UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended September 30, 2019 .
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
(Exact name of registrant as specified in its charter)
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| (State or other jurisdiction of incorporation or organization) |
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(I.R.S. Employer Identification No.) | |
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| (Address of principal executive office) |
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(Zip Code) |
(414 ) 359-4000
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
| Title of Each Class |
Trading Symbol |
Name of Each Exchange on Which Registered | ||
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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 (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes
☒
☐
No Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation Yes
S-T
(§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). ☒
☐
NoIndicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a
non-accelerated
filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2
of the Exchange Act.| |
☒ |
Accelerated Filer |
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| Non-accelerated filer |
☐ |
Smaller reporting company |
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| Emerging growth company |
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If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.
☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule ☒ No
12b-2
of the Act.) ☐
Yes Class A Common Stock Outstanding as of October 31, 2019 - 26,052,953 shares
Common Stock Outstanding as of October 31, 2019 - 137,059,015 shares
Index
A. O. Smith Corporation
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| Item 2. |
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| Item 3. |
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| Item 4. |
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| Part II. |
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| Item 1. |
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| Item 2. |
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| Item 6. |
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2
PART I - FINANCIAL INFORMATION
ITEM 1 - FINANCIAL STATEMENTS
A. O. SMITH CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS
(dollars in millions, except for per share data)
(unaudited)
| Three Months Ended September 30, |
Nine Months Ended September 30, |
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| 2019 |
2018 |
2019 |
2018 |
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| Net sales |
$ | |
$ | |
$ | |
$ | |
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| Cost of products sold |
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| Gross profit |
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| Selling, general and administrative expenses |
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| Restructuring and impairment expenses |
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| Interest expense |
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| Other income |
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| Earnings before provision for income taxes |
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| Provision for income taxes |
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| Net Earnings |
$ | |
$ | |
$ | |
$ | |
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| Net Earnings Per Share of Common Stock |
$ | |
$ | |
$ | |
$ | |
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| Diluted Net Earnings Per Share of Common Stock |
$ | |
$ | |
$ | |
$ | |
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| Dividends Per Share of Common Stock |
$ | |
$ | |
$ | |
$ | |
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A. O. SMITH CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE EARNINGS
(dollars in millions)
(unaudited)
| Three Months Ended September 30, |
Nine Months Ended September 30, |
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| 2019 |
2018 |
2019 |
2018 |
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| Net earnings |
$ | |
$ | |
$ | |
$ | |
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| Other comprehensive (loss) earnings |
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| Foreign currency translation adjustments |
( |
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| Unrealized net (losses) gains on cash flow derivative instruments, less related income tax benefit (provision) of $ |
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| Adjustment to pension liability, less related income tax benefit (provision) of $ |
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| Comprehensive Earnings |
$ | |
$ | |
$ | |
$ | |
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S
ee accompanying notes to unaudited condensed consolidated financial statements. 3
PART I - FINANCIAL INFORMATION
ITEM 1 - FINANCIAL STATEMENTS
A. O. SMITH CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(dollars in millions)
| (unaudited) September 30, 2019 |
December 31, 2018 |
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| Assets |
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| Current Assets |
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| Cash and cash equivalents |
$ | |
$ | |
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| Marketable securities |
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| Receivables |
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| Inventories |
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| Other current assets |
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| Total Current Assets |
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| Property, plant and equipment |
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| Less accumulated depreciation |
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| Net property, plant and equipment |
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| Goodwill |
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| Other intangibles |
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| Operating lease assets |
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| Other assets |
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| Total Assets |
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$ | |
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| Liabilities |
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| Current Liabilities |
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| Trade payables |
$ | |
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| Accrued payroll and benefits |
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| Accrued liabilities |
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| Product warranties |
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| Debt due within one year |
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| Total Current Liabilities |
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| Long-term debt |
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| Pension liabilities |
