A. O. Smith Corporation — Q3 2023 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2023. The company 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. Amounts below are in U.S. dollars; financial statements are unaudited.
Financial performance
| Metric | Q3 2023 | Q3 2022 | Nine months 2023 | Nine months 2022 |
|---|---|---|---|---|
| Net sales | $937.5 million | $874.2 million | $2,864.7 million | $2,817.8 million |
| Gross profit | $356.2 million | $305.0 million | $1,115.0 million | $981.0 million |
| Gross margin | 38.0% | 34.9% | 38.9% | 34.8% |
| Net earnings | $135.4 million | $109.8 million | $419.3 million | $355.8 million |
| Diluted EPS | $0.90 | $0.71 | $2.77 | $2.27 |
Q3 sales rose 7.2% year over year and net earnings rose about 23%. For the first nine months, sales increased about 1.7% and net earnings about 18%. Management attributed improved gross margins mainly to lower material costs. Higher employee and incentive compensation contributed to increased SG&A expense.
- Segments: Q3 North America sales were $709.9 million, up from $652.9 million; segment earnings were $170.0 million versus $141.8 million, with margin of 23.9% versus 21.7%. Rest of World sales were $233.4 million versus $230.2 million; earnings were $23.2 million versus $21.8 million, with margin of 9.9% versus 9.5%.
- For the first nine months, North America sales were $2,184.9 million and segment earnings $557.7 million. Rest of World sales were $696.7 million and segment earnings $56.8 million. Rest of World earnings included a $12.5 million Turkey-sale impairment.
- Cash flow: Nine-month operating cash flow was $439.0 million, versus $214.7 million; capital expenditures were $42.7 million, versus $50.9 million. Free cash flow, a non-GAAP measure defined as operating cash flow less capital expenditures, was $396.3 million, versus $163.8 million.
- Liquidity and debt: September 30 cash and marketable securities totaled $341.8 million, compared with $481.8 million at December 31, 2022. Total debt was $129.6 million, down from $344.5 million; leverage as a share of total capitalization was 6.4%, versus 16.5%. Working capital was $608.9 million, versus $699.5 million. The $500 million revolving facility had no borrowings outstanding, and the company reported covenant compliance.
- Capital returns: The company repurchased 2.388 million shares for $161.4 million in the first nine months and expected approximately $300 million of repurchases for full-year 2023. It paid $135.7 million in dividends during the period. The board declared a quarterly dividend of $0.32 per share payable in November.
Material changes and unusual items
- North America water heater volumes supported growth; boiler sales were lower. The company cited approximately $13 million of unfavorable currency impact on Q3 sales and approximately $53 million for the first nine months.
- Rest of World first-nine-month sales were down year over year, including an approximately $42 million unfavorable currency impact. China’s economy and consumer confidence remained challenged.
- The company sold its Turkey business in April 2023. It recorded a $15.6 million first-quarter impairment and released $11.0 million of accumulated foreign-currency translation losses upon the sale.
- Nine-month results included $6.0 million of pension settlement income. Other expense/income, net was $10.5 million of income for the period, compared with $6.4 million of expense in 2022. Interest expense rose to $10.9 million from $6.0 million, primarily due to higher debt levels and interest rates.
- Q3 2022 included an $11.5 million patent judgment benefit and $4.3 million of terminated-acquisition costs. Management presents adjusted, non-GAAP results that exclude specified unusual items; these should be considered alongside GAAP results.
Outlook, commentary and risks
Management expected 2023 consolidated sales to increase about 2% from 2022, with GAAP diluted EPS of $3.63–$3.73 and adjusted EPS of $3.70–$3.80. It projected operating cash flow of $640–$665 million, free cash flow of $575–$600 million, capital expenditures of approximately $65 million, and depreciation and amortization of approximately $70 million. Segment margin expectations were approximately 25% for North America and 9% for Rest of World, or approximately 10% adjusted for the Turkey impairment. The company expected residential water heater industry volumes to grow about 4%, commercial water heater volumes to increase in the mid-teens, and North America water treatment sales to rise about 5–7%; it reduced its boiler sales outlook to a high-single-digit decline. China sales were projected to grow 3–5% in local currency, with currency translation expected to reduce sales by about 6%.
Management cited supply-chain constraints, inflation or recession, weaker U.S. housing and replacement markets, Chinese economic weakness, foreign-exchange movements, tariffs and geopolitical events, commodity availability and cost, competition, customer credit risk, acquisition execution, cybersecurity, regulation, and the shift toward decarbonization and energy efficiency as factors that could cause actual results to differ from expectations. The company said available cash, credit facilities and operating cash flows should meet foreseeable needs. It reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether full-year sales, EPS, cash-flow and segment-margin guidance was achieved, and how actual results compared with the stated ranges.
- Whether lower material costs, pricing and product volumes continued to support margins, particularly amid the revised boiler outlook.
- China demand, currency effects, and the performance and profitability of the Rest of World segment after the Turkey divestiture.
- Cash conversion and working-capital trends, debt repayment, and the scale and timing of share repurchases relative to investment needs.
- Potential exposure under China distributor inventory-repurchase arrangements: gross contingent repurchases were approximately $1.7 million before estimated resale proceeds and related rebate reductions; reserves were immaterial.