Lennox International Inc.
Q4 2020 Earnings Call Transcript

Published: 2 Feb 2021

[Operator:]

Ladies and gentlemen, thank you for standing by. Welcome to the Lennox International Fourth Quarter Earnings Conference Call. At the request of your host, all lines are currently 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 Mr. Steve Harrison, Vice President of Investor Relations. Please go ahead.

[Steve Harrison:]

Good morning. Thank you for joining us for this review of Lennox International's financial performance for the fourth quarter and full year of 2020.

[Todd Bluedorn:]

Thanks, Steve. Good morning everyone and thank you for joining us. In the fourth quarter, we continue to see strong momentum in our Residential business, and year-over-year improvement in Commercial and Refrigeration. Overall, for the company, revenue was up 3% and held a new fourth quarter high of $914 million. GAAP operating income was a $139 million compared to a $192 million in the prior year quarter that included $93 million net gain from insurance recoveries. GAAP EPS from continuing operations was $2.91 compared to $2.92 in the prior year quarter that included $93 million of insurance benefit I mentioned in a $39 million pre-tax pension settlement. In addition, to record fourth quarter revenue, the company set new fourth quarter highs for total segment profit and margin and adjusted EPS from continuing operations. As reported, total segment profit was a fourth quarter record a $139 million up 5% from the prior year quarter that included $25 million of insurance recovery. Total segment margin was a fourth quarter record 15.2% up 10 basis points. Adjusted EPS from continuing operations rose 18% to fourth quarter record of $2.89. From an operating perspective, excluding the $25 million of insurance benefit in the prior year quarter, total segment profit was up 29% and segment margin expanded 300 basis points.

[Joe Reitmeier:]

Thank you, Todd. And good morning, everyone. Let me start with a quick summary of our full year 2020 for the company, and then the financial details on the business segments for the quarter and full year. Overall, for the company, revenue for 2020 was $3.63 billion down 5% on a GAAP basis and down 4% on adjusted basis, excluding the impact from the divestitures in the prior year. Foreign Exchange was neutral to revenue. GAAP operating income was $479 million compared to $657 million in the prior year. That included a $179 million net gain from insurance recoveries. GAAP EPS from continuing operations was $9.26 compared to $10.38 in the prior year; that included the $179 million insurance benefit and $99 million in pre-tax pension settlements. Total adjusted segment profit for the full year was $507 million compared to $610 million in the prior year. That included a $99 million of insurance recovery. Total adjusted segment margin was 13.9% for the year, compared to 16.2% in the prior year with the insurance benefit. Adjusted EPS from continuing operations was $9.94 compared to $11.19 in the prior year with the insurance benefit and pension settlements. From an operational perspective, excluding the $99 million of insurance benefit in the prior year. Total segment profit was down 1% and total segment margin was up 40 basis points. Now turning to the business segments for the quarter and the year. In the fourth quarter, revenue from residential heating and cooling was a fourth quarter record $553 million up 11%. Volume was up 10%, price was up 1% and mix was flat with foreign exchange neutral to revenue. Residential profit was a fourth quarter record $116 million up 18%. Segment margin was a fourth quarter record 20.9% up 130 basis points.

[Operator:]

Certainly. And first from the line of Jeff Hammond with KeyBanc. Please go ahead.

[Jeff Hammond:]

Hey, good morning, guys.

[Todd Bluedorn:]

Morning Jeff.

[Jeff Hammond:]

Hey, Todd, good to see the execution was much better than your football team.

[Todd Bluedorn:]

I think, we're both watching other people's teams this weekend.

[Jeff Hammond:]

Yes, yes. Just I want to understand on resi margins, just the strength there. I mean, it was considerably higher, and just what were the big drivers, and if there was any real impact, as you kind of produce more to kind of restock and if that continues into 1Q?

[Todd Bluedorn:]

Yeah, I mean, I read your pre note, yes, the short answer is there was some benefit from absorption as we continue to produce in fourth quarter for the demand rolling into 2021. But even more important than that, as the drivers of the margin were the aggressive SG&A costs that the team took out early in the year, we haven't added back a lot of them. And so, we had great SG&A leverage. Also, we had very strong quarter material costs, and just in the factories themselves, even above absorption some of the productivity initiatives really kicked in second half of the year and we saw the benefits so, absorption helped. And it will help as you suggest as we roll in the next year. But there was benefits across, there was strong performance across the board and resi.

