Lennox International Inc (LII) 2010 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by.

Welcome to the Lennox International Q3 2010 earnings conference call.

At the request of your host, all lines are in 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, sir.

Good morning.

Thank you for joining us for this review of Lennox International's financial performance for the third quarter.

I am here today with Todd Bluedorn, CEO, and Bob Hau, CFO.

Todd will review highlights for the quarter and Bob 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 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 are subject to numerous risks and uncertainties that could cause actual results to differ materially from such statements.

For information concerning these risks and uncertainties, see Lennox International's publicly available filings with the SEC.

Lennox disclaims any intention or obligation to update or revise any forward-looking statements whether as a result of new information, future events or otherwise.

Before I turn the call over to Todd, I would like to announce the date of our annual investment community meeting.

It will be held the morning of December 15 in New York.

Please mark your calendars.

Invitations and more details will follow.

The event will also be webcast.

Now let me turn the call over to CEO, Todd Bluedorn.

Thanks, Steve.

Good morning, everyone and thanks for joining us.

We continue to be encouraged by the improved end market conditions overall that we saw in third quarter.

Company revenue was up 9%, led by 14% growth in Commercial.

Refrigeration revenue was up 11% adjusted for our strategic exit of the third-party coil business in Australia.

Service Experts grew 10%.

In Residential, revenue grew 7%.

Overall for the Company, volume was up 7% and price and mix were up 2% on a greater percentage of replacement business and the success of our new products in the market.

Adjusted earnings per share from continuing operations grew 15% in third quarter from a year ago.

And GAAP EPS from continuing operations grew 29%.

As expected, increased commodity costs were a significant headwind in the third quarter, impacting profitability and margins.

Total segment margin was 8.8% for the Company, down 20 basis points from 9% in the third quarter a year ago.

Excluding the headwind from increased commodity costs however, total segment margin was up over 100 basis points from the third quarter a year ago.

Let me highlight a few key points for the quarter on each business segment.

In our Commercial business segment, revenue was up 16% at constant currency.

Despite commodity cost headwinds, Commercial profit margin was up 300 basis points to 14.1%.

Replacement business was up in the quarter on the strength of planned replacement business and national accounts.

And our school business continued to do well with 40% growth.

In both these markets, our new Energence rooftop, the most energy-efficient in the market, continued to do very well.

On the new construction front at Commercial, business was up for the second consecutive quarter.

In Europe, our Commercial HVAC revenue grew double digits at constant currency, led by strength in Western Europe in the quarter.

Europe HVAC was profitable for the second consecutive quarter and we expect the business to be profitable for the full year.

In our Refrigeration business segment, revenue was up 9% at constant currency, adjusting for the strategic exit of the third-party coil business in Australia.

With the impact of higher commodity costs, Refrigeration profit margin was down 30 basis points to 12.3%.

In constant currency, revenue grew double digits in every region accept Australia.

We saw the fastest growth rates in South America, followed by Europe and China.

In North America, supermarkets and cold storage continue to show strength.

And we are seeing a pickup in the large cold storage projects contributing to our solid backlog position.

In Residential, revenue was up 6% at constant currency.

Replacement business in our core Lennox brand business was up high single digits while business from new construction was down substantially following the first full quarter after the expiration of the government tax credit for housing.

Warm weather in the quarter helped the replacement business with cooling degree days above both normal and last year.

System repair instead of system replace remains high, both incrementally better than last year.

Turning to profitability in Residential, segment profit margin was down 70 basis points to 10.5% in the third quarter.

The main driver was commodity cost headwind.

In addition, we had some inefficiencies in the factory and in distribution tied to the new product launch of our furnace platform.

Turning to longer-term strategy, let me give you a quick update on our Lennox Residential distribution strategy.

We now have six of the eight planned regional distribution centers open.

The newest one just outside of Harrisburg, Pennsylvania.

The other new RDCs are in Atlanta, Dallas, Columbus, Calgary and Toronto.

We opened 13 more storefronts in the third quarter and now have 53 open under the new model on our way to 120 new storefronts.

To reiterate the main benefits we expect are to increase our replacement business by doubling our physical distribution locations and to improve same day/next day service levels from 35% under our historic model to 85% under the new model.

And we expect improved logistics productivity versus our historic model.

In total, we are targeting $25 million incremental benefit to EBIT by 2012.

About half of that from cost savings and the other half from incremental share gains.

