Sterne, Agee.

The reduction in the corporate overhead in the quarter looked like it was what you were previously planning for the full year.

How do we think about the ongoing year-over-year declines in the corporate overhead for the balance of the year?

Good morning, Michael, it's Sue.

Let me take this one on.

As I look at the first quarter and the $8 million expense reduction from the first quarter of 2007, I would characterize that as a combination of timing, items and just overall cutting.

In February, when we talked to you, we said that we knew that the first half of the year was going to be difficult.

And so as we planned for our expenses, particularly those that we could control, we pushed them out to later in the year.

To give you some parameters around that and what to do with that, when we talked to you in December and in February, we talked about corporate expenses being about $75 million for the year.

We now think that corporate expenses will be just south of $70 million for the year.

And so that kind of gives you a baseline for the timing versus the actual expense reductions.

Okay.

And the $3 million increase in the SG&A -- is that to be viewed as one-time?

Or do you think you'll see more of that in the balance of the year?

No, I think we'll just continue to monitor that.

And I think the additional color I would give, Michael, is what Sue said earlier.

If you adjust for OpEx increases, on a constant effects basis, SG&A was actually down year-over-year by about 3%.

Okay, great.

Thank you.

Jeff Hammond, KeyBanc.

So, just to follow-up on the raw material.

Have you seen any of your steel providers come back with surcharges to this point?

We have not -- and I'm parsing my words -- we have not accepted any surcharges from our suppliers.

Okay.

And then have you announced any price increases in any of your businesses near-term?

Or maybe just run through --

The last price increase that we announced publicly was in our Commercial business back in December.

And I'll look around there and have someone correct me if I misstate this, 5% to 8% price increase on our Commercial business.

Okay.

So, given your earlier comment in the run in commodities, how should we be thinking about price increases going forward?

Again, I'm going to just be very precise on my words.

As our commodity costs increase, we will be disciplined, as we have in the past, on passing on price to our customers.

Okay.

Sue, can you just update us on the tax rate for the year?

It did come in a little bit higher for Q1.

Our tax guidance will remain the same at 36% to 37% for the year.

Okay.

And then final follow-up.

As you get through this share repurchase at the end of Q2 on an accelerated basis, how should we think of capital allocation on a go-forward basis?

I think the way that I would think about it is -- we'll finish the share repurchase in the second quarter.

We'll stop and we'll assess what's next.

And in our second quarter earnings call, we'll come back to you with some outlook for what's next.

And I think the color that I would add to that, Jeff, is our stated intent -- and this has been Lennox's stated intent for several years -- has been it's continued to return cash to our shareholders in the absence of beneficial acquisition or expansion opportunities.

Okay.

Great.

Thanks, guys.

(OPERATOR INSTRUCTIONS).

[Dev Nigeson, Pie & Cobble].

Thanks for taking my question.

With regards to the projections that you guys have made to achieve your revenue guidance of flat to up 2%, what kind of haircut is implicit in the backlog number that you're receiving from your national accounts?

I'm not sure I understand the question.

I think maybe I would answer it this way -- our current guidance reflects both our backlog and our order rate history and our projected expectations from our national accounts.

So our guidance reflects what our current understanding is of our national account business.

Yes, I guess that's what I mean.

I mean, your national accounts give you a certain number that they've budgeted for the year.

Do you haircut that in order to come up with your guidance?

If your point is, do we take what our customers give us at face value, we make adjustments and sort of put our own wisdom on top of numbers that we give.

And we have operational numbers that we prepare to build to, and then we have financial forecasts that we submit.

And on both those, we obviously put common sense and our own understanding of market dynamics.

Yes.

No, I'm trying to get a sense for the magnitude of that number.

I'm not going to give that to you.

Okay.

The EPS guidance for the year -- what's the share count that's implicit in that?

In December, we talked about having between 60 million and 61 million shares.

We've -- completing the program in a second quarter, I would take that to 58 million to 59 million shares.

Dev Nigeson Okay.

Thanks very much.

Good luck for the rest of the year.

Thank you.

And with no further questions in queue, I will now turn the call back over to Mr.

Bluedorn for closing remarks.

Thanks, Operator.

As we expected, difficult residential new construction in replacement markets challenged our first quarter results.

We helped offset these headwinds with disciplined cost reduction and strong performance in our North America Commercial Refrigeration businesses.

And though the markets remain tough, 2008 is about execution.

We have accelerated cost reduction actions and reaffirm our 2008 earning outlook.

Thank you all for joining us.

And ladies and gentlemen, that does conclude your conference.

We do thank you for joining while using AT&T executive teleconferencing.

You may now disconnect.

Have a good day.