Lennox International Inc (LII)

How it makes money

Lennox earns nearly all of its revenue by selling equipment: it manufactures HVACR units and sells them to the contractors and dealers who install them, to wholesale distributors, and directly to national accounts. Alongside new equipment it sells replacement parts, components and supplies through its own stores, which is a recurring stream tied to the installed base, and in the commercial segment it also sells installation and maintenance services through National Account Services. There is no subscription: each sale is a one-off transaction, and the repeat business comes from equipment eventually wearing out and being replaced.

Revenue by segment

Lennox's advantage rests on its brands and on a distribution network it largely owns. Residential equipment is chosen in practice by the contractor who installs it, and Lennox reaches those contractors directly through its own Lennox Stores, which also supply the parts they need day to day — a relationship competitors cannot easily displace, and one that keeps the installed base coming back for replacement equipment and parts. The 10-K, however, describes the HVACR business as competitive and names its ability to compete favourably as a risk factor: several large rivals sell comparable equipment, and the advantage looks durable rather than insurmountable.

Two different demands sit inside the same company. Replacement — an air conditioner or furnace that fails and has to be changed — is largely non-deferrable and holds up through a downturn, and it is supported by the parts and service business tied to the installed base. New construction, which the company itself names as a driver in its risk factors, follows housing starts and commercial building activity and swings with rates and the economy. On top of both sits the weather: the filing says sales are seasonally higher in the second and third quarters, and that a cool summer or a mild winter depresses replacement demand. Changes in efficiency standards and refrigerant rules add their own cycle, because they can pull purchases forward before a deadline and leave a hole after it.

Key risks

• Competition in the HVACR business — The company discloses that it may not be able to compete favourably in the competitive HVACR business, where rivals contend on price, product features, efficiency and service.
• Single-location plants and key suppliers — Lennox states that its ability to meet demand and stay profitable may be limited by production facilities concentrated in single locations, by reliance on certain key suppliers, and by unanticipated swings in customer demand.
• Dependence on U.S. construction activity — The filing states that the company's financial performance is affected by the conditions and performance of the U.S. construction industry, which drives demand for equipment fitted in new homes and buildings.
• Weather — The company discloses that cooler than normal summers depress sales of replacement air conditioning and refrigeration products and services, and that warmer than normal winters have the same effect on heating products.
• Commodity prices and supply interruptions — Price volatility for the commodities and components it purchases, or significant supply interruptions, could adversely affect cash flow and results, according to the risk factors.
• Environmental and efficiency regulation — Changes in environmental and climate-related legislation, government regulations or policies — the rules that govern refrigerants and minimum efficiency standards for HVAC equipment — could adversely affect results.
• U.S. trade policy and tariffs — The company lists changes in U.S. trade policy, including the imposition of tariffs and the consequences that follow, among the factors that could adversely affect its results of operations.
• Product liability, warranty claims and recalls — Lennox discloses that it may incur substantial costs as a result of product liability, warranty claims or product recalls.

The annual report does not disclose a percentage of sales attributable to the largest customers. It describes a fragmented route to market — thousands of independent installing dealers reached directly or through company-owned Lennox Stores, independent wholesale distributors, and direct contracts with large national accounts such as retail and restaurant chains in the commercial segment — and notes reliance on the direct sales channel for a substantial part of revenue, but gives no single-customer figure.