UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
FORM 10-Q
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY
PERIOD ENDED JUNE 30, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ______________ to ________________
----------
Commission file number 001-15149
LENNOX INTERNATIONAL INC.
Incorporated pursuant to the Laws of the State of DELAWARE
----------
Internal Revenue Service Employer Identification No. 42-0991521
2140 LAKE PARK BLVD.
RICHARDSON, TEXAS
75080
(972-497-5000)
- --------------------------------------------------------------------------------
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [X] No [ ]
Indicate by check mark whether the registrant is accelerated filer (as defined
in Rule 12b-2 of the Act).
Yes [X] No [ ]
As of August 8, 2003, the number of shares outstanding of the registrant's
common stock, par value $.01 per share, was 58,597,112.
i
LENNOX INTERNATIONAL INC.
INDEX
<Table>
<Caption>
Page No
Part I. Financial Information
Item 1. Financial Statements
Consolidated Balance Sheets - June 30, 2003 (Unaudited)
and December 31, 2002............................................................. 3
Consolidated Statements of Operations (Unaudited) - Three Months
and Six Months Ended June 30, 2003 and 2002....................................... 4
Consolidated Statements of Cash Flows (Unaudited) - Six Months
Ended June 30, 2003 and 2002...................................................... 5
Notes to Consolidated Financial Statements (Unaudited)............................ 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations......................................................... 11
Item 3. Quantitative and Qualitative Disclosures About Market Risk........................ 19
Item 4. Controls and Procedures........................................................... 19
Part II. Other Information
Item 4. Submission of Matters to a Vote of Security Holders............................... 20
Item 6. Exhibits and Reports on Form 8-K.................................................. 20
</Table>
ii
PART I -- FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.
LENNOX INTERNATIONAL INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
As of June 30, 2003 and December 31, 2002
(In millions)
<Table>
<Caption>
ASSETS
June 30, December 31,
2003 2002
----------- -----------
(unaudited)
CURRENT ASSETS:
Cash and cash equivalents ................................................................ $ 64.7 $ 76.4
Accounts and notes receivable, net ....................................................... 388.9 307.3
Inventories .............................................................................. 272.2 219.7
Deferred income taxes .................................................................... 33.9 33.3
Other assets ............................................................................. 55.3 38.4
---------- ----------
Total current assets ............................................................... 815.0 675.1
PROPERTY, PLANT AND EQUIPMENT, net .......................................................... 222.5 231.0
GOODWILL, net ............................................................................... 439.4 420.8
DEFERRED INCOME TAXES ....................................................................... 79.1 82.7
OTHER ASSETS ................................................................................ 126.8 112.1
---------- ----------
TOTAL ASSETS ....................................................................... $ 1,682.8 $ 1,521.7
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Short-term debt .......................................................................... $ 13.5 $ 9.3
Current maturities of long-term debt ..................................................... 13.2 13.9
Accounts payable ......................................................................... 257.2 247.6
Accrued expenses ......................................................................... 274.4 253.9
Income taxes payable ..................................................................... 41.2 12.8
---------- ----------
Total current liabilities .......................................................... 599.5 537.5
LONG-TERM DEBT .............................................................................. 362.9 356.7
POSTRETIREMENT BENEFITS, OTHER THAN PENSIONS ................................................ 14.5 13.5
PENSIONS .................................................................................... 89.2 85.4
OTHER LIABILITIES ........................................................................... 82.4 74.2
---------- ----------
Total liabilities .................................................................. 1,148.5 1,067.3
---------- ----------
MINORITY INTEREST ........................................................................... 1.9 1.6
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Preferred stock, $.01 par value, 25,000,000 shares authorized,
no shares issued or outstanding ....................................................... -- --
Common stock, $.01 par value, 200,000,000 shares authorized, 63,268,200 shares and
63,039,254 shares issued for 2003 and 2002, respectively .............................. 0.6 0.6
Additional paid-in capital ............................................................... 407.3 404.7
Retained earnings ........................................................................ 193.1 171.3
Accumulated other comprehensive loss ..................................................... (26.6) (79.6)
Deferred compensation .................................................................... (10.9) (13.5)
Treasury stock, at cost, 3,043,916 and 3,009,656 shares
for 2003 and 2002, respectively ...................................................... (31.1) (30.7)
---------- ----------
Total stockholders' equity ......................................................... 532.4 452.8
---------- ----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY ......................................... $ 1,682.8 $ 1,521.7
========== ==========
</Table>
The accompanying notes are an integral part of these consolidated financial
statements.
3
LENNOX INTERNATIONAL INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
For the Three Months and Six Months Ended June 30, 2003 and 2002
(Unaudited, in millions, except per share data)
<Table>
<Caption>
For the For the
Three Months Ended Six Months Ended
June 30, June 30,
-------------------------- --------------------------
2003 2002 2003 2002
---------- ---------- ---------- ----------
NET SALES ......................................................... $ 819.2 $ 828.3 $ 1,469.0 $ 1,502.6
COST OF GOODS SOLD ................................................ 541.0 560.1 978.2 1,027.9
---------- ---------- ---------- ----------
Gross profit ............................................. 278.2 268.2 490.8 474.7
OPERATING EXPENSES:
Selling, general and administrative expense .................... 221.8 215.6 423.0 412.6
(Gains) losses and other expenses .............................. 0.1 -- 0.9 --
Restructurings ................................................. -- 1.2 -- 1.9
---------- ---------- ---------- ----------
Income from operations ................................... 56.3 51.4 66.9 60.2
INTEREST EXPENSE, net ............................................. 7.9 8.3 14.9 16.1
OTHER INCOME ...................................................... (1.5) (0.5) (2.1) (0.5)
MINORITY INTEREST ................................................. 0.1 0.1 0.2 0.1
---------- ---------- ---------- ----------
Income before income taxes and cumulative
effect of accounting change ............................. 49.8 43.5 53.9 44.5
PROVISION FOR INCOME TAXES ........................................ 19.4 17.9 21.0 18.3
---------- ---------- ---------- ----------
Income before cumulative effect of accounting change ..... 30.4 25.6 32.9 26.2
---------- ---------- ---------- ----------
CUMULATIVE EFFECT OF ACCOUNTING CHANGE ............................ -- -- -- (249.2)
---------- ---------- ---------- ----------
Net income (loss) ........................................ $ 30.4 $ 25.6 $ 32.9 $ (223.0)
========== ========== ========== ==========
INCOME PER SHARE BEFORE CUMULATIVE
EFFECT OF ACCOUNTING CHANGE:
Basic ........................................................ $ 0.52 $ 0.45 $ 0.57 $ 0.46
Diluted ...................................................... $ 0.51 $ 0.43 $ 0.55 $ 0.45
CUMULATIVE EFFECT OF ACCOUNTING CHANGE
PER SHARE:
Basic ........................................................ $ -- $ -- $ -- $ (4.38)
Diluted ...................................................... $ -- $ -- $ -- $ (4.27)
NET INCOME (LOSS) PER SHARE:
Basic ........................................................ $ 0.52 $ 0.45 $ 0.57 $ (3.92)
Diluted ...................................................... $ 0.51 $ 0.43 $ 0.55 $ (3.82)
</Table>
The accompanying notes are an integral part of these consolidated financial
statements.