[Jeff Hammond:]

Okay, and then maybe switching over to commercial can you just did book-to-bill - was book-to-bill positive in 4Q? Did you see order acceleration? When do you think that backlog starts to flow out in sales growth? Thanks.

[Todd Bluedorn:]

We're seeing sales growth in first quarter so far. I mean, it's starting to accelerate in first quarter. Orders have taken a bit of a pause during the first three weeks in January, which I think is normal as you go into a new year. That's not unusual for us. And I think there's a little bit of uncertainty out there in the commercial marketplace. But we're set up for a nice quarter in Q1 and the backlogs starting to build for second quarter and balance of the year.

[Jeff Hammond:]

Okay, thanks a lot.

[Operator:]

Next, we'll go to Julian Mitchell with Barclays. Please go ahead.

[Julian Mitchell:]

Hi, good morning. Maybe, hey, just the first question on the incremental margins. So just wanted to sort of check on your conviction and being able to get that 30% incremental for the year across the company. At any segment color you provide I suppose, particularly in refrigeration, how should we think about operating leverage there this year?

[Todd Bluedorn:]

The good news for anyone who's ever worked in a large corporation, the good news after having a tough year is the next year you have great comps. And I think that's true in our Refrigeration business, so I think we'll have positive news in Refrigeration. Overall, for the corporation, we guided 30% incrementals. We're still feeling pretty good about that. We're going to have price of $50 million that'll offset the commodity headwind of $30 million, freight and tariff headwind each of $5 million to $40 million of costs, and those three buckets offset with price, and the MCR and additional volume. So, as we talked about in December, we feel pretty good about the 30% incremental.

[Julian Mitchell:]

Thank you. And then, maybe just following up on the commercial side. If you could just give any color around sort of different verticals, that you're seeing, any update as well on the sort of competitive landscape in commercial, and how quickly we can expect revenue to turn positive? Is it Q2 or perhaps earlier, in terms of year-on-year?

[Todd Bluedorn:]

Yeah, I understand. I'm not going to answer that last part. We said we have double-digit backlog going into the year, where we saw the pickup in order rates in fourth quarter where and planned replacement as large national account customers got more comfortable on placing orders. And I also think some of them had capital at the end of the year that they didn't spend because of uncertainty earlier in the year. And so, we had - we didn't deliver those units, but we booked those business and that will flow into the first half of this year. Emergency replacement was up in fourth quarter, so that continues to flow. I think the area that's weakest right now, quite frankly, continues weak is commercial new construction, given the uncertainty that still exists around the recovery from COVID.

[Julian Mitchell:]

All right. Thank you.

[Operator:]

Next, we'll go to John Walsh with Credit Suisse. Please go ahead.

[John Walsh:]

Hi, good morning.

[Todd Bluedorn:]

Hey, John.

[John Walsh:]

Question around your opportunity as you see it in the K-12 vertical. We're starting to hear people talk about some of these executive actions that President Biden took, trying to get students and teachers back into schools healthily and quickly in his first 100 days. Are you seeing any of that in your commercial business?

[Todd Bluedorn:]

The schools tend to move relatively slow. So, from the time they're sort of a mandate on top until the time you see the revenue flow through the business takes time. We have a very strong K Through12 program, if you will. We have dedicated salespeople just for that vertical, our indoor air quality product serves that market, our high efficiency product serves that market. So, we're in lots of dialogues with people, but I don't think there's been a light switch turned on that market.

[John Walsh:]

Got you. And then, I guess, maybe not necessarily surprising. A bunch of the detailed items in the guidance walk didn't change. But I guess I'm a little bit surprised on the commodity costs, still in line with the December outlook, given the move in steel, maybe you could just remind us, I know you have a hedging program on copper, I thought you bought a little bit more spot steel, but maybe can you just help us understand that a little bit better?

