Lennox International Inc (LII) 2008 Q2 法說會逐字稿

Welcome to the Lennox International Q2 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 now like to turn the conference over to Steve Harrison, Vice President of Investor Relations.

Please go ahead.

Good morning.

Thank you for joining us for this review of the Lennox International's financial performance for the second 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 reconciliation of the financial metrics that will be discussed to GAAP 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 that site and make it available for replay.

I would 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 forward-looking statements are subject to risk and uncertainties.

A list of these risk 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 express to you today.

We'll now turn the call over to CEO, Todd Bluedorn.

Thanks, Steve.

Good morning, everyone, and thank you for joining us.

Lennox posted strong profits in the second quarter despite a difficult macro economic environment.

The quarter's results were driven by record sales and profits in June a month that saw above-average temperatures.

As a result, our residential replacement business performed exceptionally well as did our service experts business.

Service experts realized record sales and profits in June and record profits for the quarter.

As expected the residential new construction market remained challenging.

And the commercial market softened further.

In refrigeration we saw strong sales and profits.

We previously discussed that we expect a $40 million headwind for 2008 from the increasing commodity prices.

To offset this, we announced price increases with most taking effect at the start of July.

We expect the yield from these price increases to fully offset the $40 million impact from commodity costs this year.

Total Company revenue for the quarter was slightly over $1 billion.

4% below the prior year.

EBIT loss was 9.9%, up 40 basis points.

Earnings per share on an adjusted basis were $1.02, and EPS on a GAAP basis was $0.88.

Our strategic and cost reduction initiatives are on track.

Salaried headcount is down 6% from a year ago.

Overall corporate expenses are down significantly in the first half of 2008.

On the restructuring front, the previously announced closures of our Lynnwood, Danville, and New Zealand facilities are on track to provide $10 million pretax savings for 2009.

Among our new activities, we are announcing a transfer of refrigeration product manufacturing from our Sydney, Australia, facility to our [Wushu], China facility.

In the second quarter we took a $3 million in pretax restructuring charges for this transfer.

The annual savings is expected to be $2 million starting in 2010.

We are also beginning the move of our Merit (inaudible) product line from our Marshalltown, Iowa, facility, to Saltillo, Mexico, as we begin to ramp this new facility in the second half of 2008.

We still expect $20 million in annual savings in 2010 from this new facility.

As I have said before, we are not done, and you will hear more from us in the future on manufacturing rationalization.

Turning to cash, you may remember that due to the seasonal nature of our business, we typically consume cash in the first half of the year, and generate cash in the back half.

For the first half of 2008, however, cash from operations was $23 million and free cash flow was slightly positive.

In the first half of 2008, the Company has returned cash to stockholders to $297 million of share repurchases and $25 million of dividend.

In the second quarter we completed our $500 million share repurchase program ahead of schedule, and announced a new $300 million program.

Our balance sheet remains strong.

Debt was $470 million at the end of June, for a debt-to-EBITDA ratio of 1.4.

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

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

Although temperatures have been above average in June and July, to the benefit of our replacement business, given continuing overall softness in residential, further softening in the North American commercial market and uncertain macro economic conditions we are revising our full-year revenue growth assumptions from a range of flat to up 2% to a range of flat to down 2%.

However, by further accelerating plans to increase operational efficiencies and reduce costs, we believe volume challenges can be addressed.

We expect to meet our full-year earnings expectations and reaffirm our guidance of $2.85 to $3 on an adjusted basis.

GAAP EPS is now expected to be $2.61 to $2.76 versus previous guidance of $2.73 to $2.88.

The change in GAAP guidance reflect the impact of the restructuring charges and joint venture impairment announced in the second quarter.

Now I'll turn it over to Sue Carter.

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 on our residential heating and cooling business decreased 9% to $451 million.

While our volume was down 14%, price was up slightly and mix improved by 4%.

Sales mix to our higher efficiency premium product grew 10 percentage points from a year ago to 30%.

Segment profit was $50 million down $10 million with a margin of 11.1%.

While replacement business was very good in June, the residential new construction business continues to be weak, and overall volumes are down from a year ago.

The business continues to aggressively reduce its cost structure, improve factory efficiencies, and lower warranty expense for partially offset by commodity headwinds and increased freight rates due to fuel cost increases.

Now turning to our commercial heating and cooling business, revenue for the commercial business was $229 million, down 1%.

Excluding favorable foreign currency, revenue would have declined 6%.

Segment profit was down 12% to $27 million.

Segment profit margin was 11.6% versus 13% a year ago.

For the total segment, we realized favorable mix of 3% and price of 1% with volume down 10%.

Our European business was solidly profitable in the quarter.

However, we believe there are further cost-cutting opportunities to enhance profitability, and we continue to move forward with those initiatives.

In North America, volume was down primarily due to new construction pushouts into 2009 of certain national retail accounts.

