10-Q 1 lii-2018930x10q.htm 10-Q Document
 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
_________________________________________________
FORM 10-Q
 _________________________________________________


QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED September 30, 2018        
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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  [X]    No  [ ]
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer”, “accelerated filer”, “smaller reporting company” and “emerging growth company" in Rule 12b-2 of the Exchange Act.
Large Accelerated Filer
[X]
 
Accelerated Filer
[ ]
Non-Accelerated Filer
[ ]
 
Smaller Reporting Company
[ ]
 
 
 
Emerging growth company
[ ]
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. [ ]
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  [ ]    No  [X]
As of October 18, 2018, the number of shares outstanding of the registrant’s common stock, par value $.01 per share, was 40,283,285.

 





LENNOX INTERNATIONAL INC.
FORM 10-Q
For the three and nine months ended September 30, 2018

INDEX
 
 
Page
Part I
 
 
 
 
Consolidated Balance Sheets - September 30, 2018 (Unaudited) and December 31, 2017
 
Consolidated Statements of Operations (Unaudited) - Three Months and Nine Months Ended September 30, 2018 and 2017
 
Consolidated Statements of Comprehensive Income (Unaudited) - Three Months and Nine Months Ended September 30, 2018 and 2017
 
Consolidated Statements of Cash Flows (Unaudited) - Nine Months Ended September 30, 2018 and 2017
 
 
 
 
Part II
 
 
 
 
 

i



Part I - Financial Information
Item 1. Financial Statements
LENNOX INTERNATIONAL INC. AND SUBSIDIARIES
Consolidated Balance Sheets

(Amounts in millions, except shares and par values)
As of September 30, 2018
 
As of December 31, 2017
 
(unaudited)
 
 
ASSETS
 
 
 
Current Assets:
 
 
 
Cash and cash equivalents
$
46.1

 
$
68.2

Accounts and notes receivable, net of allowances of $6.1 and $5.9 in 2018 and 2017, respectively
580.9

 
506.5

Inventories, net
501.5

 
484.2

Other assets
58.7

 
78.4

Total current assets
1,187.2

 
1,137.3

Property, plant and equipment, net of accumulated depreciation of $772.9 and $774.2 in 2018 and 2017, respectively
374.4

 
397.8

Goodwill
186.9

 
200.5

Deferred income taxes
95.4

 
94.4

Other assets, net
66.9

 
61.5

Total assets
$
1,910.8

 
$
1,891.5

 
 
 
 
LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
Current Liabilities:
 
 
 
Short-term debt
$

 
$
0.9

Current maturities of long-term debt
22.3

 
32.6

Accounts payable
371.6

 
348.6

Accrued expenses
292.5

 
270.3

Income taxes payable
4.1

 
2.1

Total current liabilities
690.5

 
654.5

Long-term debt
1,103.6

 
970.5

Post-retirement benefits, other than pensions
2.5

 
2.6

Pensions
70.7

 
84.5

Other liabilities
130.3

 
129.3

Total liabilities
1,997.6

 
1,841.4

Commitments and contingencies


 


Stockholders' (deficit) 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, 87,170,197 shares issued
0.9

 
0.9

Additional paid-in capital
1,075.5

 
1,061.5

Retained earnings
1,805.0

 
1,575.9

Accumulated other comprehensive loss
(175.6
)
 
(157.4
)
Treasury stock, at cost, shares 46,891,591 and 45,361,145 shares as of September 30, 2018 and December 31, 2017, respectively
(2,792.6
)
 
(2,430.8
)
Total stockholders' (deficit) equity
(86.8
)
 
50.1

Total liabilities and stockholders' equity
$
1,910.8

 
$
1,891.5

The accompanying notes are an integral part of these consolidated financial statements.

1



LENNOX INTERNATIONAL INC. AND SUBSIDIARIES
Consolidated Statements of Operations
(Unaudited)

(Amounts in millions, except per share data)
For the Three Months Ended September 30,
 
For the Nine Months Ended September 30,
 
2018
 
2017
 
2018
 
2017
Net sales
$
1,030.2

 
$
1,052.3

 
$
3,040.4

 
$
2,947.9

Cost of goods sold
728.3

 
738.6

 
2,153.8

 
2,082.4

Gross profit
301.9

 
313.7

 
886.6

 
865.5

Operating Expenses:
 
 
 
 
 
 
 
Selling, general and administrative expenses
149.4

 
158.7

 
466.1

 
479.6

Losses and other expenses, net
2.7

 
3.0

 
10.0

 
8.5

Restructuring charges
0.5

 
1.9

 
1.9

 
2.1

Loss (gain), net on sale of businesses and related property
6.2

 

 
25.8

 

Loss from natural disaster, net of insurance recoveries
0.3

 

 
0.3

 

Income from equity method investments
(2.4
)
 
(4.5
)
 
(10.8
)
 
(15.5
)
Operating income
145.2

 
154.6

 
393.3

 
390.8

Interest expense, net
10.3

 
7.6

 
28.5

 
23.3

Other expense (income), net
1.1

 

 
2.4

 
(0.2
)
Income from continuing operations before income taxes
133.8

 
147.0

 
362.4

 
367.7

Provision for income taxes
25.8

 
43.0

 
77.3

 
103.8

Income from continuing operations
108.0

 
104.0

 
285.1

 
263.9

Discontinued Operations:
 
 
 
 
 
 
 
(Loss) income from discontinued operations before income taxes

 
(0.8
)
 
0.4

 
(2.3
)
Income tax (benefit) expense

 
(0.3
)
 
2.1

 
(0.9
)
Loss from discontinued operations

 
(0.5
)
 
(1.7
)
 
(1.4
)
Net income
$
108.0

 
$
103.5

 
$
283.4

 
$
262.5

 
 
 
 
 
 
 
 
Earnings per share – Basic:
 
 
 
 
 
 
 
Income from continuing operations
$
2.68

 
$
2.48

 
$
6.98

 
$
6.23

Loss from discontinued operations

 
(0.01
)
 
(0.04
)
 
(0.03
)
Net income
$
2.68

 
$
2.47

 
$
6.94

 
$
6.20

Earnings per share – Diluted:
 
 
 
 
 
 
 
Income from continuing operations
$
2.65

 
$
2.45

 
$
6.90

 
$
6.15

Loss from discontinued operations

 
(0.01
)
 
(0.04
)
 
(0.03
)
Net income
$
2.65

 
$
2.44

 
$
6.86

 
$
6.12

 
 
 
 
 
 
 
 
Weighted Average Number of Shares Outstanding - Basic
40.3

 
41.9

 
40.8

 
42.3

Weighted Average Number of Shares Outstanding - Diluted
40.7

 
42.4

 
41.3

 
42.9

 
 
 
 
 
 
 
 
Cash dividends declared per share
$
0.64

 
$
0.51

 
$
1.79

 
$
1.45


The accompanying notes are an integral part of these consolidated financial statements.

2



LENNOX INTERNATIONAL INC. AND SUBSIDIARIES
Consolidated Statements of Comprehensive Income
(Unaudited)

(Amounts in millions)
For the Three Months Ended September 30,
 
For the Nine Months Ended September 30,
 
2018
 
2017
 
2018
 
2017
Net income
$
108.0

 
$
103.5

 
$
283.4

 
$
262.5

Other comprehensive income:

 

 
 
 
 
Foreign currency translation adjustments
3.6

 
10.2

 
(9.4
)
 
39.4

Reclassification of foreign currency translation adjustments into earnings
5.0

 

 
27.9

 

Net change in pension and post-retirement liabilities
(2.5
)
 
(2.7
)
 
(6.3
)
 
(8.1
)
Reclassification of pension and post-retirement benefit losses into earnings
2.4

 
1.8

 
7.0

 
5.5

Change in available-for-sale marketable equity securities

 
0.1

 
(1.8
)
 
0.2

Net change in fair value of cash flow hedges
(3.8
)
 
3.4

 
(8.9
)
 
10.5

Reclassification of cash flow hedge gains into earnings
(0.3
)
 
(3.5
)
 
(7.3
)
 
(9.4
)
Other comprehensive income before income taxes
4.4

 
9.3

 
1.2

 
38.1

Income tax benefit (expense)
1.0

 
0.1

 
(19.4
)
 

Other comprehensive income (loss), net of tax
5.4

 
9.4

 
(18.2
)
 
38.1

Comprehensive income
$
113.4

 
$
112.9

 
$
265.2

 
$
300.6

The accompanying notes are an integral part of these consolidated financial statements.

