A. O. Smith Corporation — Q2 2016 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2016. The company manufactures and markets residential and commercial water heaters and related products. Its reporting segments are North America and Rest of World, primarily China, Europe and India. Figures are in U.S. dollars; financial statement amounts are in millions except per-share data.
Financial performance
| Metric | Q2 2016 | Q2 2015 | Six months 2016 | Six months 2015 |
|---|---|---|---|---|
| Net sales | $667.0 | $653.5 | $1,303.9 | $1,272.0 |
| Gross profit | $283.7 | $262.4 | $546.4 | $491.6 |
| Gross margin | 42.5% | 40.2% | 41.9% | 38.6% |
| Net earnings | $87.1 | $71.1 | $160.6 | $129.5 |
| Diluted EPS | $0.98 | $0.79 | $1.81 | $1.44 |
- Q2 sales rose about 2%; first-half sales rose about 2.5%. Excluding the stronger U.S. dollar against the Chinese and Canadian currencies, sales increased about 4% in both periods.
- Q2 net earnings increased about 23% and first-half net earnings about 24%. Higher U.S. and Canadian pricing, lower material costs and, in Q2, stronger U.S. commercial water-heater and boiler volumes supported margins and earnings.
- North America sales declined about 2% in Q2 and first-half operating earnings rose about 25% to $196.1. Rest of World sales grew about 8% in Q2 and 10% in the first half; operating earnings rose about 7% and 5%, respectively. China sales grew about 16% in local currency in both periods.
- Six-month cash provided by operating activities was $155.1, versus $61.2 in 2015. Capital expenditures were $37.7; cash used in investing activities was $103.6 and cash used in financing activities was $87.7. The company repurchased $82.2 of stock and paid $42.2 in dividends.
Financial position and liquidity
- At June 30, cash and cash equivalents were $287.4 and marketable securities were $379.8, totaling $667.2. The company said essentially all of that cash and securities was held by foreign subsidiaries; it had accrued $44.4 for repatriation of a portion.
- Total debt was $282.0, up from $249.0 at December 31, 2015; total debt to total capitalization was 16.0%, versus 14.7%. The $400 million revolving credit facility expires in December 2017; available borrowing capacity was $210.5. The company reported compliance with its financial covenants.
- Working capital was $833.4, up $71.2 from year-end. Management said operating cash flow and available borrowing capacity should fund existing operations for the foreseeable future.
Outlook, commentary and notable items
- Management forecast 2016 sales growth of 8%–8.5% in local currency and 6%–6.5% in U.S. dollars, and diluted EPS of $3.58–$3.64, excluding potential future acquisitions. It raised the midpoint of its full-year earnings guidance after first-half performance.
- 2016 North America operating margin guidance was 21.5%–22.0%; Rest of World guidance was approximately 13%. Management expected steel-cost increases to pressure margins in the second half, partly offset by announced price increases of 5%–8% effective August 1. ERP implementation expenses were expected to be about $25 million for 2016.
- Management expected approximately $340 million of 2016 operating cash flow, $105–$115 million of capital expenditures, and about $175 million of share repurchases. It also planned a voluntary $30 million pension contribution in the second half.
- On August 8, 2016, after quarter-end, the company acquired the parent of water-filtration company Aquasana for $87 million.
- Early adoption of share-based compensation accounting guidance generated discrete income tax benefits of $2.9 million in Q2 and $5.4 million in the first half. The first-half effective tax rate was 29.5%, versus 30.4% a year earlier.
- Foreign currency translation adjustments were a $17.1 million comprehensive loss in Q2; first-half translation loss was $8.5 million. Management cited risks including China economic growth, U.S. residential and commercial markets, raw-material price volatility, execution of pricing actions and ERP implementation, foreign exchange, competition and acquisition execution.
Important facts for investors to verify
- Whether steel-cost increases and August pricing actions deliver the forecast North America margins.
- Whether China growth, currency movements and higher selling and engineering spending align with Rest of World expectations.
- The timing and funding effects of the Aquasana acquisition, planned repurchases and voluntary pension contribution.
- The availability and practical accessibility of cash held overseas, including repatriation costs.
- Progress, costs and schedule for ERP implementation, and the company’s assumptions behind full-year guidance.