A O Smith Corp (AOS) 2002 Q1 法說會逐字稿

Good morning, ladies and gentlemen. Thank you for standing by. Welcome to the first quarter earnings release for the A.O. Smith Corporation. At this time, all participants are in a listen-only mode. Later there will be an opportunity for questions and answers with instructions provided at that time. If you should require assistance during the call, please press zero, followed by star.

As a reminder, today's conference call is being recorded.

I would now like to turn the conference call over to your first speaker Director of Investor Relations Mr. Craig Watson. Go ahead, sir.

Good morning, ladies and gentlemen and thank you for joining us on this conference call. With me this morning participating in the call are Bob O'Toole, Chairman and chief executive officer, Ken Krueger, Chief Financial Officer and John Kita, Treasurer and controller.

Before we begin with Bob's remarks, I would like to remind you that some of the comments that will be made this morning, including the answers to your question, will constitute forward-looking statements. These forward-looking statements are subject to risks that could cause actual results to be materially different. Those risks include, among others, matters that we have described in today's press release.

Bob will now make a few opening comments and Ken will discuss results in more detail.

o'toole: Thank you, Craig. This morning we are pleased to report earnings results of 50 cents per share, which solidly beat our forecast and demonstrated that our cost reductions are taking hold and the state integration is progressing smoothly.

In addition, we announced that we filed a registration statement with the SEC to issue an additional 3.5 million shares of common stock in an underwritten public offering. We intend to use the proceeds of the offering to repay debt under our credit facilities. We expect this offering to be completed in the second quarter.

Now back to operating results. Our top line continues to reflect soft markets for our motor products, as sales declined 13 percent with T-Vac and pump motor markets down 15 percent. Air conditioning inventory replenishment is progressing slower than we had anticipated at the beginning of the year. Having said that, air conditioning inventories remained at historically low levels, and offer sales upside as we progress through the year.

We are quite pleased with our early success with the State Industries acquisition. The early integration efforts, including the achievement of cost savings, are going well. At the end of the fourth quarter we projected modest improvement during the first half of 2002, followed by more favorable comparisons in the second half of the year, and we are sticking with that outlook.

Profitability expectations have been improved, and we are moving our earnings per share forecast range for 2002 up to a range of between a $1.60 to a $1.70 per share, from the prior $1.40 to $1.60 outlook that we had issued at the end of the fourth quarter. This is based on currently outstanding share levels before the effect of the stock offering. We are projecting results in the second quarter to be similar with those of the first.

Now Ken will take you through a review of the first quarter, and a more in-depth discussion of the outlook and the stock offering. Ken?

Thanks Bob. Sales in the first quarter of 2002 were 371.9 million, an increase of 53.7 million or 17 percent over sales of 318.2 million in the first quarter of 2001. Increased year over year first quarter sales for our water systems segment of 83.7 million, more than offset a decline of 30 million for our electrical product segment. The significant increase in the first quarter sales of our water systems segment was due to the 84.1 million of sales associated with our acquisition of State Industries on December 28th, 2001. Excluding State, water product sales were flat compared with last year. Higher sales in the commercial and China businesses offset a modest decline in residential sales.

In electrical products, the decline in sales reflects continued softness in the electric motor market. Our HVAC and pump businesses declined approximately 15 percent during the quarter, compared to last year, while the rest of the business declined approximately 10 percent. First quarter net earnings were 12.1 million, or 3.6 million higher than net earnings of eight and-a-half million in the first quarter of 2001. On a per-share basis, net earnings were 50 cents, compared to 36 cents in the first quarter of 2001. The increased earnings were primarily attributable to higher earnings in our water systems segment, the elimination of goodwill amortization of 1.6 million, and a decrease in the interest expense of $600,000, due to lower interest rates.

The increased earnings for our water systems segment were due to the additional sales volume, and the benefits of integration associated with the State Industries acquisition. Operating earnings for our water systems segment in the first quarter of 2002 were 13.6 million, including 3.8 million of earnings associated with the State Industries acquisition. The net 9.8 million of earnings for the base water systems business, compares to first quarter 2001 earnings of 9.9 million, and included a 1.7 million, non-recurring charge associated with the consolidation of water systems management staff.