However, mix and price were improved, and our high efficiency Stratego system continues to win in the marketplace.

Outside of national retail accounts, our business is up from a year ago, and we continue to have solid backlog and order activity.

Moving to our service experts business.

Sales in the second quarter were $183 million, down 1% or down 2% when adjusted for favorable foreign exchange.

Segment profit in the quarter was $14 million or a margin of 7.6% versus $13 million or a margin of 7.1% in the year-ago quarter.

Service experts' record second-quarter profits were driven by increased service in replacement work, successful fuel surcharge implementation, and cost reduction initiatives.

In our refrigeration segment, second-quarter sales grew 12% to $169 million or up 3% when adjusted for favorable foreign currency.

Volume was up slightly, mix was flat, and price increased 2%.

Segment profit for the quarter was $17 million, up 7% from a year ago.

Excluding the benefit from foreign currency, profit growth would have been up 2%.

Segment profit margin was 10.3% in the quarter compared to 10.8% a year ago.

Segment margin was flat at constant foreign exchange.

Corporate expenses excluding a one-time favorable adjustment improved by almost 40% year over year.

Driven by expense reductions in legal and professional fees, compensation, and overall tight budgetary controls.

In the second quarter, we recorded a favorable catch-up adjustment of $4.3 million after tax, related to currency fluctuations in prior periods on interCompany loans.

We do not expect to see such a large impact of corporate expenses related to currency fluctuations in future periods.

For 2008, we expect corporate expenses to be in the range of $60 million to $65 million.

Overall SG&A when adjusted for $6 million of unfavorable foreign currency was down 4% over the prior year.

Our cash provided by operations in the first half of 2008 was $23 million, up from $5 million cash used in operations in the first half a year ago.

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

Free cash flow was $1 million in the first half versus free cash outflow of $30 million in the first half a year ago.

Capital spending was $22 million in the first half, including $12 million in the second quarter.

Cash provided by operations in the second quarter was $56 million, down from $70 million a year ago, on lower net income and restructuring cash payments that exceeded the charges in the quarter.

Our working capital as a percent of trailing 12-month sales for the company was 18.4%, slightly higher than the 17.7% a year ago.

However, our quarter end working capital ratio at 18.7% improved 80 basis points from the second quarter of 2007.

Restructuring charges in the second quarter included $5.1 million after tax, primarily for activities in our refrigeration and residential businesses.

In addition, we had a $2.3 million after-tax impairment charge related to an equity method investment.

Together, these impacted our GAAP earnings by $0.13.

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

On the residential side we continue to experience a very difficult market environment.

NAHB currently estimates the North American new construction market down 30% for 2008.

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

Assuming the residential market is 70% replacement and 30% R&C you get to a decline of low double digits for the total residential market.

Turning to the commercial side, our retail national account business has softened further and we are seeing more pushouts.

Our non retail unitary business has been solid but we remain cautious for the balance of the year.

Overall, we saw the commercial market down in the low to mid-single digits for 2008.

Given these latest assumptions we are revising our full-year revenue guidance from a range of flat to up 2% to range of flat to down 2%.

Our 2008 adjusted 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 changes.

Our earnings guidance is adjusted earnings per share in the range of $2.85 to $3 per share, GAAP earnings per share of $2.61 to $2.76, reflecting the impact of restructuring charges and the joint venture impairment announced in Q2.

And we are also lowering our capital spending guidance from $90 million to $75 million for 2008.

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

Thank you.

Our first question is from the line of Jeff Hammond, from KeyBanc Capital Markets.

Please go ahead.

Good morning.

I just wanted to -- it sounds like in terms of your revision of the revenue guidance, is that solely a function of commercial or have you downstepped your residential assumption, as well?

The way I think about it, Jeff, is when we were together in June, we talked about how we were going to withhold touching guidance until we got through the summer period.

Or at least through second quarter.

And so I would view our revision and guidance for revenue as a reflection of everything we've learned since we had our call in April.

And so that reflects both a softening of the residential market from April until now, as well as a commercial softening.

So I -- the question is -- if I answer your question, it's all in there.

Okay.

And then residential but down 14 on units seems a little -- I know market share doesn't shift a lot quarter to quarter.

But you mentioned the better June.

Yet units down 14 seems to be still pretty ugly and a little bit, certainly a little worse than what we're hearing from a market perspective.

I think the market, on a full-year basis, we've talked about it -- and I -- obviously the ARI numbers aren't out for June yet.

But I think looking at a market down as Sue said low teens, low double digits, I think is where the market's at.

So yes, I think it's fair to say for the quarter, we might have been a hair off where the market's performing.

I think the first point you make is the right one which is obviously it's tough to look at share when you're one step and others are two step on a one-quarter basis.

I think if you look at a share over the last year, we're performing with the market.

Okay.

