A. O. Smith Corporation — Q3 2022 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2022. A. O. Smith 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 performance
| Metric | Q3 2022 | Q3 2021 | Nine months 2022 | Nine months 2021 |
|---|---|---|---|---|
| Net sales | $874.2 million | $914.6 million | $2,817.8 million | $2,543.4 million |
| Gross profit / margin | $305.0 million / 34.9% | $340.3 million / 37.2% | $981.0 million / 34.8% | $950.3 million / 37.4% |
| Net earnings | $109.8 million | $131.6 million | $355.8 million | $347.5 million |
| Diluted EPS | $0.71 | $0.82 | $2.27 | $2.15 |
| Adjusted diluted EPS (non-GAAP) | $0.69 | $0.81 | $2.28 | $2.11 |
Q3 sales fell 4.4%, mainly as lower North America residential water-heater volumes outweighed pricing. Nine-month sales rose about 11%, primarily on pricing and the Giant acquisition, partly offset by weaker China sales and lower North America residential volumes. Gross margin declined in both comparisons as higher material costs and production inefficiencies outpaced pricing actions.
- Segments: Q3 North America sales were $652.9 million, down from $658.2 million; earnings were $141.8 million versus $151.8 million. Rest of World sales were $230.2 million versus $263.1 million; earnings were $21.8 million versus $26.8 million. For nine months, North America sales were $2,127.1 million and earnings $453.5 million; Rest of World sales were $716.1 million and earnings $64.7 million.
- Cash flow: Nine-month operating cash flow was $214.7 million, down from $376.8 million; capital expenditures were $50.9 million, resulting in company-defined free cash flow of $163.8 million versus $331.5 million.
- Liquidity and debt: September 30 cash and marketable securities totaled $417.1 million, compared with $631.4 million at year-end 2021. Working capital was $668.7 million. Debt totaled $287.8 million ($6.8 million current and $281.0 million long-term), versus $196.7 million at year-end. The $500 million revolving facility had $152.1 million outstanding and $347.9 million available; the company reported covenant compliance.
- Capital returns: The company repurchased $282.0 million of stock and paid $131.1 million in dividends in the first nine months. It expected approximately $400 million of 2022 repurchases. The quarterly dividend was raised to $0.30 per share after quarter-end.
Outlook, commentary and notable items
- 2022 guidance was consolidated sales growth of 5%–7%, GAAP EPS of $1.29–$1.39 and adjusted EPS of $3.05–$3.15. Adjusted EPS excludes specified items, including the planned pension settlement charge. Free cash flow guidance was $400–$425 million; capital spending guidance was $70–$75 million.
- Management expected North America adjusted segment margin of about 21.5% and Rest of World margin of about 10%. It forecast North America residential water-heater industry volumes down approximately 12%–13%, commercial volumes down about 15%, and China sales flat to slightly down in local currency.
- Management cited persistent supply-chain and logistics constraints, volatile commodity prices, and China COVID-related shutdowns. Guidance assumed China shutdowns remained at then-current levels and did not significantly disrupt operations or stakeholders.
- The company expected to complete termination and annuitization of its largest defined-benefit pension plan in Q4 2022. The settlement was expected to accelerate approximately $445 million of non-cash, pre-tax expense, or about $1.73 per share after tax. This is a significant difference between reported GAAP results and adjusted guidance.
- An $11.5 million patent-infringement judgment against a competitor was recorded as income in Q3; related tax expense was $2.9 million. The company also recorded $4.3 million of costs for a terminated acquisition.
- Currency translation reduced nine-month comprehensive earnings, including a $52.9 million foreign-currency translation loss. Other risks include weaker demand or customer destocking, inflation/recession, supply availability and costs, China conditions, foreign-exchange movements, geopolitical disruption and acquisition integration. The company reported no material change in its market-risk disclosures and no material change in internal control over financial reporting.
Important facts for investors to verify
- Whether residential water-heater demand and customer inventory destocking tracked management’s expectations, and whether pricing can offset input costs.
- Actual pension settlement timing and final charge compared with the estimated $445 million pre-tax amount, including GAAP earnings impact.
- China demand, COVID-related restrictions and currency effects, and their impact on Rest of World sales and margins.
- Cash conversion and inventory levels, debt and available revolving capacity, and the pace of planned share repurchases.
- Whether 2022 sales, EPS and free-cash-flow guidance assumptions were achieved; the filing notes that full-year outcomes were uncertain.