SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 1999
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ________________ to _______________
Commission File Number 1-475
A.O. SMITH CORPORATION
Delaware 39-0619790
(State of Incorporation) (IRS Employer ID Number)
P. O. Box 245008, Milwaukee, Wisconsin 53224-9508
Telephone: (414) 359-4000
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months and (2) has been subject to such filing requirements for
the past 90 days. Yes X No ___
Class A Common Stock Outstanding as of April 30, 1999: 8,705,835 shares
Common Stock Outstanding as of April 30, 1999: 14,484,442 shares
Exhibit Index Page 16
Index
A. O. Smith Corporation
Part I. Financial Information
Item 1. Financial Statements (Unaudited)
Condensed Consolidated Statements of Earnings and Retained Earnings
- Three months ended March 31, 1999 and 1998 3
Condensed Consolidated Balance Sheet
- March 31, 1999 and December 31, 1998 4
Condensed Consolidated Statement of Cash Flows
- Three months ended March 31, 1999 and 1998 5
Notes to Condensed Consolidated Financial Statements
- March 31, 1999 6-8
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 9-12
Item 3. Quantitative and Qualitative Disclosure of Market Risk 12
Part II. Other Information
Item 1. Legal Proceedings 13
Item 4. Submission of Matters to a Vote of Security Holders 13
Item 6. Exhibits and Reports on Form 8-K 14
Signatures 15
Index to Exhibits 16
2
PART I--FINANCIAL INFORMATION
ITEM 1--FINANCIAL STATEMENTS
A.O. SMITH CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS
AND RETAINED EARNINGS
Three Months ended March 31, 1999 and 1998
(000 omitted except for per share data)
(unaudited)
Three Months Ended
March 31
--------
EARNINGS 1999 1998
- -------- ---- ----
Electric Motor Technologies $ 147,875 $ 111,839
Water Systems Technologies 81,988 74,554
Other 27,473 36,562
--------- ---------
NET SALES 257,336 222,955
Cost of products sold 207,003 177,186
--------- --------
Gross profit 50,333 45,769
Selling, general and administrative expenses 28,510 27,900
Interest expense 2,331 1,624
Interest income (340) (1,712)
Other expense - net 1,955 722
--------- ---------
17,877 17,235
Provision for income taxes 6,475 6,038
--------- ---------
Earnings before equity in loss of joint ventures 11,402 11,197
Equity in loss of joint ventures (note 2) - (1,019)
--------- ---------
NET EARNINGS 11,402 10,178
RETAINED EARNINGS
Balance at beginning of period 499,954 466,514
Cash dividends on common shares (2,795) (2,751)
--------- ---------
BALANCE AT END OF PERIOD $ 508,561 $ 473,941
========= =========
EARNINGS PER COMMON SHARE (note 7)
Basic $ 0.49 $ 0.42
Diluted $ 0.48 $ 0.41
DIVIDENDS PER COMMON SHARE $ 0.12 $ 0.12
See accompanying notes to unaudited condensed consolidated financial statements.
