A O Smith Corp (AOS) 2010 Q1 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the A.O. Smith Corporation first-quarter 2010 earnings call. At this time all phone lines are in a listen-only mode; later we will conduct a question-and-answer session. (Operator Instructions). As a reminder, today's conference is being recorded. I now turn the call over to Vice President Investor Relations and Treasurer, Patricia Ackerman. Please go ahead.

Thank you, Nick. Good morning, ladies and gentlemen, and thank you for joining us. With me this morning on our conference call are Paul Jones, Chief Executive Officer; Terry Murphy, Executive Vice President and Chief Financial Officer; and John Kita, Senior Vice President Corporate Finance and Controller.

Before we begin with Paul's remarks I would like to remind you that some of the comments that will be made during this conference call, including answers to your questions, 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 this morning's press release. Paul, I will now turn the call over to you.

Thank you, Pat, and good morning, ladies and gentlemen. We are pleased to announce the highest first-quarter earnings ever achieved in our proud 136-year history. Here are a few highlights behind this outstanding quarter.

First-quarter earnings of $1.01 per share compared with our previous record in 2008 of $0.72 per share. Sales of $523 million were up 9% year over year. Our water heater operations in China grew significantly over the first quarter of 2009.

Recall that a year ago the Chinese stimulus plan had not taken its full effect and it was the first quarter in many years that we experienced a sequential quarterly decline in sales. Our new product introductions in China are also contributing to our sales growth. We expect our water heater sales growth this year to be above China's GDP.

The integration of our water treatment acquisition continues, although sales are behind schedule. We are on track to improve the quality of the products for the A.O. Smith brand introduction into the retail distribution channel this summer.

Our electrical motor business experienced increased global demand as well as some inventory restocking by customers going into the summer selling season in North America. Lower operating costs and lower raw material prices in the quarter, compared with last year, leveraged the increases in sales in both businesses.

I will show a steel chart later which will highlight the squeeze on margins from higher commodity prices that will impact us in the second quarter and later this year if the trend continues. We increased our guidance last month to $3.20 to $3.40 per share as a result of the strength of our first-quarter results. I will now pass the call over to Terry Murphy who will provide more details on the financials.

Thank you, Paul. Before I go through the financial results I'd like to remind you that the GAAP accounting for the Smith Investment Company transaction which closed in the second quarter of 2009 distorts our results on a historical basis. For that reason we will provide non-GAAP information in this presentation. A reconciliation from GAAP to non-GAAP is provided in the press release that we issued this morning.

Total sales for the quarter increased to $523 million from $482 million last year as a result of higher sales in China and inventory restocking by our US motor customers. Earnings of $31 million or $1.01 per share increased significantly from the $9 million or $0.29 a share last year.

First-quarter sales of $367 million at Water Products were up 8% compared with the first quarter last year. A significant increase in China water heater sales and higher sales in Canada drove the increase in overall sales. At Electrical Products first-quarter sales of $158 million increase 10% compared with the same period in 2009. Global demand for our motors was higher and many of our North American OEM customers restocked depleted inventories ahead of the summer selling season.

Now let's talk about operating profits. At Water Products first-quarter operating profit increased by over 50% to $44 million from the $29 million reported in the first quarter of 2009. Volume increases in higher margin China water heater sales and lower operating and raw material costs contributed to higher profits. As a result operating margins expanded to 12%.

Electrical Products earned $14 million in the first quarter, a significant improvement from the loss recorded last year. Higher volumes, lower operating costs and global cost reduction activities contributed to the significant improvement in performance. Electrical Products' operating margins improved to 9.1%.

Higher working capital needed to support the increase in sales in both businesses drove negative operating cash flow of $13 million for the quarter. That being said, cash cycle days were down to 53 days; this was an improvement of over 20 days from a year ago and resulted primarily from fewer inventory days and improved vendor terms at both businesses. We're projecting operating cash flow in 2010 to be about $115 million to $125 million.

Primarily as a result of our investment in working capital, our debt levels increased by $33 million from the in the last year and our debt to total capital ratio rose to 26% from 24%. Capital spending in the quarter was about $10 million and it is expected to range between $65 million and $75 million in 2010. Depreciation and amortization is expected to total approximately $70 million.