4
LENNOX INTERNATIONAL INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Six Months Ended June 30, 2003 and 2002
(Unaudited, in millions)
<Table>
<Caption>
For the
Six Months Ended
June 30,
----------------------
2003 2002
-------- --------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) .......................................................................... $ 32.9 $ (223.0)
Adjustments to reconcile net income (loss) to net cash used in operating activities:
Minority interest and equity in unconsolidated affiliates ............................. (3.3) (2.3)
Non-cash cumulative effect of accounting change ....................................... -- 249.2
Depreciation and amortization ......................................................... 24.5 31.6
Deferred income taxes ................................................................. 1.3 (2.2)
Other (gains) losses and expenses ..................................................... 1.7 1.5
Changes in assets and liabilities, net of effects of divestitures-
Accounts and notes receivable ....................................................... (66.3) (107.2)
Inventories ......................................................................... (44.7) (15.6)
Other current assets ................................................................ (15.1) 7.8
Accounts payable .................................................................... 6.7 69.0
Accrued expenses .................................................................... 14.2 8.2
Income taxes payable and receivable ................................................. 27.9 23.3
Long-term warranty, deferred income and other liabilities ........................... 11.2 4.1
-------- --------
Net cash (used in) provided by operating activities ............................... (9.0) 44.4
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from the disposal of property, plant and equipment ............................... 6.2 1.7
Purchases of property, plant and equipment ................................................ (10.3) (12.9)
Proceeds from disposal of businesses and investments ...................................... 4.7 3.6
Acquisitions, net of cash acquired ........................................................ -- (3.4)
-------- --------
Net cash provided by (used in) investing activities ............................... 0.6 (11.0)
CASH FLOWS FROM FINANCING ACTIVITIES:
Short-term borrowings ...................................................................... 3.2 18.1
Repayments of long-term debt ............................................................... (0.8) (18.5)
Revolving long-term borrowings ............................................................. 6.0 (160.7)
Proceeds from issuance of long-term debt ................................................... -- 143.8
Sales of common stock ...................................................................... 2.6 12.1
Repurchases of common stock ................................................................ (0.4) (0.3)
Payment of deferred finance costs .......................................................... (0.5) (5.0)
Cash dividends paid ........................................................................ (16.5) (16.2)
-------- --------
Net cash used in financing activities ............................................. (6.4) (26.7)
(DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS ............................................. (14.8) 6.7
EFFECT OF EXCHANGE RATES ON CASH AND CASH EQUIVALENTS ......................................... 3.1 0.7
-------- --------
CASH AND CASH EQUIVALENTS, beginning of period ................................................ 76.4 34.4
-------- --------
CASH AND CASH EQUIVALENTS, end of period ...................................................... $ 64.7 $ 41.8
======== ========
Supplementary disclosures of cash flow information:
Net cash paid (received) during the period for:
Interest .............................................................................. $ 15.2 $ 15.9
======== ========
Income taxes .......................................................................... $ (4.7) $ 4.0
======== ========
</Table>
The accompanying notes are an integral part of these consolidated financial
statements.
5
LENNOX INTERNATIONAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
1. BASIS OF PRESENTATION AND OTHER ACCOUNTING INFORMATION:
The unaudited consolidated balance sheet as of June 30, 2003, and the
accompanying unaudited consolidated statements of operations and cash flows for
the three months and six months ended June 30, 2003 and 2002 should be read in
conjunction with Lennox International Inc.'s (the "Company" or "LII") audited
consolidated financial statements and the footnotes as of December 31, 2002 and
2001 and for each of the three years in the period ended December 31, 2002. In
the opinion of management, the accompanying consolidated financial statements
contain all material adjustments, consisting principally of normal recurring
adjustments, necessary for a fair presentation of the Company's financial
position, results of operations, and cash flows. Certain information and
footnote disclosures normally included in financial statements prepared in
accordance with generally accepted accounting principles have been condensed or
omitted pursuant to applicable rules and regulations, although the Company
believes that the disclosures herein are adequate to make the information
presented not misleading. The operating results for the interim periods are not
necessarily indicative of the results to be expected for a full year. See Note 3
(a) for a discussion of the impact of the Outokumpu Oyj joint venture
transactions in 2002 on comparability.
The Company's fiscal year ends on December 31 of each year, and the
Company's quarters are each comprised of 13 weeks. For convenience, throughout
these financial statements, the 13 weeks comprising each three month period are
denoted by the last day of the respective calendar quarter.
2. STOCK COMPENSATIONS:
The Company accounts for its stock based compensation under the
recognition and measurement principles of APB No. 25, "Accounting for Stock
Issued to Employees," and related interpretations ("APB 25") and has adopted the
disclosure-only provisions of Statement of Financial Accounting Standards ("SFAS
No. 123"). Under APB 25, no stock-based compensation cost is reflected in net
income for grants of stock options to employees because the Company grants stock
options with an exercise price equal to the market value of the stock on the
date of grant. Had the Company used the fair value based accounting method for
stock compensation expense described by Statement of Financial Accounting
Standards ("SFAS No. 123"), the Company's diluted net income per common and
equivalent share are shown in the pro-forma amounts below (in millions, except
per share data):
<Table>
<Caption>
FOR THE FOR THE
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------------ ------------------------
2003 2002 2003 2002
--------- --------- --------- ---------
Net income (loss), as reported .......... $ 30.4 $ 25.6 $ 32.9 $ (223.0)
Add: Reported stock-based compensation
expense, net of taxes ................. 1.0 0.1 2.1 0.1
Deduct: Fair value based compensation
expense, net of taxes ................. (1.8) (0.4) (3.7) (0.6)
--------- --------- --------- ---------
Net income (loss), pro-forma ............ $ 29.6 $ 25.3 $ 31.3 $ (223.5)
========= ========= ========= =========
Earnings per share:
Basic, as reported ...................... $ 0.52 $ 0.45 $ 0.57 $ (3.92)
Basic, pro-forma ........................ $ 0.51 $ 0.44 $ 0.54 $ (3.92)
Diluted, as reported .................... $ 0.51 $ 0.43 $ 0.55 $ (3.82)
Diluted, pro-forma ...................... $ 0.49 $ 0.42 $ 0.52 $ (3.79)
</Table>
6
3. REPORTABLE BUSINESS SEGMENTS:
Financial information about the Company's reportable business segments
is as follows (in millions):
<Table>
<Caption>
FOR THE FOR THE
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------------ ------------------------
2003 2002 2003 2002
--------- --------- --------- ---------
Net Sales
Residential .................................... $ 376.8 $ 348.7 $ 671.1 $ 622.6
Commercial ..................................... 132.1 115.0 224.9 201.8
--------- --------- --------- ---------
Heating and Cooling ....................... 508.9 463.7 896.0 824.4
Service Experts ................................ 243.3 251.5 440.4 456.5
Refrigeration .................................. 97.3 92.4 187.5 180.3
Corporate and other (a) ........................ -- 49.2 -- 95.1
Eliminations ................................... (30.3) (28.5) (54.9) (53.7)
--------- --------- --------- ---------
$ 819.2 $ 828.3 $ 1,469.0 $ 1,502.6
========= ========= ========= =========
Segment Profit (Loss)
Residential .................................... $ 45.9 $ 36.1 $ 68.5 $ 51.6
Commercial ..................................... 9.2 5.8 8.4 5.6
--------- --------- --------- ---------
Heating and Cooling ....................... 55.1 41.9 76.9 57.2
Service Experts ................................ 7.6 15.9 2.9 13.1
Refrigeration .................................. 9.0 9.0 17.3 17.2
Corporate and other (a) ........................ (15.5) (13.9) (28.3) (24.6)
Eliminations ................................... 0.2 (0.3) (1.0) (0.8)
--------- --------- --------- ---------
Segment Profit ............................ 56.4 52.6 67.8 62.1
Reconciliation to Income before Income Taxes:
(Gains) losses and other expenses ............ 0.1 -- 0.9 --
Restructurings ............................... -- 1.2 -- 1.9
Interest Expense, net ........................ 7.9 8.3 14.9 16.1
Minority Interest and Other .................. (1.4) (0.4) (1.9) (0.4)
--------- --------- --------- ---------
$ 49.8 $ 43.5 $ 53.9 $ 44.5
========= ========= ========= =========
</Table>
<Table>
<Caption>
AS OF JUNE 30, AS OF DECEMBER 31,
2003 2002
-------------------- --------------------
Total Assets
Residential .......................... $ 450.6 $ 374.3
Commercial ........................... 193.6 167.6
-------------------- --------------------
Heating and Cooling ............. 644.2 541.9
Service Experts ...................... 516.7 484.5
Refrigeration ........................ 276.3 234.8
Corporate and other (a) .............. 270.6 276.3
Eliminations ......................... (25.0) (15.8)
-------------------- --------------------
$ 1,682.8 $ 1,521.7
==================== ====================
</Table>
(a) In the third quarter of 2002, the Company formed joint ventures with
Outokumpu Oyj by selling to Outokumpu Oyj a 55% interest in the
Company's heat transfer business segment for approximately $55 million
in cash and notes. The Company accounts for its remaining 45% interest
using the equity method of accounting and includes such amounts in the
Corporate and other segment. The historical net sales, results of
operations and total assets of the Corporate and other segment have
been restated to include the portions of the heat transfer business
segment that was sold to Outokumpu Oyj. The results of operations of
the heat transfer business segment now presented in the Corporate and
other segment were $(0.5) million and $(1.4) million for the three
months and six months ended June 30, 2003, respectively. The historical
net sales and results of operations were $49.2 million and $(0.3)
million for the three months ended June 30, 2002 and $95.1 million and
$(1.1) million for the six months ended June 30, 2002, respectively.