3
PART I--FINANCIAL INFORMATION
ITEM 1--FINANCIAL STATEMENTS
A.O. SMITH CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEET
March 31, 1999 and December 31, 1998
(000 omitted)
(unaudited)
March 31, 1999 December 31, 1998
-------------- -----------------
ASSETS
- ------
CURRENT ASSETS
Cash and cash equivalents (note 3) $ 17,552 $ 37,666
Receivables 171,441 133,764
Inventories (note 4) 100,830 99,984
Deferred income taxes 10,882 11,376
Other current assets 5,058 4,599
----------- ------------
TOTAL CURRENT ASSETS 305,763 287,389
Property, plant and equipment 518,680 507,033
Less accumulated depreciation 265,574 258,263
----------- ------------
Net property, plant and equipment 253,106 248,770
Goodwill 146,602 146,901
Other assets 89,709 84,372
----------- ------------
TOTAL ASSETS $ 795,180 $ 767,432
=========== ============
LIABILITIES AND STOCKHOLDERS' EQUITY
- -------------------------------------
CURRENT LIABILITIES
Trade payables $ 77,244 $ 57,429
Accrued payroll and benefits 24,357 31,385
Product warranty 7,491 7,892
Accrued income taxes 9,758 6,786
Long-term debt due within one year 4,629 4,629
Other current liabilities 27,090 24,036
----------- ------------
TOTAL CURRENT LIABILITIES 150,569 132,157
Long-term debt (note 5) 131,535 131,203
Other liabilities 62,013 60,636
Deferred income taxes 44,501 42,343
STOCKHOLDERS' EQUITY:
Class A common stock, $5 par value: authorized
14,000,000 shares; issued 8,737,575 43,688 43,688
Common stock, $1 par value: authorized 60,000,000
shares; issued 23,811,787 23,812 23,812
Capital in excess of par value 51,334 51,121
Retained earnings (note 5) 508,561 499,954
Accumulated other comprehensive income (note 6) (2,230) (1,488)
Treasury stock at cost (218,603) (215,994)
----------- ------------
TOTAL STOCKHOLDERS' EQUITY 406,562 401,093
----------- ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 795,180 $ 767,432
=========== ============
See accompanying notes to unaudited condensed consolidated financial statements
4
PART I--FINANCIAL INFORMATION
ITEM 1--FINANCIAL STATEMENTS
A.O. SMITH CORPORATION
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
Three Months Ended March 31, 1999 and 1998
(000 omitted
(unaudited
Three Months Ended
March 31
--------
1999 1998
---- ----
OPERATING ACTIVITIES
CONTINUING
- ----------
Net earnings $ 11,402 $ 10,178
Adjustments to reconcile net earnings to net cash provided/
(used) by operating activities
Depreciation and amortization 9,003 6,919
Equity in loss of joint ventures (note 2) - 1,019
Net change in current assets and liabilities (17,383) (14,711)
Net change in noncurrent assets and liabilities (5,254) (6,223)
Other - net (139) 266
-------- --------
CASH USED BY OPERATING ACTIVITIES (2,371) (2,552)
INVESTING ACTIVITIES
Capital expenditures (10,395) (6,942)
Capitalized purchased software costs (408) (308)
Investment in joint ventures (note 2) - (2,652)
Acquisition of business (note 2) (531) -
-------- --------
CASH USED BY INVESTING ACTIVITIES (11,334) (9,902)
-------- --------
CASH USED BY CONTINUING OPERATIONS
BEFORE FINANCING ACTIVITIES (13,705) (12,454)
DISCONTINUED
- ------------
Cash used by discontinued operations
before financing activities (1,301) (814)
FINANCING ACTIVITIES
Long-term debt incurred 332 641
Purchase of common stock held in treasury (2,691) (20,231)
Proceeds from common stock options exercised 42 -
Tax benefit from exercise of stock options 4 -
Dividends paid (2,795) (2,751)
-------- --------
CASH USED BY FINANCING ACTIVITIES (5,108) (22,341)
-------- --------
Net decrease in cash and cash equivalents (20,114) (35,609)
Cash and cash equivalents-beginning of period (note 3) 37,666 145,896
-------- --------
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 17,552 $110,287
======== ========
See accompanying notes to unaudited condensed consolidated financial statements.
5
PART I - FINANCIAL INFORMATION
ITEM 1 - FINANCIAL STATEMENTS
A. O. SMITH CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 1999
(unaudited)
1. Basis of Presentation
The consolidated financial statements presented herein are based on
interim figures and are subject to audit. In the opinion of management,
all adjustments consisting of normal accruals considered necessary for a
fair presentation of the results of operations and of financial position
have been made. The results of operations for the three-month period
ended March 31, 1999 are not necessarily indicative of the results
expected for the full year. The consolidated balance sheet as of December
31, 1998 is derived from the audited financial statements but does not
include all disclosures required by generally accepted accounting
principles. Certain prior year amounts have been reclassified to conform
to the 1999 presentation.