First quarter 2002 operating earnings for our electrical products segment were 15.1 million, or 500,000 less than the 15.6 million of operating earnings in the first quarter of 2001, as adjusted to exclude 1.6 million of goodwill amortization. While operating earnings were down $500,000, operating margins improved from 6.9 to 7.7 percent. This favorable trend in year-to-year operating margin for electrical products, was a result of cost reduction activities. Including those announced in the fourth quarter of 2001. Gross margin was 20.7 percent, compared with 18 and-a-half percent in the first quarter of 2001. The increase is the result of cost reductions at electric products, and the addition of State. SG&A increased to 53.2 million from 38.1 million, and to 14.3 percent of sales from 12 percent in the first quarter of 2001.

This increase was a result of the incremental SG&A of State, as well as the 1.7 million non-recurring charge referred to earlier. Interest expense declined to 4.2 million from 4.8 million in 2001, as a result of significantly lower interest rates. Cash flow before financing was 14 million, an increase of 37 million over the first quarter of 2001. This improvement was a result of working capital management, reduced capital expenditures, and an accelerated tax filing process that resulted in a $12 million tax refund in the first quarter. As a result of the improved cash flow debt declined $15 million during this quarter and our debt-to-capital ratio declined to 45.7 percent compared with 47.4 percent at the end of the year. We continue to project operating cash flow of 75 to $80 million for the full year.

In addition to our ongoing cost reduction practices, our plant repositionings related to the integration are on track. Additionally, the business improvement program we announced during the fourth quarter of 2001 is also on schedule. The consolidation of warehouse and logistic operations is complete and the salaried workforce reduction will be nearly completed by the end of the second quarter.

The biggest piece of the business improvement program involves the repositioning of six additional product lines and is on track for completion by the end of the first quarter of next year. We expect the combination of these actions to generate cost savings or more than $16 million this year and between 20 and 25 million annually in 2003 and beyond.

The State integration is progressing smoothly and we will complete the relocation of our water products headquarters to Ashland City, Tennessee from Irving, Texas by the end of the second quarter. The purchasing synergies are coming in ahead of schedule and the longer-term tactical improvements have begun to take shape. We are quite pleased with the early results of this acquisition.

This morning, we filed an S-3 registration with the Securities & Exchange Commission announcing our intention to offer an additional three-and-half million shares of A.O. Smith common stock. We took this action for a number of reasons. It strengthens our balance sheet by reducing our debt leverage, which gives us the immediate flexibility to make investments if and when they're identified.

Unlike recent years, the market is very active for offerings of small committed cap industrial companies. And finally, the offering should improve our trading liquidity by increasing our float. We expect the second quarter earnings to be similar to first quarter levels.

Although we continue to be cautious about the timing and magnitude of the market recovery in 2002, we have improved our full year earnings projections to a range of $1.60 to $1.70 per share based on the early and the projected continued success of our cost reduction program as well as the integration of State Industries. As Bob said earlier, these projections are based on currently outstanding shares before giving effect to the stock offering.

In conclusion, A.O. Smith reached an important milestone at the end of 2001 with the successful acquisition of State Industries, which marks the completion of a strategic program to reposition the company into a more focused and consistently profitable enterprise. A.O. Smith now consists of two strong, well regarded platforms that are among the leaders in their respective industries. We believe electrical products and water systems both enjoy a number of competitive advantages in their respective markets, and both have strategies in place to build upon those advantages to generate continued growth and profitability. We look forward to continuing to share this story with you.

That completes our opening remarks, and we are now ready for your questions. However, SEC rules limit what we may say about the stock offering, so we look for your understanding if we tell you we won't answer your question on that subject. As a reminder, please limit your inquiries to one or two questions at a time so that everyone interested has an opportunity to participate.

Operator?

Thank you. Ladies and gentlemen if you do have a question, please press the one on your touch-tone phone at this time. You will hear a tone indicating you've been placed in the queue. You may remove yourself from the queue by pressing the pound key, should your question be answered. If you're using a speakerphone, we ask that you please pick up your handset before pressing the numbers. Again, if you have a question, please take this opportunity to press the one on your touch-tone phone. And first we will go to the line of with Robert W. Barrett.

Go ahead please.

Good morning gentlemen and congratulations on a nice quarter.

Thank you, Mike.

Mike.

First I guess on the motors side, could you give us a sense of where production levels were for you in the first quarter versus the fourth quarter -- I'm trying to dissect the margin surprise on the motor side.

I'm sorry, that was production levels in the first quarter of this year compared to the fourth quarter of last year?

Right, I'm just trying to get a sense of where you are in this de-stocking phase. And what you're doing with production levels.

