A. O. Smith Corporation — FY2018 Form 10-K
Reporting period: Fiscal year ended December 31, 2018. This is an annual filing, not a standalone fourth-quarter filing; selected Q4 results are included below. A. O. Smith manufactures water heaters, boilers, water-treatment products and, in China, air purifiers. Its reporting segments are North America and Rest of World, primarily China, Europe and India.
Financial performance
| Metric | FY2018 | FY2017 |
|---|---|---|
| Net sales | $3,187.9 million | $2,996.7 million |
| Gross profit / margin | $1,305.5 million / 41.0% | $1,232.4 million / 41.1% |
| Net earnings | $444.2 million | $296.5 million |
| Diluted EPS | $2.58 | $1.70 |
| Adjusted diluted EPS (non-GAAP) | $2.61 | $2.17 |
| Cash provided by operating activities | $448.9 million | $326.4 million |
| Capital expenditures | $85.2 million | $94.2 million |
| Total debt at year-end | $221.4 million | $410.4 million |
Revenue rose 6.4%, primarily from North American pricing actions responding to higher steel costs, increased U.S. residential water-heater and boiler sales, and growth in China water treatment. Gross margin was essentially flat. FY2018 GAAP earnings benefited from a lower tax rate: the effective rate was 20.4%, compared with 43.1% in 2017, which included an $81.8 million one-time U.S. tax-reform charge. The company reported $6.7 million of Renton plant restructuring and impairment costs in 2018.
At year-end, cash and cash equivalents plus marketable securities totaled $645.0 million, essentially all held by foreign subsidiaries. Working capital was $853.2 million, versus $973.1 million in 2017. Debt-to-total-capitalization was 11.4%, down from 19.9%. The company had $398.6 million of available borrowing capacity under its $500 million revolving facility and reported compliance with its covenants.
Segment results
| Segment | 2018 sales | 2018 earnings | 2018 margin | 2017 sales |
|---|---|---|---|---|
| North America | $2,044.7 million | $464.1 million | 22.7% | $1,904.8 million |
| Rest of World | $1,173.6 million | $149.3 million | 12.7% | $1,116.3 million |
North America earnings increased with volume and pricing, partly offset by steel costs and launch expenses. Rest of World earnings were flat year over year; its margin fell from 13.4% as higher water-treatment sales and improved India performance were offset by weaker electric water-heater and air-purifier sales and higher expenses.
Selected fourth-quarter results
Q4 2018 net sales were $812.5 million, gross profit was $337.0 million, net earnings were $126.3 million and diluted EPS was $0.74. Q4 2017 figures were $768.6 million, $322.3 million, $22.7 million and $0.13, respectively; the prior-year quarter included the U.S. tax-reform charge.
Changes, outlook and material considerations
- FY2018 sales in China increased 4% in U.S. dollars (about 1.9% excluding currency effects), but management cited weaker housing conditions, consumer sentiment and economic growth. China accounted for approximately 34% of company sales; approximately 43% of sales were outside the U.S.
- The Renton, Washington plant was closed and production transferred to other U.S. facilities; the consolidation was complete by year-end.
- Management forecast 2019 consolidated sales growth of 1%–2.5% (2.5%–4% in local-currency terms) and diluted EPS of $2.67–$2.77, excluding potential acquisitions. It expected China sales to decline 7%–10% in U.S. dollars and 3%–6% in local currency; North American boiler sales to grow about 10%; and North America water-treatment sales to rise 35%–40%. Expected 2019 segment margins were 23%–23.5% for North America and about 12%–12.5% for Rest of World.
- Management expected approximately $85 million of 2019 capital expenditures and planned approximately $200 million of share repurchases. It expected to repatriate about $150 million in the first half of 2019, principally to repay floating-rate debt.
- Key risks include China’s economic slowdown, tariffs and trade tensions, foreign-exchange movements, customer concentration (the five largest customers represented about 39% of 2018 sales), steel and other input-cost volatility, construction and replacement-market weakness, competition, product liability and warranty exposure, cybersecurity, regulation and acquisition execution.
- The pension plan was underfunded by approximately $56 million at year-end ($834 million obligation versus $778 million assets); no 2019 contribution was forecast, but future funding needs depend on market returns and actuarial assumptions. Ordinary-course legal and environmental matters were not expected by the company to have a material effect. No goodwill impairment was reported for 2018.
- Auditors issued unqualified opinions on the financial statements and internal control over financial reporting; management and the auditor considered controls effective at year-end.
Important facts for investors to verify
- Whether China demand, channel inventory and currency effects track the assumptions underlying 2019 guidance.
- Whether North American volume, pricing and steel-cost recovery support forecast sales and margins, particularly in boilers and water treatment.
- How much of reported earnings growth reflects recurring operations versus the prior-year tax charge and 2018 restructuring costs; compare GAAP and adjusted EPS.
- Cash accessibility and use: most cash and marketable securities were held abroad, while debt repayment, dividends and buybacks competed for capital.
- Customer concentration, pension funding sensitivity, warranty and product-liability reserves, and the company’s exposure to trade, currency and cybersecurity risks.