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| Long-term operating lease liabilities |
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| Other liabilities |
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| Total Liabilities |
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| Stockholders’ Equity |
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| Class A Common Stock, $ |
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| Common Stock, $ |
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| Capital in excess of par value |
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| Retained earnings |
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| Accumulated other comprehensive loss |
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| Treasury stock at cost |
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| Total Stockholders’ Equity |
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| Total Liabilities and Stockholders’ Equity |
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See accompanying notes to unaudited condensed consolidated financial statements
4
PART I - FINANCIAL INFORMATION
ITEM 1 - FINANCIAL STATEMENTS
A. O. SMITH CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(dollars in millions)
(unaudited)
| Nine Months Ended September 30, |
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| 2019 |
2018 |
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| Operating Activities |
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| Net earnings |
$ | |
$ | |
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| Adjustments to reconcile net earnings to cash provided by (used in) operating activities: |
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| Depreciation and amortization |
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| Stock based compensation expense |
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| Net changes in operating assets and liabilities: |
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| Current assets and liabilities |
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| Noncurrent assets and liabilities |
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| Cash Provided by Operating Activities |
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| Investing Activities |
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| Capital expenditures |
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| Acquisition |
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| Investments in marketable securities |
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| Net proceeds from sale of marketable securities |
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| Cash (Used in) Provided by Investing Activities |
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| Financing Activities |
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| Long-term debt incurred (repaid) |
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| Common stock repurchases |
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| Payment of contingent consideration |
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| Net (payments) proceeds from stock option activity |
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| Dividends paid |
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| Cash Used In Financing Activities |
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| Net decrease in cash and cash equivalents |
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| Cash and cash equivalents - beginning of period |
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| Cash and Cash Equivalents - End of Period |
$ | |
$ | |
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See accompanying notes to unaudited condensed consolidated financial statements
5
PART I - FINANCIAL INFORMATION
ITEM 1 - FINANCIAL STATEMENTS
A. O. SMITH CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(dollars in millions)
(unaudited)
| Three Months Ended September 30, |
Nine Months Ended September 30, |
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| 2019 |
2018 |
2019 |
2018 |
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| Class A Common Stock |
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| Balance at the beginning of period |
$ | |
$ | |
$ | |
$ | |
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| Conversion of Class A Common Stock |
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| Balance at end of period |
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$ | |
$ | |
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| Common Stock |
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| Balance at the beginning of period |
$ | |
$ | |
$ | |
$ | |
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| Conversion of Class A Common Stock |
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| Balance at end of period |
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$ | |
$ | |
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| Capital in Excess of Par Value |
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| Balance at the beginning of period |
$ | |
$ | |
$ | |
$ | |
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| Conversion of Class A Common Stock |
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| Issuance of share units |
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| Vesting of share units |
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| Stock based compensation expense |
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| Exercises of stock options |
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| Stock incentives |
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| Balance at end of period |
$ | |
$ | |
$ | |
$ | |
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| Retained Earnings |
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| Balance at the beginning of period |
$ | |
$ | |
$ | |
$ | |
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| Net earnings |
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| Cash dividends on stock |
( |
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| Balance at end of period |
$ | |
$ | |
$ | |
$ | |
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| Accumulated Other Comprehensive Loss (see Note 17) |
$ | ( |
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| Treasury Stock |
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| Balance at the beginning of period |
$ | ( |
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| Exercise of stock options |
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| Stock incentives and directors’ compensation |
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| Shares repurchased |
( |
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| Vesting of share units |
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| Balance at end of period |
$ | ( |
) | $ | ( |
) | $ | ( |
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| Total Stockholders’ Equity |
$ | |
$ | |
$ | |
$ | |
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See accompanying notes which are an integral part of these statements.
