A. O. Smith Corporation — Q1 2015 Form 10-Q
Business context and period. Unaudited results cover the three months ended March 31, 2015, compared with the same period in 2014. The company manufactures water heaters and related products through its North America and Rest of World segments.
Financial performance
| Metric | Q1 2015 | Q1 2014 |
|---|---|---|
| Net sales | $618.5 million | $552.2 million |
| Gross profit / gross margin | $229.2 million / 37.1% | $195.9 million / 35.5% |
| Operating earnings, segments combined | $97.4 million | $80.4 million |
| Earnings before taxes | $82.8 million | $64.9 million |
| Net earnings | $58.4 million | $46.7 million |
| Diluted earnings per share | $0.65 | $0.51 |
| Cash from (used in) operating activities | $(3.4) million | $11.8 million |
Sales increased about 12%; net earnings rose about 25%. Higher product volumes lifted gross margin. SG&A increased to $147.2 million from $130.9 million, primarily from selling, advertising and engineering support for growth in China. The effective tax rate was 29.5%, versus 28.0%.
- Segments: North America sales were $429.2 million versus $388.5 million; operating earnings were $71.2 million versus $55.3 million, with a 16.6% operating margin versus 14.2%. Rest of World sales were $195.9 million versus $172.8 million; operating earnings were $26.2 million versus $25.1 million, while margin declined to 13.4% from 14.5%.
- Cash flow and investment: Continuing-operations operating cash flow was negative $3.2 million, compared with positive $12.3 million; increased working-capital outlays more than offset higher earnings. Capital expenditures were $14.9 million versus $25.3 million. Cash and cash equivalents ended at $284.1 million, down from $319.4 million.
- Liquidity and debt: Cash, cash equivalents and marketable securities totaled $574.9 million, all held by foreign subsidiaries; the company had accrued $50.7 million for repatriation of a portion. Working capital was $780.5 million. Total debt increased to $303.9 million from $223.8 million; total debt to capitalization was 17.8%, versus 13.9%. Available borrowing capacity under the $400 million revolving facility was $247.9 million; the company reported compliance with its financial covenants.
- Other items: The company repurchased 333,033 shares for $20.7 million and paid dividends of $0.19 per share, versus $0.15 a year earlier. Foreign-currency translation reduced other comprehensive earnings by $9.3 million. Pension expense was minimal versus $6.6 million in Q1 2014 following the plan sunset for most employees at year-end 2014.
Outlook, commentary and risks
Management raised 2015 full-year EPS guidance to $2.72–$2.82, excluding potential future acquisitions. It expected Q2 2015 EPS to be about flat with Q2 2014 after adding back $0.03 per share of non-operating pension costs to the prior-year comparison, citing anticipated lower U.S. volumes after a Q1 customer pre-buy and about $4 million of incremental ERP costs. Full-year guidance included operating cash flow of $270–$280 million and capital expenditures of $100–$110 million. The company expected about $100 million of share repurchases in 2015, subject to business and market factors.
Management attributed North America’s strong quarter partly to a pre-buy ahead of April 2015 price increases associated with new U.S. residential water-heater efficiency standards (NAECA III). The standards apply to products manufactured after April 15; compliant products are more expensive to manufacture, and the company announced an average price increase of about 20% for affected U.S. residential products. Management expected modestly higher 2015 industry shipments, continued growth in commercial boilers and China sales growth at approximately twice China GDP growth. Rest of World margin faced pressure from a larger India loss tied to water-treatment launches and costs for air-purifier launches in China.
Identified risks include NAECA III-related costs, execution and timing of ERP implementation, potential weakness in the U.S. high-efficiency boiler industry, raw-material price volatility, competition and pricing execution, market and construction conditions, slower Chinese growth, foreign-currency movements, acquisition execution and broader economic or capital-market deterioration. The company said legal and environmental matters had no material changes from its 2014 Form 10-K. Management concluded disclosure controls were effective as of March 31, 2015, with no significant quarterly changes in internal control over financial reporting.
Important facts for investors to verify
- Whether Q1 North America demand was pulled forward by the customer pre-buy and how Q2 volumes and NAECA III pricing affect margins.
- Progress, costs and timing of ERP implementation, including the forecast incremental costs.
- China growth, launch spending and the trajectory of the India business, which weighed on Rest of World margins.
- Conversion of earnings into cash, working-capital trends, and the location and repatriation costs of foreign-held liquidity.
- Debt, covenant headroom, planned capital expenditures and share repurchases relative to the full-year outlook.
- Execution against the $2.72–$2.82 EPS guidance and the stated operating-cash-flow and capital-spending ranges.