A. O. Smith Corporation — FY 2014 Form 10-K
Reporting period: Fiscal year ended December 31, 2014. The filing is an annual report, not a standalone fourth-quarter filing; selected fourth-quarter results are included below. A. O. Smith manufactures water heaters, boilers and water treatment products through its North America and Rest of World segments. The former Electrical Products business is reported as discontinued operations.
Financial performance
| Metric | 2014 | 2013 |
|---|---|---|
| Net sales | $2,356.0 million | $2,153.8 million |
| Gross profit / gross margin | $859.3 million / 36.5% | $773.8 million / 35.9% |
| Earnings from continuing operations | $207.8 million | $169.7 million |
| Diluted EPS from continuing operations | $2.28 | $1.83 |
| Operating cash flow, continuing operations | $265.7 million | $282.2 million |
| Capital expenditures | $86.1 million | $97.7 million |
| Total debt | $223.8 million | $191.9 million |
| Working capital | $713.8 million | $614.7 million |
Sales rose 9.4% and continuing-operations earnings increased 22.5%. Fourth-quarter sales were $626.8 million versus $558.9 million; net earnings were $53.2 million versus $42.4 million, and diluted EPS was $0.59 versus $0.46. Cash flow from continuing operations less capital expenditures was $179.6 million in 2014, a derived measure.
North America sales increased 6.7% to $1,621.7 million; segment operating earnings were $238.7 million and operating margin was 14.7%. Rest of World sales increased 15.0% to $768.3 million; segment operating earnings were $106.7 million and operating margin was 13.9%. China sales grew 18.4% to $694.0 million. India sales declined, and the segment reported $7.5 million of losses there.
Liquidity, debt and capital allocation
- Year-end cash and cash equivalents were $319.4 million and marketable securities were $222.5 million. All $541.9 million of cash, cash equivalents and marketable securities was held by foreign subsidiaries; repatriating funds to the U.S. would incur costs. The company had accrued $50.7 million for tax on a portion of foreign earnings.
- The company had $219.5 million of available capacity under its $400 million revolving credit facility, which expires in December 2017, and reported compliance with its financial covenants. Debt to total capitalization was 13.9%, up from 12.6%.
- 2014 share repurchases totaled $103.8 million; dividends paid were $0.60 per share. The company forecast approximately $100 million of share repurchases and $0.76 per share of dividends in 2015.
Changes, outlook and risks
- Higher U.S. and China volumes and improved product mix supported sales and gross-margin growth; higher U.S. material costs partly offset gains. SG&A rose to $572.1 million, including higher selling and advertising expenses and approximately $9 million of incremental planned ERP implementation costs.
- Management forecast 2015 sales growth of approximately 10% and diluted EPS of $2.65–$2.80. It expected China sales to grow at roughly twice China GDP growth, Lochinvar sales to rise 10%, and North American water-heater industry volumes to be flat or show modest growth.
- Management expected 2015 operating cash flow of $270–$280 million and capital expenditures of $100–$110 million, including ERP and capacity investments. It anticipated some inefficiencies and one-time costs in the first half of 2015 during the NAECA III product transition. The new standards take effect April 16, 2015, affect approximately 80% of U.S. residential water heaters, and prompted an announced average price increase of approximately 20% on compliant products.
- Other material risks include China economic slowdown, foreign exchange exposure, steel and other input-cost volatility, customer concentration (five largest customers were approximately 35% of sales), competition, construction and replacement-market weakness, ERP implementation, product liability and warranty claims, and pension funding. The U.S. pension plan was underfunded by approximately $133 million at year-end; management forecast no required 2015 contribution.
- Ordinary-course legal, environmental and product-liability matters were disclosed; management believed reserves and insurance were adequate and did not expect the matters to materially affect financial position or results. No goodwill or indefinite-lived intangible impairment was recorded in 2014. The auditor issued unqualified opinions on the financial statements and internal control over financial reporting.
Important facts for investors to verify
- Whether NAECA III pricing recovers higher manufacturing costs and offsets transition-related disruption.
- Whether China growth, Lochinvar growth and the 2015 sales and EPS outlook are achieved, particularly given the stated market and execution risks.
- Cash availability and potential tax costs of repatriating foreign-held funds, alongside planned capital spending, dividends and repurchases.
- Developments in the pension deficit, product-liability and warranty reserves, and ERP implementation costs and control changes.