A. O. Smith Corporation — Q2 2022 Form 10-Q
Reporting period: Three and six months ended June 30, 2022. Figures are unaudited and in U.S. dollars unless noted. The company manufactures water heaters, boilers, tanks and water-treatment products; its reporting segments are North America and Rest of World, primarily China, Europe and India.
Financial results
| Metric | Q2 2022 | Q2 2021 | Six months 2022 | Six months 2021 |
|---|---|---|---|---|
| Net sales | $965.9 million | $859.8 million | $1,943.6 million | $1,628.8 million |
| Gross profit margin | 34.6% | 37.4% | 34.8% | 37.5% |
| Net earnings | $126.2 million | $118.2 million | $246.0 million | $215.9 million |
| Diluted EPS | $0.81 | $0.73 | $1.56 | $1.33 |
Q2 sales rose 12.3%; first-half sales rose about 19%. Price increases and the 2021 Giant acquisition supported growth, while higher steel, materials and logistics costs outpaced pricing and compressed gross margin. Q2 other expense was $0.3 million versus $3.9 million of other income in the prior-year quarter, reflecting in part a shift from pension income to expense.
Cash flow and liquidity: First-half operating cash flow was $54.4 million, down from $196.0 million; free cash flow, a non-GAAP measure, was $23.7 million versus $165.3 million. Higher working-capital outlays, lower China customer deposits and incentive payments offset earnings growth. Cash and cash equivalents were $359.4 million, with another $100.0 million in marketable securities. Working capital was $702.9 million.
Total debt was $298.4 million at June 30, 2022, up from $196.7 million at year-end 2021; debt to total capitalization increased to 14.3% from 9.7%. The company had $160.0 million outstanding under its $500 million revolving facility and $340.0 million available; it reported compliance with its covenants. First-half capital expenditures were $30.7 million. The company repurchased $190.4 million of stock and paid $87.9 million in dividends.
Segments and material changes
- North America: Q2 sales were $744.1 million, up from $603.6 million; segment earnings were $159.9 million versus $141.7 million. Margin fell to 21.5% from 23.5%, mainly as higher input, logistics and production costs outpaced pricing. Giant contributed about $30.8 million of Q2 sales and $62.8 million in the first half.
- Rest of World: Q2 sales were $229.9 million, down from $263.2 million, and segment earnings were $18.1 million versus $22.3 million. China sales fell 14% in local currency, largely amid COVID-related lockdowns; currency depreciation reduced Q2 sales by approximately $5 million. First-half segment sales were essentially flat year over year, while earnings rose to $42.9 million from $34.1 million.
- North America pricing actions implemented in 2021 cumulatively increased water-heater prices by approximately 50%. The company acquired a privately held water-treatment business in Q2 for $5.5 million, net of cash acquired.
Outlook, commentary and risks
Management forecast 2022 consolidated sales growth of 12%–14%, including approximately $100 million of incremental Giant sales. Full-year diluted GAAP EPS guidance was $1.56–$1.76; adjusted EPS guidance was $3.35–$3.55. The difference reflects an expected approximately $445 million non-cash, pre-tax pension settlement charge, or about $1.73 per share, expected in Q4 2022. Adjusted measures exclude pension settlement and non-operating pension items. Management also forecast free cash flow of $450–$500 million, North America adjusted segment margin of 22.5%–23.0%, and Rest of World segment margin of 9.5%–10.0%.
Management expected North American residential water-heater industry volumes to decline 4%–6% and commercial volumes 7%–9% in 2022; it expected boiler sales to rise about 25% and water-treatment sales, including acquisitions, about 15%. China sales were expected to be flat in local currency. Outlook depends on China COVID restrictions subsiding in the second half and assumes no significant COVID-related impact on operations, employees, customers or suppliers. The filing also notes ongoing supply constraints, logistics bottlenecks, volatile commodity costs and softness in residential water-heater orders as customers adjusted inventories.
Risks include further China lockdowns, inability to obtain materials or maintain pricing, weaker demand, currency movements, acquisition integration, and geopolitical disruption. The filing added discussion of potential indirect effects from the Ukraine conflict, including trade restrictions, cyberattacks, supply disruption and commodity volatility. A China distributor-financing arrangement could require inventory repurchases if specified conditions occur; the gross contingent amount was approximately $3.5 million, before resale proceeds, rebates and provider indemnification, and estimated loss reserves were immaterial. The company reported no material changes in legal proceedings and said disclosure controls were effective.
Important facts for investors to verify
- Whether pricing continues to offset elevated material, logistics and production costs, and whether margins recover.
- Whether China demand and sales meet the outlook as COVID restrictions, currency movements and consumer conditions evolve.
- The timing and final accounting impact of the expected Q4 pension settlement, including the distinction between GAAP and adjusted EPS guidance.
- Whether operating cash flow and free cash flow recover from the first-half working-capital-related decline.
- Debt, share repurchases and liquidity needs: the company expected about $400 million of 2022 repurchases, subject to business conditions and alternative investment opportunities.