4. INVENTORIES:
Components of inventories are as follows (in millions):
<Table>
<Caption>
AS OF JUNE 30, AS OF DECEMBER 31,
2003 2002
--------------- ------------------
Finished goods .............................................. $ 181.8 $ 139.0
Repair parts ................................................ 36.2 32.5
Work in process ............................................. 13.9 13.9
Raw materials ............................................... 88.5 81.4
--------------- ---------------
320.4 266.8
Excess of current cost over last-in, first-out cost ......... (48.2) (47.1)
--------------- ---------------
$ 272.2 $ 219.7
=============== ===============
</Table>
7
5. SHIPPING AND HANDLING:
Shipping and handling costs are included as part of selling, general
and administrative expense in the accompanying Consolidated Statements of
Operations in the following amounts (in millions):
<Table>
<Caption>
FOR THE FOR THE
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
- ------------------------ ------------------------
2003 2002 2003 2002
- ------- ------- ------- -------
$ 34.0 $ 32.8 $ 64.0 $ 62.4
</Table>
6. WARRANTIES:
The changes in the carrying amount of the Company's total warranty
liabilities for the six months ended June 30, 2003 are as follows (in millions):
<Table>
Total warranty liability at December 31, 2002 ............. $ 63.3
Payments made in 2003 ..................................... (11.1)
Changes resulting from issuance of new warranties ......... 14.5
----------
Total warranty liability at June 30, 2003 ................. $ 66.7
==========
</Table>
The change in warranty liability that results from changes in estimates
of warranties issued prior to 2003 is not material.
7. CASH, LINES OF CREDIT AND FINANCING ARRANGEMENTS:
The Company has bank lines of credit aggregating $335.7 million, of
which $19.5 million was borrowed and outstanding, and $50.1 million was
committed to standby letters of credit at June 30, 2003. The remaining $266.1
million was available for future borrowings, subject to covenant limitations.
Included in the lines of credit is a domestic facility in the amount of $270
million governed by agreements between the Company and a syndicate of banks. The
facility contains certain financial covenants and bears interest, at the
Company's option, at a rate equal to either (a) the greater of the bank's prime
rate or the federal funds rate plus 0.5% or (b) the London Interbank Offered
Rate plus a margin equal to 0.5% to 2.25%, depending upon the ratio of total
funded debt to earnings before interest, taxes, depreciation and amortization
("EBITDA"). The Company pays a commitment fee, depending upon the ratio of total
funded debt to EBITDA, equal to 0.15% to 0.50% of the unused commitment. The
agreements place restrictions on the Company's ability to incur additional
indebtedness, encumber its assets, sell its assets, or pay dividends. The
Company has entered discussions with its bank syndicate to extend its domestic
credit facility, which expires in August 2004. LII expects the amendment process
to be completed in the third quarter of 2003. As of June 30, 2003, LII was in
compliance with all covenant requirements and LII believes that cash flow from
operations, as well as available borrowings under its revolving credit facility,
will be sufficient to fund its operations for the foreseeable future. The
Company has included in cash and cash equivalents in the accompanying
consolidated balance sheet $39.3 million of restricted cash related to letters
of credit.
8. ACCOUNTS AND NOTES RECEIVABLE:
Accounts and Notes Receivable have been shown net of allowance for
doubtful accounts of $21.7 million and $23.1 million, and net of accounts
receivable sold under an ongoing asset securitization arrangement of $154.2
million and $99.0 million as of June 30, 2003 and December 31, 2002,
respectively. In addition, approximately $78.4 million and $106.2 million of
accounts receivable as reported in the accompanying consolidated balance sheets
at June 30, 2003 and December 31, 2002, respectively, represent retained
interests in securitized receivables that have restricted disposition rights per
the terms of the asset securitization agreement and would not be available to
satisfy obligations to creditors. The Company has no significant concentration
of credit risk within its accounts and notes receivable.
9. DIVESTITURES:
In March 2003, the Company sold the net assets of a heating,
ventilation and air conditioning ("HVAC") distributor included in the
residential heating and cooling segment for $4.6 million in cash and notes. The
sale resulted in a pre-tax loss of approximately $0.8 million that is included
in (gains) losses and other expenses. The revenues and results of operations of
the distributor were immaterial for all prior periods.
8
10. EARNINGS PER SHARE:
Basic earnings per share are computed by dividing net income by the
weighted average number of common shares outstanding during the period. Diluted
earnings per share are computed by dividing net income by the sum of the
weighted average number of shares and the number of equivalent shares assumed
outstanding, if dilutive, under the Company's stock-based compensation plans. As
of June 30, 2003, the Company had 61,267,332 shares outstanding of which
3,043,916 were held as treasury shares. Diluted earnings per share are computed
as follows (in millions, except per share data):
<Table>
<Caption>
FOR THE FOR THE
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------------ ------------------------
2003 2002 2003 2002
---------- ---------- ---------- ----------
Net income (loss) ................................................... $ 30.4 $ 25.6 $ 32.9 $ (223.0)
========== ========== ========== ==========
Weighted average shares outstanding ................................. 58.2 57.1 58.1 57.0
Effect of diluted securities attributable to stock options and
performance share awards .......................................... 1.7 1.9 1.5 1.4
---------- ---------- ---------- ----------
Weighted average shares outstanding, as adjusted .................... 59.9 59.0 59.6 58.4
---------- ---------- ---------- ----------
Diluted earnings (loss) per share ................................... $ 0.51 $ 0.43 $ 0.55 $ (3.82)
========== ========== ========== ==========
</Table>
Options to purchase 3,239,009 shares of common stock at prices ranging
from $13.90 to $49.63 per share and 3,301,151 shares of common stock at prices
ranging from $13.90 to $49.63 per share were outstanding at June 30, 2003 and
2002, respectively, but were not included in the diluted earnings per share
calculation because the assumed exercise of such options would have been
anti-dilutive. The Company's convertible notes were not considered in the
diluted earnings per share calculation because the required trading prices of
either the Company's common stock or the convertible notes to allow conversion
of such notes had not been met as of the reporting period. The notes are
convertible into approximately 8 million shares.
11. COMPREHENSIVE INCOME (LOSS):
Comprehensive income (loss) is computed as follows (in millions):
<Table>
<Caption>
FOR THE FOR THE
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------------ ------------------------
2003 2002 2003 2002
--------- --------- --------- ---------
Net income (loss) ................................ $ 30.4 $ 25.6 $ 32.9 $ (223.0)
Foreign currency translation adjustments ......... 29.1 17.8 45.6 17.5
Cash flow hedges ................................. (0.1) -- 1.3 3.7
Minimum pension liability ........................ (0.2) -- (2.3) --
Unrealized gains (losses) on investments ......... 3.6 -- 8.4 --
--------- --------- --------- ---------
Total comprehensive income (loss) ................ $ 62.8 $ 43.4 $ 85.9 $ (201.8)
========= ========= ========= =========
</Table>
12. RESTRUCTURING CHARGES:
Retail Restructuring Program. A summary of other exit costs associated
with the Retail Restructuring Program is as follows (in millions):
<Table>
<Caption>
BALANCE BALANCE
DECEMBER 31, NEW CASH OTHER JUNE 30,
2002 CHARGES PAYMENTS CHANGES 2003
------------ --------- --------- --------- ---------
Other exit costs ....... $ 3.7 $ -- $ (3.2) $ -- $ 0.5
========= ========= ========= ========= =========
</Table>
The $0.5 million in other exit costs existing at June 30, 2003
represents lease payments and other exit costs which are expected to be fully
paid during 2003.
9
Manufacturing and Distribution Restructuring Program. A summary of the
severance and other exit costs associated with the Manufacturing and
Distribution Restructuring Program is included in the following table (in
millions):
<Table>
<Caption>
BALANCE BALANCE
DECEMBER 31, NEW CASH OTHER JUNE 30,
2002 CHARGES PAYMENTS CHANGES 2003
------------ --------- --------- --------- ---------
Severance and benefits ......... $ 2.0 $ 0.3 $ (0.6) $ (0.3) $ 1.4
Other exit costs ............... 1.3 -- (0.7) -- 0.6
--------- --------- --------- --------- ---------
Total ............... $ 3.3 $ 0.3 $ (1.3) $ (0.3) $ 2.0
========= ========= ========= ========= =========
</Table>
The severance and benefit obligations will be paid through November
2003. The other exit costs consist of lease payments and other exit costs that
will be settled in cash payments through 2004.