We had -- we were at about 60 to 65 percent capacity utilization in the fourth quarter, and we believe that's moved 70 to 75 percent in the first.

OK.

Based on hours.

And, I'm sorry go ahead.

I was going to say, just from seasonality obviously we do, we have more sales in the first quarter so I would have anticipated that we had a modestly more production in the first quarter.

And are you still in a mode though where you believe there's excess inventory even in your channel? Because obviously the industry inventories are seven or eight year lows, but where do you believe your inventories at levels are.

Mike what we see is customers in all kinds of our market areas that are very cautious right now. And I don't know that it's excess inventories out there, cause certainly where we can them, like in the air conditioning industry, they're looking very good right now. It's simply the fact that the customers are very cautious. They don't seem to be listening to the economists.

Well, and does that caution explain why you commented before that the restocking by the channel has been somewhat behind schedule in your opinion?

o'toole: Yes, I would have personally, Mike, have expected it to higher at this point in time.

OK. And then, the margin surprise on the motor side. Again, it's a seasonally strong period for you, a seasonally strong quarter, but the second quarter is generally even seasonally stronger. Could you give us some indication as to where you expect margins to go in the second quarter?

Yes, let me just back up a minute and talk about that eight-tenths of an improvement in the operating margin. And what we framed there is obviously we had 30 million less sales the first quarter of this year, relative to last year. So at our normal contribution margins, you might expect that profitability would be down about nine million.

Right.

In fact, profitability was about flat, once you dial goodwill amortization out of the equations.

Exactly.

What's really reflective there, as you know, as we've talked in prior periods, , about the impact of the plant repositionings relative to , as we talked about the salaried head count reductions in the fourth quarter, all of that's coming into play. And then, there's the ongoing activities that we do on the purchasing side to reduce material costs, on the design side that we do to get the most efficient and the lowest cost product. That all came together. And that effectively is what drove the $9 million offset, if you will, in the improvement in the margins.

I guess what I was trying to drive at in a circuitous fashion here is your guidance is essentially similar, quote unquote, to this quarter for next quarter. But yet, if you take everything you've said here, Ken, that you've got all these cost savings coming into play. You should have a seasonally stronger quarter, even in the second quarter. To me, that says motor margins are going higher. And with everything going on, on the water side of the business, it seems like earnings should sequentially increase. Are you just being conservative on the guidance?

Yes, I would allow, Mike, that it would be similar to higher. Clearly, as you know, our second quarter is our strongest period from a sales standpoint, as the channel on the HVAC side tends to draw in more inventory and sells more product during the second quarter. So similar was meant to indicate that it'll be in that same sort of range. I guess I couldn't deny that it should be a little higher in the second quarter.

OK, I'll get back in line. Thank you.

And next, we have a question from the line of from Goldman Sachs. Go ahead, please.

Oh, hi. This is , sitting in for . How are you?

o'toole: Good.

Hi, .

Hi, just a few questions. The elimination for goodwill at 1.6, this is higher than what was previously articulated, correct?

No, I believe it's right on line with the seven million roughly that we had projected at the last quarter.

OK, because I think I had like four cents per quarter, so it's actually around -- a little higher than that, right?

Just slightly higher than that our annual amortization associated with goodwill was kind of in the $6.5 million range on annual basis and that would be kind of, you know 18 cents or so, somewhere in that range.

OK. Also interest expense can we expect these levels for the rest of the year?

Clearly right now the interest expense is based upon our, you know the about two-thirds of our debt is at variable rates. So to the degree that rates would increase, it would go up a little bit.

OK.

And as we've said the proceeds of the stock offering would be used to pay down debt and that clearly would reduce our interest expense.

OK. And finally just the State Industries contribution to EPS for the year, do you have any -- a better idea of what that could be for this year?

Yeah we had said before that we were talking about accretion in the 15 cent range for State.

Right, right.

And as you just heard us say we had a $3.8 million boost in profitability in the first quarter and that clearly would lead us to believe that we're going to earn at least the 15 cents and it could be up to 10 cents more than that.

OK that's what I was wondering if it was going to be any higher. All right, thank you.

And next we have a question from the line of of Bank of America Securities. Go ahead please.

Yeah I think you answered most of what I wanted to ask through Mike, but essentially on the cost savings that we're getting on the repositioning of the facility we'll see a greater effect in the second quarter and actually -- and then even more on the back half as we move through the year. Is that correct?