[Todd Bluedorn:]

Well, I'll give you the specific answer and then I'll directly answer the broader question of why then change it narrowly. We buy steel a couple different ways. We have some fixed contracts. We have some contracts that are tied to scrap. And then majority of it is we buy from the mills based on CRU pricing the prior quarter. When you - so when we're quote unquote predicting copper and aluminum, we have a large hedge already in our books. And so, we have a pretty good view what we're going to have. For steel, we have to sort of predict what's going to happen. Now as the answer, in December, we were depending I guess what side of the trade you were on, we are either bearish or bullish but we assumed steel was going to go up and we rolled that into our guide. And so, it's plus or minus commodities is still a $30 million headwind.

[John Walsh:]

Great. Thank you. Appreciate it.

[Todd Bluedorn:]

Thanks.

[Operator:]

Our next question is from Gautam Khanna with Cowen. Please go ahead.

[Gautam Khanna:]

Good morning. Thanks, guys.

[Todd Bluedorn:]

Hi, Gautam. How are you?

[Gautam Khanna:]

Doing well, thank you, I was curious, just can you speak to any changes in the competitive dynamics, we'd heard that Daikin's Goodman facility was, there was some COVID outbreaks and then you saw kind of the big channel refill in resi in Q4. I'm just curious, like, any sort of things to think about year-over-year as we kind of comp the weirdness of 2020 in resi competitively?

[Todd Bluedorn:]

Yeah, I mean, I think the most important thing is what I spent a ton of time talking about in December, which is, the broader your - the larger your independent distribution network is the more our belief is that you pulled volume from 2021 and to 2020, and that distributors not only were reloading for inventory that was down, but sort of the scarcity mindset was taking over and they were trying to make sure they had lots of inventory in case OEMs ran into production issues. And so our sense is people with independent distribution have inflated sales numbers in fourth quarter and that will bleed off as you go through the year compared to us, which is, we delivered in resi up 11% overall. And that we think in fact we know in our Lennox business, which is 80% of our residential, we see demand when the customers buying the unit to a vast large degree. So, I think that's the one thing to model for. And as we talked about with us narrowly, that sort of the timing of EPS or earnings is a little bit different to normal, that we expect about half of our EPS to come in first half and about half of the EPS in second half, which is a little different weighting that what we've had in the past.

[Gautam Khanna:]

That's helpful. And Todd, maybe I know you used to work at Carrier. I'm just curious, have you seen any change in their behavior competitively now that it's an independent company? Anything you can speak to just based on

[Todd Bluedorn:]

No, I think the short answer is no, Carrier has always been a very good competitor and they publicly different things happen and they say different things on the earnings call, but on the ground, it's the same tried and true sales force and strong dealer network. And they've always had good product. And they haven't changed their pricing strategy, they haven't changed, I don't think how they buy components and commodities or sourcing strategies. And they haven't changed their distribution strategy. So, from where we sit, it's very similar to what we have seen in past.

[Gautam Khanna:]

Thank you.

[Operator:]

Next, we'll go to Nicole DeBlase with Deutsche Bank. Please go ahead.

[Nicole DeBlase:]

Yes, thanks. Good morning, guys.

[Todd Bluedorn:]

Good morning, Nicole.

[Nicole DeBlase:]

So the commentary around the first half versus second half, what is definitely helpful. But, Todd, anything you want to say about calibrating expectations for 1Q based on what you guys have seen like into January?

[Todd Bluedorn:]

I'll answer the question obliquely. In Residential, we continue to see strong momentum. And in Commercial and Refrigeration as I talked about, backlogs are up double-digits as we ended the year. And so, we're hitting first quarter at a pretty stiff pace, we'll see how the balance of the quarter goes. But we feel pretty good as we start the year.

[Nicole DeBlase:]

Okay, got it. Thanks. And then on the seasonality of free cash flow, how do we think about the quarters in 2021 relative to what you normally see just thinking about how the cadence of working capital used could look throughout the year?