Engineered Machine Tool Business Restructuring Program. A summary of
the severance and other exit costs associated with the Engineered Machine Tool
Business Restructuring Program is included in the following table (in millions):
<Table>
<Caption>
BALANCE BALANCE
DECEMBER 31, NEW CASH OTHER JUNE 30,
2002 CHARGES PAYMENTS CHANGES 2003
------------ ---------- ---------- ---------- ----------
Severance and benefits ......... $ 0.9 $ -- $ (0.8) $ -- $ 0.1
Other exit costs ............... 2.1 -- (1.2) -- 0.9
---------- ---------- ---------- ---------- ----------
Total ............... $ 3.0 $ -- $ (2.0) $ -- $ 1.0
========== ========== ========== ========== ==========
</Table>
The other exit costs consist of contractual lease and contract takeover
obligations that will be settled in cash payments through November 2005.
13. GOODWILL:
On January 1, 2002, the Company adopted SFAS No. 142 and recorded a
$285.7 million impairment of goodwill ($249.2 million, net of tax). The changes
in the carrying amount of goodwill for the six months ended June 30, 2003, in
total and by segment, are as follows (in millions):
<Table>
<Caption>
BALANCE BALANCE
DECEMBER 31, GOODWILL FOREIGN CURRENCY JUNE 30,
SEGMENT 2002 IMPAIRMENT TRANSLATION & OTHER 2003
- ------------------------------------ ------------ ------------ ------------------- ------------
Residential ...................... $ 27.1 $ -- $ (1.0) $ 26.1
Commercial ....................... 25.9 -- 1.4 27.3
------------ ------------ ------------ ------------
Heating and Cooling ......... 53.0 -- 0.4 53.4
Service Experts .................. 307.5 -- 12.0 319.5
Refrigeration .................... 60.3 -- 6.2 66.5
------------ ------------ ------------ ------------
Total ...................... $ 420.8 $ -- $ 18.6 $ 439.4
============ ============ ============ ============
</Table>
The change in the residential segment includes $(0.8) million allocated
to the disposal of the HVAC distributor included in Note 9.
14. INVESTMENTS IN AFFILIATES:
For the joint ventures with Outokumpu Oyj and LII's other joint venture
investments, the Company records its equity in the earnings of the joint
ventures as a component of selling, general and administrative expense in the
accompanying Consolidated Statements of Operations.
10
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
The Company participates in four reportable business segments of the
heating, ventilation, air conditioning and refrigeration ("HVACR") industry. The
first reportable segment is residential heating and cooling, in which LII
manufactures and markets a full line of heating, air conditioning and hearth
products for the residential replacement and new construction markets in the
United States and Canada. The second reportable segment is commercial heating
and cooling, in which LII manufactures and sells primarily rooftop products and
related equipment for light commercial applications. Combined, the residential
and commercial heating and cooling segments form LII's heating and cooling
business. The third reportable segment is Service Experts, which includes sales
and installation of, and maintenance and repair services for, HVAC equipment by
approximately 185 LII-owned service centers in the United States and Canada. The
fourth reportable segment is refrigeration, which consists of the manufacture
and sale of unit coolers, condensing units and other commercial refrigeration
products.
On July 8, 2003, LII announced organizational changes and assignments
in an effort to streamline the reporting of the Company's four business
segments. First, Scott J. Boxer was named President and Chief Operating Officer
("COO") of Service Experts Inc. ("SEI"), the Company's retail sales and service
business. Mr. Boxer was formerly President of Lennox Industries Inc. and had
also been serving as interim President of SEI since March 24, 2003. Second,
Robert J. McDonough was named President and COO, Worldwide Heating and Cooling,
encompassing the Company's Lennox Industries Inc. and North American Distributed
Products ("NADP") businesses. Mr. McDonough was formerly President, Worldwide
Refrigeration. Third, Michael G. Schwartz was named President and COO, Worldwide
Refrigeration, replacing Mr. McDonough. Mr. Schwartz was formerly President,
NADP.
During August 2002, LII formed joint ventures with Outokumpu Oyj of
Finland ("Outokumpu"). Outokumpu purchased a 55 percent interest in the
Company's former heat transfer business segment in the U.S. and Europe for $55
million in cash and notes, with LII retaining 45 percent ownership. The net
after-tax gain on the sale and the related expenses and charges was $6.4
million. LII accounts for its remaining 45 percent ownership interest using the
equity method of accounting. The Company currently reports the historical
results of operations of its former heat transfer business segment in the
"Corporate and other" business segment.
LII's customers include distributors, installing dealers, property
owners, national accounts and original equipment manufacturers. The demand for
LII's products and services is influenced by national and regional economic and
demographic factors, such as interest rates, the availability of financing,
regional population and employment trends, new construction, general economic
conditions and consumer confidence. In addition to economic cycles, demand for
LII's products and services is seasonal and dependent on the weather. Hotter
than normal summers generate strong demand for replacement air conditioning and
refrigeration products and colder than normal winters have the same effect on
heating products. Conversely, cooler than normal summers and warmer than normal
winters depress sales of HVACR products.
The principal components of cost of goods sold in LII's manufacturing
operations are component costs, raw materials, factory overhead, labor and
estimated costs of warranty expense. In LII's Service Experts segment, the
principal components of cost of goods sold are equipment, parts and supplies and
labor. The principal raw materials used in LII's manufacturing processes are
copper, aluminum and steel. In instances where LII is unable to pass on to its
customers increases in the costs of copper and aluminum, LII enters into forward
contracts for the purchase of those materials. LII attempts to minimize the risk
of price fluctuations in key components by entering into contracts, typically at
the beginning of the year, which generally provide for fixed prices for its
needs throughout the year. These hedging strategies enable LII to establish
product prices for the entire model year while minimizing the impact of price
increases of components and raw materials on its margins. Warranty expense is
estimated based on historical trends and other factors.
On January 1, 2002, LII adopted Statement of Financial Accounting
Standards No. 142 "Goodwill and Other Intangible Assets" ("SFAS No. 142"), and
recorded a $285.7 million impairment of goodwill ($249.2 million, net of taxes).
The impairment charge related primarily to the 1998 to 2000 acquisitions of
LII's Service Experts and hearth products operations, where lower than expected
operating results occurred.
11
LII's fiscal year ends on December 31 of each year and its interim
fiscal quarters are each comprised of 13 weeks. For convenience, throughout this
Management's Discussion and Analysis of Financial Condition and Results of
Operations, the 13 week periods comprising each fiscal quarter are denoted by
the last day of the calendar quarter.