Paul will present a few more details about our outlook and then we will open the call up for your questions. Paul?

Well, thank you, Terry. In addition to the record profitability in the first quarter, we also recently achieved several exciting milestones, our green product technology initiatives. At Water Products we launched four new energy efficient water heater product lines earlier this month. This is the largest new product launch for Water Products in our history. Several offer renewable energy technologies including solar and heat pump water heaters and the remainder set net efficiency standards for natural gas and hybrid and instantaneous water heaters.

Earlier this year our electric motor group secured several HVAC accounts to supply energy efficient variable speed motors beginning in 2010. These wins to supply variable speed motors for HVAC applications are preceded by variable speed motor supply contracts with our leisure pool and spa pump OEMs. All of these new energy efficient products will qualify for a combination of federal tax credits and local and utility energy rebates.

As we look ahead the real spoiler for the remainder of the year could be raw material price volatility. This chart shows the quarterly average of CRU steel prices. As many of you know, our steel prices are derived from an index based on a lag. A simple way to think about it, although it is not exact, is the average in the first quarter of this year will largely determine our costs in the second quarter. And the April 2010 data point is a precursor to our third-quarter cost.

Looking at this chart you can see the dramatic inflection point that we will experience in the second quarter of this year. Our year-over-year comparisons for steel costs will change from favorable to unfavorable. This will squeeze margins going forward.

So while we set an earnings record in the first quarter and had some great momentum in Asia, we are cautious about 2010. Earning guidance for the year is projected to be $3.20 per share to $3.40 per share. We welcome your questions and ask our operator to open the lines at this time. Nick, do you want to go ahead and open it up for questions?

(Operator Instructions). Matt Summerville, KeyBanc.

Hey, good morning, guys. This is actually Joe on for Matt today. Obviously you had some absorption benefit from inventory build in the quarter, was that mostly related to motors? And do you expect that to continue into the second quarter given your comments in the release that you expect improvement in the motor business later in the year?

Yes, it was primarily in motors. And it was a very small amount, but there was a little bit of absorption in there.

Okay. And so do you expect to build inventory in the second quarter as well?

I think our inventories will probably level off. Just to remind you, we put in a new operating system there and we still think we have improvements in inventory. We made some dramatic improvements last year. And the first quarter is typically a cash using quarter for us. If you look historically, we historically use a lot more cash than we did this quarter. So the operating system is helping us manage our inventories better. And I would not say that we're going to have absorption in every quarter through the rest of the year. I don't think that will happen.

Okay. And then in China, how much of that year-over-year growth in China water was attributed to water heater sales growth versus revenue from Tianlong that you didn't have last year, or --?

It was mostly water heater. Obviously the Tianlong is kicking in for the first quarter. But it was a fairly small amount.

Okay. And then I'll just -- one more on raw materials. Do you have any raw material protection built into your large retail contracts, either pass-throughs or some degree of variable pricing? Or is it a fixed-price arrangement similar to historical precedent?

We do have escalation clauses and de-escalation clauses with our major retail customers.

Okay. Great, thanks a lot.

Ned Borland, Hudson Securities.

Good morning, guys, great quarter. I think I want to delve into the first quarter and just sort of the volume trends that you saw and the end markets here -- commercial, China, and why would it not follow a typical seasonal pattern? Generally the second quarter and third quarter are much stronger.

Well, we did have -- inventories in the supply-chain from us to the end customer where at all-time low levels at the end of the year. So we thought we would have some increase in stocking by our OEMs as well as our distribution customers. I can tell you that the distribution piece of it on the motor side has had an incredibly strong start to the year. As you know, that's been an area that we've put a lot of time and effort in over the last several years to pick up new lines with our major distribution partners.

We've had very good success there, the partnerships are very strong, we get very high marks for how well we're serving those distribution customers and their businesses appear to be picking up. I'm not ready to say that we're seeing a trend where we're still seeing more repair of HVAC by the homeowners versus replacement of a unit. Although we're certainly seeing evidence that there might be more of that than we thought there would be.

Okay. Because if I look at the cost reduction activity that you've pulled off in motors it would seem that margins could still stay at an elevated level ex raw materials, correct?

Correct. That's why we did all that work over several years.