3



LENNOX INTERNATIONAL INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(Unaudited)
(Amounts in millions)
For the Nine Months Ended September 30,
 
2018
 
2017
Cash flows from operating activities:
 
 
 
Net income
$
283.4

 
$
262.5

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Gain on sale of real estate
(23.8
)
 

Impairment/loss on the sale of Australia business
13.0

 

Impairment/loss on the sale of Brazil business
36.6

 

Income from equity method investments
(10.8
)
 
(15.5
)
Dividend from Affiliates
6.6

 
7.8

Restructuring charges, net of cash paid
0.5

 
1.0

Provision for bad debts
3.8

 
3.2

Unrealized losses (gains) on derivative contracts
1.4

 
(0.7
)
Stock-based compensation expense
21.0

 
18.8

Depreciation and amortization
49.4

 
48.1

Deferred income taxes
(5.6
)
 
(3.9
)
Pension expense
6.5

 
4.1

Pension contributions
(20.3
)
 
(1.4
)
Other items, net
0.3

 
1.0

Changes in assets and liabilities, net of effects of divestitures:
 
 
 
Accounts and notes receivable
(114.0
)
 
(118.3
)
Inventories
(73.7
)
 
(102.6
)
Other current assets
(8.6
)
 
(7.3
)
Accounts payable
46.9

 
31.0

Accrued expenses
35.6

 
7.6

Income taxes payable and receivable
(1.4
)
 
(9.9
)
Other
(15.5
)
 
3.5

Net cash provided by operating activities
231.3

 
129.0

Cash flows from investing activities:
 
 
 
Proceeds from the disposal of property, plant and equipment
0.1

 
0.2

Purchases of property, plant and equipment
(60.9
)
 
(60.5
)
Net proceeds from sale of businesses and related property
115.9

 

   Insurance recoveries received for property damage incurred from natural disaster
4.2

 

Net cash provided by (used in) investing activities
59.3

 
(60.3
)
Cash flows from financing activities:
 
 
 
Short-term borrowings, net
(1.5
)
 
(1.4
)
Asset securitization borrowings
155.0

 
275.0

Asset securitization payments
(53.7
)
 

Long-term debt payments
(32.9
)
 
(200.8
)
Borrowings from credit facility
1,820.0

 
1,883.0

Payments on credit facility
(1,766.5
)
 
(1,701.0
)
Proceeds from employee stock purchases
2.5

 
2.3

Repurchases of common stock
(350.2
)
 
(250.0
)
Repurchases of common stock to satisfy employee withholding tax obligations
(21.1
)
 
(16.0
)
Cash dividends paid
(68.2
)
 
(58.4
)
Net cash used in financing activities
(316.6
)
 
(67.3
)
(Decrease) increase in cash and cash equivalents
(26.0
)
 
1.4

Effect of exchange rates on cash and cash equivalents
3.9

 
9.1

Cash and cash equivalents, beginning of period
68.2

 
50.2

Cash and cash equivalents, end of period
$
46.1

 
$
60.7

 
 
 
 

4



LENNOX INTERNATIONAL INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(Unaudited)
Supplemental disclosures of cash flow information:
 
 
 
Interest paid
$
25.9

 
$
22.5

Income taxes paid (net of refunds)
$
87.2

 
$
115.5

Insurance recoveries received
$
45.0

 
$

The accompanying notes are an integral part of these consolidated financial statements.

5



LENNOX INTERNATIONAL INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. General:

References in this Quarterly Report on Form 10-Q to "we," "our," "us," "LII," or the "Company" refer to Lennox International Inc. and its subsidiaries, unless the context requires otherwise.

Basis of Presentation

The accompanying unaudited Consolidated Balance Sheet as of September 30, 2018, the accompanying unaudited Consolidated Statements of Operations for the three and nine months ended September 30, 2018 and 2017, the accompanying unaudited Consolidated Statements of Comprehensive Income for the three and nine months ended September 30, 2018 and 2017, and the accompanying unaudited Consolidated Statements of Cash Flows for the nine months ended September 30, 2018 and 2017 should be read in conjunction with our audited consolidated financial statements and footnotes included in our Annual Report on Form 10-K for the year ended December 31, 2017. The accompanying unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. The accompanying consolidated financial statements contain all material adjustments, consisting principally of normal recurring adjustments, necessary for a fair presentation of our financial position, results of operations and cash flows. Certain information and footnote disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to applicable rules and regulations, although we believe 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 that may be expected for a full year.

Our fiscal quarterly periods are comprised of approximately 13 weeks, but the number of days per quarter may vary year-over-year. Our quarterly reporting periods usually end on the Saturday closest to the last day of March, June and September. Our fourth quarter and fiscal year ends on December 31, regardless of the day of the week on which December 31 falls.

Use of Estimates

The preparation of financial statements requires us to make estimates and assumptions about future events. These estimates and the underlying assumptions affect the amounts of assets and liabilities reported, disclosures about contingent assets and liabilities, and reported amounts of revenues and expenses. Such estimates include the valuation of accounts receivable, inventories, goodwill, intangible assets and other long-lived assets, contingencies, guarantee obligations, indemnifications, and assumptions used in the calculation of income taxes, pension and post-retirement medical benefits, and stock-based compensation, among others. These estimates and assumptions are based on our best estimates and judgment.

We evaluate these estimates and assumptions on an ongoing basis using historical experience and other factors, including the current economic environment. We believe these estimates and assumptions to be reasonable under the circumstances and will adjust such estimates and assumptions when facts and circumstances dictate. Volatile equity, foreign currency and commodity markets combine to increase the uncertainty inherent in such estimates and assumptions. Future events and their effects cannot be determined with precision and actual results could differ significantly from these estimates. Changes in these estimates will be reflected in the financial statements in future periods.

Reclassifications

Certain amounts have been reclassified from the prior year presentation to conform to the current year presentation.

Recently Adopted Accounting Guidance

In August 2016, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2016-15, Classification of Certain Cash Receipts and Cash Payments. The amendments in this ASU clarify the classification for eight different types of activities, including debt prepayment and extinguishment costs, proceeds from insurance claims and distributions from equity method investees. For public business entities, the standard is effective for financial statements issued for fiscal years beginning after December 15, 2017. This standard did not have a material impact on our consolidated financial statements.

We also adopted other new accounting standards during the first quarter of 2018. The impact of these additional standards are discussed in their respective Notes to the Consolidated Financial Statements.

6




Recent Accounting Pronouncements
On February 25, 2016, the FASB issued ASU No. 2016-02, Leases (ASC 842). Lessees will need to recognize almost all leases on their balance sheet as a right-of-use asset and a lease liability. It will be critical to identify leases embedded in a contract to avoid misstating the lessee’s balance sheet. For income statement purposes, the FASB retained a dual model, requiring leases to be classified as either operating or finance. Classification will be based on criteria that are largely similar to those applied in current lease accounting, but without explicit bright lines. ASU 2016-02 is effective for public companies for annual reporting periods beginning after December 15, 2018, and interim periods within those fiscal years. As a result of the new standard, all of our leases greater than one year in duration will be recognized in our Consolidated Balance Sheets as both operating lease liabilities and right-of-use assets upon adoption of the standard. We will adopt the standard using the prospective approach. We have completed a qualitative and quantitative assessment of our lease portfolio and are in the process of testing our new lease accounting system, collecting data for leases entered into during 2018 and implementing new processes and controls to account for our leases in accordance with the new standard. Upon adoption, we expect to record right-of-use assets and operating lease liabilities between $150 million and $200 million in our Consolidated Balance Sheet.
In August 2018, the SEC issued Release No. 33-10532 that amends and clarifies certain financial reporting requirements. The principal change to our financial reporting will be the inclusion of the annual disclosure requirement of changes in stockholders’ equity in Rule 3-04 of Regulation S-X to interim periods. We will adopt this new rule beginning with our financial reporting for the quarter ended March 31, 2019. Upon adoption, we will include our Consolidated Statements of Stockholders' Equity with each quarterly filing on Form 10-Q.

2. Revenue Recognition:

On January 1, 2018, we adopted the new accounting standard ASC 606, Revenue from Contracts with Customers and all the related amendments (“the new revenue standard”) and applied it to all contracts using the modified retrospective method. We recognized the cumulative effect of initially applying the new revenue standard as an adjustment to the opening balance of retained earnings. The comparative information has not been restated and continues to be reported under the accounting standards in effect for those periods. We expect the impact of the adoption of the new standard to be immaterial to our net income on an ongoing basis.

