A. O. Smith Corporation — FY 2015 Form 10-K
Business context and reporting period
Annual report for the fiscal year ended December 31, 2015; the filing also reports fourth-quarter results. A. O. Smith manufactures water heaters and boilers in North America and internationally, and sells water treatment products primarily in Asia and air purification products in China. Its reporting segments are North America and Rest of World, primarily China, Europe and India. Electrical Products is reported as a discontinued operation.
Financial performance and liquidity
- Revenue: Record continuing-operations sales of $2,536.5 million, up 7.7% from $2,356.0 million in 2014. North America sales rose 5.0% to $1,703.0 million; Rest of World rose 12.7% to $866.1 million.
- Profit: Net earnings were $282.9 million versus $207.8 million, up about 36%. Diluted EPS was $3.16 versus $2.28. The effective tax rate increased to 29.7% from 27.5%.
- Margins: Gross margin expanded to 39.8% from 36.5%. North America operating margin increased to 20.0% from 14.7%; Rest of World operating margin declined to 13.0% from 13.9%.
- Cash flow and investment: Operating cash flow was $344.4 million versus $263.9 million. Capital expenditures were $72.7 million, down from $86.1 million. Management forecast approximately $320 million of operating cash flow and $120–$130 million of capital expenditures for 2016.
- Liquidity and debt: Working capital was $802.1 million. Cash and marketable securities totaled $645.2 million, essentially all held by foreign subsidiaries; $47.9 million was accrued for repatriation taxes on a portion of foreign earnings. Total debt was $249.0 million, up from $223.8 million; debt-to-total-capitalization was 14.7%. The company had $253.0 million of available borrowing capacity under its $400 million revolving facility, which expires in December 2017. Management said available cash, borrowing capacity and operating cash flow should fund operations for the foreseeable future.
- Shareholder returns: 2015 repurchases totaled $128.1 million (1.9 million shares); dividends were $0.76 per share. The company planned approximately $150 million of repurchases and anticipated $0.96 per share in dividends for 2016.
Changes versus the prior comparable period
- North America benefited from price increases, stronger commercial water heater and condensing boiler sales, lower steel costs and sharply lower pension expense. U.S. residential water heater volumes fell, and Canadian sales faced unfavorable currency translation.
- China sales increased 13.7% in reported dollars and 16.1% excluding the stronger U.S. dollar. Growth reflected water heaters, water treatment and the 2015 launch of air purification products. Higher selling, engineering and launch expenses contributed to lower Rest of World operating margin.
- Gross margin improved 3.3 percentage points. SG&A rose $38.6 million to $610.7 million, mainly due to China selling, engineering and air-purification launch costs.
- Pension expense fell to $0.1 million from $28.6 million, largely reflecting the sunset of benefit accruals for most employees at year-end 2014. Interest expense rose to $7.4 million from $5.7 million, partly due to higher debt and the replacement of some revolving borrowings with term notes.
- Fourth-quarter 2015 sales were $639.4 million versus $626.8 million; net earnings were $79.8 million versus $53.2 million; diluted EPS was $0.90 versus $0.59.
Outlook, risks and unusual items
- For 2016, management forecast sales growth of 9%–10% in local-currency terms and 7%–8% in U.S. dollars, with earnings of $3.40–$3.55 per share. China sales were expected to grow approximately 15% in local currency; Lochinvar sales approximately 10%; North American water heater volumes were expected to grow modestly.
- Management expected 2016 ERP implementation costs of approximately $25 million, about $9 million higher than in 2015; a 30.5%–31% effective tax rate; and other income approximately $5 million lower than in 2015.
- Principal risks include China economic slowdown, foreign-exchange movements, customer concentration (five largest customers represented about 38% of sales), construction and replacement-market weakness, steel and supplier volatility, competition, product liability/warranty exposure, ERP execution, international and repatriation risks, and pension funding sensitivity. The company reported a $134 million pension-plan underfunding at year-end but forecast no required 2016 contribution.
- The filing describes ordinary-course legal, environmental and product-liability matters and says reserves and insurance are believed adequate; it does not expect a material adverse effect. No goodwill or indefinite-lived intangible impairment was recorded in 2015. The major restructuring and supplier settlement items described relate to 2013, not 2015.
- Independent auditors gave unqualified opinions on the financial statements and internal control over financial reporting; management also concluded controls were effective. ERP implementation remained a multi-year project and was changing some financial-reporting controls.
Important facts for investors to verify
- Whether China demand, local-currency growth and new product launches deliver the forecast while currency translation and launch costs remain manageable.
- Whether North American commercial growth and higher-efficiency boiler adoption offset residential volume and construction-market risks.
- ERP implementation milestones, projected costs and any operational or control disruptions.
- Cash availability and repatriation constraints: $645.2 million of cash and marketable securities were held by foreign subsidiaries, with repatriation tax accrued on only a portion.
- Debt maturities and refinancing capacity, particularly the revolving facility’s December 2017 expiration, alongside planned buybacks and dividends.
- Customer concentration, product liability reserves and insurance, and pension-plan funding assumptions and future contribution needs.