In our Service Experts business, segment revenue was up 9% at constant currency driven in part by warm weather.

Again, this quarter, we saw very strong growth in the commercial service as we continue to leverage our relationships with national accounts.

Commercial service now comprises a quarter of our business in this segment.

Profit margin for the third quarter was off 180 basis points from a year ago, primarily on increased variable selling expenses and timing of insurance expense.

Before I turn it over to Bob, let me talk about our stock repurchase program.

In the third quarter, we repurchased $50 million of stock and have repurchased $144 million through the first nine months of the year.

Since 2007, we have repurchased more than $700 million of stock.

Under our current stock repurchase authorization, we have $141 million remaining and we expect to continue buying back stock in the fourth quarter.

Now I'll turn it over to Bob.

Thank you, Todd and good morning to everyone.

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

In the third quarter, revenue from residential heating and cooling was $371 million, up 7%.

Currency had a positive 1 point impact, volume was up 5% and price and mix were up 1%.

Favorable mix was primarily driven by the growth in replacement business and the decline in residential new construction in the quarter.

Residential segment profit was $39 million, flat with the third quarter a year ago.

Segment profit margin was 10.5% compared to 11.2% a year ago, impacted significantly by higher commodity costs, as Todd has mentioned.

Turning to our commercial heating and cooling, in the third quarter, revenue from the Commercial business was $176 million, up 14%.

Currency had a negative 2 point impact, volume was up 12%, price and mix were up 4%.

Segment profit was $25 million, up 46% from the third quarter a year ago and segment profit margin was 14.1%, up 300 basis points from the third quarter of last year.

Our North American commercial HVAC revenue was up high teens at constant currency and our European commercial HVAC revenue grew low double digits at constant currency.

Moving to our Service Experts business, in the third quarter, revenue was $150 million, up 10%.

Currency had a positive 1 point impact, volume was up 5%, price and mix were up 4% due to continued strong commercial services growth in the quarter.

Segment profit in the third quarter was $6 million compared to $8 million a year ago.

Segment profit margin was 4.0% compared to 5.8% in the third quarter a year ago.

Margin declined in the third quarter, primarily from an increase in variable selling expenses and timing of insurance expense.

In our Refrigeration segment, revenue in the third quarter was $141 million, up 5%.

Currency had a positive 1 point impact, volume was up 3% and price and mix were up 1%.

Against the commodity cost headwind, the Refrigeration segment profit was $17 million in the third quarter, up 3%.

Segment profit was 12.3% compared to 12.6% in third quarter a year ago.

Restructuring charges and other items in the third quarter were $3.6 million after tax.

This included a $3.5 million after-tax charge for restructuring activities and $1 million for a special legal contingency charge related to litigation.

Other items netted to a gain of $900,000.

In total, these charges impacted GAAP EPS from continuing operations by $0.07 in the third quarter.

Corporate expenses were approximately $15 million in the third quarter compared to $13 million in the prior year quarter.

For 2010, our corporate expense guidance remains approximately $65 million.

SG&A was $163 million in the third quarter, up 4% from $157 million in the prior year quarter on higher selling-related expenses and incentive compensation, partially offset by lower bad debt expense.

For the third quarter, cash from operations was $70 million, down from $131 million in the prior year quarter, primarily due to working capital changes as we grow the top line and from timing of tax payments.

Capital spending was $10 million in the third quarter compared to $12 million in the prior year quarter and free cash flow was $59 million in the third quarter compared to $118 million a year ago.

Working capital as a percent of trailing 12 month sales for the Company was 16.8% compared to 18.9% in the prior year period and at quarter-end, working capital ratio was 18.9% compared to 17.7% a year ago.

Looking at liquidity, cash and cash equivalents were $92 million at the end of September.

Our total debt was $371 million, giving us a debt to EBITDA of 1.4 ending the third quarter.

Now before I turn it over to Q&A, I will briefly talk about our outlook for the remainder of 2010.

First, as is our practice, let me give you our assumptions on shipments for the industry overall.

In the residential market, we now expect industry shipments in North America to be up mid single digits for 2010 versus our previous expectation for industry shipments to be up high single digits.

In the commercial market, we now expect North America commercial unitary shipments to be up low single digits for the full year versus our prior assumption of down mid single digits.

In the refrigeration market, we still expect global refrigeration shipments to be up low single digits for the full year.