The cumulative effect of the changes made to our consolidated January 1, 2018 balance sheet for the adoption of the new revenue standard was as follows (in millions):
BALANCE SHEET
Balance at December 31, 2017
 
Adjustments Due to ASC 606
 
Balance at January 1, 2018
ASSETS
 
 
 
 
 
Accounts and notes receivable, net
$
506.5

 
$
8.3

 
$
514.8

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
 
 
Accounts payable
348.6

 
9.3

 
357.9

Retained earnings
1,575.9

 
(1.0
)
 
1,574.9


In accordance with the new revenue standard requirements, the disclosure of the impact of adoption on our Consolidated Balance Sheet and Consolidated Statement of Operations was as follows (in millions):

7



 
September 30, 2018
 
As Reported
 
Balances Without Adoption of ASC 606
 
Effect of Change Higher/(Lower)
BALANCE SHEET
 
 
 
 
 
ASSETS
 
 
 
 
 
Accounts and notes receivable, net
$
580.9

 
$
572.4

 
$
8.5

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
 
 
Accounts payable
371.6

 
361.4

 
10.2

Retained earnings
1,805.0

 
1,806.7

 
(1.7
)
 
For the Three Months Ended September 30, 2018
 
As Reported
 
Activity Without Adoption of ASC 606
 
Effect of Change Higher/(Lower)
STATEMENT OF OPERATIONS
 
 
 
 
 
Net sales
$
1,030.2

 
$
1,030.2

 
$

Net income
108.0

 
108.1

 
(0.1
)
 
For the Nine Months Ended September 30, 2018
 
As Reported
 
Activity Without Adoption of ASC 606
 
Effect of Change Higher/(Lower)
STATEMENT OF OPERATIONS
 
 
 
 
 
Net sales
$
3,040.4

 
$
3,040.6

 
$
(0.2
)
Net income
283.4

 
283.5

 
(0.1
)

The following table disaggregates our revenue by business segment by geography which provides information as to the major source of revenue. See Note 16 for additional description of our reportable business segments and the products and services being sold in each segment.
 
For the Three Months Ended September 30,2018
Primary Geographic Markets
Residential Heating & Cooling
 
Commercial Heating & Cooling
 
Refrigeration
 
Consolidated
Americas
$
594.7

 
$
236.9

 
$
132.0

 
$
963.6

Europe

 
38.9

 
27.7

 
66.6

Total
$
594.7

 
275.8

 
159.7

 
1,030.2


 
For the Nine Months Ended September 30, 2018
Primary Geographic Markets
Residential Heating & Cooling
 
Commercial Heating & Cooling
 
Refrigeration
 
Consolidated
Americas
$
1,764.4

 
$
668.1

 
$
369.4

 
$
2,801.9

Europe

 
105.4

 
83.4

 
188.8

Asia Pacific

 

 
49.7

 
49.7

Total
$
1,764.4

 
773.5

 
502.5

 
3,040.4


Our revenue recognition practices for the sale of goods depend upon the shipping terms for each transaction. Shipping terms are primarily FOB Shipping Point and, therefore, revenue is recognized for these transactions when products are shipped to customers and title and control passes. Certain customers in our smaller operations, primarily outside of North America, have shipping terms where risks and rewards of ownership do not transfer until the product is delivered to the customer. For these transactions, revenue is recognized on the date that the product is received and accepted by such customers. We experience returns for miscellaneous reasons and record a reserve for these returns at the time we recognize revenue based on historical experience. Our historical rates of return are insignificant as a percentage of sales. We also recognize revenue net of sales taxes. We have elected to recognize the revenue and cost for freight and shipping when control over the sale of goods passes to our customers.

8




For our businesses that provide services, revenue is recognized at the time services are completed. Our Commercial Heating & Cooling segment also provides sales, installation, maintenance and repair services under fixed-price contracts. Revenue for services is recognized as the services are performed under the contract based on the relative fair value of the services provided. We allocate a portion of the revenue for extended labor warranty obligations and recognize the revenue over the term of the extended warranty. See Note 7 for more information on product warranties.

Residential Heating & Cooling - We manufacture and market a broad range of furnaces, air conditioners, heat pumps, packaged heating and cooling systems, equipment and accessories to improve indoor air quality, comfort control products, replacement parts and supplies and related products for both the residential replacement and new construction markets in North America. These products are sold under various brand names and are sold either through direct sales to a network of independent installing dealers, including through our network of Lennox PartsPlus stores or to independent distributors. For the segment, for the three and nine months ended September 30, 2018, direct sales represent approximately $459.9 million and $1,346.2 million of revenues and sales to independent distributors represent approximately $134.8 million and $418.2 million of revenues, respectively. Given the nature of our business, customer product orders are fulfilled at a point in time and not over a period of time.

Commercial Heating & Cooling - In North America, we manufacture and sell unitary heating and cooling equipment used in light commercial applications, such as low-rise office buildings, restaurants, retail centers, churches and schools. These products are distributed primarily through commercial contractors and directly to national account customers in the planned replacement, emergency replacement and new construction markets. Revenue for the products sold is recognized at a point in time when control transfers to the customer, which is generally at time of shipment. Lennox National Account Service provides installation, service and preventive maintenance for commercial HVAC national account customers in the United States and Canada. Revenue related to service contracts is recognized as the services are performed under the contract based on the relative fair value of the services provided. In Europe, we manufacture and sell unitary products and applied systems. For the segment, for the three and nine months ended September 30, 2018, equipment sales represent approximately $242.6 million and $679.2 million of revenues while $33.2 million and $94.3 million of our revenue is generated from our service business, respectively.

Refrigeration - We manufacture and market equipment for the global commercial refrigeration markets under the Heatcraft Worldwide Refrigeration name. Our products are used in the food retail, food service, cold storage as well as non-food refrigeration markets. We sell these products to distributors, installing contractors, engineering design firms, original equipment manufacturers and end-users. Revenue for the products sold is $156.8 million and $495.8 million for the three and nine months ended September 30, 2018 and and is recognized at a point in time when control transfers to the customer, which is generally at time of shipment. The remaining segment revenue relates to service revenues related to start-up and commissioning activities.

Variable Consideration - We engage in cooperative advertising, customer rebate, and other miscellaneous programs that result in payments or credits being issued to our customers. We record these customer discounts and incentives as a reduction of sales when the sales are recorded. For certain cooperative advertising programs, we also receive an identifiable benefit (goods or services) in exchange for the consideration given, and, accordingly, record a ratable portion of the expenditure to Selling, general and administrative (“SG&A”) expenses. All other advertising, promotions and marketing costs are expensed as incurred.

Other Judgments and Assumptions - We apply the practical expedient in ASC 606-10-50-14 and do not disclose information about remaining performance obligations that have original expected durations of one year or less. Applying the practical expedient in ASC 340-40-25-4, we recognize the incremental costs of obtaining contracts as an expense when incurred if the amortization period of the assets that we otherwise would have recognized is one year or less. These costs are included in SG&A expenses. ASC 606-10-32-18 allows us to not adjust the amount of consideration to be received in a contract for any significant financing component if we expect to receive payment within twelve months of transfer of control of goods or services. We have elected this expedient as we expect all consideration to be received in one year or less at contract inception. We have also elected not to provide the remaining performance obligations disclosures related to service contracts in accordance with the practical expedient in ASC 606-10-55-18. We recognize revenue in the amount to which the entity has a right to invoice and have adopted this election to not provide the remaining performance obligations related to service contracts.

Contract Assets - We do not have material amounts of contract assets since revenue is recognized as control of goods is transferred or as services are performed. There are a small number of installation services that may occur over a period of time, but that period of time is generally very short in duration and right of payment does not exist until the installation is completed. Any contract assets that may arise are recorded in Other assets in our Consolidated Balance Sheet.

Contract Liabilities - Our contract liabilities consist of advance payments and deferred revenue. Our contract liabilities are reported in a net position on a contract-by-contract basis at the end of each reporting period. We classify advance payments and deferred revenue as current or noncurrent based on the timing of when we expect to recognize revenue. Generally all contract

9



liabilities are expected to be recognized within one year and are included in Accounts payable in our Consolidated Balance Sheet. The noncurrent portion of deferred revenue is included in Other liabilities in our Consolidated Balance Sheet.

Net contract assets (liabilities) consisted of the following:
 
September 30, 2018
 
December 31, 2017
 
$ Change
 
% Change
Contract assets
$
3.5

 
$
2.1

 
$
1.4

 
66.7
 %
Contract liabilities - current
(6.2
)
 
(7.3
)
 
1.1

 
(15.1
)%
Contract liabilities - noncurrent
(6.0
)
 
(5.5
)
 
(0.5
)
 
9.1
 %
Total
$
(8.7
)
 
$
(10.7
)
 
$
2.0

 
 

For the three and nine months ended September 30, 2018, we recognized revenue of $1.3 million and $4.2 million related to our contract liabilities at January 1, 2018, respectively. Impairment losses recognized in our receivables and contract assets were de minimis in the third quarter of 2018.