RESULTS OF OPERATIONS
The following table sets forth, as a percentage of net sales, income
data for the three months and six months ended June 30, 2003 and 2002:
<Table>
<Caption>
FOR THE FOR THE
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
--------------------- ---------------------
2003 2002 2003 2002
-------- -------- -------- --------
Net sales ....................................................... 100.0% 100.0% 100.0% 100.0%
Cost of goods sold .............................................. 66.0 67.6 66.6 68.4
-------- -------- -------- --------
Gross profit ........................................... 34.0 32.4 33.4 31.6
Selling, general and administrative expense ..................... 27.1 26.0 28.7 27.5
(Gains) losses and other expenses ............................... -- -- 0.1 --
Restructurings .................................................. -- 0.2 -- 0.1
-------- -------- -------- --------
Income from operations ................................. 6.9 6.2 4.6 4.0
Interest expense, net ........................................... 1.0 1.0 1.0 1.0
Other income .................................................... (0.2) (0.1) (0.1) --
Minority interest ............................................... -- -- -- --
-------- -------- -------- --------
Income before income taxes and cumulative effect of
accounting change ................................ 6.1 5.3 3.7 3.0
Provision for income taxes ...................................... 2.4 2.2 1.5 1.2
-------- -------- -------- --------
Income before cumulative effect of accounting change ... 3.7 3.1 2.2 1.8
Cumulative effect of accounting change .......................... -- -- -- (16.6)
-------- -------- -------- --------
Net income (loss) ...................................... 3.7% 3.1% 2.2% (14.8)%
======== ======== ======== ========
</Table>
The following table sets forth net sales by business segment and
geographic market (dollars in millions):
<Table>
<Caption>
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
2003 2002 2003 2002
----------------------- ----------------------- ----------------------- -----------------------
AMOUNT % AMOUNT % AMOUNT % AMOUNT %
---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
BUSINESS SEGMENT:
Residential ............ $ 376.8 46.0% $ 348.7 42.1% $ 671.1 45.7% $ 622.6 41.4%
Commercial ............. 132.1 16.1 115.0 13.9 224.9 15.3 201.8 13.5
---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
Heating and Cooling .. 508.9 62.1 463.7 56.0 896.0 61.0 824.4 54.9
Service Experts ........ 243.3 29.7 251.5 30.4 440.4 30.0 456.5 30.4
Refrigeration .......... 97.3 11.9 92.4 11.2 187.5 12.8 180.3 12.0
Corporate and other .... -- -- 49.2 5.9 -- -- 95.1 6.3
Eliminations ........... (30.3) (3.7) (28.5) (3.5) (54.9) (3.8) (53.7) (3.6)
---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
Total net sales ...... $ 819.2 100.0% $ 828.3 100.0% $ 1,469.0 100.0% $ 1,502.6 100.0%
========== ========== ========== ========== ========== ========== ========== ==========
GEOGRAPHIC MARKET:
U.S. ................... $ 635.9 77.6% $ 657.8 79.4% $ 1,132.3 77.1% $ 1,189.9 79.2%
International .......... 183.3 22.4 170.5 20.6 336.7 22.9 312.7 20.8
---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
Total net sales ...... $ 819.2 100.0% $ 828.3 100.0% $ 1,469.0 100.0% $ 1,502.6 100.0%
========== ========== ========== ========== ========== ========== ========== ==========
</Table>
THREE MONTHS ENDED JUNE 30, 2003 COMPARED TO THREE MONTHS ENDED JUNE 30, 2002
Net Sales
Net sales decreased $9.1 million, or 1.1%, to $819.2 million for the
three months ended June 30, 2003 from $828.3 million for the comparable period a
year ago. Adjusted for the favorable impact of foreign currency translation, net
sales declined 4.0% compared to the same period last year. The net sales decline
was attributable to the absence of net sales from the Company's former heat
transfer business segment, 55 percent of which was sold to Outokumpu during the
third quarter of 2002, lower net sales in the Company's Service Experts business
segment and the wind-down of the Company's engineered machine tool business. The
Company currently reports the historical results of operations of its former
heat transfer business segment in the "Corporate and other" business segment.
12
Adjusting for the loss of $49.2 million of net sales from the Company's former
heat transfer business segment and $24.0 million favorable impact of foreign
currency translation, net sales increased $16.1 million, or 2.1%, for the three
months ended June 30, 2003 compared to the three months ended June 30, 2002 as
shown in the following table (dollars in millions):
<Table>
<Caption>
THREE MONTHS ENDED
JUNE 30,
----------------------------
2003 2002 $ CHANGE % CHANGE
---------- ---------- ---------- ----------
Net sales, as reported ...................... $ 819.2 $ 828.3 $ (9.1) (1.1)%
Net sales from former heat transfer
business segment ......................... -- (49.2) 49.2
Impact of foreign currency translation ...... (24.0) -- (24.0)
---------- ---------- ---------- ----------
Net sales, as adjusted ...................... $ 795.2 $ 779.1 $ 16.1 2.1%
========== ========== ========== ==========
</Table>
Net sales in the residential heating and cooling business segment
increased $28.1 million, or 8.1%, to $376.8 million for the three months ended
June 30, 2003 from $348.7 million for three months ended June 30, 2002. Adjusted
for the impact of foreign currency translation, net sales increased 6.8%, or
$23.8 million, compared to the three months ended June 30, 2002. Net sales
increases were achieved by all of the Company's home comfort equipment brands,
including hearth products, for the three months ended June 30, 2003 compared to
the same period last year. These net sales increases were achieved in spite of
difficult market conditions. For example, according to the Air-Conditioning and
Refrigeration Institute ("ARI"), U.S. factory shipments of unitary air
conditioners and heat pumps were down 1% for the first six months of 2003
compared to the same period a year ago. Additionally, distributor shipments for
the first six months of 2003 were down 8% from the same period last year
indicating end-market softness. According to the National Oceanic and
Atmospheric Administrations 's Climate Prediction Center ("CPC"), total U.S.
cooling degree days, on a population-weighted basis, were 7% below normal
year-to-date through June 2003 and down 20% from the comparable period last
year.
Net sales in the commercial heating and cooling business segment
increased $17.1 million, or 14.9%, to $132.1 million for the three months ended
June 30, 2003 compared to the three months ended June 30, 2002. After adjusting
for the impact of foreign currency exchange, net sales increased $8.9 million,
or 7.7%, compared to the three months ended June 30, 2002. The higher net sales
were driven primarily by the Company's domestic operations where 33 new national
accounts were signed year-to-date through June 2003. Net sales were also higher
in the Company's European operations for the three months ended June 30, 2003
compared to the same period last year; however, most of the increase was due to
the favorable impact of foreign currency exchange.
Net sales in the Service Experts business segment were $243.3 million
for the three months ended June 30, 2003, a decrease of $8.2 million, or 3.3%,
from $251.5 million for the same period a year ago. The sales decline was 5.1%
after adjusting for the impact of foreign currency exchange. The sales decline
was entirely in the commercial new construction business due in part to
unfavorable weather in certain sales areas, sluggish commercial construction
starts and price competition. Compared to the three months ended June 30, 2002,
net sales were slightly higher in the service and replacement businesses and the
residential new construction business.
Refrigeration business segment net sales increased $4.9 million, or
5.3%, to $97.3 million for the three months ended June 30, 2003 compared to the
three months ended June 30, 2002. However, after adjusting for the impact of
foreign currency exchange, net sales decreased $2.7 million, or 2.9%, for the
three months ended June 30, 2003 compared to the same period last year. The
sales decline, after adjusting for the impact of foreign currency exchange, was
due primarily to continued depressed domestic and international market demand
from retail customers, notably supermarkets.
Gross Profit
Gross profit was $278.2 million for the three months ended June 30,
2003 compared to $268.2 million for the three months ended June 30, 2002, an
increase of $10.0 million. Gross profit margin improved 1.6% to 34.0% for the
three months ended June 30, 2003 from 32.4% for the comparable period in the
prior year. Gross profit margin improved in the Company's residential heating
and cooling, commercial heating and cooling and refrigeration business segments.
13
In the Company's residential heating and cooling business segment,
gross profit margins improved 0.5% for the three months ended June 30, 2003
compared to the same period last year due primarily to higher volumes, a
favorable mix of higher-margin premium products and improved hearth products
performance. Gross profit margins improved 1.8% in the Company's commercial
heating and cooling business segment over the same period due to higher volumes,
increased factory productivity and the benefits of paring back under-performing
international operations. In the Company's Service Experts business segment,
gross profit margin declined 0.7% over the same period due primarily to lower
margins in the new construction businesses. In the Company's refrigeration
business segment, gross profit margin improved 1.1% over the same period due to
purchasing savings and lower overhead in the Company's domestic operations and
purchasing savings in the Company's Asia Pacific operations. The absence of
lower margin business from the Company's former heat transfer business segment
also contributed to the gross profit margin improvement for the three months
ended June 30, 2003 compared to the same period last year. LIFO (last in, first
out) inventory liquidations did not have a material impact on gross profit
margins.
Selling, General and Administrative Expense
Selling, general and administrative ("SG&A") expenses were $221.8
million for the three months ended June 30, 2003, an increase of $6.2 million,
or 2.9%, from $215.6 million for the three months ended June 30, 2002. The
increase in SG&A expenses was due primarily to higher insurance costs. As a
percentage of total net sales, SG&A expenses increased to 27.1% for the three
months ended June 30, 2003 from 26.0% compared to the same period a year ago, of
which 0.8% was due to the revenue decline caused by the sale of the former heat
transfer business segment.
Restructurings
Pre-tax restructuring charges of $1.2 million for the three months
ended June 30, 2002 principally included personnel termination charges in the
Company's residential heating and cooling business segment and the relocation of
production lines in Europe in the Company's refrigeration business segment.
These restructuring charges resulted from the Company's decision to sell or
abandon certain manufacturing and distribution operations in the fourth quarter
of 2001.
Interest Expense, Net
Interest expense, net, for the three months ended June 30, 2003
decreased $0.4 million, or 4.8%, from $8.3 million for the three months ended
June 30, 2002. The lower interest expense resulted from lower debt levels. As of
June 30, 2003, total debt of $389.6 million was $121.1 million lower than total
debt as of June 30, 2002.