Therefore, based on these underlying market assumptions and with Company revenue up 10% through the first nine months of 2010, we are raising our revenue growth guidance for the full year from a previous range of 5% to 8% to a range of 7% to 9%, including a positive 1 point impact from foreign currency.

As mentioned last quarter, year-over-year comparisons become notably more difficult in the fourth quarter.

We continue on track with our plans to save approximately $35 million from our global sourcing initiatives and $15 million from our announced restructuring projects in 2010.

However, as expected, commodity costs became a headwind for us in the third quarter and are in the fourth quarter as well.

In total for the second half, we now expect approximately $20 million of headwind from higher commodity costs in the second half versus our prior guidance range of $20 million to $25 million.

We are narrowing our 2010 guidance for adjusted EPS from continuing operations from a prior range of $2.20 to $2.45 to a new range of $2.35 to $2.45.

Our GAAP EPS guidance range is now $2.07 to $2.17, reflecting the narrower adjusted EPS guidance and the full-year impact of our announced restructuring activities through the third quarter.

The tax rate is expected to be approximately 35% for 2010, the low end of our guidance range of 35% to 36%.

Our average diluted share count for the full year is still expected to be approximately 55 million to 56 million shares.

And finally, our capital spending guidance for 2010 is now $60 million versus our prior guidance of $65 million on the timing of projects between 2010 and 2011.

With that, let's turn it over to Q&A.

(Operator Instructions).

Keith Hughes, SunTrust.

Yes, thank you.

I just wanted to dig into the price mix on Residential.

You said 1% in the quarter.

With all the things going on with tax credit and things of that nature, I would have thought that would have been a little higher.

I would just like to get your thoughts on that.

Well, I mean there are multiple forces at work.

I mean during the second quarter, we talked about a negative price mix and made the point that, while we are seeing with the move to 410A as we are getting a lot more system installations and we are selling more coils and air handler, which is lower margin equipment, the upside in the quarter was a little bit more mix on high efficiency, but order of magnitude, about half of our Lennox product was high efficiency third quarter this year, which is up about 10 points -- 8, 9 or 10 points from where it was last year.

The other mix positive that we had was RNC, residential new construction, being down and replacement being up.

Okay.

And so as you look towards '11 with the tax credit going away, do you think that is going to be a negative, a big negative mix for you in 2011?

I think it will have an impact.

I don't know if I would say a major negative impact.

I mean we are thinking through how we want to combat that if it goes away.

I think we are in a position where we have spent a lot of time with our dealers, a lot of time with the field people making the sale on high efficiency.

The economics, even without the $1500 tax credit, are compelling in many geographies to sell up.

We were on a trend of mixing up in '07 and '08 even before the stimulus money kicked in.

So it will clearly have some impact, but we think we will work our way through it.

Okay, thank you.

(Operator Instructions).

Gentlemen, there are no further questions -- I'm sorry -- a few people just queued up.

We will go to the line of Robert Wertheimer with Morgan Stanley.

Good morning, guys.

How are you?

Sorry about that.

There is a bunch of calls this morning, so I didn't know if I would get it in queue before it ended.

Todd, you gave great color on the resi pricing.

Are you able to give apples-to-apples pricing?

I don't know if you ever do that for competitive reasons, but apples-to-apples pricing.

Is it okay, is it negative or positive on the resi side?

Yes, we tend to just give color commentary.

Our sense is apples-to-apples pricing is flattish right now.

Sort of on the margins, there is always skirmishes, but our sense is we have had flattish pricing.

Perfect.

And then there is a lot of folks who think they gained share I guess this summer, this quarter.

There is a lot of back and forth.

Do you have a sense of what your share did?

Again, is it positive on the resi side?

On the commercial side, I assume it is up?

Yes, my experience is it is very hard in any given quarter because people have different business models, which I know you understand and so some people are reloading distribution, some aren't.

We are selling directly to dealers.

My sense is our share in resi was probably flattish during the quarter.

And on a full-year basis, our sense is, in the Lennox brand, we have gained share.

In our Allied brands, we have lost a little bit of share and net net, we probably gained some share, but not material amounts.

Perfect.

And my last one, is there any glimmers of a potential renewal of the tax credit or is that just kind of off the table, do you think?

I think there is -- well, I have to be careful how I phrase this.

I think there is lots of ambiguity right now in DC about what is going to be the priorities after the elections and into first quarter.

So we worked through our industry organization and through our own government affairs office to make the case on why we think this is important both for environmental reasons and also for jobs.

