Yahoo Finance Lennox International Inc. (NYSE:LII) Q1 2024 Earnings Call Transcript
Lennox International Inc. (NYSE:LII) Q1 2024 Earnings Call Transcript April 24, 2024
Lennox International Inc. beats earnings expectations. Reported EPS is $3.47, expectations were $3.17. Lennox International Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).
Operator: Welcome to the Lennox First Quarter 2024 Earnings Conference Call. [Operator Instructions] As a reminder, this call is being recorded. And I would now like to turn the conference over to Chelsey Pulcheon from the Lennox Investor Relations team. Chelsey, please go ahead.
Chelsey Pulcheon: Thank you, Savanna. Good morning, and thank you for joining us today. We are excited to share our 2024 first quarter results. Joining me as CEO, Alok Maskara; and CFO, Michael Quenzer. Each will share their prepared remarks before we move into the Q&A session. Turning to Slide 2. A reminder that during today's call, we will be making certain forward-looking statements, which are subject to numerous risks and uncertainties as outlined on this page. We may also refer to certain non-GAAP financial measures that management considers relevant indicators of underlying business performance. Please refer to our SEC filings available on our Investor Relations website for additional details, including a reconciliation of all GAAP to non-GAAP measures.
The earnings release, today's presentation and the website archive link for today's call are available on our Investor Relations website at investor.lennox.com. Now please turn to Slide 3 as I turn the call over to our CEO, Alok Maskara.
Alok Maskara: Thank you, Chelsey. Good morning. I want to begin by expressing my gratitude to our customers and employees whose loyalty to Lennox helped us deliver strong Q1 results marked by record profit margins. Specifically, I want to extend my appreciation to our dealers, distributors and key account customers for trusting Lennox to deliver industry leading HVACR products and solutions across North America. The success of our transformational effort to strengthen our distribution network, elevate customer experience, advance innovative platforms, execute pricing excellence and drive productivity can be entirely credited to the unwavering support from our employees and customers. This successful quarter further demonstrates our ability to maintain our growth momentum, navigate complex end markets and effectively prepare for the upcoming low GWP regulatory changes.
Now let's dive into the details of this quarter on Slide 3 where I would like to highlight four key messages: first, Lennox's core revenue grew 6% and our adjusted segment margin expanded 157 basis points to 15.9% resulting in our adjusted earnings per share increasing 23% to $3.47. Our operating cash usage was $23 million, a significant improvement from $79 million usage in the prior year. Second, Home Comfort Solutions delivered a slight revenue decline alongside moderate EBIT growth. With the destocking effect on volume, counterbalanced by price and mix, we delivered 30 basis point margin expansion, and we are all glad to see the destocking phase nearing its end. Third, our Building Climate Solutions team delivered record Q1 margins supported by both revenue and profit growth.
We remain on track for the opening of our new Saltillo Mexico factory in early Q3, which will enable us to fully satisfy customer demand and outgrew presence in emergency replacement market segment. Lastly, we are delighted to announce the updated fiscal guidance for this year as the Q1 results give us greater confidence in our earnings per share range. Michael will provide a detailed review of the guidance later in the call. But for now, let's turn to Slide 4 for more details on the upcoming low GWP refrigerant transition. We are fully prepared and on schedule for the upcoming refrigerant transition. Our product designs, manufacturing processes and technology engineering have all been finalized. We are currently transitioning our raw material inventory to facilitate the product launches, and we plan to start shipping the new low GWP refrigerant product, later this year in time to meet expected demand, we anticipate price increase of 10-plus percent for the new product line.
During this low GWP transition, we will face manufacturing headwinds as we convert each production line in our factories. Our approach to reconfiguring our factories will effectively balance production flexibility with cost efficiency. Looking ahead, we foresee 2024 as predominantly in R-410A refrigerant year. As we move into 2025, we expect the demand for the new low GWP product to reach approximately half to 2/3 of the end market. This shift in demand will benefit our product mix and also position us favorably to capture market share. Ultimately, we are well prepared and confident in our ability to navigate this transition successfully. Now please turn to Slide 5 for an overview of our initiatives to become a better distributor of HVAC products.
As you know, Lennox is a top-tier HVAC distributor in North America with substantial geographical coverage through over 250 outlets supported by more than 25 regional distribution centers. Nearly 45% of Lennox's residential sales are now through our digital platform, lennoxpros.com where our contractor partners also have access to a digital service dashboard for equipment prognosis, diagnosis and monitoring. We have the opportunity to grow our market share by expanding geographical coverage and improve our share of wallet through greater focus on parts and accessories. We also have an opportunity to increase dealer loyalty with improved fill rate and an enhanced customer experience. The distribution network improvements and the three core changes highlighted on this page will accelerate our growth and increase our margin resiliency.