Other Income
Other income was $1.5 million for the three months ended June 30, 2003
compared to $0.5 million for the same period last year. Other income is
comprised of foreign currency exchange gains or losses, which relate principally
to the Company's operations in Canada, Australia and Europe. Appreciation of
Australia's, Europe's and Canada's currencies, as compared to the U.S. dollar,
was primarily responsible for the overall change when comparing the three months
ended June 30, 2003 to the same period a year ago.
Provision for Income Taxes
The provision for income taxes was $19.4 million for the three months
ended June 30, 2003 compared to $17.9 million for the three months ended June
30, 2002. The effective tax rate was 39.0% and 41.1% for the three months ended
June 30, 2003 and 2002, respectively. The lower effective tax rate was primarily
due to a favorable mix of pre-tax income where companies in lower tax
jurisdictions had proportionally more pre-tax income than in prior years.
SIX MONTHS ENDED JUNE 30, 2003 COMPARED TO SIX MONTHS ENDED JUNE 30, 2002
Net Sales
Net sales decreased $33.6 million, or 2.2%, to $1,469.0 million for the
six months ended June 30, 2003 from $1,502.6 million for the comparable period a
year ago. Adjusted for the favorable impact of foreign currency translation, net
sales declined 4.9% compared to the same period last year. The net sales decline
was attributable to
14
the absence of net sales from the Company's former heat transfer business
segment, 55 percent of which was sold to Outokumpu during the third quarter of
2002, lower net sales in the Company's Service Experts business segment and the
wind-down of the Company's engineered machine tool business. The Company
currently reports the historical results of operations of its former heat
transfer business segment in the "Corporate and other" business segment.
Adjusting for the loss of $95.1 million of net sales from the Company's former
heat transfer business segment and $39.5 million favorable impact of foreign
currency translation, net sales increased $22.0 million, or 1.6%, for the six
months ended June 30, 2003 compared to the six months ended June 30, 2002 as
shown in the following table (dollars in millions):
<Table>
<Caption>
SIX MONTHS ENDED
JUNE 30,
----------------------------
2003 2002 $ CHANGE % CHANGE
---------- ---------- ---------- ----------
Net sales, as reported ...................... $ 1,469.0 $ 1,502.6 $ (33.6) (2.2%)
Net sales from former heat transfer
business segment ......................... -- (95.1) 95.1
Impact of foreign currency translation ...... (39.5) -- (39.5)
---------- ---------- ---------- ----------
Net sales, as adjusted ...................... $ 1,429.5 $ 1,407.5 $ 22.0 1.6%
========== ========== ========== ==========
</Table>
Net sales in the residential heating and cooling business segment
increased $48.5 million, or 7.8%, to $671.1 million for the six months ended
June 30, 2003 from $622.6 million for six months ended June 30, 2002. Adjusted
for the impact of foreign currency translation, net sales increased 6.8%, or
$42.4 million, compared to the six months ended June 30, 2002. Net sales
increases were achieved by all of the Company's home comfort equipment brands,
including hearth products, for the six months ended June 30, 2003 compared to
the same period last year. These net sales increases were achieved in spite of
difficult market conditions. For example, according to ARI, U.S. factory
shipments of unitary air conditioners and heat pumps were down 1% for the first
six months of 2003 compared to the same period a year ago. Additionally,
distributor shipments for the first six months of 2003 were down 8% from the
same period last year indicating end-market softness. According to the CPC,
total U.S. cooling degree days, on a population-weighted basis, were 7% below
normal year-to-date through June 2003 and down 20% from the comparable period
last year.
Net sales in the commercial heating and cooling business segment
increased $23.1 million, or 11.4%, to $224.9 million for the six months ended
June 30, 2003 compared to the six months ended June 30, 2002. After adjusting
for the impact of foreign currency exchange, net sales increased $9.1 million,
or 4.5%, compared to the six months ended June 30, 2002. The higher net sales
were driven primarily by the Company's domestic operations where 33 new national
accounts were signed year-to-date through June 2003. Net sales were also higher
in the Company's European operations for the six months ended June 30, 2003
compared to the same period last year; however, most of the increase was due to
the favorable impact of foreign currency exchange.
Net sales in the Service Experts business segment were $440.4 million
for the six months ended June 30, 2003, a decrease of $16.1 million, or 3.5%,
from $456.5 million for the same period a year ago. The sales decline was 5.0%
after adjusting for the impact of foreign currency exchange. The sales decline
was entirely in the commercial new construction business due in part to
unfavorable weather in certain sales areas, sluggish commercial construction
starts and price competition. Compared to the six months ended June 30, 2002,
net sales were slightly higher in the service and replacement businesses and the
residential new construction business.
Refrigeration business segment net sales increased $7.2 million, or
4.0%, to $187.5 million for the six months ended June 30, 2003 compared to the
six months ended June 30, 2002. However, after adjusting for the impact of
foreign currency exchange, net sales decreased $6.5 million, or 3.6%, for the
six months ended June 30, 2003 compared to the same period last year. The sales
decline, after adjusting for the impact of foreign currency exchange, was due
primarily to depressed domestic and international market demand from retail
customers, notably supermarkets.
Gross Profit
Gross profit was $490.8 million for the six months ended June 30, 2003
compared to $474.7 million for the six months ended June 30, 2002, an increase
of $16.1 million. Gross profit margin improved 1.8% to 33.4% for the six months
ended June 30, 2003 from 31.6% for the comparable period in the prior year.
Gross profit margin improved in the Company's residential heating and cooling,
commercial heating and cooling and refrigeration business segments.
15
In the Company's residential heating and cooling business segment,
gross profit margins improved 0.9% for the six months ended June 30, 2003
compared to the same period last year due primarily to higher volumes, a
favorable mix of higher-margin premium products and improved hearth products
performance. In the Company's commercial heating and cooling business segment,
gross profit margin improved 1.2% over the same period due to higher volumes,
increased factory productivity and the benefits of paring back under-performing
international operations. Gross profit margins were relatively flat over the
same period in the Company's Service Experts business segment. In the Company's
refrigeration business segment, gross profit margin improved 1.2% over the same
period due to purchasing savings and lower overhead in the Company's domestic
operations and purchasing savings in the Company's Asia Pacific operations. The
absence of lower margin business from the Company's former heat transfer
business segment also contributed to the gross profit margin improvement for the
six months ended June 30, 2003 compared to the same period last year. LIFO (last
in, first out) inventory liquidations did not have a material impact on gross
profit margins.
SG&A Expense
SG&A expenses were $423.0 million for the six months ended June 30,
2003, an increase of $10.4 million, or 2.5%, from $412.6 million for the six
months ended June 30, 2002. The increase in SG&A expenses was due primarily to
higher insurance costs. As a percentage of total net sales, SG&A expenses
increased to 28.7% for the six months ended June 30, 2003 from 27.5% compared to
the same period a year ago of which, 0.8% was due to the revenue decline caused
by the sale of the former heat transfer business segment.
(Gains) Losses and Other Expenses
Pre-tax (gains) losses and other expenses were $0.9 million for the six
months ended June 30, 2003. (Gains) losses and other expenses included pre-tax
expenses totaling $2.6 million from the loss on the sale of a HVAC distributor
in the Company's residential heating and cooling business segment and other
expenses partially offset by a $1.7 million pre-tax gain on the sale of a
manufacturing facility in Europe in the Company's refrigeration business
segment.
Restructurings
Pre-tax restructuring charges of $1.9 million for the six months ended
June 30, 2002 principally included personnel termination charges in the
Company's residential heating and cooling business segment and the relocation of
production lines in Europe in the Company's refrigeration business segment.
These restructuring charges resulted from the Company's decision to sell or
abandon certain manufacturing and distribution operations in the fourth quarter
of 2001.
Interest Expense, Net
Interest expense, net, for the six months ended June 30, 2003 decreased
$1.2 million, or 7.5%, from $16.1 million for the six months ended June 30,
2002. The lower interest expense resulted from lower debt levels. As of June 30,
2003, total debt of $389.6 million was $121.1 million lower than total debt as
of June 30, 2002.
Other Income
Other income was $2.1 million for the six months ended June 30, 2003
compared to $0.5 million for the same period last year. Other income is
comprised of foreign currency exchange gains or losses, which relate principally
to the Company's operations in Canada, Australia and Europe. Appreciation of
Australia's, Europe's and Canada's currencies, as compared to the U.S. dollar,
was primarily responsible for the overall change when comparing the six months
ended June 30, 2003 to the same period a year ago.
