A. O. Smith Corporation — 2017 Form 10-K
Reporting period: Fiscal year ended December 31, 2017. A. O. Smith manufactures and markets water heaters, boilers and water treatment products in North America and internationally; its Rest of World segment includes primarily China, Europe and India.
Financial performance
| Metric | 2017 | 2016 | Change / context |
|---|---|---|---|
| Net sales | $2,996.7 million | $2,685.9 million | Up 11.6% |
| Gross profit margin | 41.3% | 41.7% | Down 0.4 percentage points |
| Net earnings | $296.5 million | $326.5 million | Down 9.2%; includes $81.8 million provisional U.S. tax reform charge |
| Diluted EPS | $1.70 | $1.85 | Adjusted EPS, excluding the tax charge, was $2.17 vs. $1.85 |
| Cash provided by operating activities | $326.4 million | $446.6 million | Lower mainly due to working-capital outflows |
| Capital expenditures | $94.2 million | $80.7 million | Includes China capacity expansion |
| Total debt | $410.4 million | $323.6 million | Debt to total capitalization rose to 19.9% from 17.6% |
| Working capital | $978.3 million | $796.4 million | Increased year over year |
Year-end cash and cash equivalents were $346.6 million, with marketable securities of $473.4 million. Approximately $815 million of cash, cash equivalents and marketable securities were held by foreign subsidiaries. The company had $217.1 million of available capacity under its $500 million revolving credit facility and reported compliance with its financial covenants.
Business trends and changes
- North America sales increased 9.3% to $1,904.8 million; segment earnings rose to $428.6 million from $385.9 million, and segment margin improved to 22.5% from 22.1%. Higher volumes and pricing helped, partly offset by higher steel costs.
- Rest of World sales increased 15.6% to $1,116.3 million; segment earnings rose to $149.3 million from $129.1 million. Segment margin was 13.4%, unchanged from 2016. China sales exceeded $1 billion and increased 15.9% in reported dollars, or 17.9% excluding currency effects.
- Higher steel costs more than offset pricing actions at the consolidated level, contributing to the decline in gross margin. SG&A increased $59.3 million to $718.2 million, primarily to support sales, advertising and brand-building.
- The company acquired Hague Quality Water International in September 2017 for $43.1 million net of acquired cash, expanding its North American water-treatment business. Hague contributed $8.6 million in sales from acquisition through year-end.
- Cash from operations declined as working capital absorbed cash, including increases in receivables and inventory. Total assets increased to $3,197.3 million from $2,891.0 million.
Outlook, risks and unusual items
- 2018 outlook: Management forecast consolidated sales growth of 8.5%–9.5% and EPS of $2.50–$2.58, excluding potential future acquisitions. Forecast EPS includes the expected benefit of a lower tax rate.
- Management expected 2018 operating cash flow of $475–$500 million, capital expenditures of approximately $100 million, and an effective tax rate of approximately 22.0%–22.5%. It forecast China sales growth of about 13%, North America boiler sales growth of 10%, and North America water-treatment sales growth of about 50%.
- The $81.8 million provisional tax reform charge reduced 2017 EPS by $0.47. It primarily reflected the mandatory tax on undistributed foreign earnings; the company cautioned that the provisional tax amounts could be revised in 2018. Management expected to repatriate approximately $200 million in the first half of 2018 and use the proceeds to repay floating-rate debt.
- Fourth-quarter 2017 net earnings were $22.7 million, versus $82.7 million in fourth-quarter 2016, primarily reflecting the tax reform charge.
- Principal disclosed risks include dependence on China and foreign markets, currency and trade exposure, customer concentration (five largest customers represented about 38% of sales), steel-price volatility, competition, construction and replacement-market conditions, regulation, cybersecurity, product liability, and acquisition integration. The company also identified a $48 million underfunding of defined-benefit pension obligations; it forecast no required or voluntary pension contribution in 2018.
- Management said unresolved legal matters, including product liability, environmental and other claims, were not expected to materially affect financial position or results, based on current knowledge, reserves and insurance. The auditors issued an unqualified opinion on the financial statements and internal controls; Hague was excluded from management’s internal-control assessment.
Investor verification priorities
- Track final tax reform calculations and cash taxes, including the timing and use of planned foreign cash repatriation.
- Test whether China growth and the 2018 sales and EPS outlook were achieved, including the contribution from water treatment and air purification.
- Monitor steel costs, pricing recovery and gross-margin trends, alongside working-capital movements and operating cash conversion.
- Assess debt, floating-rate exposure, repurchases and dividends against cash generation and planned investment.
- Review Hague integration and growth, pension funding assumptions, and developments in product-liability or environmental contingencies.