Commission File Number 1-475
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 ___
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act) Yes X No ___
Class A Common Stock Outstanding as of September 30, 2004 -- 8,491,906 shares
Common Stock Outstanding as of September 30, 2004 -- 20,995,654 shares
Exhibit Index Page 16
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ITEM 1--FINANCIAL STATEMENTS
A.O. SMITH CORPORATIONCONDENSED CONSOLIDATED STATEMENT OF EARNINGSThree and Nine Months ended September 30, 2004 and 2003(dollars in millions, except for per share data)(unaudited)
See accompanying notes to unaudited condensed consolidated financial statements.
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A.O. SMITH CORPORATIONCONDENSED CONSOLIDATED BALANCE SHEETSSeptember 30, 2004 and December 31, 2003(dollars in millions)
See accompanying notes to unaudited condensed consolidated financial statements
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A.O. SMITH CORPORATIONCONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS Nine Months Ended September 30, 2004 and 2003 (dollars in millions)(unaudited)
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ITEM 2 —MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Sales were $389.9 million in the third quarter of 2004, or 9.4 percent higher than in last year’s third quarter. Sales for the first nine months of the year were $1.24 billion or 7.0 percent higher than sales of $1.16 billion in the same period last year. The increase in third quarter and year-to-date sales was due primarily to higher prices related to the introduction of new regulatory-mandated water heaters, price increases related to increases in raw material costs, higher sales of electric motors and continued strong performance in our Chinese water heater operation.
Our gross profit margin for the third quarter of 2004 declined to 15.9 percent from 17.3 percent in the third quarter of 2003. Our year-to-date gross margin in 2004 was 18.4 percent compared with 19.2 percent in the same period in 2003. For the quarter and year-to-date, the decline in gross profit margin is in Water Systems and is primarily due to increased freight and material costs, partially offset by price increases and higher margins on new products.
Selling, general and administrative expenses in the third quarter and first nine months of 2004 were higher than the same periods in 2003 by $8.6 million and $20.5 million, respectively. The increases resulted primarily from higher selling and advertising costs at Water Systems, higher corporate expense and lower pension income. Also, the increase for the nine months is offset by a $3.3 million non-recurring favorable adjustment in our Water Systems segment which was recorded in the second quarter of 2004 and resulted from the reversal of a reserve established at the time of the State Industries acquisition.
Interest expense was $3.3 million in the third quarter or $.2 million higher than the same quarter last year due to higher interest rates. Interest expense for the first nine months of 2004 was $.6 million higher than the comparable period in 2003 due primarily to incremental interest on $50.0 million of senior notes issued in June 2003 to repay commercial paper.
We have significant pension benefit costs and credits that are developed from actuarial valuations. The valuations reflect key assumptions regarding, among other things, discount rates, expected return on assets, retirement ages, and years of service. Consideration is given to current market conditions, including changes in interest rates in making these assumptions. Our assumptions for the expected rate of return on pension plan assets is 9.0 percent in 2004, unchanged from 2003. The discount rate used to determine net periodic pension costs and credits decreased from 6.75 percent in 2003 to 6.25 percent in 2004. Pension income recognized in the third quarter and first nine months of 2004 was $1.5 million and $4.5 million, respectively, and compared with $2.9 million and $8.7 million in the comparable periods of 2003. Total pension income for 2004 is projected to be $6.0 million. Our pension income is reflected as reductions to cost of products sold and selling, general and administrative expense.
Our year-to-date 2004 effective tax rate was reduced from 33.5 percent to 28 percent as of September month end. The reduction was due to lower forecasted domestic earnings resulting in a larger portion of our earnings being concentrated in our foreign operations where the income tax rates are lower. The resulting year-to-date favorable adjustment amounted to $2.3 million and is reflected in the third quarter tax credit.
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Net earnings for the third quarter of 2004 were $3.0 million or $.10 per share with $2.3 million or $.08 per share being attributable to the aforementioned tax rate adjustment. Net earnings for the third quarter of 2003 were $6.0 million or $.20 per share. Year-to-date earnings were $31.0 million or $1.04 per share and compare to nine month earnings of $39.6 million or $1.33 per share in 2003. The decline in earnings for both the third quarter and first nine months is due mostly to higher costs for freight and raw materials and operating inefficiencies which more than offset the positive impact of our product repositioning programs and new product introductions.
