Business Context and Reporting Period
Company: A. O. Smith Corporation (SMITH A O CORP)
Filing Type: Form 10-Q (Unaudited)
Period Ended: June 30, 2009
Business Overview: The company operates in two primary segments: Water Products (residential and commercial water heaters) and Electrical Products (electric motors). The reporting period is significantly impacted by a reverse acquisition of Smith Investment Company (SICO) closed on April 22, 2009, which altered the accounting treatment of prior periods and earnings per share calculations. The company also completed the spin-off of discontinued businesses (printing and warehousing) in January 2009.
Key Financial Metrics
| Metric (in millions) | Q2 2009 | Q2 2008 | YTD 2009 | YTD 2008 |
|---|---|---|---|---|
| Net Sales | $498.7 | $622.1 | $980.4 | $1,193.6 |
| Gross Profit | $122.4 | $141.5 | $223.9 | $274.1 |
| Gross Margin % | 24.5% | 22.7% | 22.8% | 23.0% |
| Net Earnings (GAAP) | $21.3 | $9.5 | $24.0 | $15.9 |
| Diluted EPS (GAAP) | $0.84 | $1.00 | $1.38 | $1.67 |
| Operating Cash Flow (YTD) | $93.6 | $20.3 | ||
| Cash & Equivalents (End Period) | ||||
| Total Debt | $293.4 | $334.8 | ||
| Working Capital |
Note: YTD figures for Cash Flow and Debt represent the six-month period or balance sheet date respectively.
Material Changes vs. Prior Period
- Revenue Decline: Net sales decreased 20% in Q2 and 18% YTD compared to 2008. This was driven by lower volumes in residential and commercial water heaters (North America) and a 33% drop in Electrical Products sales due to weak construction markets and customer inventory reductions.
- Earnings Volatility: While GAAP net earnings increased to $21.3M in Q2 2009 from $9.5M in Q2 2008, this is largely due to the SICO reverse acquisition accounting. On a non-GAAP basis (excluding SICO impacts), earnings decreased to $23.7M ($0.79/share) from $32.0M ($1.06/share).
- Segment Performance:
- Water Products: Sales down 11% in Q2; operating earnings remained flat at $36.5M due to cost reductions and pricing offsetting volume loss.
- Electrical Products: Sales down 33% in Q2; operating earnings dropped significantly to $7.6M from $22.5M due to volume declines.
- Balance Sheet: Total debt decreased by $41.4M to $293.4M. Inventory levels dropped by $56.0M due to reduction programs. Cash provided by operating activities improved significantly to $93.6M YTD from $20.3M in the prior year.
Guidance, Outlook, and Risks
- Outlook: Management does not foresee a recovery in U.S. residential construction for the remainder of 2009. Commercial demand is expected to remain weak. A modest, short-lived seasonal uptick in HVAC is anticipated.
- Earnings Guidance: Full-year 2009 earnings outlook increased to $2.25 - $2.50 per share (GAAP) and $2.05 - $2.25 per share (non-GAAP). This revision follows a correction to a deferred tax adjustment in Q1.
- Liquidity: The company maintains a $425 million credit facility with $268.2 million available. Management expects operating cash flow of $140M-$150M for the full year.
- Dividends: The quarterly dividend was increased to $0.195 per share (2.6% increase).
- Risks: Key risks include volatility in raw material prices (copper, aluminum), further weakening in housing and commercial construction, and potential impacts from the global recession on customer liquidity.
Investor Verification Checklist
- Accounting Treatment: Verify the impact of the SICO reverse acquisition on EPS calculations, as GAAP figures include SICO historical data adjusted for the exchange ratio, which distorts year-over-year comparisons.
- Non-GAAP Reconciliation: Review the non-GAAP earnings reconciliation to understand the core operating performance excluding the SICO transaction effects.
- Deferred Tax Correction: Confirm the details of the Q1 deferred tax adjustment correction that altered the full-year earnings outlook.
- Derivative Liabilities: Note the significant non-cash decline in derivative contracts liability ($57.3M) which impacted working capital but not cash flow.
- Segment Margins: Monitor the divergence between Water Products (stable margins) and Electrical Products (compressed margins due to volume) to assess future profitability.