[Todd Bluedorn:]

I think it'll be more of a normal year where we'll sort of peak and working capital early and then burn it off second half of the year where 2020 was abnormal, that we never sort of reloaded on working capital second half. And so, we outperformed on free cash flow. I think it'll be more of a traditional year. And, again, just to connect some of the dots, so I'll take your question and expand on areas that I want to talk about. Maybe Nicole you didn't directly asked, but I would just sort of underline the free cash flow of $535 million in 2020, which is a record. We're guiding for 325 next year. Over the two-year period, it's about 110% of net income. So, 2020, 2021 over the two-year period, 110% of our adjusted net income which is a pretty strong performance in cash flow over a couple year period.

[Nicole DeBlase:]

Got it. And thanks for expanding. I'll pass it on.

[Operator:]

And we'll go to Nigel Coe with Wolfe Research. Please go ahead.

[Nigel Coe:]

Thanks. Good morning. We had a pretty thorough vetting in '21 back in December. So, this is not for me. But I'm curious the 10% growth in residential during 4Q, how does that look by brands, Allied versus Lennox brands?

[Todd Bluedorn:]

Yeah. Overall, we're up 11%. Our Lennox was up high single digits, and our Allied grew mid-20s. And so, what we saw in our business is what we've been saying others are seeing, which is our independent distribution business. Allied grew much stronger than our Lennox business, but not because they're winning share just, we have distributors who are reloading and quite frankly, with a scarcity mindset trying to pull some volume in.

[Nigel Coe:]

Okay. The Hardy data, I mean, I'm not sure how accurate that actually is. But the Hardy data showed big pickup in sugar shipments in December. And I'm curious if you saw the same pattern in the announcements with in terms of the sell through to the dealers. It makes sense from the weather perspective I was just curious what you saw?

[Todd Bluedorn:]

No, I mean, we didn't - I mean, just from a weather perspective, it wasn't so cold in January this year versus last year - December this year versus last year. We saw some pickup in December, but not near the Hardy data. Again, I think you're right that the Hardy data in any given month is suspect. I think directionally over a 12 month rolling data sort of gives you the right area for the number but I think in any given month, it could be a little misleading.

[Nigel Coe:]

Thank you.

[Operator:]

And next we'll go to Steve Tusa with JP Morgan. Please go ahead.

[Steve Tusa:]

Hey, good morning. Can you just maybe clarify the margin kind of color on resi, I think to Julian's question. You mentioned refrigeration will be good. I just didn't catch what you said on resi specifically.

[Todd Bluedorn:]

I reframed the question. I'm not sure he asked me a question on residential margins.

[Steve Tusa:]

Sorry, I thought he asked about residential margins. So, you had said overall guide 30% incrementals and positive - but refrigeration would be pretty positive. So, what's kind of the - what's the resi kind of view?

[Todd Bluedorn:]

Yeah, I think on the round they're all plus or minus 30. So, from a resi view 30, commercial 30. And refrigeration that was could probably be a little bit higher. But that's such a small part of our business, the other two will drive it then what we do on corporate expenses.

[Steve Tusa:]

Got it. And then just lastly, kind of looking out over the next couple of years. I know there's another efficiency regulation coming in. Is there any kind of change to your approach on product development beyond '22? Do you see the industry shifting more towards these kind of hybrid ductless products with the inverters in them beyond that with this new step up in cost on this efficiency regulation? And are you guys - what are you doing to kind of address that vertical that kind of hybrid ductless inverter-based product vertical?

[Todd Bluedorn:]

Yeah, I mean, the hybrid ductless, again, we can develop whatever product we want. But 80% of the product is replacement. And the ducts are already in the home. And so, the lowest cost solution for the 80% that's add on or replacement is our ducted systems. We are coming out with a 28 seri unit in first quarter that we talked about. We think we have as good or better variable speed technology with our compression partners. And so, we think we're playing right in the sweet spot, which is to have the lowest cost point to have the highest efficiency in the marketplace. And we think with our compression technology, our coil strategy and our Mexican Assembly Facility we're able to do that.

[Steve Tusa:]

Got it. And when you look out to the next couple years, I mean, do you expect prebuy in '22 what's kind of your - what's your latest and greatest on kind of the multiyear view?