Electrical Products
Third quarter sales for our Electrical Products segment were $215.9 million, or $14.7 million higher than the third quarter of 2003. Third quarter sales to the pump, ventilation, general industries and Asian markets all increased by more than 15 percent while sales to the heating and air conditioning market were flat. Year-to-date sales for this segment increased by 3.9 percent from $641.9 million in 2003 to $667.1 million in 2004.
Operating earnings for our Electrical Products segment in the third quarter increased to $12.6 million from $9.6 million in the third quarter of 2003. The increase resulted from contribution from the higher sales and savings from the product repositioning program partially offset by higher raw material and freight costs. Earnings for the first nine months of 2004 were $47.1 million or $1.2 million higher than the same period last year.
Water Systems
Third quarter sales for our Water Systems segment were $174.0 million or $18.8 million higher than the third quarter of 2003. Year-to-date sales increased by 10.9 percent to $576.6 million in 2004. The sales increase in both the third quarter and first nine months was due to higher prices associated with new regulatory-mandated product, increased volume for commercial product, continued strong growth in China and price increases related to higher costs for steel and freight.
Our Water Systems segment incurred an operating loss of $2.1 million in the third quarter as compared to earnings of $7.9 million in the same period last year. Operating earnings decreased from $37.7 million in the first nine months of 2003 to $25.4 million in the same period in 2004. The earnings decline in both the third quarter and first nine months resulted from increased steel and freight costs, as well as manufacturing inefficiencies caused by the conversion of residential water heaters to meet new efficiency standards, standardization of the A. O. Smith and State Industries residential product lines, relocation of production between the Ashland City, TN, and McBee, S.C. plants and an information systems conversion. The adverse impact of higher costs for raw material, freight and conversion programs more than offset the benefit of the increase in sales.
As a result of the revised income tax rate, we now project 2004 earnings to range between $1.05 and $1.10 per share.
Throughout the year our businesses have faced cost pressures due to increases in the price of steel, aluminum and other materials, as well as higher freight costs. Several price increases have been implemented in an effort to offset the cost increases. Costs have continued to rise. While our price increases mitigated this impact, they have not covered all of the cost increases. In order to cover these costs, including anticipated increases, we are again implementing significant price increases in both of our business segments, which will take effect in the first quarter of 2005.
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Our working capital, excluding short-term debt, was $353.2 million at September 30, 2004, $47.3 million higher than at December 31, 2003. The majority of the increase in working capital was due to an increase in accounts receivable balances of $36.3 million related to higher sales levels. In addition, higher inventory levels of $14.6 million, primarily made up of higher finished goods at Water Systems, contributed to the higher working capital. Cash provided by operating activities during the first nine months of 2004 was $26.1 million, the same level of cash provided by operating activities through the first nine months last year. As a result of lower expected earnings and higher working capital during the second half of 2004, we now project cash provided by operating activities to be between $60 and $70 million for the full year.
Our capital expenditures during the first nine months of 2004 totaled $29.5 million, compared to $28.1 million spent through the first nine months of 2003. We are projecting 2004 capital expenditures to approximate $45 million, about the same level as 2003 spending. We believe that our present facilities and planned capital expenditures are sufficient to provide adequate capacity for our operations in 2004.
Our total debt increased by $19.5 million from $275.5 million at December 31, 2003 to $295.0 million at September 30, 2004. Our leverage as measured by the ratio of total debt to total capitalization was 33%, up slightly from the 32% at the end of 2003. We did not enter into any significant operating leases during the first nine months of 2004. At September 30, 2004, our company had available borrowing capacity of $147.5 million under our credit facility. We believe that the combination of available borrowing capacity and operating cash flow will provide sufficient funds to finance our existing operations for the foreseeable future.
On October 12, 2004, our board of directors declared a regular quarterly cash dividend of $.16 per share on our Common stock and Class A common stock, which is payable on November 15, 2004 to stockholders of record on October 29, 2004.