6
PART I - FINANCIAL INFORMATION
ITEM 1 - FINANCIAL STATEMENTS
A. O. SMITH CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2019
(unaudited)
1. |
Basis of Presentation |
The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (GAAP) for interim financial information and pursuant to the rules and regulations of the Securities and Exchange Commission (SEC). Accordingly, they do not include all of the information and footnotes required for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three and nine months ended September 30, 2019 are not necessarily indicative of the results expected for the full year. It is suggested the accompanying condensed consolidated financial statements be read in conjunction with the audited consolidated financial statements and the notes thereto included in the Annual Report on Form
A. O. Smith Corporation’s (the Company)
10-K
for the year ended December 31, 2018 filed with the SEC on February 15, 2019.Recent Accounting Pronouncements
In January 2017, the Financial Accounting Standards Board (FASB) amended Accounting Standards Codification (ASC) 350, (issued under Accounting Standards Update (ASU) Any loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. The amendment requires adoption on January 1, 2020. The Company does not expect that the adoption of ASU
Intangibles – Goodwill and Other
2017-04,
“Simplifying the Test for Goodwill Impairment”). This amendment simplifies the test for goodwill impairment by only requiring an entity to perform an annual or interim goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount and recognize an impairment charge for the amount that the carrying amount exceeds the reporting unit’s fair value.2017-04
will have a material impact on its consolidated balance sheets, statements of earnings or statements of cash flows.In June 2016, the FASB issued ASC 326, (issued under ASU
Financial Instruments – Credit Losses
2016-13)
which modifies the measurement of expected credit losses on certain financial instruments. ASU 2016-13
requires adoption on January 1, 2020. The Company does not expect that the adoption of ASU 2016-13
will have a material impact on its consolidated balance sheets, statements of earnings or statements of cash flows.In February 2016, the FASB amended ASC 842, (issued under ASU
Leases
2016-02).
This amendment requires the recognition of lease assets and lease liabilities on the balance sheet for most leasing arrangements classified as operating leases. The Company applied the modified retrospective transition method and elected the transition option to use the effective date of January 1, 2019, as the date of the initial application. The Company elected the package of practical expedients as well as a separate practical expedient not to separate lease and non-lease
components. The Company did not elect the hindsight practical expedient. The adoption of ASU 2016-02
did not have a material impact on the Company’s consolidated balance sheets, statements of earnings or statements of cash flows. Refer to Note 4, Leases, for additional information.7
2. |
Revenue Recognition |
Substantially all of the Company’s sales are from contracts with customers for the purchase of its products. Contracts and customer purchase orders are used to determine the existence of a sales contract. Shipping documents are used to verify shipment. For substantially all of its products, the Company transfers control of products to the customer at the point in time when title and risk are passed to the customer, which generally occurs upon shipment of the product. Each unit sold is considered an independent, unbundled performance obligation. The Company’s sales arrangements do not include other performance obligations that are material in the context of the contract.
The nature, timing and amount of revenue for a respective performance obligation are consistent for each customer. The Company measures the sales transaction price based upon the payment terms associated with the transaction and whether the sales price is subject to refund or adjustment. Sales and value added taxes are excluded from the measurement of transaction price. The Company’s payment terms for the majority of its customers are 30 to 90 days from shipment.
Additionally, certain customers in China pay the Company prior to the shipment of products resulting in a customer deposits liability of $43.7 million and $47.0 million at September 30, 2019 and December 31, 2018, respectively. The Company assesses collectability of customer receivables based on the creditworthiness of a customer as determined by credit checks and analysis, as well as the customer’s payment history. The Company’s allowance for doubtful accounts was $6.2 million and $6.4 million at September 30, 2019 and December 31, 2018, respectively
.
Rebates and incentives are based on pricing agreements and are tied to sales volume. The amount of revenue is reduced for variable consideration related to customer rebates which are calculated using expected values and are based on program specific factors such as expected rebate percentages based on expected volumes. In situations where the customer has the right to return eligible products, the Company reduces revenue for its estimates of expected product returns, which are primarily based on an analysis of historical experience. Changes in such accruals may be required if actual sales volume differs from estimated sales volume or if future returns differ from historical experience. Shipping and handling costs billed to customers are included in net sales and the related costs are included in cost of products sold and are activities performed to fulfill the promise to transfer products.
Disaggregation of Net Sales
The Company is comprised of two reporting segments: North America and Rest of World. The Rest of World segment is primarily comprised of China, Europe and India. Both segments manufacture and market comprehensive lines of residential and commercial gas and electric water heaters, boilers, tanks, and water treatment products. Both segments primarily manufacture and market in their respective regions of the world. The Rest of World segment also manufactures and markets
in-home
air purification products in China.As each segment manufactures and markets products in its respective region of the world, the Company has determined that geography is the primary factor in reporting its sales. The Company further disaggregates its North America segment sales by major product line as each of North America’s major product lines is sold through distinct distribution channels and these product lines may be impacted differently by certain economic factors. Within the Rest of World segment, particularly in China and India, the Company’s major customers purchase across the Company’s product lines, utilizing the same distribution channel regardless of product type. In addition, the impact of economic factors is unlikely to be differentiated by product line in the Rest of World segment.