Provision for Income Taxes
The provision for income taxes was $21.0 million for the six months
ended June 30, 2003 compared to $18.3 million for the six months ended June 30,
2002. The effective tax rate was 39.0% and 41.1% for the six months ended June
30, 2003 and 2002, respectively. The lower effective tax rate was primarily due
to a favorable mix of pre-tax income where companies in lower tax jurisdictions
had proportionally more pre-tax income than in prior years.
16
Cumulative Effect of Accounting Change
The cumulative effect of accounting change represents an after-tax,
non-cash, goodwill impairment charge of $249.2 million for the six months ended
June 30, 2002. This charge resulted from the adoption of SFAS No. 142 which
became effective January 1, 2002 and requires that goodwill and other intangible
assets with an indefinite useful life no longer be amortized as expenses of
operations but rather be tested for impairment upon adoption and at least
annually by applying a fair-value-based test. During the first quarter of 2002,
LII conducted such fair-value-based tests and recorded a pre-tax goodwill
impairment charge of $285.7 million. The charge primarily relates to the
Company's Service Experts and residential heating and cooling business segments.
The tax benefit of this charge was $36.5 million. During the first quarter of
2003, LII again conducted such fair-value-based tests and determined that no
further goodwill impairment charge was necessary.
LIQUIDITY AND CAPITAL RESOURCES
LII's working capital and capital expenditure requirements are
generally met through internally generated funds and bank lines of credit.
During the first six months of 2003, cash used in operating activities
was $9.0 million compared to $44.4 million provided by operating activities in
2002. The change is primarily due to cooling inventory buildup driven by low
field inventory levels, the introduction of new products and overall increased
use of working capital. Net cash provided by investing activities in 2003
includes the proceeds from the sale of the net assets of a distributor in the
residential segment and the proceeds from the sale of a closed factory in the
refrigeration segment. Net cash used in financing activities in 2002 reflects
the Company's private placement of $143.8 million of 6.25% convertible
subordinated notes due 2009. The Company used the net proceeds of approximately
$139 million to reduce its indebtedness under its revolving credit facility.
Capital expenditures of $10.3 million and $12.9 million in the first
three months of 2003 and 2002, respectively, were primarily for production
equipment in the North American residential and international refrigeration
products manufacturing plants in 2003 and for the North American residential and
heat transfer products manufacturing plants in 2002.
The Company has bank lines of credit aggregating $335.7 million, of
which $19.5 million was borrowed and outstanding, and $50.1 million was
committed to standby letters of credit at June 30, 2003. The remaining $266.1
million was available for future borrowings, subject to covenant limitations.
Included in the lines of credit is a domestic facility in the amount of $270
million governed by agreements between the Company and a syndicate of banks. The
facility contains certain financial covenants and bears interest, at the
Company's option, at a rate equal to either (a) the greater of the bank's prime
rate or the federal funds rate plus 0.5% or (b) the London Interbank Offered
Rate plus a margin equal to 0.5% to 2.25%, depending upon the ratio of total
funded debt to earnings before interest, taxes, depreciation and amortization
("EBITDA"). The Company pays a commitment fee, depending upon the ratio of total
funded debt to EBITDA, equal to 0.15% to 0.50% of the unused commitment. The
agreements place restrictions on the Company's ability to incur additional
indebtedness, encumber its assets, sell its assets, or pay dividends. The
Company has entered discussions with its bank syndicate to extend its domestic
credit facility, which expires in August 2004. LII expects the amendment process
to be completed in the third quarter of 2003. As of June 30, 2003, LII was in
compliance with all covenant requirements and LII believes that cash flow from
operations, as well as available borrowings under its revolving credit facility,
will be sufficient to fund its operations for the foreseeable future. The
Company has included in cash and cash equivalents in the accompanying
consolidated balance sheet $39.3 million of restricted cash related to letters
of credit.
Under an on-going asset securitization arrangement, the Company had
sold, at June 30, 2003, $154.2 million of receivables on a non-recourse basis.
The receivables are sold at a discount from face value and this discount
aggregated $1.8 million through six months of 2003. The discount expense is
shown as a component of selling, general and administrative expense in the
Consolidated Statements of Operations. The Company has no significant
concentration of credit risk among its diversified customer base.
17
RECENT ACCOUNTING PRONOUNCEMENTS
In May 2003, Statement of Financial Accounting Standards ("SFAS") No.
150, "Accounting for Certain Instruments with Characteristics of Both
Liabilities and Equity" was issued. The standard establishes how an issuer
classifies and measures certain freestanding financial instruments with
characteristics of liabilities and equity and requires that such instruments be
classified as liabilities. The standard is effective for financial instruments
entered into or modified after May 31, 2003 and is otherwise effective at the
beginning of the first interim period beginning after June 15, 2003. Adoption of
the standard is not expected to have a material effect on the Company's
financial statements.
During May 2003, the Emerging Issues Task Force ("EITF") of the
Financial Accounting Standards Board ("FASB") released EITF Issue No. 01-8,
"Determining Whether an Arrangement Contains a Lease." The new requirements of
EITF 01-8 potentially affects companies that sell or purchase products or
services through supply, commodity, transportation, and data-processing
outsourcing contracts. The guidance in this new release is designed to mandate
reporting revenue as rental or leasing income that would otherwise be reported
as part of product sales or services revenue. EITF 01-8 requires both parties to
an arrangement to determine whether a service contract or similar arrangement
includes a lease within the scope of SFAS No. 13, "Accounting for Leases," which
means focusing on agreements conveying the right to use property, plant, or
equipment. The application of this issue is not expected to have a material
effect on the Company's financial statements.
In November 2002, the EITF reached a consensus on Issue No. 00-21,
"Accounting for Revenue Arrangements with Multiple Deliverables." This EITF
establishes the criteria for recognizing revenue in arrangements when several
items are bundled into one agreement. EITF 00-21 does not allow revenue
recognition unless the fair value of the undelivered element(s) is available and
the element has stand-alone value to the customer. EITF 00-21 also provides
guidance on allocating the total contract revenue to the individual elements
based upon the available fair value of each deliverable. The consensus is
effective prospectively for arrangements entered into in fiscal periods
beginning after June 15, 2003. The Company does not believe this pronouncement
will have a material effect on its financial statements.
In January 2003, the FASB issued Interpretation No. 46, "Consolidation
of Variable Interest Entities, an interpretation of ARB No. 51." This
interpretation addresses the consolidation by business enterprises of variable
interest entities, as defined in the interpretation, when the reporting
enterprise is the primary beneficiary of the variable interest entities. The
interpretation applies immediately to variable interests in variable interest
entities created after January 31, 2003, and as of July 1, 2003, to variable
interests in variable interest entities created before February 1, 2003. The
application of this interpretation is not expected to have a material effect on
the Company's financial statements.
FORWARD LOOKING INFORMATION
This Report contains forward-looking statements and information that
are based on the beliefs of LII's management as well as assumptions made by and
information currently available to management. All statements other than
statements of historical fact included in this Report constitute forward-looking
statements within the meaning of the Private Securities Litigation Reform Act of
1995, including but not limited to statements identified by the words "may,"
"will," "should," "plan," "predict," "anticipate," "believe," "intend,"
"estimate" and "expect" and similar expressions. Such statements reflect
Lennox's current views with respect to future events, based on what it believes
are reasonable assumptions; however, such statements are subject to certain
risks, uncertainties and assumptions. These include, but are not limited to,
warranty and product liability claims; ability to successfully complete and
integrate acquisitions; ability to manage new lines of business; the
consolidation trend in the HVACR industry; adverse reaction from customers to
the Company's acquisitions or other activities; the impact of the weather on
business; competition in the HVACR business; increases in the prices of
components and raw materials; general economic conditions in the U.S. and
abroad; labor relations problems; operating risks and environmental risks.
Should one or more of these risks or uncertainties materialize, or should
underlying assumptions prove incorrect, actual results may differ materially
from those in the forward-looking statements. LII disclaims any intention or
obligation to update or review any forward-looking statements or information,
whether as a result of new information, future events or otherwise.
18
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
LII's results of operations can be affected by changes in exchange
rates. Net sales and expenses in currencies other than the United States dollar
are translated into United States dollars for financial reporting purposes based
on the average exchange rate for the period. Net sales from outside the United
States represented 22.9% and 20.8% of total net sales for the six months ended
June 30, 2003 and 2002, respectively. Historically, foreign currency transaction
gains (losses) have not had a material effect on LII's overall operations.