2. Acquisitions
Prior to December 1998, the company had majority interests in two joint
ventures in the People's Republic of China. These ventures were accounted
for on the equity method as the local partners held certain participating
rights. In December 1998, the company purchased its partner's interest in
the water systems venture, and the company consolidated this entity at
December 31, 1998.
In January 1999, the company purchased its partner's interest in the
Chinese fiberglass piping venture. The excess of the consideration paid,
including the distribution to the partner of certain inventories and
equipment over the fair values of the assets acquired amounted to
$750,000 and has been recorded as goodwill. The company consolidated this
entity effective January 1, 1999.
3. Statement of Cash Flows
For purposes of the Consolidated Statement of Cash Flows, cash and cash
equivalents include short-term investments held primarily for cash
management purposes. These investments normally mature within three
months from the date of acquisition.
6
4. Inventories (000 omitted)
Mar. 31, 1999 Dec. 31, 1998
------------- -------------
Finished products $ 59,688 $ 58,534
Work in process 18,806 18,354
Raw materials 49,344 50,542
Supplies 1,768 1,350
----------- -----------
129,606 128,780
Allowance to state inventories
at LIFO cost 28,776 28,796
----------- -----------
$ 100,830 $ 99,984
=========== ============
5. Long-Term Debt
The company's long-term credit agreements contain certain conditions and
provisions which restrict the company's payment of dividends. Under the
most restrictive of these provisions, retained earnings of $65.5 million
were unrestricted as of March 31, 1999 for cash dividends and treasury
stock purchases.
6. Comprehensive Earnings (Loss)
Statement of Financial Accounting Standards (SFAS) No. 130 - "Reporting
Comprehensive Income" requires the company to disclose comprehensive
earnings/(loss), consisting of net earnings and all other non-owner
changes in equity during the period. The company's comprehensive earnings
for the first quarter 1999 and 1998 were $10,660,000 and $9,866,000,
respectively. Comprehensive earnings, for both periods presented, were
comprised of net earnings and foreign currency translation adjustments.
No provisions or benefits for U.S. income taxes have been made on these
foreign currency translation adjustments.
7. Earnings per Share of Common Stock
The numerator for the calculation of basic and diluted earnings per share
is net earnings. The following table sets forth the computation of basic
and diluted weighted average shares used in the earnings per share
calculations:
Three Months Ended
March 31
---------------------------
1999 1998
----------- -----------
Denominator for basic earnings per share
- weighted-average shares 23,224,580 24,092,946
Effect of dilutive stock options 517,766 620,564
----------- ------------
Denominator for diluted earnings per share 23,742,346 24,713,510
=========== ============
7
8. Operations by Segment
(000 omitted) Three Months Ended
March 31
-------------------------
1999 1998
---------- ---------
Net Sales
---------
Electric Motor Technologies $ 147,875 $ 111,839
Water Systems Technologies 81,988 74,554
Other 27,473 36,562
---------- ---------
Net Sales $ 257,336 $ 222,955
========== =========
Earnings before Interest and Taxes
----------------------------------
Electric Motor Technologies $ 18,146 $ 12,917
Water Systems Technologies 8,360 6,719
Other (1) 2,161
----------- ---------
Total Segments 26,505 21,797
General Corporate and Research
and Development Expenses (6,637) (6,334)
Interest (Expense)Income - Net (1,991) 88
---------- ---------
Earnings before Income Taxes 17,877 15,551
Provision for Income Taxes (6,475) (5,373)
---------- ---------
Net Earnings $ 11,402 $ 10,178
========== =========
Intersegment sales, which are immaterial, have been excluded from segment
revenues. Total assets by segment at March 31, 1999 have not changed
materially from December 31, 1998.
8
PART I - FINANCIAL INFORMATION
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
FIRST THREE MONTHS OF 1999 COMPARED TO 1998
Sales were $257.3 million in the first quarter of 1999, an increase of $34.3
million or 15% over sales of $223.0 million in the first quarter of 1998. Most
of the increase in sales was attributable to the acquisition of General
Electric's hermetic motor business in Scottsville, Kentucky in July of 1998.