Yeah that's what I would anticipate. Clearly most of what we got in the first quarter was the result of the work that we did in 2001 as we marched through there during the plant repositionings relative to . As we announced in the fourth quarter there will be six additional product lines repositioned during 2002 and the impact of those will come later in 2002.

Good. Thank you.

And we have a question from the line of with Robert W. Baird. Please go ahead.

Hello again. A couple of follow-up questions on State, first could you tell us what aside from the production, I'm sorry, from the purchasing savings that you realized during the quarter has been done in terms of the integration or movement of product lines or workforce reductions?

Sure. If you'll remember back when we talked about the synergies related to the State acquisition, they really fell into three buckets. The first bucket was the elimination of what I'll call corporate overhead, things like the legal bills, the audit bills and to some degree the very executive management. The second bucket, excuse me, was the material cost savings. And that's really where we did pretty well in the quarter. If you remember we announced the acquisition of State Industries in October, and as we've said before, we didn't complete the acquisition until December 28th, so we really had an opportunity to work early, and make sure that we worked those -- understood where our material volumes came together, and were able to reach understandings with the vendors even really hit the ground with our feet running on almost day one of the acquisition. So that was the second piece of the synergies.

And the third piece ...

Mike the Communization of product lines and that type of thing really are further out in the schedules.

OK. I was just ...

Thank you. That was the third piece, which is the any ability to sort of align the manufacturing is, that's probably what we referred to earlier is we've got the planning for that well underway, but there's really nothing actively being pursued at this time.

OK. And then the China operations during the quarter -- can you give us a sense of what the revenue was and what the growth rate was?

China revenue was fairly similar to last year's first quarter. Our first quarter in China is typically our weakest because of the holidays, the national holidays they have. But we did see an improvement in profit year over year as we cost justified some things et cetera.

OK. And that operation though is definitely profitable at this point?

In the first quarter, cause of lower sales volume it is kind of a break even type situation, .

OK. And now you were speaking of just the water operations in China, correct?

Yes.

Could you give us an update on where you are on the motor strategy in China?

Yeah, Mike the motor operation we are in the process right now of getting customer approvals, and we anticipate that we'll be getting into production in a few months. At this point in time, we're getting all the supply chain set up, we're getting the people retrained, and so we don't really anticipate production of any significance until the back half of the year.

OK, and how much, or how many of the product lines of the six you mentioned that are going to be transitioned, are actually being transitioned to the Chinese operations?

None of those were in, were in our numbers Mike. The six that we were talking about were all transiting to Mexico.

OK, so the lines that would be produced in China, are those new motor lines, or are they going to be supplementary capacity to some of the domestic and Mexican capacity?

In the beginning it's supplementary, and then as we go further, we will be moving some equipment.

OK. Ken, final nit on the cash flow statement you've got four million in cash from the discontinued operations. Could you just give men some color on that?

Yes, that was very straightforward. That was a tax refund relative to the sales.

OK, great. Congratulations again.

Thanks.

And as a reminder, ladies and gentlemen, if you do have questions, please take this opportunity to press the one on your touch-tone phone at this time.

We have a follow-up question from the line of with Bank of America Securities. Go ahead, please.

Yes, sort of similar to the question you answered on electric products. In water products, where are we running at the capacity utilization?

o'toole: On a combined basis, you know, trying to put the two together?

Yes.

o'toole: Let me just do a little bit of a calculation in my mind. I'd say probably 75, 78 percent.

OK. And does that increase throughout the year? Does that stay steady?

o'toole: It stays reasonably steady. There's a little bit of seasonality to the business in the summer. It slows a little bit in the summer, , particularly on the replacement side. And then, it picks up again in the third, fourth quarter.

Good. Thank you.

And there are no further questions in queue at this time, please proceed.

Well, thank you for joining us, ladies and gentlemen. And we look forward to talking to you next quarter.

Ladies and gentlemen, that does conclude your conference call for today. The conference is available for replay beginning at 11:40 a.m. today, the 12th of April, 2002, until tomorrow, April 13, 2002 at 1:59 p.m. To access the AT&T Executive Playback Service during that time, please dial 1-800-475-6701, and enter the access code of 634239. The numbers again are 1-800-475-6701; the access code is 634239. And once again, that does conclude your conference call for today. Thank you for your participation, and for using AT&T's Executive Teleconference Service. You may now disconnect.

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