3. Inventories:
     
The components of inventories are as follows (in millions):
 
As of September 30, 2018
 
As of December 31, 2017
Finished goods
$
315.4

 
$
331.9

Work in process
6.3

 
5.5

Raw materials and parts
232.2

 
199.2

Subtotal
553.9

 
536.6

Excess of current cost over last-in, first-out cost
(52.4
)
 
(52.4
)
Total inventories, net
$
501.5

 
$
484.2


4. Goodwill:
The changes in the carrying amount of goodwill for the first nine months of 2018, in total and by segment, are summarized in the table below (in millions):
 
Balance at December 31, 2017
 
Write-off due to divested businesses
 
Changes in foreign currency translation rates
 
Balance at September 30, 2018
Residential Heating & Cooling
$
26.1

 
$

 
$

 
$
26.1

Commercial Heating & Cooling
62.2

 

 
(0.5
)
 
61.7

Refrigeration
112.2

 
(11.5
)
 
(1.6
)
 
99.1

Total Goodwill
$
200.5

 
$
(11.5
)

$
(2.1
)
 
$
186.9


We perform our annual goodwill impairment test in the fourth quarter of each year. We continue to monitor our reporting units for indicators of impairment throughout the year to determine if a change in facts or circumstances warrants a re-evaluation of our goodwill. In the current year, we wrote off $11.5 million of goodwill as a part of the completed sales of our Australia, New Zealand, Asia and Brazil businesses (discussed further in Note 14 of the Notes to the Consolidated Financial Statements).

5. Derivatives:

Objectives and Strategies for Using Derivative Instruments

Commodity Price Risk - We utilize a cash flow hedging program to mitigate our exposure to volatility in the prices of metal commodities used in our production processes. Our hedging program includes the use of futures contracts to lock in prices, and as a result, we are subject to derivative losses should the metal commodity prices decrease and gains should the prices increase. We utilize a dollar cost averaging strategy so that a higher percentage of commodity price exposures are hedged near-term and

10



lower percentages hedged at future dates. This strategy allows for protection against near-term price volatility while allowing us to adjust to market price movements over time.

Interest Rate Risk - A portion of our debt bears interest at variable rates, and as a result, we are subject to variability in the cash paid for interest. To mitigate a portion of that risk, we may choose to engage in an interest rate swap hedging strategy to eliminate the variability of interest payment cash flows. We are not currently hedged against interest rate risk.

Foreign Currency Risk - Foreign currency exchange rate movements create a degree of risk by affecting the U.S. dollar value of assets and liabilities arising in foreign currencies. We seek to mitigate the impact of currency exchange rate movements on certain short-term transactions by periodically entering into foreign currency forward contracts.

In August 2017, the FASB issued ASU 2017-12, Derivatives and Hedging (Topic 815), Targeted Improvements to Accounting for Hedging Activities. ASU 2017-12 intends to simplify the application of hedge accounting guidance and better align an entity's risk management activities and financial reporting for hedging relationships through changes to both the designation and measurement guidance for qualifying hedging relationships and the presentation of hedge results. The amendments expand and refine hedge accounting for both nonfinancial and financial risk components and align the recognition and presentation of the effects of the hedging instrument and the hedged item in the financial statements. We early adopted ASU No. 2017-12 during the first quarter of 2018. The adoption of ASU No. 2017-12 did not have a material impact on our consolidated results of operations, cash flows, and statement of financial position. With the early adoption of ASU No. 2017-12 we began entering into commodity futures contracts designated as cash flow hedges related to aluminum purchases.

Cash Flow Hedges

We have foreign exchange forward contracts and commodity futures contracts designated as cash flow hedges that are scheduled to mature through December 2018 and February 2020, respectively. Unrealized gains or losses from our cash flow hedges are included in Accumulated other comprehensive loss (“AOCL”) and are expected to be reclassified into earnings within the next 18 months based on the prices of the commodities and foreign currencies at the settlement dates. We recorded the following amounts in AOCL related to our cash flow hedges (in millions):
 
As of September 30, 2018
 
As of December 31, 2017
Unrealized losses (gains) on unsettled contracts
$
4.9

 
$
(11.3
)
Income tax (benefit) expense
(1.1
)
 
3.9

Losses (Gains) included in AOCL, net of tax (1)
$
3.8

 
$
(7.4
)
(1) Assuming commodity and foreign currency prices remain constant, we expect to reclassify $2.9 million of derivative losses into earnings within the next 12 months.

We had the following outstanding commodity futures contracts designated as cash flow hedges (in millions of pounds):
 
As of September 30, 2018
 
As of December 31, 2017
Copper
13.7

 
20.6

Aluminum
29.3

 


We had the following outstanding foreign exchange forward contracts designated as cash flow hedges (in millions):
 
As of September 30, 2018
 
As of December 31, 2017
Notional Amounts (in local currency):
 
 
 
Mexican Peso
49.2

 
207.3

Canadian Dollar
12.6

 
68.6




11



Derivatives not Designated as Cash Flow Hedges

For commodity derivatives not designated as cash flow hedges, we follow the same hedging strategy as derivatives designated as cash flow hedges, except that we elect not to designate them as cash flow hedges at the inception of the arrangement. We had the following outstanding commodity futures contracts not designated as cash flow hedges (in millions of pounds):
 
As of September 30, 2018
 
As of December 31, 2017
Copper
0.8

 
1.8

Aluminum
1.0

 
1.8

We also had the following outstanding foreign currency forward contracts not designated as cash flow hedges (in millions):
 
As of September 30, 2018
 
As of December 31, 2017
Notional Amounts (in local currency):
 
 
 
Chinese Yuan

 
73.8

Mexican Peso
68.0

 
136.6

Euro
28.8

 
64.4

Canadian Dollar
23.0

 
27.3

British Pound
8.3

 
4.5

Singapore Dollar

 
7.0

Australian Dollar

 
107.0

New Zealand Dollar

 
5.0

Indian Rupee

 
39.8


Information about the Locations and Amounts of Derivative Instruments

The following tables provide the locations and amounts of derivative fair values in the Consolidated Balance Sheets and derivative gains and losses in the Consolidated Statements of Operations (in millions):
 
 
Fair Values of Derivative Instruments (1)
 
Derivatives Designated as Hedging Instruments
 
Derivatives Not Designated as Hedging Instruments
 
As of September 30, 2018
 
As of December 31, 2017
 
As of September 30, 2018
 
As of December 31, 2017
Current Assets:
 
 
 
 
 
 
 
Other Assets
 
 
 
 
 
 
 
Commodity futures contracts
$

 
$
11.0

 
$

 
$
1.2

Foreign currency forward contracts
0.5

 
0.1

 

 
0.9

Non-Current Assets:
 
 
 
 
 
 
 
Other Assets, net
 
 
 
 
 
 
 
Commodity futures contracts

 
0.6

 

 
0.1

Total Assets
$
0.5

 
$
11.7

 
$

 
$
2.2

Current Liabilities:
 
 
 
 
 
 
 
Accrued Expenses
 
 
 
 
 
 
 
Commodity futures contracts
$
5.2

 
$

 
$
0.3

 
$

Foreign currency forward contracts

 
0.3

 
0.1

 
1.1

Non-Current Liabilities:
 
 
 
 
 
 
 
Other Liabilities
 
 
 
 
 
 
 
Commodity futures contracts
0.3

 

 

 

Total Liabilities
$
5.5

 
$
0.3

 
$
0.4

 
$
1.1

 (1) All derivative instruments are classified as Level 2 within the fair value hierarchy. See Note 17 for more information.

12




Derivatives Designated as Cash Flow Hedges
 
For the Three Months Ended September 30,
 
For the Nine Months Ended September 30,
 
 
2018
 
2017
 
2018
 
2017
Amount of Gain reclassified from AOCL into Income (effective portion) (1)
 
$
(0.3
)
 
$
(3.5
)
 
$
(7.3
)
 
$
(9.4
)
Amount of (Gains)/Loss recognized in Net income (ineffective portion) (2)(3)
 

 
(0.1
)
 
$

 
1.1

Derivatives Not Designated as Hedging Instruments
 
For the Three Months Ended September 30,
 
For the Nine Months Ended September 30,
 
 
2018
 
2017
 
2018
 
2017
Amount of Loss/(Gain) Recognized in Net Income:
 
 
 
 
 
 
 
 
Commodity futures contracts (2)
 
$
0.3

 
$
(0.2
)
 
$
0.9

 
$
(1.3
)
Foreign currency forward contracts (2)
 

 
(0.4
)
 
(0.3
)
 
(4.3
)
 
 
$
0.3

 
$
(0.6
)
 
$
0.6

 
$
(5.6
)
(1) The gain was recorded in Cost of goods sold in the accompanying Consolidated Statements of Operations.
(2) The (gain)/loss was recorded in Losses and other expenses, net in the accompanying Consolidated Statements of Operations.
(3) ASU 2017-12 eliminates the requirement to disclose the amount of hedge ineffectiveness prospectively because this amount is no longer separately measured and reported.
6. Income Taxes:

As of September 30, 2018, we had approximately $0.3 million in total gross unrecognized tax benefits and of this amount, all if recognized, would be recorded through the Consolidated Statement of Operations. As of September 30, 2018, we had an insignificant amount in interest recognized in income tax expense in accordance with FASB Accounting Standards Codification (“ASC”) Topic 740.

We are currently under examination for our U.S. federal income taxes under the Internal Revenue Service's Compliance Assurance Program for 2018, and 2017 and are subject to examination by numerous other taxing authorities in the U.S. and in jurisdictions such as France, India and Germany. We are generally no longer subject to U.S. federal, state and local, or non-U.S. income tax examinations by taxing authorities for years prior to 2011.