Stronger sales of other motor products and water heaters were partially offset
by sharply lower sales of storage tanks and fiberglass piping.
First quarter net earnings of $11.4 million increased $1.2 million or 12% over
1998's first quarter net earnings of $10.2 million primarily as a result of the
increased sales. The higher net earnings, and lower shares outstanding that
resulted from common stock repurchases during the last twelve months, generated
diluted earnings per share of $.48, an increase of 17% compared with $.41 in the
first quarter of 1998.
The company's gross profit margin for the first quarter was 19.6% compared with
a margin of 20.5% in the first quarter of 1998. The lower gross profit margin
was primarily due to the lower sales volume in the company's Other business
segment, which includes the company's storage tanks and fiberglass piping
businesses.
First quarter sales in the Electric Motor Technologies segment were $147.9
million or $36.1 million higher than the same period last year. The increase was
primarily attributable to the Scottsville motor acquisition; the Tier One supply
agreement with York International negotiated in July of 1998; and the
continuation of a healthy air conditioning motor market during the first quarter
of 1999.
First quarter operating profits for Electric Motor Technologies increased
significantly from $12.9 million in 1998 to $18.1 million in 1999 as a result of
the higher volume and improved operating efficiencies.
First quarter sales of the Water Systems Technologies segment were $82.0 million
or 10% higher than 1998 first quarter sales of $74.6 million. A stronger market
for standard commercial product, an increase in residential unit volume, and
consolidation of the company's Chinese water products operation accounted for
the higher sales. In December 1998, the company purchased its partner's interest
in the Chinese water systems joint venture and began consolidating financial
results at year-end 1998.
First quarter profits of Water Systems Technologies of $8.4 million were $1.7
million, or 25% higher than the $6.7 million generated in the first quarter of
1998 primarily as a result of the increased volume.
9
First quarter sales in the Other segment declined 25% from the same period last
year. Demand for fiberglass pipe declined more steeply than storage tank
products as both petroleum production and chemical markets continued at levels
significantly lower than in last year's first quarter. The soft demand in these
markets is attributable to weak commodity prices and an associated reduction in
capital spending by customers in those markets. First quarter sales of bolted
storage tanks also declined because of weak commodity prices and a reduction in
associated capital spending. In January 1999 the company purchased its partner's
interest in its Chinese fiberglass pipe joint venture. Financial results are
consolidated in the Other segment.
As a result of the significantly lower volume, earnings of the Other segment
were essentially break-even compared with the $2.2 million profit generated in
the first quarter of 1998.
Selling, general and administrative (SG&A) expenses for the first quarter of
1999 increased $.6 million from the same period of 1998. As the result of a
significantly higher level of sales combined with a relatively small increase in
administrative expense, SG&A decreased to 11.1% of sales in the first quarter of
1999, from 12.5% in the first quarter of 1998.
The company recognized net interest expense of $2 million in the first quarter
of 1999, compared with net interest income of $.1 million in the same period
last year. The decline in net interest income was primarily the result of the
aforementioned Scottsville acquisition.
Other expense increased from $.7 million in the first quarter of 1998 to $2.0
million in the same period of 1999. The increase was primarily due to the
amortization of goodwill associated with the Scottsville acquisition.
The first quarter effective tax rate was 36.2% in 1999 compared with a 35.0%
rate in 1998. The 1998 rate benefited from higher research and development tax
credits relative to 1999.
As previously mentioned, the company purchased its partners' interests in the
Chinese water products and fiberglass pipe joint ventures effective in December
1998 and January 1999, respectively. In 1998, losses associated with these
entities were recorded on an equity basis. In 1999, operating results of these
entities are consolidated.