And so I think when you have both of those things in your favor, there is a lot of constituents who would support it.

But there is lots of uncertainty right now what the priorities are going to be.

Makes sense.

Thank you.

Steve Tusa, JPMorgan.

Hi, good morning.

Can you here me okay?

Sorry, I am on a cell phone here.

Just a question, the revenue numbers looked pretty good.

Your resi numbers held up certainly better than others in the industry.

The margins just didn't show the type of leverage that they showed in the first half.

I know there is some product launch in there; there is some extra cost for Service Experts.

Can you just maybe walk through those items?

Sorry, I just jumped on the call, so if you guys have already explained what those were in your kind of a preamble, then I will just go back to the transcript, but if you haven't, if you could maybe flesh a couple of those items out.

I think we said a little bit, but I think it is probably worth underlining a little bit, Steve.

The biggest driver for the quarter, and we have been talking about it for a while, were the commodity costs.

So on a year-over-year basis, we had commodity tailwind first half; we had commodity headwind second half.

We called out earlier in the script that adjusting for the commodities, our margins would have been up over 100 basis points.

So instead of being slightly down, they would have been up over 100 basis points adjusting with commodities.

To a lesser degree, we had a little bit of ramp-up issues in Residential.

That was $3 million or $4 million of headwind there and then the final piece, even to a smaller degree, was just the timing of some payments in our Service Experts business.

And I think we lost Mr.

Tusa's line.

Okay.

Hopefully he heard my answer.

Michael Coleman, Sterne, Agee.

Good morning.

I was wondering if you could maybe talk about what you expect the industry to attempt in terms of price either this winter or next spring.

Yes, I will talk about us, maybe less about the industry.

Over the years, we have been disciplined about raising prices in response to increased commodity costs and we have been successful in making them stick.

And given the dramatic run-up in copper costs over the last quarter, we are planning to take pricing action in response to the higher commodity costs and so as we roll into 2011, we will be talking more about that.

Okay.

And you mentioned the repair versus replacement, and I think you indicated that maybe the replacement is gaining a little versus repair.

But just kind of given the magnitude or the severity of the hot summer, the repair is certainly growing.

I was wondering if you could maybe talk about whether you think that -- at what point does that replacement actually start to overcome the repair portion of it.

To just parse my comments a bit, and then I will directly answer your question, I think on a historical level, back to what it was in '06, '05, there is still a significant amount of repair versus replace.

My comments were just on an annual basis this year versus last year.

Our sense is, incrementally, it is better and I think it is just driven by the fact that it is an additional year of pent-up demand in place where it makes it harder.

Some of the things that people were fixing back in '06 are now coming due where they have to replace them.

I think what dramatically unleashes the pent-up demand that we all know is there is consumer confidence and unemployment and those are flatlined.

I know consumer confidence, it may have come out during this call, but it is coming out today, we will see where that stands.

But I think as we go into the cooling season next year, I think what will drive pent-up demand in a significant way will be if we have sort of reached a stability point on the economy.

Okay.

And I mean the assumptions are, in the marketplace, that the channel is pretty lean given commentary from other players.

I was wondering if you had any comments regarding where you think the channel stands for the industry.

Yes, I don't have a broad perspective on others.

When we talk to our independent distributors who we handle through our Allied brands, they are clearly lean and so as demand picks up here as we go into the furnace season, we will see the volume flow through our Allied products.

I mean distributors are cautiously optimistic is how I would characterize it, but they want to rely on us to carry the inventory.

Okay.

And historically, has a lean channel been beneficial for the price increase or the attempted price increase?

I am thinking about that, Michael.

You could argue that it helps the speed of implementing the price increase because the more product you have to price protect that is already in the marketplace, the more challenge that you would have in the speed of implementing it.

But all that being said, I think we have an advantage given that 80% of our volume on the resi side and all the volume on our commercial side, we sell direct to dealers.

In our Refrigeration side, about half of what we sell is through wholesalers, about half is to OEMs.

So I think we have an advantage on speed on price increase maybe versus some others to that narrow point about having product in the channel.

Okay, good.

And just one more.

You talked about Australia and you are exiting a coil business there.

I was wondering if you could just kind of talk a little bit more about that or whether or not there is a benefit from cost savings in the out year associated with that.

We announced restructuring early this quarter and then in second quarter around exiting the business.

I think we used a different phrasing.

I think maybe we said OEM coils.

Earlier.

Earlier in the quarter.