Since January 1, 2018, several states have enacted legislation effective for tax years beginning on or after January 1, 2018, including changes to tax rates and apportionment methods. The impact of these changes is immaterial.

On October 24, 2016, the FASB issued ASU No. 2016-16, Accounting for Income Taxes: Intra-Entity Asset Transfers of Assets Other than Inventory, which requires companies to recognize the income tax effects of intercompany sales and transfers of assets other than inventory in the period in which the transfer occurs. Prior to ASU 2016-16, companies were required to defer the income tax effects of intercompany transfers of assets until the asset had been sold to an outside party or otherwise recognized. The new guidance is effective for public business entities for annual periods beginning after December 15, 2017 and interim periods within those annual periods. The guidance requires companies to apply a modified retrospective approach with a cumulative catch-up adjustment to opening retained earnings in the period of adoption. Accordingly, we recorded a $5.1 million decrease to opening retained earnings in the period ending March 31, 2018.

On December 22, 2017, the U.S. government enacted comprehensive tax legislation commonly referred to as the Tax Cuts and Jobs Act (the “Tax Act”). The Tax Act makes broad and complex changes to the U.S. tax code, including, but not limited to, the new global intangible low-taxed income ("GILTI") tax rules. Because of the complexity of the new GILTI tax rules, we are continuing to evaluate this provision of the Tax Act and the application of ASC 740. Under U.S. GAAP, we are allowed to make an accounting policy choice of either (1) treating taxes due on future U.S. inclusions in taxable income related to GILTI as a current-period expense when incurred (the “period cost method”) or (2) factoring such amounts into a company’s measurement of its deferred taxes (the “deferred method”). Our selection of an accounting policy with respect to the new GILTI tax rules will depend, in part, on analyzing our global income to determine whether we expect to have future U.S. inclusions in taxable income related to GILTI and, if so, what the impact is expected to be. We are not currently able to reasonably estimate the effect of the new GILTI tax rules on future U.S. inclusions in taxable income as the expected future impact of this provision of the Tax Act depends on our current structure and business. Therefore, although we have considered the current effects of GILTI when estimating

13



our annual effective tax rate, we have not made any adjustments related to potential GILTI tax in our deferred taxes and have not made a policy decision regarding whether to record deferred taxes on GILTI.

On February 14, 2018, the FASB issued ASU No. 2018-02, Income Statement - Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income, which permits companies to reclassify stranded tax effects caused by 2017 tax reform between accumulated other comprehensive income (“AOCI”) and retained earnings. We have elected to adopt ASU 2018-02 to reclassify the income tax effects of the 2017 Act from AOCI to retained earnings for the period ending March 31, 2018. Accordingly, we recorded a $22.7 million increase to opening retained earnings in the period ending March 31, 2018 to reclassify the effect of the change in the U.S. federal corporate income tax rate, including the reduction in the federal benefit associated with state taxes, on the gross deferred tax amounts and related valuation allowances at the date of enactment of the Tax Cuts and Jobs Act related to items remaining in AOCI.

The SEC staff issued Staff Accounting Bulletin No. 118 (“SAB 118”), which provides guidance on accounting for the tax effects of the Tax Act. SAB 118 provides a measurement period that should not extend beyond one year from the Tax Act enactment date for companies to complete the accounting under ASC 740. In accordance with SAB 118, a company must reflect the income tax effects of those aspects of the Act for which the accounting under ASC 740 is complete. To the extent that a company’s accounting for certain income tax effects of the Tax Act is incomplete but it is able to determine a reasonable estimate, it must record a provisional estimate in the financial statements. If a company cannot determine a provisional estimate to be included in the financial statements, it should continue to apply ASC 740 on the basis of the provisions of the tax laws that were in effect immediately before the enactment of the Tax Act.

Due to the Tax Act, several applications for changes in accounting method have been filed with the IRS to accelerate deductions into the 2017 U.S. federal income tax return. As of September 30, 2018 we have recognized discrete tax benefits of $4.3 million associated with the finalization of the calculations for accounting method changes for credit reserves, prepaid expenses, IBNR medical expenses and depreciable asset reclassifications and repairs. In addition, we have recognized a discrete tax benefit of $3.0 million associated with the finalization of the Domestic Production Activities deduction due to Tax Act impacts. As of September 30, 2018, we have recognized a discrete tax expense of $2.7 million for the transition tax on the mandatory deemed repatriation of undistributed foreign earnings required by the Tax Act and $0.1 million of tax expense due to changes in estimate of the decrease of our net federal deferred tax assets (“DTA”) from our year-end provision.

7. Commitments and Contingencies:

Product Warranties and Product Related Contingencies

We provide warranties to customers for some of our products and record liabilities for the estimated future warranty-related costs based on failure rates, cost experience and other factors. We periodically review the assumptions used to determine the product warranty liabilities and will adjust the liabilities in future periods for changes in assumptions, as necessary.


14



Liabilities for estimated product warranty costs related to continuing operations are included in the following captions on the accompanying Consolidated Balance Sheets (in millions):
 
As of September 30, 2018
 
As of December 31, 2017
Accrued expenses
$
36.6

 
$
34.8

Other liabilities
73.6

 
75.1

Total warranty liability
$
110.2

 
$
109.9

The changes in product warranty liabilities related to continuing operations for the nine months ended September 30, 2018 were as follows (in millions):
Total warranty liability as of December 31, 2017
$
109.9

Warranty claims paid
(23.9
)
Changes resulting from issuance of new warranties
29.0

Changes in estimates associated with pre-existing liabilities
(3.1
)
Changes in foreign currency translation rates and other
(0.4
)
Warranty liability from Divestitures
(1.3
)
Total warranty liability as of September 30, 2018
$
110.2

   
We have incurred, and will likely continue to incur, product costs not covered by insurance or our suppliers’ warranties, which are not included in the tables immediately above. Also, to satisfy our customers and protect our brands, we have repaired or replaced installed products experiencing quality-related issues, and will likely continue such repairs and replacements. Liabilities, for such quality related issues, are not material.

Litigation

We are involved in a number of claims and lawsuits incident to the operation of our businesses. Insurance coverages are maintained and estimated costs are recorded for such claims and lawsuits, including costs to settle claims and lawsuits, based on experience involving similar matters and specific facts known.

Some of these claims and lawsuits allege personal injury or health problems resulting from exposure to asbestos that was integrated into certain of our products. We have never manufactured asbestos and have not incorporated asbestos-containing components into our products for several decades. A substantial majority of these asbestos-related claims have been covered by insurance or other forms of indemnity or have been dismissed without payment. The remainder of our closed cases have been resolved for amounts that are not material, individually or in the aggregate. Our defense costs for asbestos-related claims are generally covered by insurance; however, our insurance coverage for settlements and judgments for asbestos-related claims varies depending on several factors and are subject to policy limits, so we may have greater financial exposure for future settlements and judgments. For the nine months ended September 30, 2018 and 2017, expense for asbestos-related litigation was $3.3 million and $3.9 million, respectively, net of probable insurance recoveries, for known and future asbestos-related litigation and is recorded in Losses and other expenses, net in the Consolidated Statements of Operations. For the three months ended September 30, 2018 and 2017, expense for asbestos-related litigation was $1.4 million and $1.5 million, respectively, net of probable insurance recoveries.

It is management's opinion that none of these claims or lawsuits or any threatened litigation will have a material adverse effect on our financial condition, results of operations or cash flows. Claims and lawsuits, however, involve uncertainties and it is possible that their eventual outcome could adversely affect our results of operations for a particular period.

Marshalltown Tornado and Recovery

On July 19, 2018 our manufacturing facility in Marshalltown, Iowa was severely damaged by a tornado. Insurance covers the repair or replacement of our assets that suffered damage or loss, and we are working closely with our insurance carriers and claims adjusters to ascertain the full amount of insurance recoveries due to us as a result of the damage and loss we suffered. Our insurance policies also provide business interruption coverage, including lost profits, and reimbursement for other expenses and costs that have been incurred relating to the damages and losses suffered. These costs and insurance recoveries are shown in Loss from natural disaster, net of insurance recoveries in the Consolidated Statements of Operations.


15



The following table summarizes the loss from natural disaster, net of insurance recoveries:

(Amounts in millions)
For the Nine Months Ended September 30, 2018
Write-off of property, plant and equipment
$
4.2

Write-off of inventory
5.2

Site clean-up and remediation
28.4

Factory inefficiencies due to lower productivity
4.9

Other
6.7

Total expense
49.4

Insurance recoveries received
45.0

Insurance recoveries receivable (1)
4.1

Loss from natural disaster, net of insurance recoveries
$
0.3

(1) The insurance recoveries receivable is recorded in Other assets in the Consolidated Balance Sheets.