During 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities" (the Statement)
which is required to be adopted for years beginning after June 15, 1999. The
Statement will require the company to recognize all derivatives in the balance
sheet at fair value. The company will adopt the Statement no later than January
1, 2000, and estimates that the effect will not be material to its results of
operations, financial position, or cash flows.
10
Liquidity & Capital Resources
The company's working capital was $155.2 million at March 31, 1999, essentially
unchanged from December 31, 1998. Lower cash levels and sales related increases
to accounts payable offset the $37.7 million sales related increase to accounts
receivable. Cash used by operations was $13.7 million during the quarter, very
similar to the $12.5 million used during the first quarter of last year.
Capital expenditures during the first quarter totaled $10.4 million compared
with $6.9 million during the same period in 1998. The majority of the increase
in capital spending was related to capacity expansion in the motor business. The
company expects higher capital spending in 1999 compared to 1998, but expects
such capital expenditures to be covered by operating cash flow.
The company repurchased 126,400 shares of its common stock during the first
quarter under the company's stock repurchase program. Since the program's
inception in January 1997, approximately 8.6 million shares have been
repurchased.
At its April 15, 1999 meeting, A. O. Smith's Board of Directors declared a
regular quarterly dividend of $.12 per share on its common stock (Class A Common
and Common). The dividend is payable on May 17, 1999 to shareholders of record
April 30, 1999.
Year 2000
A.O. Smith continues the efforts begun several years ago to address its
potential Year 2000 (Y2K) issues. It has organized its activities to prepare for
Y2K under a company-wide plan that involves four steps: assessment,
modification, testing and implementation..
The company's business segments operate independently of each other. Each
business segment has a core of full-time individuals who have been assigned
specific Y2K responsibilities in addition to their regular assignments. The Y2K
readiness project is a company wide effort and is monitored centrally.
The assessment phase is complete and the modification phase is nearing
completion. Key customers, vendors and service providers have been queried about
their Y2K readiness, and their responses have been analyzed. Follow-up efforts
have commenced to obtain feedback from critical suppliers.
The testing and implementation phases for renovated Information Technology (IT)
systems are underway. Implementation of all new and renovated systems that are
Y2K compliant should be completed by mid-1999. Testing will be completed during
the second half of 1999.
Costs specifically associated with renovating software for Y2K readiness are
funded through operating cash flows and expensed as incurred. Y2K-related costs
have not had a material effect on the company's financial position or results of
operations. The company expects to incur total costs of approximately $2.0
million on the Y2K problem of which the remaining costs are estimated to be $375
thousand. Costs of
11
replacing some of the company's systems with Year 2000 compliant systems have
been capitalized as these new systems were acquired for business reasons and not
to remediate Y2K problems, if any, in the former systems.
The company believes that all critical IT and non-IT systems and processes will
be Y2K compliant and allow the company to continue operations in the Year 2000
and beyond with no material impact on its financial position or results of
operations. Unanticipated problems including, but not limited to, critical
suppliers and business partners not meeting their commitments to be Y2K ready,
and the loss of critical skilled personnel, could result in an undetermined
financial risk.
As part of its ongoing Year 2000 Project, business continuity plans may be
expanded during 1999 for potential contingencies regarding currently unforeseen
Y2K problems.
ITEM 3. - QUANTITATIVE AND QUALITATIVE DISCLOSURE OF MARKET RISK
As is more fully described in the company's annual report on Form 10-K for the
year ended December 31, 1998, the company is exposed to various types of market
risks, primarily currency and certain commodities. The company monitors its
risks in such areas on a continuous basis and, generally enters into futures
contracts to minimize such exposures for periods of less than one year. The
company does not engage in speculation in its derivatives strategies. There have
been no material changes in the company's futures contracts since December 31,
1998.