Our accounting policies are described in Note 1 of Notes to Consolidated Financial Statements as disclosed in the Form 10-K for the fiscal year ended December 31, 2003. Also as disclosed in Note 1, the preparation of financial statements in conformity with accounting principles generally accepted in the United States requires the use of estimates and assumptions about future events that affect the amounts reported in the financial statements and accompanying notes. Future events and their effects cannot be determined with absolute certainty. Therefore, the determination of estimates requires the exercise of judgment. Actual results inevitably will differ from those estimates, and such differences may be material to the financial statements.
The most significant accounting estimates inherent in the preparation of our financial statements include estimates associated with the evaluation of the impairment of goodwill, as well as the recoverability of receivables resulting from the payment of claims associated with the dip tube class action lawsuit (see Part II, Item I of this report). There are also significant estimates used in the determination of liabilities related to warranty activity, litigation, product liability, environmental matters and pensions and other post-retirement benefits. Various assumptions and other factors underlie the determination of these significant estimates. The process of determining significant estimates is fact-specific and takes into account factors such as historical experience and trends, and in some cases, actuarial techniques. We constantly reevaluate these significant factors and adjustments are made when facts and circumstances dictate. Historically, actual results have not significantly deviated from those determined using the estimates described above.
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ITEM 3 – QUANTITATIVE AND QUALITATIVE DISCLOSURE OF MARKET RISK
As is more fully described in our annual report on Form 10-K for the year ended December 31, 2003, we are exposed to various types of market risks, primarily currency and certain commodities. We monitor our risks in these areas on a continuous basis and generally enter into forward and futures contracts to minimize these exposures for periods of less than one year. Our company does not engage in speculation in our derivative strategies. It is important to note that gains and losses from our forward and futures contract activities are offset by changes in the underlying costs of the transactions being hedged.
ITEM 4 – CONTROLS AND PROCEDURES
The chief executive officer and chief financial officer have evaluated the effectiveness of the company’s disclosure controls and procedures as of September 30, 2004 and have concluded that these disclosure controls and procedures were adequate and effective to ensure that material information relating to the company and its consolidated subsidiaries would be made known to them by others within those entities.
There were no significant changes in our internal controls over financial reporting or in other factors that could significantly affect our disclosure controls and procedures nor were there any significant deficiencies or material weaknesses in our internal controls. As a result, no corrective actions were required or undertaken.
This filing contains statements that we believe are “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements generally can be identified by the use of words such as “may,” “will,” “expect,” “intend,” “estimate,” “anticipate,” “believe,” “continue,” or words of similar meaning. These forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from those anticipated as of the date of this release. Factors that could cause such a variance include the following: instability in our electric motor and water products markets; the inability to generate the synergistic cost savings from the acquisition of State Industries; the inability to implement cost-reduction programs; adverse changes in general economic conditions; significant increases in raw material prices; competitive pressures on our company’s businesses; and the potential that assumptions on which we based our expectations are inaccurate or will prove to be incorrect.
Forward-looking statements included in this filing are made only as of the date of this filing, and our company is under no obligation to update these statements to reflect subsequent events or circumstances. All subsequent written and oral forward-looking statements attributed to A. O. Smith, or persons acting on its behalf, are qualified entirely by these cautionary statements.
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ITEM 1 — LEGAL PROCEEDINGS
There have been no material changes in the legal and environmental matters previously reported in Part I, Item 3 and Note 14 of the Notes to Consolidated Financial Statements in the company’s Annual Report on Form 10-K for the year ended December 31, 2003, and Part II, Item 1 in the company’s quarterly report on Form 10-Q for the quarter ended June 30, 2004, which are incorporated herein by reference.
ITEM 4 — SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 5 — OTHER INFORMATION
ITEM 6 — EXHIBITS AND REPORTS ON FORM 8-K
On July 13, 2004, the Company filed a Current Report on Form 8-K, reporting under Item 5, announcing an increased quarterly dividend and announcing judgment in the dip tube trial. On July 15, 2004, the Company filed a Current Report on Form 8-K, reporting under Items 7 and 12, announcing the Company’s results for the quarter ended June 30, 2004.
On September 14, 2004, the Company filed a Current Report on Form 8-K, reporting under Items 7.01 and 9.01, reducing the Company’s third quarter and full year earnings estimates.
On October 14, 2004, the Company filed a Current Report on Form 8-K, reporting under Items 2.02 and 9.01 announcing the Company’s results for the quarter ended September 30, 2004.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has authorized this report to be signed on its behalf by the undersigned.
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