8. Lines of Credit and Financing Arrangements:

The following table summarizes our outstanding debt obligations and their classification in the accompanying Consolidated Balance Sheets (in millions):
 
As of September 30, 2018
 
As of December 31, 2017
Short-Term Debt:
 
 
 
Foreign obligations
$

 
$
0.9

Total short-term debt
$

 
$
0.9

Current maturities of long-term debt:
 
 
 
Capital lease obligations
$
0.4

 
$
3.2

Domestic credit facility
22.5

 
30.0

Debt issuance costs
(0.6
)
 
(0.6
)
    Total current maturities of long-term debt
$
22.3

 
$
32.6

Long-Term Debt:
 
 
 
Asset Securitization Program
$
377.3

 
$
276.0

Capital lease obligations
11.9

 
11.9

Domestic credit facility
368.0

 
337.0

Senior unsecured notes
350.0

 
350.0

Debt issuance costs
(3.6
)
 
(4.4
)
Total long-term debt
$
1,103.6

 
$
970.5

Total debt
$
1,125.9

 
$
1,004.0


Short-Term Debt

Foreign Obligations

Through several of our foreign subsidiaries, we have facilities available to assist in financing seasonal borrowing needs for our foreign locations. We had $0.0 million and $0.9 million of foreign obligations outstanding as of September 30, 2018 and December 31, 2017, respectively, that were primarily borrowings under non-committed facilities. Proceeds on these facilities were $40.2 million and $19.1 million during the nine months ended September 30, 2018 and 2017, respectively. Repayments on the facilities were $38.5 million and $20.5 million during the nine months ended September 30, 2018 and 2017, respectively.


16



Asset Securitization Program

Under the Asset Securitization Program (“ASP”), we are eligible to sell beneficial interests in a portion of our trade accounts receivable to a financial institution for cash. The ASP contains a provision whereby we retain the right to repurchase all of the outstanding beneficial interests transferred. As a result of the repurchase right, the transfer of the receivables under the ASP is not accounted for as a sale. Accordingly, the cash received from the transfer of the beneficial interests in our trade accounts receivable is reflected as secured borrowings in the accompanying Consolidated Balance Sheets and proceeds received are included in Cash flows from financing activities in the accompanying Consolidated Statements of Cash Flows. Our continued involvement with the transferred assets includes servicing, collection and administration of the transferred beneficial interests. The accounts receivable securitized under the ASP are high-quality domestic customer accounts that have not aged significantly. The receivables represented by the retained interest that we service are exposed to the risk of loss for any uncollectible amounts in the pool of receivables transferred under the ASP.

The ASP provides for a maximum securitization amount ranging from $225.0 million to $380.0 million, depending on the period. The maximum capacity under the ASP is the lesser of the maximum securitization amount or 100% of the net pool balance less allowances, as defined by the ASP. Eligibility for securitization is limited based on the amount and quality of the qualifying accounts receivable and is calculated monthly. The eligible amounts available and beneficial interests sold were as follows (in millions):
 
September 30, 2018
 
As of December 31, 2017
Eligible amount available under the ASP on qualified accounts receivable
$
380.0

 
$
290.0

Less: Beneficial interest transferred
(377.3
)
 
(276.0
)
Remaining amount available
$
2.7

 
$
14.0

We pay certain discount fees to use the ASP and to have the facility available to us. These fees relate to both the used and unused portions of the securitization. The used fee is based on the beneficial interest sold and calculated on either the average LIBOR rate or floating commercial paper rate determined by the purchaser of the beneficial interest, plus a program fee of 0.70%. The average rates as of September 30, 2018 and December 31, 2017 were 2.98% and 2.60%, respectively. The unused fee is based on 101% of the maximum available amount less the beneficial interest transferred and is calculated at a 0.35% fixed rate throughout the term of the agreement. We recorded these fees in Interest expense, net in the accompanying Consolidated Statements of Operations.

The ASP contains certain restrictive covenants relating to the quality of our accounts receivable and cross-default provisions with our Sixth Amended and Restated Credit Facility Agreement ("Domestic Credit Facility"), senior unsecured notes and any other indebtedness we may have over $75.0 million. The administrative agent under the ASP is also a participant in our Domestic Credit Facility. The participating financial institutions have investment grade credit ratings. As of September 30, 2018, we believe we were in compliance with all covenant requirements.

Long-Term Debt

Domestic Credit Facility

On August 30, 2016, we replaced an earlier credit facility with the Domestic Credit Facility, which consists of a $650.0 million unsecured revolving credit facility and a $250.0 million unsecured term loan and matures in August 2021 (the "Maturity Date"). Under our Domestic Credit Facility, we had outstanding borrowings of $390.5 million, of which $190.0 million was the term loan balance, as well as $2.5 million committed to standby letters of credit as of September 30, 2018. Subject to covenant limitations, $447.0 million was available for future borrowings. The unsecured term loan also matures on the Maturity Date and requires quarterly principal repayments of $7.5 million. The revolving credit facility includes a subfacility for swingline loans of up to $65.0 million. Additionally, at our request and subject to certain conditions, the commitments under the Domestic Credit Facility may be increased by a maximum of $350.0 million as long as existing or new lenders agree to provide such additional commitments.


17



Our weighted average borrowing rate on the facility was as follows:
 
As of September 30, 2018
 
As of December 31, 2017
Weighted average borrowing rate
3.41
%
 
2.76
%
Our Domestic Credit Facility is guaranteed by certain of our subsidiaries and contains financial covenants relating to leverage and interest coverage. Other covenants contained in the Domestic Credit Facility restrict, among other things, certain mergers, asset dispositions, guarantees, debt, liens, and affiliate transactions. The financial covenants require us to maintain a defined Consolidated Indebtedness to Adjusted EBITDA Ratio and a Cash Flow (defined as EBITDA minus capital expenditures) to Net Interest Expense Ratio. The required ratios under our Domestic Credit Facility are detailed below:
 
Consolidated Indebtedness to Adjusted EBITDA Ratio no greater than
3.5 : 1.0
Cash Flow to Net Interest Expense Ratio no less than
3.0 : 1.0
Our Domestic Credit Facility contains customary events of default. These events of default include nonpayment of principal or interest, breach of covenants or other restrictions or requirements, default on certain other indebtedness or receivables securitizations (cross default), and bankruptcy. A cross default under our Domestic Credit Facility could occur if:
We fail to pay any principal or interest when due on any other indebtedness or receivables securitization of at least $75.0 million; or
We are in default in the performance of, or compliance with any term of any other indebtedness or receivables securitization in an aggregate principal amount of at least $75.0 million or any other condition exists which would give the holders the right to declare such indebtedness due and payable prior to its stated maturity.

Each of our major debt agreements contains provisions by which a default under one agreement causes a default in the others (a "cross default"). If a cross default under the Domestic Credit Facility, our senior unsecured notes, our lease of our corporate headquarters in Richardson, Texas (recorded as an operating lease), or our ASP were to occur, it could have a wider impact on our liquidity than might otherwise occur from a default of a single debt instrument or lease commitment.

If any event of default occurs and is continuing, lenders with a majority of the aggregate commitments may require the administrative agent to terminate our right to borrow under our Domestic Credit Facility and accelerate amounts due under our Domestic Credit Facility (except for a bankruptcy event of default, in which case such amounts will automatically become due and payable and the lenders’ commitments will automatically terminate). As of September 30, 2018, we believe we were in compliance with all covenant requirements.

Senior Unsecured Notes

We issued $350.0 million of senior unsecured notes in November 2016 (the "Notes") which will mature on November 15, 2023 with interest being paid on May 15 and November 15 at 3.00% per annum semiannually. The Notes are guaranteed, on a senior unsecured basis, by each of our domestic subsidiaries that guarantee indebtedness under our Domestic Credit Facility. The indenture governing the Notes contains covenants that, among other things, limit our ability and the ability of the subsidiary guarantors to: create or incur certain liens; enter into certain sale and leaseback transactions; and enter into certain mergers, consolidations and transfers of substantially all of our assets. The indenture also contains a cross default provision which is triggered if we default on other debt of at least $75.0 million in principal which is then accelerated, and such acceleration is not rescinded within 30 days of the notice date. As of September 30, 2018, we believe we were in compliance with all covenant requirements.

9. Pension and Post-Retirement Benefit Plans:

On March 10, 2017, the FASB issued ASU 2017-07, Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost. ASU 2017-07 changes the income statement presentation of defined benefit plan expense by requiring separation between operating expense (service cost component) and non-operating expense (all other components, including interest cost, amortization of prior service cost, curtailments and settlements, etc.). The operating expense component is reported with similar compensation costs while the non-operating components are reported in Other expense (income), net in the Statement of Operations. In addition, only the service cost component is eligible for capitalization as part of an asset such as inventory or property, plant and equipment. We elected the practical expedient to use the prior year's disclosure as a basis for the retroactive adoption of the ASU. The ASU did not have a material impact on our financial results.

