A. O. Smith Corporation — FY2022 Form 10-K
Reporting period: Fiscal year ended December 31, 2022. A. O. Smith manufactures water heaters, boilers and water-treatment products through its North America and Rest of World segments.
Financial performance
| Metric | 2022 | 2021 |
|---|---|---|
| Net sales | $3,753.9 million | $3,538.9 million |
| Gross profit / margin | $1,329.6 million / 35.4% | $1,310.9 million / 37.0% |
| Net earnings | $235.7 million | $487.1 million |
| Diluted EPS | $1.51 | $3.02 |
| Adjusted earnings / adjusted diluted EPS (non-GAAP) | $488.7 million / $3.14 | $477.3 million / $2.96 |
| Cash from operating activities | $391.4 million | $641.1 million |
| Free cash flow (non-GAAP) | $321.1 million | $566.0 million |
| Cash and marketable securities at year-end | $481.8 million | $631.4 million |
| Total debt at year-end | $344.5 million | $196.7 million |
Sales rose 6.1%, driven mainly by inflation-related pricing and $94.3 million of incremental sales from Giant, acquired in October 2021. Higher steel and other input costs and production inefficiencies outpaced pricing benefits, lowering gross margin. Operating cash flow fell primarily due to lower customer deposits in China, incentive payments and working-capital outlays.
North America sales increased to $2,819.1 million from $2,529.5 million. Reported segment earnings were $266.0 million, including $346.8 million of pension settlement expense; adjusted segment earnings were $611.0 million and adjusted margin was 21.7%. Rest of World sales decreased to $965.8 million from $1,036.5 million, while segment earnings increased to $96.3 million and margin rose to 10.0%. China sales were affected by COVID-19 disruptions; India sales increased 28% in local currency.
Year-end working capital was $699.5 million, versus $633.8 million. The company had $208 million outstanding under its revolving facility and $292 million of available capacity. Debt-to-total-capitalization was 16.5%, compared with 9.7%. The company repurchased $403.5 million of stock and paid $1.14 per share in dividends during 2022.
Material changes and unusual items
- In the fourth quarter, termination and settlement of the defined-benefit pension plan generated $417.3 million of pretax expense, partly offset by $167.7 million of tax benefits. The plan liabilities were settled through lump-sum payments and annuity purchases; the insurer’s future payments for covered beneficiaries began March 1, 2023.
- The company reported $11.5 million of pretax income from a patent-infringement judgment against a competitor and $4.3 million of expenses related to a terminated acquisition.
- The 2022 effective tax rate was a benefit of 5.4%, mainly reflecting pension-settlement tax effects. Management estimated a 2023 full-year effective tax rate of approximately 24%.
- The company acquired a privately held water-treatment business for $5.5 million in 2022. Giant contributed $94.3 million of incremental 2022 sales.
Outlook, risks and contingencies
Management projected 2023 consolidated sales approximately flat with 2022, within plus or minus 3%, and diluted EPS of $3.15–$3.45. It forecast free cash flow of $550–$600 million, capital expenditures of $70–$75 million, North America segment margin of approximately 23%, and Rest of World margin of approximately 10%. The outlook assumes China’s COVID-related impacts improve in the second half of 2023 and excludes potential acquisitions. Management expected China sales to grow 3–5% in local currency, North America residential water-heater industry volumes to decline 2–5%, and North America boiler sales to increase 10–12%.
- Principal risks include economic weakness and inflation, volatile steel and logistics costs, supply interruptions, competition, changing energy-efficiency and decarbonization regulation, currency movements, and demand disruptions in China. China represented approximately 22% of 2022 sales; approximately 34% of sales were outside the U.S.
- The five largest customers represented approximately 39% of 2022 sales. The company also cited construction-market exposure, cybersecurity threats, product defects and warranty claims, and risks associated with acquisitions.
- Product warranty reserves were $182.5 million; product-liability reserves were $31.7 million. The filing describes ordinary-course legal and environmental matters and states management believes they will not materially affect financial position or results. Firm purchase obligations were $211.4 million, mostly expected to be ordered in 2023.
- At year-end, $472.1 million of cash and marketable securities was held by foreign subsidiaries, principally in China. Currency movements reduced 2022 sales by approximately $61 million.
Ernst & Young issued unqualified opinions on the financial statements and internal control over financial reporting. The auditor identified valuation of product warranty liability as a critical audit matter. Management reported effective disclosure controls and internal control over financial reporting.
Key facts for investors to verify
- Reconcile GAAP net earnings and EPS to adjusted figures, with particular attention to the pension settlement and the company’s non-GAAP exclusions.
- Assess whether input-cost recovery, production efficiency and pricing can support the projected 2023 margins and earnings range.
- Track China demand, currency translation and the timing and pace of the projected sales recovery.
- Review operating cash conversion, inventory and customer-deposit trends against the $550–$600 million free-cash-flow outlook.
- Monitor debt, share repurchases and dividends, including management’s stated intention to repurchase approximately $200 million of stock in 2023.
- Evaluate customer concentration, warranty exposure and the company’s ability to manage regulatory shifts toward electrification and decarbonization.