[Todd Bluedorn:]

I don't think there'll be a prebuy in any meaningful way. Again, it always comes down to the fine tuning of the actual details how it's implemented. But the last time we did this, which was a more normal way to do it. You had sort of months to prepare and get it correct. And you don't have this huge step function change, like we did back in, that the industry had back in 2006, 2007. So, I think there may be a bit of prebuy, but not like there's been in the past.

[Steve Tusa:]

Got it. So, there won't be that much of a change in competitive landscape coming away from this in your mind?

[Todd Bluedorn:]

No, and again, it's - when we went from 10 to 13, or the industry, I wasn't here, but we went from 10 to 13, that had been the first major jump in a while that really screwed up the premium competitors in retrospect, and a big one it's was Goodman, because all of a sudden differentiation got collapsed. One, I think everybody's understood that and so one of the reasons we come out with 28 seri in 2021 is to prepare to sort of have the high end stretched out for when we have to make the transition. And then the other is, it's a much smaller bite when you're going from 14 to 15, that's as much difference than going from 10 to 13 as a percentage, obviously. So, you just don't have this huge cost shock to the system and sigh shock to the system with the big units back in 2006, 2007. So, I view it as sort of, not quite home , but pretty close to home. And then the other thing that's on the horizon residential regulatory wise is changing refrigerants to lower greenhouse gas emissions. And with the current administration it looks like it's going to be national rather than just a few states. And again, we'll be prepared for that as I think the rest of the industry will.

[Steve Tusa:]

But that California reg was pushed, right? More or less?

[Todd Bluedorn:]

California reg was pushed. But it looks like it's going to the Biden administration, our best understanding is it will drive it as a national implementation just not card.

[Steve Tusa:]

Wow. Okay, got it. Thanks a lot. Appreciate the color.

[Operator:]

Our next question is from Joe Ritchie with Goldman Sachs. Please go ahead.

[Joe Ritchie:]

Thanks. Good morning, everybody.

[Todd Bluedorn:]

Good morning.

[Joe Ritchie:]

Maybe just starting off on refrigeration margins, I know you mentioned there was a mix issues in the quarter and some step up in SG&A. Can you guys just maybe parse that out a little further and help quantify some of the impacts this quarter?

[Todd Bluedorn:]

Yeah, I mean, the two, I gave you were sort of the - are the two rattled off are the two big drivers. It was the fact that we were up in HVAC in Europe and down in our North America refrigeration business had a significant impact on the margins. And then, the other piece was just the timing of costs. And getting to the accounting sort of accrual adjustments and sort of year-over-year differences and fourth quarter took a hit compared to fourth quarter last year. As I think, I mentioned in the script, we expect to have margins up in Q1 in refrigeration and for them to be up full year.

[Joe Ritchie:]

Got it. As you maybe take a look at your backlog in refrigeration and it sounds to me like there's going to be a mixed benefit then in 2021. Are you seeing the North America PCO business growing well versus in Europe at this point?

[Todd Bluedorn:]

Yes.

[Joe Ritchie:]

Okay, cool. And then just - my one final question going back to commercial for a second. On planned replacement, I'm just curious. It seemed like you saw an uptick there in the quarter. I'm just curious, I guess in terms of like getting on-premise access for your services, like, how did things compared today with coronavirus cases surging versus what we saw maybe earlier in 2020?

[Todd Bluedorn:]

Can you - you broke up a little bit right in here. Can you ask question one more time?

[Joe Ritchie:]

Sure. No problem. Sorry about that. So, the question is really just around getting on premise access to do your plans replacements today versus what you saw in that?

[Todd Bluedorn:]

We have no issue. We're able to get on the job site, do what we need to do. Our guys are matched up and commercial customers have no issue in them.

[Joe Ritchie:]

All right. Great. Thank you.

[Operator:]

And with no further questions in queue, I'll turn it over to you Mr. Bluedorn for any closing comments.

[Todd Bluedorn:]

Thanks to everyone. To wrap up, as I mentioned in Q&A and during the script, momentum continues in first quarter and 2021 is off to a nice start. Lennox team is executing well to capitalize on market growth and share gains. We look forward to a year of strong growth and profitability. Thanks again for everyone for joining us today.

[Operator:]

Ladies and gentlemen, that does conclude your conference. Thank you for your participation. You may now disconnect.