18



The components of net periodic benefit cost were as follows (in millions):
 
For the Three Months Ended September 30,
 
2018
 
2017
 
2018
 
2017
 
Pension Benefits
 
Other Benefits
Service cost
$
1.3

 
$
1.3

 
$

 
$

Interest cost
3.1

 
3.2

 

 

Expected return on plan assets
(4.7
)
 
(5.3
)
 

 

Amortization of prior service cost
0.1

 

 
(0.3
)
 
(0.6
)
Recognized actuarial loss
2.3

 
2.0

 
0.3

 
0.4

Settlements and curtailments
0.3

 

 

 

Net periodic benefit cost
$
2.4


$
1.2

 
$

 
$
(0.2
)
 
For the Nine Months Ended September 30,
 
2018
 
2017
 
2018
 
2017
 
Pension Benefits
 
Other Benefits
Service cost
$
4.0

 
$
3.8

 
$

 
$

Interest cost
9.3

 
9.5

 

 

Expected return on plan assets
(14.1
)
 
(16.0
)
 

 

Amortization of prior service cost
0.1

 
0.1

 
(1.0
)
 
(1.8
)
Recognized actuarial loss
6.9

 
6.1

 
1.0

 
1.1

Settlements and curtailments
0.3

 
0.6

 

 

Net periodic benefit cost
$
6.5

 
$
4.1

 
$

 
$
(0.7
)
In January 2018, we reduced our estimated long-term rate of return on plan assets for U.S. pension plans from 7.5% to 6.5%. A 25 basis point decrease in the long-term rate of return will result in a $0.7 million increase in net periodic benefit cost for U.S. pension plans.
10. Stock-Based Compensation:

We issue various long-term incentive awards, including performance share units, restricted stock units and stock appreciation rights under the Lennox International Inc. 2010 Incentive Plan, as amended and restated. Stock-based compensation expense related to continuing operations is included in Selling, general and administrative expenses in the accompanying Consolidated Statements of Operations as follows (in millions):
 
For the Three Months Ended September 30,
For the Nine Months Ended September 30,
 
2018
 
2017
2018
 
2017
Stock-based compensation expense (1)
$
7.4

 
$
6.3

$
21.0

 
$
18.8

(1) All expense was recorded in our Corporate and Other business segment.

11. Stock Repurchases:

Our Board of Directors has authorized a total of $2.5 billion to repurchase shares of our common stock (collectively referred to as the "Share Repurchase Plans"), including a $500 million share repurchase authorization in March 2018. Under this program, we may repurchase shares from time to time in open market transactions and in privately negotiated transactions based on business, market, applicable legal requirements and other considerations. The repurchase program does not require the repurchase of a specific number of shares and may be terminated at any time. As of September 30, 2018, $546 million of shares may be repurchased under the Share Repurchase Plans.

On February 8, 2018, the Company entered into a Fixed Dollar Accelerated Share Repurchase Transaction (the “ASR Agreement”) with MUFG Securities EMEA plc ("MUFG"), to effect an accelerated stock buyback of our common stock. Under the ASR Agreement, on February 8, 2018, we paid MUFG an initial purchase price of $150 million, and MUFG delivered to us

19



common stock, representing approximately 85% of the shares expected to be purchased under the ASR Agreement. The ASR was completed in April of 2018 and MUFG delivered additional shares for a total of 0.7 million shares of common stock repurchased as part of this ASR Agreement.

We repurchased 1.0 million shares for $200.2 million from open market transactions during the second quarter of 2018.

We also repurchased 0.1 million shares for $21.1 million during the nine months ended September 30, 2018 from employees who surrendered their shares to satisfy minimum tax withholding obligations upon the exercise of long-term incentive awards.

12. Comprehensive Income:

The following table provides information on items not reclassified in their entirety from AOCL to Net income in the accompanying Consolidated Statements of Operations (in millions):
 
 
For the Three Months Ended September 30,
 
For the Nine Months Ended September 30,
 
Affected Line Item(s) in the Consolidated Statements of Operations
 
 
2018
 
2017
 
2018
 
2017
 
Gains/(Losses) on cash flow hedges:
 
 
 
 
 
 
 
 
 
 
Commodity futures contracts/foreign exchange forward contracts
 
$
0.3

 
$
3.5

 
$
7.3

 
$
9.4

 
Cost of goods sold
Income tax expense
 
(0.1
)
 
(1.3
)
 
(1.7
)
 
(3.4
)
 
Provision for income taxes
Net of tax
 
$
0.2

 
$
2.2

 
$
5.6

 
$
6.0

 
 
 
 
 
 
 
 
 
 
 
 
 
Defined Benefit Plan items:
 
 
 
 
 
 
 
 
 
 
Pension and post-retirement benefit costs
 
$
(2.4
)
 
$
(1.8
)
 
$
(7.0
)
 
$
(5.5
)
 
Cost of goods sold; Selling, general and administrative expenses
Income tax benefit
 
0.6

 
0.7

 
1.7

 
2.0

 
Provision for income taxes
Net of tax
 
$
(1.8
)
 
$
(1.1
)
 
$
(5.3
)
 
$
(3.5
)
 
 
 
 
 
 
 
 
 
 
 
 
 
Foreign Currency Translation Adjustments:
 
 
 
 
 
 
 
 
 
 
Foreign currency adjustments upon sale of business
 
$
(5.0
)
 
$

 
$
(27.9
)
 
$

 
Loss (gain), net on sale of businesses and related property
Income tax benefit
 

 

 

 

 
Provision for income taxes
Net of tax
 
$
(5.0
)
 
$

 
$
(27.9
)
 
$

 
 
 
 
 
 
 
 
 
 
 
 
 
Total reclassifications from AOCL
 
$
(6.6
)
 
$
1.1

 
$
(27.6
)
 
$
2.5

 
 

The following table provides information on changes in AOCL, by component (net of tax), for the nine months ended September 30, 2018 (in millions):
 
 
Gains (Losses) on Cash Flow Hedges
 
Unrealized Gains on Available-for-Sale Securities
 
Defined Benefit Pension Plan Items
 
Foreign Currency Translation Adjustments
 
Total AOCL
Balance as of December 31, 2017
 
$
7.4

 
$
1.8

 
$
(127.5
)
 
$
(39.1
)
 
$
(157.4
)
Other comprehensive loss before reclassifications
 
(5.6
)
 
(1.8
)
 
(29.0
)
 
(9.4
)
 
(45.8
)
Amounts reclassified from AOCL
 
(5.6
)
 

 
5.3

 
27.9

 
27.6

Net other comprehensive (loss) income
 
(11.2
)
 
(1.8
)
 
(23.7
)
 
18.5

 
(18.2
)
Balance as of September 30, 2018
 
$
(3.8
)
 
$

 
$
(151.2
)
 
$
(20.6
)
 
$
(175.6
)


20



13. Restructuring Charges:

We record restructuring charges associated with management-approved restructuring plans when we reorganize or remove duplicative headcount or infrastructure within our businesses. Restructuring charges include severance costs to eliminate a specified number of employees, infrastructure charges to vacate facilities and consolidate operations, contract cancellation costs and other related activities. The timing of associated cash payments is dependent upon the type of restructuring charge and can extend over a multi-year period. Restructuring charges are not included in our calculation of segment profit (loss), as more fully explained in Note 16.

Restructuring Activities in 2018

Information regarding the restructuring charges for all ongoing activities is presented in the following table (in millions):
 
 
Charges Incurred in 2018
 
Charges Incurred to Date
 
Total Charges Expected to be Incurred
Severance and related expense
$
0.7

 
$
12.0

 
$
12.0

Asset write-offs and accelerated depreciation

 
3.2

 
3.2

Lease termination
0.7

 
0.9

 
0.9

Other
0.5

 
4.6

 
4.8

Total restructuring charges
$
1.9

 
$
20.7

 
$
20.9

While restructuring charges are excluded from our calculation of segment profit (loss), the table below presents the restructuring charges associated with each segment (in millions):
 
Charges Incurred in 2018
 
Charges Incurred to Date
 
Total Charges Expected to be Incurred
Residential Heating & Cooling
$
0.5

 
$
1.9

 
$
2.1

Commercial Heating & Cooling
0.8

 
2.8

 
2.8

Refrigeration
0.7

 
13.8

 
13.8

Corporate & Other
(0.1
)
 
2.2

 
2.2

Total restructuring charges
$
1.9

 
$
20.7

 
$
20.9

Restructuring accruals are included in Accrued expenses in the accompanying Consolidated Balance Sheets. The table below details the activity in 2018 within the restructuring accruals (in millions):
 
Balance as of
December 31, 2017
 
Included in
Earnings
 
Cash
Utilization
 
Non-Cash Utilization and Other
 
Balance as of September 30,2018
Severance and related expense
$
0.2

 
$
0.7

 
$
(0.8
)
 
$

 
$
0.1

Lease termination

 
0.7

 
(0.1
)
 
(0.2
)
 
0.4

Other

 
0.5

 
(0.5
)
 

 

Total restructuring accruals
$
0.2

 
$
1.9

 
$
(1.4
)
 
$
(0.2
)
 
$
0.5



21



14. Divestitures:

Australia, New Zealand and Asia Divestiture:

During the first quarter of 2018, we obtained board approval and signed an agreement with Beijer Ref AB, a Stockholm Stock Exchange-listed company, for the sale of our Australia, New Zealand and Asia business except for the Milperra property that was sold during the second quarter of 2018. We completed the sale to Beijer Ref AB in the second quarter of 2018 with the final post-completion adjustment being recorded in the third quarter of 2018. The following table summarizes the net loss recognized in connection with this divestiture:

(Amounts in millions)
For the Nine Months Ended September 30, 2018
Cash received from the buyer
$
82.9

Net assets sold (1)
(87.2
)
AOCI reclassification adjustments, primarily foreign currency translation
(3.2
)
Direct costs to sell
(5.5
)
Loss on sale of business
$
(13.0
)
(1) Includes $10.3 million of net assets that were written down during the quarter ended March 31, 2018 based on the expected proceeds from the sale, net of selling costs for the sale for our Australia, New Zealand and Asia business.