8
2. Revenue Recognition (continued)
The North America segment major product lines are defined as the following:
Water heaters
Boilers
Water treatment
products
point-of-entry
water softeners, solutions for problem well water, and whole-home water filtration products, to on-the-go
filtration bottles and point-of-use
carbon and reverse osmosis products. Typical applications for the Company’s water treatment products include residences, restaurants, hotels and offices. The Company sells water treatment products through its wholesale and retail distribution channels, similar to water heater products and related parts. The Company’s water treatment products are also sold through independent water quality dealers as well as directly to consumers including through internet sales channels. A portion of the Company’s sales of water treatment products in the North America segment is comprised of replacement filters. 9
2. Revenue Recognition (continued)
| (dollars in millions) |
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| Three Months Ended September 30, |
Nine Months Ended September 30, |
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| 2019 |
2018 |
2019 |
2018 |
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| North America |
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| Water heaters and related parts |
$ | |
$ | |
$ | |
$ | |
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| Boilers and related parts |
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| Water treatment products (1) |
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| Total North America |
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| Rest of World |
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| China |
$ | |
$ | |
$ | |
$ | |
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| All other Rest of World |
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| Total Rest of World |
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| Inter-segment sales |
( |
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) | ( |
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| Total Net Sales |
$ | |
$ | |
$ | |
$ | |
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(1) |
Includes the results of Water-Right, Inc. from April 8, 2019, the date of acquisition |
3. |
Acquisitions |
On April 8, 2019 , the Company acquired 100 percent of the shares of Water-Right, Inc. and its affiliated entities (Water-Right), a Wisconsin-based water treatment company. With the addition of Water-Right, the Company grew its North America water treatment platform. Water-Right is included in the Company’s North America segment for reporting purposes.
The Company paid an aggregate cash purchase price of $107.0 million, net of cash acquired. In addition, the Company established a $4.0 million escrow to satisfy any potential obligations of the former owners of Water-Right, should they arise.
The following table summarizes the preliminary estimate of the fair value of the assets acquired and liabilities assumed at the date of acquisition of Water-Right for purposes of allocating the purchase price. The Company is in the process of finalizing the fair value estimates; therefore, the allocation of the purchase price is subject to refinement. The preliminary $57.6 million of acquired identifiable intangible assets was comprised of the following: $38.3 million of customer relationships being amortized over 20 years, $18.2 million of trademarks not subject to amortization, and $1.1 million of 7.5 years.
non-compete
agreements being amortized over 10
3. Acquisitions (continued)
| April 8, 2019 (dollars in millions) |
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| Current assets, net of cash acquired |
$ | |
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| Property, plant and equipment |
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| Intangible assets |
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| Goodwill |
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| Total assets acquired |
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| Current liabilities |
( |
) | ||
| Total liabilities assumed |
( |
) | ||
| Net assets acquired |
$ | |
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The acquisition was accounted for using the purchase method of accounting, and accordingly, the results of operations have been included in the Company’s consolidated financial statements from April 8, 2019, the date of acquisition. Revenues and 29.9 million and $5.0 million, respectively, which included $5.4 million of operating earnings less $0.4 million of acquisition-related costs incurred by the Company resulting from the acquisition.