Right, okay. So are there any -- with regard to the launched products are there any launch costs that happened in the first quarter that are not likely to occur going forward? Or are there other launch costs to think about going forward?

Well, we've had -- these are all the results of several years of product development. We've already incurred all those costs to develop the products. We did -- I think our marketing folks did a first-class job of introducing the product. We had a very nice introduction kit that went out to our major customers and we've already incurred all those costs.

Okay. And then on India, it looks like production starts -- I think it was this month or next month?

As we speak we are producing product there.

So, how is this likely to ramp? Is it going to be -- are you going to be adding it in -- I mean, how quickly are things going to ramp up there?

Well, we think it's going to ramp up fairly quickly, a lot faster than China did in the early days with China. We rocked along the first five years we went into China between $3 million and $5 million a year, we actually had a couple of down years. We did $6 million or so in India last year. It's going to be substantially up from that this year we believe. And we're off to a good start. We're running ahead of what our original projection was for India sales.

That being said, Ned, we're still not projecting that it will be an income producer this year. It might, but it's probably going to be right around break even. The big pay off from India will come in subsequent years.

Okay, thank you.

Mike Halloran, Robert W. Baird.

Good morning. When you think about sustainable margin levels for both the water side as well as the motor side, could you talk a little bit about what you see there at the current volume levels?

Well, for years we've been saying 12% plus at water and 10% at motors. I think when we were saying that we were anticipating a stronger market than we currently have and we do not have -- everybody knows we do not have a robust housing market in North America yet. And that's probably not going to happen for another couple years. But I think all of the cost reduction efforts that we've done have certainly allowed us to get through the storm of the so-called great recession and weather that storm very well.

And right now our focus is on growth. We get volume growth it's going to have a pretty good conversion rate to the bottom line. So we're still standing by those numbers; time will tell whether we're able to do it or not. But it's certainly -- we feel pretty good that we've got the current operating profit levels at, frankly, topline numbers that we didn't think we'd see. But it's a reality of the marketplace and we're still turning in some pretty good earnings numbers.

On the raw material side, could you talk -- I know the slide highlighted the trend line there and how the inflationary impacts and the commodity prices are trending. But could you talk a little bit about your ability to offset that, whether through pricing increases or through some of these index adjustments that you mentioned earlier with one of the large retailers out there? How much of that are you guys going to be able to capture?

Well, we do have indices on some of the retail customers on the Water Products side, and essentially all the OEMs on the motor side. For the wholesaler, which is about half our marketplace for water heaters and the growing distribution element; for motors that's one where it would take a price increase to offset these costs.

Could you talk a little bit about the pricing environment on that side?

I'd rather not. We're too concentrated in industry and all I'll ask you to do is just look back, when our costs have moved up in the past we've been able to report decent margins during those time periods by doing what we had to do.

Fair enough. And then on the inventory replenishment side, could you just give a little bit more color there about which end markets on the motor side you're seeing some of that replenishment of inventory? And I guess a little bit on the sustainability of that.

Well, it's kind of back to what it used to be, Mike. Historically the first quarter and into the second quarter the HVAC and the pump OEMs would build up their inventories so that when the summer months came and people turned on their swimming pools and turned on their air conditioners some of those motors are going to fail and they would be ready to replace them right away.

As I reported a year ago, a lot of our customers -- almost all of them -- just said they weren't going to build inventory because a year ago they weren't even sure they were going to get access to their bank lines of credit at this time. So last year we went into the year without replacement inventory and some of you've heard the story -- I had an air-conditioning unit at my house that went out and it was 11 days before I got it replaced. In years past it would have been replaced that day or the next day.

So this year we're seeing the distribution -- this is the Johnstone Supply's, WW Grainger's, South Central Pool -- the distribution piece as well as the OEMs in both pump and HVAC are putting in -- I'm not going to say normal inventory builds into the -- as we go into the summer months, but it's certainly above what it was last year.

So I guess then it seems what you're saying is that the sequential build or a normal sequential build from first quarter to second quarter is inventory replenishment -- it doesn't take away from your ability to have that normal sequential build. If anything it seems like you're seeing more of a normalized pattern?