And then how would you characterize replacement into July with the favorable weather?

Has that persisted?

And then can you just speak to inventories within the channel as you exit the second part of the -- enter the second part of the selling season?

Yes.

Inventory levels appear to be fine.

As you know, we're less impacted by that since we don't have independent distributors.

So when we see the demand we can sell through our own distribution.

In terms of the heat in July, as you suggest, July is starting warmer than last year, which is a good, solid start for the quarter.

But it's early in the quarter.

Okay.

And then just final couple of housekeeping items.

Do you have a free cash flow expectation for year end and full-year tax rate?

We have not given the free cash flow guidance for the year.

What we've given is the $75 million now of capital expenditure.

The tax rate for the full year we expect to be around 37%.

Okay.

Just a follow-on to the free cash.

Would you expect working capital to be a use, a source, neutral for the year?

Given some of the moving pieces and demand, and?

I can tell you what we've done so far this year, which I think is a helpful point.

We're running ahead both for the second quarter and for the six months year to date.

We're about $30 million favorable to where we were on working capital a year ago.

So I think we've got good controls in place.

And I would expect our working capital performance to continue.

Okay.

Great.

Thanks.

Thanks, Jeff.

Thank you.

Our next question is from the line of Keith Hughes from SunTrust.

Thank you.

On the Corporate expense, the $60 million to $65 million a year, does that include or exclude the currency adjustment you referred to earlier?

That's our total spending that we expect for the year.

So that includes it.

It includes it.

I'll include it.

That means you're going to be spending a lot more on Corporate in the second half of the year than you did in the first half of the year.

What's going to change in the second half to cause that?

Let me talk to you about a couple of things.

And that will help you to baseline it.

First of all, you have the $4.5 million of the foreign exchange on interCompany loans.

The other piece that we've talked about, particularly in our first-quarter 10-Q was that on our long-term compensation programs, we revised our forfeiture rates, again, exits of executives over the last, 12 to 18 months.

And we also revised our performance estimates in line with what our current performance targets are.

So if you talked about that being in the range of $3.5 million to $4 million in the first quarter and you added those two items back on to the first half run rate and then you look at the second half where we expect to have a little better spending, a little more spending, more accurately, on our sourcing initiatives and our IT infrastructure, you get to a run rate that looks like $60 million to $65 million.

That will put you at slightly under 2% of sales.

Is that what we should expect from Lennox moving forward?

Is that artificially low, again, some of the things that you've just explained?

How do we look at that longer term?

I think what you look at is, we've dialed out the unusual items for you, we've looked at the tight budgetary controls.

Obviously there's a lot of moving pieces in terms of the compensation programs and market fluctuations.

But I think our expectation is that we're going to continue with work that we started and maintain tight controls on Corporate spending.

Final question -- in service experts, you referred to the hot weather.

Given that, I would have expected the revenues to be up more.

The EBIT was fantastic compared to what it's done in the past.

Is it fair to say that cost cuts drove more of the EBIT than poor or bad weather?

At the segment?

This is -- short answer is yes.

The broader answer that I would lay out for everyone on the call is when we've talked about service experts, we've talked about the way we're going to compete against local players is to put a national infrastructure and things like the call center, things like a common operating system, and that when we have those infrastructure in place we'll be able to drive efficiencies and the fact of this greater than local competitors.

What we saw is when we got a little bit of hot weather and some demand in the second quarter we saw the margins go up.

It's both from those investments that allow us to drive down our costs.

But then as you suggest, we also had good cost containment actions in second quarter given the concerns about the market that we saw.

All right.

Thank you.

Thank you.

(OPERATOR INSTRUCTIONS) We'll go to the line of Michael Coleman from Sterne, Agee.

Please go ahead.

Good morning.

Hey, Michael.

How are you?

Good.

Could you talk on your revenue guidance, what does that assume regarding refrigeration or has there been a change in your thinking on refrigeration at all?

No.

Short answer is when we think about our change in guidance from -- from 0 to up to 0 to down 2, it really reflects the changes in the market in North America for our residential business and our commercial HVAC business.

We think the second half for refrigeration will look much like the first half.

So you haven't seen a slowing of refrigeration in Europe or in North America?

What we've seen, Michael, is we've seen our revenue hang in there if you will.

So we -- quite frankly, although there's no industry data as you know, we think we're gaining share both in the US and in Europe.

That combined with we've -- albeit off a very small base have seen dramatic growth in China and Asia.

And so net-net, we think we're one growing faster than the market and second half will look a lot like the first half.

Okay.

And on the transfer of production from Sydney to Wushu what is your -- what does that do for your capacity availability in your China facility over the next couple of years?

Part of the restructuring charges that are -- part of the restructuring plan and movement plan is we're adding an extension to our China facility.