First, we have established a decentralized and better aligned organization that is consistent with distribution best practices. As a result, local leaders with better visibility into local market conditions will have increased autonomy for faster decision-making. Furthermore, we have established five regional P&Ls led by experienced leaders who are accountable for both regional sales and stores. In addition, we are building our capabilities in critical areas such as revenue operations, pricing excellence and distribution management. This is a long-term journey, and we are pleased with the early progress we have seen thus far. Second, to improve the quality of our customer service, we completed a physical distribution network analysis to ensure that we have sufficient growth capacity and optimal cost structure.
We have streamlined and digitized our end-to-end demand and inventory deployment processes, and we are also implementing a modern warehouse management system throughout Lennox. It will take us a few years to fully realize the benefit of these changes. But thus far, we are pleased with the recent trend in our fulfillment rate. Third, we have created customer charter for our businesses and have established Net Promoter Score practices across the company. This allows us to collect feedback and set numerical goals around our customer interactions. We are delighted with the improvements we are seeing in our Net Promoter Scores and know that this is a commitment that will continue to yield results over the long term. To summarize, we are becoming a technology-enabled distributor, and we are investing in talent and resources to support this growth opportunity.
While there are early signs of promising results, this is a multiyear endeavor that will accelerate growth and promote margin resiliency. Now let me hand the call over to Michael, who will take you through the details of Q1 financial performance.
Michael Quenzer: Thank you, Alok. Good morning, everyone. Please turn to Slide 6. Expanding on to Alok's earlier comments, I'm excited to share our Q1 results, which not only reflect a strong start to the year, but also highlight record first quarter margins and an impressive 23% growth in adjusted earnings per share. Core revenue was $1 billion, up 6% as price gains and revenue from the AES acquisition were the main drivers of year-over-year improvement. Adjusted segment profit increased $25 million, where most of the growth came from $40 million of price and mix benefits. This was partially offset by continued inflation and investment in SG&A and distribution. Total adjusted segment margin was 15.9%, up approximately 160 basis points versus prior year.
Corporate expenses were $24 million, which includes $3 million of expenses previously considered noncore adjustments. Beginning in 2024, we will include certain previously categorized noncore adjustments in our adjusted earnings. This approach aims to reduce recurring or immaterial adjustments, which improves our overall quality of earnings reported. Our adjusted earnings will continue to exclude the effects of business divestitures and significant nonrecurring items such as restructuring programs. Our first quarter tax rate was 19.4% and diluted shares outstanding were 35.8 million compared to 35.6 million in the prior year quarter. Now let's direct our attention to Slide 7, where we can review the financial performance of our Home Comfort Solutions Segment.
Revenue declined 1% to $681 million in the first quarter. The volume in our 2-step distribution channel continues to feel the effects of industry destocking and was down mid-teens. Our direct-to-contractor sales volumes were up low single digits with solid growth in the new construction channel as new homebuilding starts have rebounded. Price yield was 3%, an improvement from the 2% price yield we earned in the second half of 2023, reflecting our successful execution of pricing initiatives in the quarter. The Home Comfort Solutions segment profit increased $1 million to $112 million, and segment margin also experienced approximately 30 basis points of growth to 16.6%, although pricing initiatives are progressing well, results are still impacted by inflation as well as the ongoing investments in distribution and sales.
Overall, given the challenging conditions in the end market, we are proud of our execution to increase profit margins even with volume and mix headwinds. We are prepared to launch the new low GWP product in the coming months and ensure the new product pricing material maintains gross margins. Turning to Slide 8 in our Building Climate Solutions segment that delivered another strong quarter. The Building Climate Solutions revenue was up an impressive 21% this quarter, propelled by 7% volume growth and our best performance in many quarters. Combined price and mix were up 8%, and revenue from our AES acquisition contributed 6% revenue growth in the quarter. Building Climate Solutions profit grew by $28 million or 56% and segment margin expanded 480 basis points to 21%.
These results were primarily driven by price and sales volume gains. Our profit results also reflect $2 million headwind for our new Saltillo Mexico factory ramp-up expenses. Despite ongoing production and supply chain challenges, unit production volume from the Stuttgart, Arkansas factory shows steady improvement. Additionally, we are excited for product output from the new Saltillo factory in early Q3 and we'll launch our new low GWP product in early 2025. We continue to be impressed by the Building Climate Solutions team's strong efforts in executing initiatives to pave the way for achieving our long-term targets. If you will now turn to Slide 9, I will review our cash flow performance and capital deployment strategies. Operating cash flow used in the quarter was $23 million compared to $79 million in the prior year quarter.
Capital expenditures were $30 million for the quarter, a decrease of $5 million compared to the prior year. Later in 2024, we anticipate temporary increases in working capital as we ramp up our new Saltillo, Mexico factory and prepare for the transition to the new low GWP product. Concurrently, the team is focused on improving processes and generating efficiencies in both accounts payable and accounts receivable. Both items are reflected in our full year free cash flow guidance and long-term cash conversion targets. Our commitment to high ROIC drives strategic and targeted investments that enhance our performance and competitiveness in the marketplace. As previously mentioned, the new Saltillo factory and the transition to the new refrigerant products is proceeding as planned and showing positive progress.
