A. O. Smith Corporation — Q1 2022 Form 10-Q
Reporting period: Three months ended March 31, 2022; comparisons are with the three months ended March 31, 2021 unless otherwise noted. A. O. Smith manufactures residential and commercial water heaters, boilers, tanks, and water treatment products. Its reporting segments are North America and Rest of World, primarily China, Europe, and India.
Financial performance
| Metric | Q1 2022 | Q1 2021 |
|---|---|---|
| Net sales | $977.7 million | $769.0 million |
| Gross profit / margin | $341.6 million / 34.9% | $288.6 million / 37.5% |
| Net earnings | $119.8 million | $97.7 million |
| Diluted EPS | $0.76 | $0.60 |
| Operating cash flow | $16.5 million | $104.4 million |
| Free cash flow (non-GAAP) | $3.6 million | $87.3 million |
- Sales increased 27.1%, driven mainly by North American pricing and higher China sales; the Giant acquisition contributed $32.0 million of sales and approximately $0.02 of EPS.
- Gross margin declined 2.6 percentage points as steel and other material costs rose faster than pricing actions. SG&A was $179.8 million, up $13.3 million, primarily due to higher North American selling costs. Other expense was $3.7 million, versus $5.0 million of other income a year earlier, reflecting a shift from pension income to pension expense.
- North America sales were $730.1 million, up from $552.9 million; segment earnings were $151.8 million and segment margin was 20.8%, compared with $130.4 million and 23.6%. Rest of World sales were $256.0 million, up from $222.3 million; segment earnings were $24.8 million and margin was 9.7%, compared with $11.8 million and 5.3%.
- Adjusted diluted EPS, a non-GAAP measure excluding pension expense or income, was $0.77 versus $0.59.
Liquidity and capital
- At March 31, 2022, cash and cash equivalents were $405.8 million and marketable securities were $173.6 million. Total debt was $295.4 million, including $288.6 million of long-term debt and $6.8 million due within one year. Total debt increased $98.7 million from year-end, primarily to fund share repurchases.
- Working capital was $719.3 million, versus $633.8 million at December 31, 2021. Cash from operations fell to $16.5 million, as higher incentive payments and working-capital investment—particularly inventory—more than offset higher earnings.
- The $500 million revolving credit facility expires April 1, 2026; $155.0 million was outstanding and $345.0 million of capacity remained. The company reported compliance with its leverage and interest-coverage covenants. Debt to total capitalization, excluding operating lease liabilities, was 14.0%, versus 9.7% at year-end.
- Q1 capital expenditures were $12.9 million. The company repurchased 1,486,500 shares for $107.9 million and expects approximately $400 million of repurchases in 2022. It expects to repatriate approximately $100 million during 2022 for debt repayment and repurchases.
Outlook, risks, and notable items
- 2022 guidance: consolidated sales growth of 14%–16%; GAAP EPS of $1.56–$1.76; adjusted EPS of $3.35–$3.55; and free cash flow of $500–$525 million. Guidance excludes future acquisitions and assumes China COVID-related lockdowns subside during Q2 and COVID-19 does not significantly disrupt operations or stakeholders.
- Management expects 2022 North America segment margin of 22.5%–23.0%, excluding pension expense, and Rest of World margin of 9.5%–10%. It forecasts residential water heater industry volumes in North America down approximately 2%, commercial volumes flat to slightly down, boiler sales up 18%–20%, and water treatment sales up 13%–14%. China sales are expected to be flat in local currency.
- The planned termination and settlement of the company’s largest defined-benefit pension plan, representing over 95% of pension liabilities, is expected in Q4 2022. Management estimates approximately $445 million of non-cash, pre-tax pension expense, or about $1.73 per share. The 2022 GAAP and adjusted EPS guidance differ substantially because adjusted EPS excludes pension settlement and non-operating pension items.
- Management cited supply constraints, logistics bottlenecks, volatile steel and commodity costs, Omicron-related absenteeism, and China lockdowns. The Ukraine conflict could further disrupt supply, commodity and energy markets, currencies, trade, or demand; the company reported no current expectation of a direct material adverse effect, but escalation could change that assessment.
- A contingent China distributor-financing arrangement could require inventory repurchases if specified conditions are met; the gross amount contingent on default of all outstanding loans was approximately $6.8 million at quarter-end, before specified offsets. Estimated loss reserves were immaterial.
- The company reported no material changes to previously disclosed legal proceedings or most risk factors. Disclosure controls were assessed as effective at quarter-end.
Investor verification priorities
- Track whether pricing continues to offset material, freight, and logistics inflation, and whether gross and segment margins recover.
- Verify delivery of sales, EPS, and free-cash-flow guidance against China lockdown conditions, regional demand, and supply-chain availability.
- Assess the timing, final accounting, and cash or funding implications of the expected pension-plan settlement and the distinction between GAAP and adjusted EPS.
- Monitor debt and liquidity alongside planned repurchases, including the remaining revolver capacity and the expected use of repatriated cash.
- Review developments in the Ukraine conflict, COVID-19 disruption, commodity costs, and the contingent China inventory repurchase exposure.