pre-tax
earnings associated with Water-Right included in the consolidated statement of earningsfor the nine months ended September 30, 2019
totaled $4. |
Leases |
The Company’s lease portfolio consists of operating leases for buildings and equipment, such as forklifts and copiers, primarily in the United States and China. The Company defines a lease as a contract that gives the Company the right to control the use of a physical asset for a stated term. The Company pays the lessor for that right, with a series of payments defined in the contract and a corresponding right of use operating lease asset and liability are recorded. The Company has elected not to record leases with an initial term of 12 months or less on its condensed consolidated balance sheet. To determine balance sheet amounts, required legal payments are discounted using the Company’s incremental borrowing rate. The incremental borrowing rate is the rate of interest that the Company would
incur if it were
to borrow, on a collateralized basis, an amount equal to the value of the leased item over a similar term, in a similar economic environment. Variable lease components not based on an index or rate are excluded from the measurement of the lease asset and liability and expensed as incurred for all asset classes. Certain leases include one or more options to renew or terminate. Renewal terms can extend the lease term from one to five years and options to terminate can be effective within one year. The exercise of lease renewal or termination is at the Company’s discretion and when it is determined to be reasonably certain to renew or terminate, the option is reflected in the measurement of lease asset and liability. The Company’s lease agreements do not contain any material residual value guarantees or material restrictive covenants or material subleases. Cash flows associated with leases are
materially
consistent with the expense recorded in the condensed consolidated statement of earnings. 1
1
4. Leases (continued)
Supplemental balance sheet information related to leases was as follows:
| (dollars in millions) |
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| September 30, 2019 |
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| Liabilities |
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| Short term: Accrued liabilities |
$ | |
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| Long term: Operating lease liabilities |
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| Total operating lease liabilities |
$ | |
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| Less: Rent incentives and deferrals |
( |
) | ||
| Assets |
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| Operating lease assets |
$ | |
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| Lease Term and Discount Rate |
September 30, 2019 |
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| Weighted-average remaining lease term |
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| Weighted-average discount rate |
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% | ||
The components of lease expense were as follows:
| (dollars in millions) |
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| Three months ended |
Nine months ended |
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| Lease Expense |
Classification |
September 30, 2019 |
September 30, 2019 |
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| Operating lease expense (1) |
Cost of products sold |
$ |
|
$ |
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| Selling, general and administrative expenses |
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(1) |
Includes short-term lease expense of $ |
Maturities of lease liabilities were as follows:
| (dollars in millions) |
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| September 30, 2019 |
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| 2019 |
$ | |
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| 2020 |
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| 2021 |
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| 2022 |
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| 2023 |
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| After 2023 |
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| Total lease payments |
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| Less: imputed interest |
( |
) | ||
| Present value of operating lease liabilities |
$ | |
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1
2
5. |
Restructuring and Impairment Expenses |
In the first quarter of 2018, the Company announced a move of manufacturing operations from its Renton, Washington facility to other U.S. facilities. At that time, the Company recognized $6.7 million of restructuring and impairment expenses, comprised of $4.0 million of severance and compensation related costs, lease exit costs of $2.1 million and impairment charges related to long-lived assets totaling $0.6 million, as well as a corresponding $1.7 million tax benefit related to the charges. The consolidation of operations from the Renton facility to other U.S. facilities was completed in 2018.
The following table presents an analysis of the Company’s restructuring reserve as of and for the
ni
months ended September 30, 2019: n
e
(dollars in millions) |
||||||||||||
Severance Costs |
Lease Exit Costs |
Total |
||||||||||
Balance at January 1, 2019 |
$ | $ | $ | |||||||||
Cash payments |
( |
) | ( |
) | ||||||||
Balance at March 31, 2019 |
||||||||||||
Cash payments |
( |
) | ( |
) | ||||||||
Balance at June 30, 2019 |
$ | $ | $ | |||||||||
Cash payments |
( |
) | ( |
) | ||||||||
Balance at September 30, 2019 |
$ | $ | $ | |||||||||
6. |
Inventories |
The following table presents the components of the Company’s inventory balances:
(dollars in millions) |
||||||||
September 30, 2019 |
December 31, 2018 |
|||||||
Finished products |
$ | $ | ||||||
Work in process |
||||||||
Raw materials |
||||||||
Inventories, at FIFO cost |
||||||||
LIFO reserve |
( |
) | ( |
) | ||||
Net inventory |
$ | $ | ||||||
1
3
7. |
Product Warranties |
The Company offers warranties on the sales of certain of its products with terms that are consistent with the market and records an accrual for the estimated future claims. The following table presents the Company’s warranty liability activity.
Three September 30, |
||||||||
(dollars in millions) |
||||||||
2019 |
2018 |
|||||||
Balance at July 1, |
$ | $ | ||||||
Expense |
||||||||
Claims settled |
( |
) | ( |
) | ||||
Balance at September 30, |
$ | |||||||