A. O. Smith Corporation — Q1 2011 Form 10-Q
Reporting period: Three months ended March 31, 2011. Amounts are in millions of dollars, except per-share data. The filing is unaudited. A. O. Smith’s continuing business was Water Products; Electrical Products (EPC) was classified as discontinued operations pending its sale.
Financial results and liquidity
| Metric | Q1 2011 | Q1 2010 |
|---|---|---|
| Continuing-operations net sales | $417.4 | $366.7 |
| Gross profit / gross margin | $127.0 / 30.4% | $108.3 / 29.5% |
| Water Products operating earnings | $48.9 | $43.9 |
| Earnings from continuing operations | $24.2 | $21.3 |
| Net earnings attributable to A. O. Smith | $41.0 | $30.9 |
| Diluted EPS: continuing / discontinued / total | $0.52 / $0.36 / $0.88 | $0.46 / $0.21 / $0.67 |
| Cash used in operating activities, continuing operations | $52.3 | $5.9 |
| Cash and cash equivalents at period end | $124.2 | $79.8 |
- Continuing-operations sales rose 13.8%; management attributed growth chiefly to China water-heater sales, including demand ahead of an April price increase, and the acquired Takagi tankless-water-heater business.
- At March 31, total debt was $339.8, up from $261.0 at year-end 2010; debt to total capitalization was 27%, versus 23%. The company reported $205.3 of available borrowing capacity under its $425 revolving facility and compliance with its financial covenants.
- Continuing-operations working capital was $259.8, up $50.3 from December 31, primarily reflecting higher receivables as sales increased. First-quarter capital expenditures were $12.4.
- Continuing-operations cash use reflected a $45 pension contribution and working-capital investment. The company expected total 2011 pension contributions of $175, operating cash flow of approximately $10–$20, and capital expenditures of $60–$70.
Material changes and significant items
- Q1 2011 continuing-operations gross margin improved to 30.4% from 29.5%, which management attributed to volume and a greater contribution from higher-margin China products. SG&A rose $12.3 to $89.3, mainly to support China sales and new products, with additional Takagi-related expense.
- EPC, reported as discontinued operations, generated sales of $200.4 versus $156.7 and after-tax earnings of $16.8 versus $9.5. The planned sale to Regal Beloit is for $700 in cash plus approximately 2.83 million Regal Beloit shares; closing was expected mid-year, subject to approvals and customary conditions. The Department of Justice had requested additional information.
- The company recorded a $1.6 charge in continuing-operations other expense for the mark-to-market of an equity collar covering half of the expected Regal Beloit shares. The collar’s accounting impact was excluded from EPS guidance.
- On May 5, 2011, the company agreed to a supplier settlement totaling $35.5 in cash. It expected an approximately $11 pretax benefit in Q2 for previously expensed costs, while evaluating a separate component-quality issue that could offset some or all of that benefit. The settlement payment was expected in Q2.
- Q1 continuing-operations operating cash flow was materially more negative than the prior-year quarter. Total debt increased by $78.8 during the quarter, including $77.2 of long-term debt incurred. The company expected to use part of EPC sale proceeds to repay floating-rate debt.
Outlook, risks and contingencies
- Management reaffirmed 2011 continuing-operations EPS guidance of $1.90–$2.10, excluding potential acquisitions and future equity-collar mark-to-market effects. It estimated a full-year gross margin of approximately 30% and a 2011 effective tax rate consistent with Q1’s 28.2%.
- Management expected China water-heater sales to grow at two to three times China GDP growth, supported by geographic expansion, store openings and new products. It expected North American residential and commercial water-heater industry sales to be essentially flat for the year.
- Management cited weak housing and commercial construction and rising commodity costs as headwinds; an April price increase was implemented in response to higher steel costs. Risks disclosed include commodity volatility, pricing and competitive pressure, market weakness, a China slowdown, pension funding demands, and failure or delay of regulatory approvals or other sale conditions.
- The company expected an additional $130 pension contribution in 2011. It also reported $11.8 of restricted assets associated with its runoff captive insurer. The filing describes currency, commodity and interest-rate exposures managed with derivatives and states that derivatives are not used for speculation.
- The company reported effective disclosure controls as of March 31, 2011 and no significant changes in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether the EPC sale closed on the anticipated terms and timing, including regulatory approval and the value of the Regal Beloit shares received.
- Progress against the $1.90–$2.10 continuing-operations EPS guidance, including the effect of the collar and any acquisitions.
- Whether working-capital needs, pension contributions and capital spending align with the company’s cash-flow expectations.
- The timing and use of EPC sale proceeds, debt repayment, and compliance with revolving-credit covenants.
- The final Q2 impact of the $35.5 supplier settlement and the separate component-quality issue that could offset its expected benefit.