The Company enters into commodity futures contracts to stabilize prices
to be paid for raw materials and parts containing high copper and aluminum
content. These contracts are for quantities equal to, or less than, quantities
expected to be consumed in future production. As of June 30, 2003, the Company
had metal futures contracts maturing at various dates through December 31, 2003
with a fair value as an asset of $0.8 million.
ITEM 4. CONTROLS AND PROCEDURES
In accordance with Rules 13a-15 and 15d-15 of the Securities Exchange
Act of 1934 (the "Exchange Act"), the Company carried out an evaluation, under
the supervision and with the participation of the Company's management,
including its Chief Executive Officer and Chief Financial Officer, of the
effectiveness of its disclosure controls and procedures as of the end of the
period covered by this report. Based on that evaluation, the Chief Executive
Officer and Chief Financial Officer concluded that the Company's disclosure
controls and procedures were effective as of June 30, 2003 to provide reasonable
assurance that information required to be disclosed in the Company's reports
filed or submitted under the Exchange Act is recorded, processed, summarized and
reported within the time periods specified in the Securities and Exchange
Commission's rules and forms.
There has been no change in the Company's internal controls over
financial reporting that occurred during the three months ended June 30, 2003
that has materially affected, or is reasonably likely to materially affect, the
Company's internal controls over financial reporting.
19
PART II -- OTHER INFORMATION
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
The Company's 2003 Annual Meeting of Stockholders ("Annual Meeting")
was held on May 16, 2003. At the Annual Meeting, the Company's stockholders
elected five directors with terms expiring at the Company's Annual Meeting of
Stockholders in 2006. In addition, the stockholders rejected a stockholder
proposal that the Board adopt an executive compensation policy that all future
stock option grants to senior executives shall be indexed to industry
performance.
(a) The following sets forth the results of voting at the Annual
Meeting for the election of directors *:
<Table>
<Caption>
Directors For Withheld Abstentions
--------- ---------- ---------- -----------
Linda G. Alvarado 48,713,379 263,939 *
Steven R. Booth 48,577,167 400,151 *
David V. Brown 48,716,391 260,927 *
John E. Major 47,007,088 1,970,230 *
Walden W. O'Dell 48,727,609 249,709 *
</Table>
*With respect to the election of Directors, the form of proxy permitted
stockholders to check boxes indicating votes either "For" or "Withhold
Authority," or to vote "Exceptions" and to name exceptions. Votes relating to
directors designated above as "Withheld" include votes cast as "Withhold
Authority" and for named exceptions.
Following the Annual Meeting, Janet K. Cooper, C.L. (Jerry) Henry,
Robert E. Schjerven, Terry D. Stinson and Richard L. Thompson, having terms
expiring in 2004, and David H. Anderson, Thomas W. Booth, James J. Byrne, John
W. Norris III, and John W. Norris, Jr., having terms expiring in 2005, continued
in office.
(b) The votes for, against and abstaining in connection with the
rejection by the stockholders that the Board adopt an executive compensation
policy that all future stock option grants to senior executives shall be indexed
to industry performance:
<Table>
<Caption>
For Against Abstentions
--------- ------------ -------------
7,842,117 31,414,558 562,776
</Table>
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
Exhibit Number Description
- -------------- -----------
* 3.1 -- Restated Certificate of Incorporation of Lennox
(Incorporated herein by reference to Exhibit 3.1 to
Lennox's Registration Statement on Form S-1 (Registration
No. 333-75725)).
* 3.2 -- Amended and Restated Bylaws of Lennox (Incorporated herein
by reference to Exhibit 3.2 to Lennox's Registration
Statement on Form S-1 (Registration No. 333-75725)).
* 4.1 -- Specimen stock certificate for the Common Stock, par value
$.01 per share, of Lennox (Incorporated herein by reference
to Exhibit 4.1 to the Company's Registration Statement on
Form S-1 (Registration No. 333-75725)).
10.1 -- Second Amended and Restated Receivables Purchase Agreement,
dated as of June 16, 2003, among LPAC Corp., Lennox
Industries Inc., Blue Ridge Asset Funding Corporation,
Liberty Street Funding Corp., The Bank of Nova Scotia and
Wachovia Bank, N.A. (filed herewith)
10.2 -- Second Amendment to Purchase and Sale Agreement, dated as
of June 16, 2003, by and among LPAC Corp., Lennox
Industries Inc., Advanced Distributor Products LLC and
Heatcraft Refrigeration Products LLC. (filed herewith)
20
10.3 -- Receivables Purchase Agreement dated as of June 27, 2003
among LPAC Corp. II, Lennox Industries, Jupiter
Securitization Corporation, The Financial Institutions from
time to time parties thereto, and Bank One, NA. (filed
herewith)
10.4 -- Receivables Sale Agreement dated as of June 27, 2003 among
Armstrong Air Conditioning Inc., and Lennox Hearth Products
Inc. and LPAC Corp. II. (filed herewith)
12.1 -- Lennox International Inc. and Subsidiaries Computation of
Ratio of Earnings to Fixed Charges (Unaudited) For the Six
Months Ended June 30, 2003. (filed herewith)
31.1 -- Certification of the Principal Executive Officer. (filed
herewith)
31.2 -- Certification of the Principal Financial Officer. (filed
herewith)
32.1 -- Certification of the Principal Executive Officer and the
Principal Financial Officer of the Company pursuant to 18
U.S.C. Section 1350. (filed herewith)
* Incorporated herein by reference as indicated.
Reports on Form 8-K
During the three-month period ending June 30, 2003, the
Company filed or furnished one Current Report on Form 8-K
dated April 22, 2003 and filed April 23, 2003 reporting under
Item 9 - Regulation FD Disclosure a press release reporting
the Company's financial results for the quarter ended March
31, 2003.
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
LENNOX INTERNATIONAL INC.
Date: August 13, 2003
/s/ Richard A. Smith
-------------------------------------
Principal Financial Officer
and Duly Authorized Signatory
21
INDEX TO EXHIBITS
<Table>
<Caption>
Exhibit Number Description
- -------------- -----------
* 3.1 -- Restated Certificate of Incorporation of Lennox
(Incorporated herein by reference to Exhibit 3.1 to
Lennox's Registration Statement on Form S-1 (Registration
No. 333-75725)).
* 3.2 -- Amended and Restated Bylaws of Lennox (Incorporated herein
by reference to Exhibit 3.2 to Lennox's Registration
Statement on Form S-1 (Registration No. 333-75725)).
* 4.1 -- Specimen stock certificate for the Common Stock, par value
$.01 per share, of Lennox (Incorporated herein by reference
to Exhibit 4.1 to the Company's Registration Statement on
Form S-1 (Registration No. 333-75725)).
10.1 -- Second Amended and Restated Receivables Purchase Agreement,
dated as of June 16, 2003, among LPAC Corp., Lennox
Industries Inc., Blue Ridge Asset Funding Corporation,
Liberty Street Funding Corp., The Bank of Nova Scotia and
Wachovia Bank, N.A. (filed herewith)
10.2 -- Second Amendment to Purchase and Sale Agreement, dated as
of June 16, 2003, by and among LPAC Corp., Lennox
Industries Inc., Advanced Distributor Products LLC and
Heatcraft Refrigeration Products LLC. (filed herewith)
10.3 -- Receivables Purchase Agreement dated as of June 27, 2003
among LPAC Corp. II, Lennox Industries, Jupiter
Securitization Corporation, The Financial Institutions from
time to time parties thereto, and Bank One, NA. (filed
herewith)
10.4 -- Receivables Sale Agreement dated as of June 27, 2003 among
Armstrong Air Conditioning Inc., and Lennox Hearth Products
Inc. and LPAC Corp. II. (filed herewith)
12.1 -- Lennox International Inc. and Subsidiaries Computation of
Ratio of Earnings to Fixed Charges (Unaudited) For the Six
Months Ended June 30, 2003. (filed herewith)
31.1 -- Certification of the Principal Executive Officer. (filed
herewith)
31.2 -- Certification of the Principal Financial Officer. (filed
herewith)
32.1 -- Certification of the Principal Executive Officer and the
Principal Financial Officer of the Company pursuant to 18
U.S.C. Section 1350. (filed herewith)
</Table>
* Incorporated herein by reference as indicated.