And what it is was a small business that we had in Australia that we were manufacturing coils for HVAC manufacturers in Australia and we were no longer competitive.

We exited that business, allowed us to free up the investment that we had in it and also positions us to liquidate some real estate that we own in Australia that will have a material cash impact in future quarters.

Okay, thank you.

Steve Tusa, JPMorgan.

Hi, sorry about that.

Just a question on -- there is a lot of buzz in the industry around dryshipped R22 units.

How are you guys approaching that for next year and do you guys have a strategy around ramping up the volume there to offset some of the volume you might lose from the tax credit going away?

For those on the call who sort of aren't plugged into the issue, the issue is, in compliance with the Montreal protocols, EPA issued guidance that said, for 2010, HVAC OEMs could no longer produce R22 charged units for new installations and therefore, 410A was the refrigerant that we would be producing out of our factories.

In the final writing of the code, my words, not the EPA words, there is a loophole that allows you to ship a unit to the field that is charged with nitrogen, which is an inert gas and then in the field, you can charge it with R22.

And there are some advantage with that, I think everyone understands, around system costs.

If you already have an existing R22 system in your home, and you have an R22 outdoor unit, you save in installation costs versus having to upgrade the whole system to 410A.

So that is sort of the background.

I mean our belief as the industry leader in high efficiency equipment and environmental sustainability, we don't think that selling R22 equipment to be charged in the field is the spirit of the Montreal protocols.

But that being said, my opinion doesn't matter.

What matters is what the EPA says and as long as this loophole exists, we are not going to be at a competitive disadvantage.

So if it exists as we enter the cooling season, we will compete.

So are there incremental costs to you guys ramping that back up?

No.

Okay.

It is not.

You guys can pretty easily sell some of that stuff through?

Yes, it is just a compressor insertion.

Got you.

Okay.

And then last question, there has been also talk about relatively aggressive warranties that are being put out there by the industry.

Do you see this as an issue that maybe there are some people that are kind of underpricing that cost and that could be an issue going forward or how are you guys managing your warranties on new products?

We continue to manage warranties as we have in the past, which fully accounts for the financial impact.

I mean we extended our warranties a year or so ago across our productline to 10 years for parts, not for labor and we think that is competitive in the marketplace.

Okay.

And one last question.

As you look out to '11 will there be, would you say, at this point, you can see growth in the industry or will we be down on the resi side?

The honest answer is I am not sure.

The narrow answer to your question is I can see growth, but I can also see other things and so when we sit down at the December meeting, I will sort of give you a crisper answer on what our base case is.

And then depending on how the world unfolds, we will also talk about other alternatives and how we will respond to those.

I am optimistic by nature and I think -- and I have said this -- as I have been in New York the last couple of times, where I think eight or nine months ago I think what I saw on CNBC was ahead of what I saw on the ground.

And I think now it has sort of flipped a little bit, which is what I see on CNBC is more negative than what I see on the ground.

And so we have had a couple of very good quarters in our Commercial business.

We have had three very good quarters in our Residential business, a couple good quarters in Refrigeration and if I had to pick a most likely case, I think 2011 bubbles along, albeit the comps get much harder starting in Q4 on the revenue side.

Right.

And sorry, one last question while I have got you guys.

How sustainable is the Commercial performance?

I think the short answer is the comps get harder.

What has driven the growth over the last two quarters has been planned replacement of our major national accounts and in some ways, it is sort of the stereotypical dead cat bounce, right, which is, last year, they weren't spending anything; this year, they are spending some.

That being said, there were some new stores built, year-over-year improvement and I think we are -- I don't think, I know we are at the exact right place with our Energence rooftop, which makes a very compelling case to retailers.

And so I think if we have even a decent Christmas selling season, I think we will be well positioned for continued growth next year.

Okay, great, thanks a lot.

Sorry for all the questions.

I appreciate it.

I will now turn it back to Mr.

Bluedorn for closing comments.

Thank you very much.

We continue to be encouraged by the improved end-market conditions overall that we saw in third quarter.

In Commercial, we are again raising our end-market growth assumptions for the full year.

For the Company, we are raising our revenue growth guidance for 2010 and narrowing our adjusted EPS guidance at the high end of our previous range.

As we close out 2010, Lennox will continue its focus on productivity improvements and strong operational execution to drive revenue growth and profitability.

I want to thank everyone for joining us.

Have a good day.

Thank you.

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

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

You may now disconnect.