We also continue to look at bolt-on M&A opportunities that align closely with their overreaching company strategy. Net debt to adjusted EBITDA was 1.4x down from 2.1x in the prior year. Our approach to capital deployment remains consistent. We prioritize capital expenditure investments with strong returns, grow dividends with earnings, continue to explore M&A opportunities, and supplement with share repurchases when necessary. Additionally, we are committed to maintaining our investment-grade rating. Turning to Slide 10. Let's review the 2024 full year guidance. Our outlook on revenue provided during our last conference call remains unchanged as first quarter trends performed as expected. As a reminder, I will reiterate a few revenue guidance points.
RECONNECT The table on the left highlights full year revenue growth factors. Total company revenue is projected to increase by approximately 7%. We also expect stable sales volumes with a slight increase from Building Climate Solutions and flat for Home Comfort solutions. Price and mix are expected to drive a mid-single-digit revenue growth where price increases will ensure we remain price/cost positive. As a result of our strong first quarter profit performance, we are also revising our full year earnings per share guidance to $19 to $20 from the previously guided range of $18.50 to $20. Our free cash flow guidance remains unchanged at $500 million to $600 million. Those product and other cost assumptions also remain unchanged. Component cost inflation is anticipated to be up mid-single digits including large increases in our cost to acquire R-410A refrigerant and recent inflation in commodity prices.
We expect this cost inflation to be partially offset by material cost reduction programs. We anticipate ramp-up costs of approximately $10 million for the new Saltillo Mexico factory, along with approximately $5 million to $10 million associated with the refrigerant transition across our home comfort solutions manufacturing facilities. SG&A expenses are expected to increase in the year, a result of both inflationary pressures and investments. Our investments are focused on resources to improve customer service, information system advancements and distribution growth initiatives. We will also be making investments in both sales and marketing to support our long-term growth targets. Capital expenditures remain unchanged at $175 million. Interest expense is still expected to be approximately $50 million and our tax rate is expected to be approximately 20%.
With that, please turn to Slide 11, and I'll turn it back to Alok for an overview of end markets.
Alok Maskara: Thank you, Michael. On Slide 11, I will share our outlook on the end markets for both segments, which align with the full year guidance that Michael just went through. Within our Home Comfort Solutions segment, we have started to see a rebound in residential new construction, signaling consumer health resiliency. Nevertheless, we continue to closely monitor the repair versus replace dynamic amidst macro uncertainties. We are pleased to see distributor inventory return to near normal levels. However, the introduction of new low GWP refrigerant product and pending EPA updates on component manufacturing cut-off dates, does add inventory management ambiguity for dealers and distributors. With that said, we anticipate that most of this year's sales will still come from R-410A products with limited adoption of the new R454B product towards the end of this year.
Transitioning to the Building Climate Solutions segment, we expect deceleration in new construction accompanied by potential project delays. However, order rates and backlog remained strong driven by pent-up replacement demand. Insights from our National Account Services team highlight a significant upcoming need for replacements as well as increased interest in our new cradle to grave services. Our market share prospects in the BCS segment will be driven by volume from the new Saltillo Mexico factory and our expansion in the emergency replacement market. We are also securing additional wins in national accounts with our new integrated offerings made possible due to the AES acquisition. Overall, our outlook for this year remains cautiously optimistic.
Given Lennox's track record of success during regulatory transitions, we anticipate benefit from new product pricing and potential market share gain. We acknowledge that the market remain uncertain, but we are confident in our proactive strategies aimed at driving growth, optimizing margins and delivering exceptional value to our customers and shareholders. We do this by focusing on controllables and action items that we can drive. Now please turn to Slide 12. As a recap, Lennox operates in growth end markets, had resilient margins, demonstrates execution consistency and serves with customers through advanced technology and high-performance talent. The five reasons we remain confident in Lennox being a great investment opportunity is: first, we will continue to make strategic growth investments to improve our go-to-market effectiveness and support customer demand; second, margins remain a focus as we continue to evaluate our pricing strategy, implement innovative solutions to increase productivity and optimize our direct-to-dealer network; third, by leveraging the Lennox unified management system, our teams will be able to streamline processes, leverage best practices and consistently execute our strategy; fourth, our continued technological advancement will enable Lennox to remain at the forefront of innovation for our customers; finally, our team's focus on core values and guiding behaviors, is the foundation of a high-performance culture.
Our pay-for-performance incentive structure further aligns the talents of our team with the interest of our shareholders. Allow me to wrap up by saying thank you to each of our dedicated employees and valued customers. I'm proud of all that we have been able to accomplish, and I'm looking forward to the promising future that lies ahead of Lennox, as our best days are still ahead of us. Thank you. We'll be happy to take your questions now. Savannah, let's go to Q&A.
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