We are seeing a normalized pattern. Last year, if you remember, our motor business had a very strong third quarter that was primarily driven by all the replacements that happened in the summer months that in normal years we would have shipped those motors in the first and second quarter; they got shipped in the second and third quarter last year because there was not the first quarter build. That's not that big of a deal, but it's just something that we're monitoring as we go forward.

I appreciate the time, thanks.

Thank you, Mike.

Scott Graham, Ladenburg Thalmann.

Good morning. Hey, I want to put this raw materials thing to rest here because I know on the copper side you guys are pretty locked down there with a combination of hedging, escalator clauses -- I know you have exposure to spot, but copper seems to be behaving a little bit better and certainly didn't mention it on the call and I think I understand why there's more -- there's less variability there, right now at least.

On the steel side, obviously that's a point of concern, particularly for Water Products. And I'm just -- I know you're not going to answer, Paul, the question about pricing and the ability to get pricing from wholesale customers. But if we parse this up into two big pieces, you've got retailers and you've got wholesalers, right, in the US.

And I guess what I'm thinking here is that with the retailers, particularly a large customer that I thank you serve, you have a contract that I think is a win-win for both, both on the escalator and de-escalator. And on the wholesale side you guys are the big gorilla in the room.

And so it seems to me as we've -- you know I've been with the story for a while -- you've always been able to get price increases really in all circumstances. So isn't this more of a matter of just shifting the timing of earnings as opposed to a reduction in earnings? Is that a fair characterization, Paul?

Well, I would like to think so, Scott. In years past, you're right, that's why I keep referring back to just look at how we've performed. The reason we're probably making a big deal out of the steel escalation, it's been going up $15 a week since last October/November. And I don't think that can continue.

But obviously if it does, and even being at the levels it is, it puts a squeeze on margins and we owe it to our -- to the people that own our stock, the owners of our company, to let you know that that's something that we're monitoring closely, we're watching it closely and we're going to do what we need to do to try to make sure that we meet our commitments to our shareholders this year.

Fair. Okay, thank you. Two other questions, maybe on the more positive side of things. So, you've won some new contracts with ECM and I'm just wondering have they started to ship, or is that something that you'd be able to talk maybe -- can you quantify any of that?

Yes, it is starting but it's at a very, very low level. That market -- we have a competitor that's essentially been clearly the lead in that market. And they shipped probably a couple million units last year. We're just getting started. I like the future, but yes, we have started shipping a few units, we have a lot on test and we have a lot that we're tooling up for that we will be going into higher production on as this year rolls out.

The typical win there, Scott, it like takes three years to ramp up to where we're at the supplier level that we have reached agreements with with the customers. But the good news is we've got some wins, the product is performing well and we're excited about the future.

Good. Okay, last question. If you were to look at the order book -- however it is you want to talk about that, sales trends, what have you, because I know you're very short cycle -- today versus maybe a month or two ago, can you characterize residential versus commercial for us here in North America? Is residential still improving? Commercial not as bad as it could've been? That was kind of your tone about a month and a half, two months ago. Could you kind of bring us forward onto today?

Well, residential is still weak, although we're seeing maybe some positive trends. I think a year and a half ago -- Scott knows with you -- that I thought it was going to be flat all year long. Some people are predicting an uptick later in the year. I maybe moved a notch up on that. Maybe we will see a little bit of an uptick this year, it remains to be seen on residential.

But it's not going to be a big deal, it's just going to be a slight uptick and it will certainly be positive. And I agree with what you said on the commercial, the commercial markets still appear to be declining, but we've seen some strength in the replacement that we didn't anticipate. And we're seeing stronger business in the commercial side than we thought we'd see.

Excellent. Well, thank you, the three of you, very much and please say hi to Craig.

We will. Thank you. Nick, are there any more questions?

At this time there are no further questions in queue.

Okay. Well, we're going to get back to work. Thanks, everybody, for your interest in the Company and, as always, call us anytime with any questions. Nick, do you want to tell them how to get the replay?

Certainly. Today's conference will be recorded for replay and available. You may dial the AT&T replay service at 1-800-475-6701 and enter the access code of 153-354. The number again is 1-800-475-6701 with an access code of 153-354 and international callers may use 320-365-3844. Any further closing comments?

No, just thanks, everyone, for their time and attention.

Thank you, everyone, you may now disconnect.