A. O. Smith Corporation — Q1 2014 Form 10-Q
Reporting period: Three months ended March 31, 2014; unaudited. The company manufactures water heaters, boilers and water-treatment products through its North America and Rest of World segments.
Financial performance
| Metric | Q1 2014 | Q1 2013 |
|---|---|---|
| Net sales | $552.2 million | $509.6 million |
| Gross profit | $195.9 million | $179.3 million |
| Gross margin | 35.5% | 35.2% |
| Operating earnings, total segments | $80.4 million | $72.3 million |
| Net earnings | $46.7 million | $39.0 million |
| Diluted EPS | $0.51 | $0.42 |
| Adjusted diluted EPS (non-GAAP) | $0.54 | $0.48 |
| Cash provided by operating activities | $11.8 million | $33.3 million |
Sales rose about 8%. Net earnings increased about 20%. Gross margin was essentially flat: higher U.S. and China volumes were offset by higher North American steel prices, lower Canadian volumes and the weaker Canadian dollar. Q1 2013 included $12.7 million of restructuring and impairment expense and an $11.0 million supplier-settlement gain; adjusted comparisons exclude these items and non-operating pension costs.
Segment results
- North America: Sales of $388.5 million, versus $378.7 million; operating earnings of $55.3 million, versus $54.1 million. Adjusted operating earnings were $59.1 million, versus $59.4 million, and adjusted margin was 15.2%, versus 15.7%. Higher steel costs, weaker Canadian sales and currency effects offset U.S. growth and manufacturing savings.
- Rest of World: Sales of $172.8 million, versus $138.3 million; operating earnings of $25.1 million, versus $18.2 million. China sales grew about 25%; management said customer inventory changes contributed approximately $10 million to the quarter-on-quarter sales increase. Improved product mix and water-treatment profitability helped earnings, partly offset by selling costs and expenses from a new China plant.
Cash, liquidity and debt
- Cash and cash equivalents were $369.8 million at March 31, 2014; marketable securities were $102.7 million. The company reported that all $472.5 million of cash, cash equivalents and marketable securities was held by foreign subsidiaries; $56.4 million was accrued for repatriation costs on a portion of the funds.
- Operating cash flow from continuing operations was $12.3 million, compared with $34.1 million a year earlier, primarily reflecting increased working-capital requirements. Capital expenditures were $25.3 million, versus $18.4 million.
- Total debt was $227.0 million, up from $191.9 million at year-end 2013; debt to total capitalization was 14.5%, versus 12.6%. The company had $164.7 million of available borrowing capacity under its $400 million revolving facility, which expires in December 2017, and was in compliance with its financial covenants.
- Working capital was $661.7 million, up $47.0 million from December 31, 2013. The filing attributes most of the increase to lower accounts payable balances in China.
Outlook, risks and notable items
- Management raised 2014 guidance to GAAP EPS of $2.06–$2.21 and adjusted EPS of $2.20–$2.35; guidance excludes potential effects of future acquisitions. The company expects continuing-operations operating cash flow of $240–$250 million, capital expenditures of $75–$85 million and depreciation and amortization of approximately $65 million.
- Management expected U.S. residential water-heater industry shipments to grow about 4%, commercial water-heater shipments about 3%, and Lochinvar sales about 10% in 2014. It expected China sales growth at approximately twice China GDP growth. A mid-single-digit North America price increase was announced to take effect May 1, 2014.
- Key stated risks include raw-material cost volatility, competitive pressure and execution of pricing actions; changes in U.S. construction and replacement markets; a slowdown in China; foreign-exchange movements; ERP implementation costs and timing; and general economic or capital-market deterioration.
- The board authorized an additional 1.5 million shares for repurchase on April 7, 2014. During Q1 the company repurchased 445,792 shares for $21.3 million; approximately 706,984 shares remained under the authorization at March 31. The board also declared a $0.15-per-share dividend payable May 15, 2014.
- The company reported no material changes to legal and environmental matters disclosed in its 2013 Form 10-K. Warranty liability was $135.9 million at March 31, 2014, compared with $128.9 million a year earlier. Management reported effective disclosure controls and no significant quarterly change in internal control over financial reporting.
Investor verification points
- Assess whether China’s growth and the approximately $10 million customer-inventory contribution to Q1 sales are sustainable.
- Monitor North American input costs, the announced price increase, Canadian demand and currency effects for margin impact.
- Track working-capital needs and cash conversion, given the year-over-year decline in quarterly operating cash flow and the concentration of cash overseas.
- Review debt, borrowing capacity and repurchases alongside the planned capital expenditures and full-year cash-flow outlook.
- Compare reported results with both GAAP guidance and management’s adjusted, non-GAAP measures; adjusted results exclude specified pension and unusual items.