Forward Looking Statements
Certain statements in this report are forward-looking statements. Although the
company believes that its expectations are based upon reasonable assumptions
within the bounds of its knowledge of its business, there can be no assurance
that its financial goals will be realized. Although a significant portion of the
company's sales are derived from the replacement of previously installed product
and such sales are therefore less volatile, numerous factors may affect actual
results and may cause results to differ materially from those expressed in
forward-looking statements made by or on behalf of the company. Among such
numerous factors the company includes the continued growth of the worldwide
heating, ventilating and air conditioning market; the weather and its impact on
the heating and air conditioning market; the pricing environment for residential
water heaters; capital spending trends in the oil, petrochemical and chemical
markets; and the successful development of the company's business in China.
12
PART II - OTHER INFORMATION
ITEM 1 - LEGAL PROCEEDINGS
Dip Tube Litigation
Generally, residential water heaters with a top inlet connection for the cold
water supply have a plastic tube which brings the cold water near the bottom of
the heater. This tube, which is called the "dip tube", is intended to prevent
incoming cold water from mixing with existing hot water. Some of the dip tubes
that were supplied by Perfection Corporation to A. O. Smith's Water Products
Company and most other water heater manufacturers between August, 1993 and
October, 1996 were defective. The defective dip tubes in some instances break
off within the water heater or slowly disintegrate and may release small white
plastic particles into the plumbing. In either case, the supply of hot water is
reduced. Perfection Corporation has advised the Company that the dip tubes are
made of non-toxic materials and pose no health risk. The United States Consumer
Products Safety Commission has also advised consumers that it poses no health
risk.
Since learning of the dip tube problem, the Company has been replacing defective
dip tubes and flushing affected water heaters, hot water lines and appliances
connected to hot water lines at no cost to consumers. Company-provided toll-free
telephone lines and service procedures have been utilized by consumers and
plumbers to correct the problem. Nevertheless, ten lawsuits have been filed in
1999 in the state courts of Kansas, Missouri, Illinois, Michigan, California and
Tennessee by individual water heater owners against Perfection Corporation and
various water heater manufacturers including Rheem Manufacturing Company,
American Water Heater Company, Bradford White Corporation, State Industries,
Inc., Lochinvar Corporation and A. O. Smith, seeking (i) compensation for
alleged damages related to defective dip tubes, (ii) certification as a state
class action, and (iii) other forms of relief. Also, the Michigan Attorney
General's office in 1999 began an investigation of this matter and served a
notice of intended action on the same parties noted above. The Company and other
water heater manufacturers that are involved in this investigation are
cooperating with the Michigan Attorney General.
Based on information currently available to the Company, as well as the
Company's prior experience with litigation, the Company's program to remedy dip
tube problems at no cost to the consumer, and the availability of insurance to
Perfection Corporation and its customers (the water heater manufacturers), the
Company's management believes that the dip tube litigation will not have a
material effect on its financial position or results of operation.
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
13
ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
(27) Financial Data Schedule
(27-1) Restated Financial Data Schedule
(b) Reports on Form 8-K
No reports on Form 8-K were filed by the company in the first quarter
of 1999.
14
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
A. O. SMITH CORPORATION
May 14, 1999 /s/John J. Kita
John J. Kita
Vice President,
Treasurer and Controller
May 14, 1999 /s/G. R. Bomberger
G. R. Bomberger
Executive Vice President
and Chief Financial Officer
15
INDEX TO EXHIBITS
-----------------
Exhibit
Number Description
- ------ -----------
(27) Financial Data Schedule
(27-1) Restated Financial Data Schedule
16
5
1,000
3-MOS
DEC-31-1999
MAR-31-1999
3,726
13,826
171,441
0
100,830
305,763
518,680
(265,574)
795,180
150,569
131,535
67,500
0
0
339,062
795,180
257,336
257,336
207,003
207,003
30,125
0
2,331
17,877
6,475
11,402
0
0
0
11,402
0.49
0.48
5
1,000
3-MOS
DEC-31-1998
MAR-31-1998
3,907
106,380
144,163
0
79,132
349,030
454,745
(246,478)
703,447
130,081
101,605
45,053
0
0
341,773
703,447
222,955
222,955
177,186
177,186
26,910
0
1,624
17,235
6,038
10,178
0
0
0
10,178
0.42
0.41