So sort of the art of this as you well know is to, in a place that's growing as fast as our business in China, is to stay ahead of that -- that curve but not so far ahead that you have overhead and factory absorption issues.

So short answer is by moving that production there, we're building an expansion to our existing facility.

It will help drive us to critical mass, allow us to hire more skilled folks as well as drive cost reduction on the production of the product.

Okay.

Great.

And do you have a rough estimate of what China represents of the refrigeration revenues?

I mean, at this point in time, Michael, it's still nonmaterial.

I think the point is we're -- doubling, tripling the -- our sales every quarter.

And as what I've said before, in two or three years, it becomes material.

Now it's not.

Okay.

Great.

Thank you.

Thanks.

Thank you.

We have a follow-up from the line of Jeff Hammond from KeyBanc Capital Markets.

Please go ahead.

Hi, guys.

Just a follow-up on the commercial piece.

You mentioned your guidance for the year being low to mid-single digits for commercial.

I just want to understand that, is that units for the industry or just commercial construction in general?

I mean help me frame that versus kind of the minus 10, units you had, you had this quarter on a core basis?

Our point of view when -- the guidance I'm giving on low to mid-single digits is an estimate on unit for the industry full year.

And then I would say that what we're seeing is the segment of the market that accounts for approximately half our sales is the retail national account segment.

And that's down more than low single digits.

So half our segment's down more than 6%.

The other segment of the market which is everything else, health care, schools, the other unitary side of the business, we actually saw our revenue up in second quarter.

So it's really sort of a tale of two markets.

So.

What would you say your units was for the -- down for the first half of the year?

You said down 10 for 2Q?

Yes.

And by the way, the 10% was for the total commercial segment, right?

Right.

So that's Europe and the US.

I'm not sure we've given those numbers.

Okay.

So is it fair to say that just a function of your -- your higher national account retail exposure, you would -- you would be underperforming this low to mid-single on a full-year basis?

Here's how I would answer it.

And I know what you're looking for, but I'll answer it a slightly different way.

In both the segments that we play, national, retail national accounts and the balance of the industry, I think we're winning in the marketplace which means we're gaining share in each of those segments.

But given that we're -- half our business segment is down more than the market overall, I think our unit volume will probably be lower than the market.

Okay.

Then just a follow-on on the restructuring.

You're taking your GAAP EPS guidance down $0.12.

Three was this JV impairment.

I guess there's another chunk from this Australia to China move.

Is there any other restructuring that -- that's getting, that's incremental to what you've already announced?

Well -- what we've included in the guidance is what we've announced.

So the change in the GAAP guidance is exactly the ones that just outlined, Jeff.

The transfer from Wushu to -- from Sydney to Wushu, the transfer of the Merit product line from Marshalltown to the Mexico facility, and the JV impairment.

Okay.

Thanks a lot.

Thank you.

Our next question is from the line of [Bob Nicholson] from [Pine Cobble Capital].

Nice quarter in a tough environment.

Could you talk about the commodity headwinds?

I know publicly there's been talk about the price increases you and some competitors have taken.

Given in particular where steel has gone, and I think in the past you've talked about the difficulty in foreseeing forward contracts.

Could you just walk us through some of the math on how get comfortable with the commodity headwinds are adequately dealt with?

Yes.

When I -- when we think about the commodity headwinds, obviously the biggest drivers of that for us are copper and steel.

We've seen from last year to now copper prices up about 20%.

Now as you probably know, we hedge our copper on a banding strategy.

So we're approximately hedged 70% for the balance of the year.

So we're -- we understand our copper costs to a large degree.

Steel, as you suggested, everyone got -- everyone in Corporate America I believe got the surcharge increases last quarter.

We like most or all had no choice but to accept them.

We did.

We announced depending on the business between a 3% and a 6% price increase between June and 1st of July.

All our major competitors announced similar price increases.

So far, while it's early, they seem to be sticking as expected.

What I said at a meeting we had in June was we said between copper, steel, and fuel, commodity increases we had a headwind of approximately $40 million year over year, '07 to '08.

And we thought the price increases and now we -- we're even more confident that the price increases that we've announced will allow us to offset those commodity increases with price.

Okay.

Thank you.

Thanks.

Thank you.

There are no further questions.

We will now turn the call back over to Mr.

Bluedorn for closing comments.

Thank you very much, operator.

The second quarter saw strong results driven by a record June performance overall.

July is off to a solid start.

Although temperatures have been above average in June and July to the benefit of our replacement business, given continuing overall softness in residential, further softening in the North America commercial market and uncertain macro economic conditions, we are reducing our revenue growth assumptions to a range of flat to down 2% for the full year.

However, we reaffirm our adjusted EPS guidance for the year.

Our strategic initiatives and accelerated cost reduction programs are on track, and we remain focused on solid execution.

Thank you all for joining us.

Have a good day.

Thank you.

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

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

You may now disconnect.