The Milperra property was sold during the quarter ended June 30, 2018. We received net cash proceeds of $37.2 million net of direct costs to sell of $1.5 million. The net gain recognized in connection with this sale was $23.8 million.

Brazil Divestiture:

During the second quarter of 2018, we obtained board approval and signed an agreement with Elgin SA, a private Brazilian company, for the sale of our South America business. The sale was subject to Brazilian antitrust approval. We obtained antitrust approval and completed the sale to Elgin SA in the third quarter of 2018. The following table summarizes the net loss recognized in connection with this divestiture:
(Amounts in millions)
For the Nine Months Ended September 30, 2018
Cash received from the buyer
$
4.2

Net assets sold (2)
(13.2
)
AOCI reclassification adjustments, primarily foreign currency translation
(24.7
)
Direct costs to sell
(2.9
)
Loss on sale of business
$
(36.6
)
(2) Includes $1.2 of net assets that were written down during the quarter ended June 30, 2018 based on the expected proceeds from the sale, net of selling costs for the sale for our Brazil business.

The total Loss (gain), net on sale of businesses and related property in our Consolidated Statements of Operations of $25.8 million is comprised of the $13.0 million loss on the sale of our Australia, New Zealand and Asia business, the $23.8 million gain on the sale of our Milperra property, and the $36.6 million loss on the sale of our Brazil business.



22



15. 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 our stock-based compensation plans.

The computations of basic and diluted earnings per share for Income from continuing operations were as follows (in millions, except per share data):
 
For the Three Months Ended September 30,
 
For the Nine Months Ended September 30,
 
2018
 
2017
 
2018
 
2017
Net income
$
108.0

 
$
103.5

 
$
283.4

 
$
262.5

Add: Loss from discontinued operations

 
0.5

 
1.7

 
1.4

Income from continuing operations
$
108.0

 
$
104.0

 
$
285.1

 
$
263.9

 
 
 
 
 
 
 
 
Weighted-average shares outstanding – basic
40.3

 
41.9

 
40.8

 
42.3

Add: Potential effect of dilutive securities attributable to stock-based payments
0.4

 
0.5

 
0.5

 
0.6

Weighted-average shares outstanding – diluted
40.7

 
42.4

 
41.3

 
42.9

 
 
 
 
 
 
 
 
Earnings per share – Basic:
 
 
 
 
 
 
 
Income from continuing operations
$
2.68

 
$
2.48

 
$
6.98

 
$
6.23

Loss from discontinued operations

 
(0.01
)
 
(0.04
)
 
(0.03
)
Net income
$
2.68

 
$
2.47

 
$
6.94

 
$
6.20

 
 
 
 
 
 
 
 
Earnings per share – Diluted:
 
 
 
 
 
 
 
Income from continuing operations
$
2.65

 
$
2.45

 
$
6.90

 
$
6.15

Loss from discontinued operations

 
(0.01
)
 
(0.04
)
 
(0.03
)
Net income
$
2.65

 
$
2.44

 
$
6.86

 
$
6.12


The following stock appreciation rights and restricted stock units were outstanding but not included in the diluted earnings per share calculation because the assumed exercise of such rights would have been anti-dilutive (in millions, except for per share data):
 
For the Three Months Ended September 30,
 
For the Nine Months Ended September 30,
 
2018
 
2017
 
2018
 
2017
Weighted-average number of shares
0.2

 
0.2

 
0.2

 
0.2

Price per share
$
205.53

 
$
156.94

 
$
205.53

 
$
156.94

    

23



16. Reportable Business Segments:

We operate in three reportable business segments of the heating, ventilation, air conditioning and refrigeration (“HVACR”) industry. Our segments are organized primarily by the nature of the products and services we provide. The following table describes each segment:
 
Segment
 
Product or Services
 
Markets Served
 
Geographic Areas
Residential Heating & Cooling
 
Furnaces, air conditioners, heat pumps, packaged heating and cooling systems, indoor air quality equipment, comfort control products, replacement parts
 
Residential Replacement;
Residential New Construction
 
United States
Canada
Commercial Heating & Cooling
 
Unitary heating and air conditioning equipment, applied systems, controls, installation and service of commercial heating and cooling equipment
 
Light Commercial
 
United States
Canada
Europe
Central America
South America
Refrigeration
 
Condensing units, unit coolers, fluid coolers, air cooled condensers, air handlers, process chillers, controls, compressorized racks, supermarket display cases and systems
 
Light Commercial;
Food Preservation;
Non-Food/Industrial
 
United States
Canada
Europe
Asia Pacific*
South America*
Central America

*Our businesses in the Asia Pacific and South America area were sold in the second and third quarter of 2018, respectively. Refer to Note 14 for details regarding the divestiture of the business.

We use segment profit or loss as the primary measure of profitability to evaluate operating performance and to allocate capital resources. We define segment profit or loss as a segment’s income or loss from continuing operations before income taxes included in the accompanying Consolidated Statements of Operations, excluding certain items. The reconciliation in the table below details the items excluded.

Our corporate costs include those costs related to corporate functions such as legal, internal audit, treasury, human resources, tax compliance and senior executive staff. Corporate costs also include the long-term share-based incentive awards provided to employees throughout LII. We record these share-based awards as corporate costs because they are determined at the discretion of the Board of Directors and based on the historical practice of doing so for internal reporting purposes.

Any intercompany sales and associated profit (and any other intercompany items) are eliminated from segment results. There were no significant intercompany eliminations for the periods presented.


24



Segment Data

Net sales and segment profit (loss) for each segment, along with a reconciliation of segment profit (loss) to Operating income, are shown below (in millions):
 
For the Three Months Ended September 30,
 
For the Nine Months Ended September 30,
 
2018
 
2017
 
2018
 
2017
Net sales
 
 
 
 
 
 
 
Residential Heating & Cooling
$
594.7

 
$
590.5

 
$
1,764.4

 
$
1,663.8

Commercial Heating & Cooling
275.8

 
269.4

 
773.5

 
723.5

Refrigeration
159.7

 
192.4

 
502.5

 
560.6

 
$
1,030.2

 
$
1,052.3

 
$
3,040.4

 
$
2,947.9

 
 
 
 
 
 
 
 
Segment profit (loss) (1) 
 
 
 
 
 
 
 
Residential Heating & Cooling
$
113.0

 
$
114.7

 
$
317.9

 
$
297.6

Commercial Heating & Cooling
46.7

 
50.0

 
118.9

 
113.8

Refrigeration
23.0

 
20.0

 
55.8

 
55.7

Corporate and other
(28.1
)
 
(23.7
)
 
(61.8
)
 
(58.5
)
Total segment profit
154.6

 
161.0

 
430.8

 
408.6

Reconciliation to Operating income:
 
 
 
 
 
 
 
Special inventory write down

 

 
0.2

 

Special product quality adjustment

 
0.5

 

 
5.7

Loss (gain), net on sale of businesses and related property
6.2

 

 
25.8

 

Loss from natural disaster, net of insurance recoveries
0.3

 

 
0.3

 

Items in losses (gains) and other expenses, net that are excluded from segment profit (loss) (1)
2.4

 
4.0

 
9.3

 
10.0

Restructuring charges
0.5

 
1.9

 
1.9

 
2.1

Operating income
$
145.2

 
$
154.6

 
$
393.3

 
$
390.8

(1) We define segment profit (loss) as a segment's operating income included in the accompanying Consolidated Statements of Operations, excluding:
The following items in Losses (gains) and other expenses, net:
Net change in unrealized losses (gains) on unsettled futures contracts,
Special legal contingency charges,
Asbestos-related litigation,