A. O. Smith Corporation — Q1 2013 Form 10-Q
Reporting period: Three months ended March 31, 2013. Unaudited results; amounts are in U.S. dollars. Per-share figures reflect the two-for-one stock split declared after quarter-end.
Business context and results
A. O. Smith manufactures water heaters, boilers and water-treatment products. Its reporting segments are North America and Rest of World, principally China, India and Europe.
| Metric | Q1 2013 | Q1 2012 |
|---|---|---|
| Net sales | $509.6 million | $468.6 million |
| Gross profit | $179.3 million | $149.1 million |
| Gross margin | 35.2% | 31.8% |
| Income before taxes | $57.1 million | $69.9 million |
| Net earnings | $39.0 million | $47.5 million |
| Diluted EPS | $0.42 | $0.51 |
| Adjusted earnings and adjusted diluted EPS (non-GAAP) | $44.7 million; $0.48 | $31.7 million; $0.34 |
Sales increased about 9%, supported by U.S. water-heater and boiler demand and China growth. Gross margin improved with higher volumes and pricing. Reported net earnings fell because Q1 2012 included a $27.2 million pretax gain on Regal Beloit shares; 2013 results also included restructuring costs and a supplier-settlement gain. The company introduced adjusted non-GAAP measures that exclude specified items, including non-operating pension costs.
Segments and material changes
- North America: Sales were $378.7 million versus $353.3 million. Operating earnings were $54.1 million versus $42.2 million; adjusted segment operating earnings were $59.4 million versus $43.2 million. Growth reflected U.S. residential and commercial water heaters and Lochinvar products; Canadian sales declined.
- Rest of World: Sales were $138.3 million versus $124.2 million; operating earnings were $18.2 million versus $14.2 million. China branded-product sales grew approximately 15%; lower Europe and Middle East sales partly offset that growth.
- Acquisition: In February, the company acquired Turkish water-treatment company MIM for an initial $6.1 million cash payment, with $1.0 million estimated fair value of contingent consideration. Its quarter contribution was not material.
Cash flow, liquidity and capital
- Cash from operating activities was $35.8 million, including $36.6 million from continuing operations, compared with total operating cash used of $3.5 million in Q1 2012. Continuing-operations cash flow in that period was $15.1 million.
- Capital expenditures were $18.4 million; investing activities provided $26.8 million, including net security-sale proceeds. Cash and cash equivalents were $306.9 million at quarter-end, up from $266.9 million at year-end.
- Total debt was $229.1 million, down from $243.7 million at December 31, 2012. The company reported $254.8 million of available borrowing capacity under its $400 million revolving facility, which expires in December 2017. It was in compliance with its leverage and interest-coverage covenants.
- Working capital was $628.7 million. Marketable securities were $144.5 million. The filing states that available borrowing capacity and operating cash flows should fund existing operations for the foreseeable future.
- Quarterly dividends paid were $9.4 million. The board subsequently approved a 20% increase in the cash dividend and a two-for-one stock split.
Outlook, commentary and notable items
- Management raised 2013 guidance to GAAP EPS of $1.50–$1.58 and adjusted EPS of $1.70–$1.78, both on a post-split basis. The adjusted forecast excludes non-operating pension costs, the Canadian plant restructuring and supplier-settlement gain; it excludes potential future acquisitions.
- Management forecast continuing-operations operating cash flow of $210–$230 million, capital expenditures of $80–$90 million, and full-year depreciation and amortization of $55–$60 million. Estimated full-year effective tax rate: 30.0%–30.5%.
- The company is transferring production from Fergus, Ontario, with most consolidation expected by July 1, 2013. It recorded $12.7 million of pretax severance and asset-impairment charges, expects about $5 million of additional restructuring charges in 2013, and forecasts approximately $10 million of annual pretax savings in 2014.
- A former-supplier settlement generated an $11.0 million pretax gain and cash payment to the company. The 2013 income statement reports $1.7 million of net restructuring, impairment and settlement expense, reflecting the offsetting items.
- Management cited improving U.S. conditions and continued China growth, while cautioning about plant-transition costs and timing, boiler-market weakness, acquisition execution, raw-material volatility, competition, pricing, replacement markets, construction activity, China’s economy, currency movements and broader economic or capital-market deterioration.
- Product-liability self-insured retention increased from $5.0 million to $7.5 million for 2013. The filing reports no other material change in legal or environmental matters from the prior annual report.
Important facts for investors to verify
- Reconcile GAAP and adjusted earnings, particularly the 2012 Regal Beloit share-sale gain and 2013 restructuring and settlement items.
- Track execution, remaining charges and savings from the Fergus production transfer.
- Assess whether U.S. demand and China growth support the guidance and planned capacity investments.
- Monitor operating cash generation, capital spending, debt, facility availability and covenant compliance.
- Review warranty and pension assumptions, market risks, and the increased product-liability self-insured retention.