A. O. Smith Corporation — FY2020 Form 10-K
Business context and reporting period. This annual report covers the fiscal year ended December 31, 2020; it is not a standalone fourth-quarter report. A. O. Smith manufactures and sells 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 and liquidity
| Metric | FY2020 | FY2019 | Change |
|---|---|---|---|
| Net sales | $2,895.3 million | $2,992.7 million | Down 3.3% |
| Gross profit / margin | $1,108.2 million / 38.3% | $1,180.7 million / 39.5% | Margin down 1.2 percentage points |
| Net earnings | $344.9 million | $370.0 million | Down 6.8% |
| Diluted EPS | $2.12 | $2.22 | Down 4.5% |
| Operating cash flow | $562.1 million | $456.2 million | Up $105.9 million |
| Capital expenditures | $56.8 million | $64.4 million | Down $7.6 million |
| Total debt | $113.2 million | $284.0 million | Down $170.8 million |
Lower China sales and weaker commercial water-heater and North American boiler sales drove the consolidated revenue decline. Higher North American residential water-heater and water-treatment sales partly offset the declines. Gross margin fell mainly because of lower sales volumes. SG&A decreased to $660.3 million from $715.6 million, largely reflecting lower selling and advertising expense in China. The effective tax rate rose to 22.3% from 21.6%.
- North America: Sales increased 1.7% to $2,118.3 million. Segment earnings were $503.5 million, up from $488.9 million; reported segment margin was 23.8%, versus 23.5%. Water-treatment sales rose 25% to $177.2 million.
- Rest of World: Sales declined 14.5% to $800.3 million. China sales fell 15% in U.S. dollar terms and 16% in local currency. The segment reported breakeven earnings, compared with $40.2 million in 2019; 2020 adjusted segment earnings were $5.0 million after excluding restructuring charges.
Cash and cash equivalents were $573.1 million, with $116.5 million of marketable securities, at year-end. Working capital was $731.7 million. The company had no borrowings under its $500 million revolving credit facility and reported $500 million of available capacity; it was in compliance with its debt covenants. Debt-to-capitalization was 5.8%, excluding operating lease liabilities, versus 14.6% in 2019. Operating cash flow benefited from working-capital movements, including higher payables and customer deposits. The filing reports a pension-plan funded deficit of approximately $11 million.
Material changes, outlook and management commentary
- COVID-19 disrupted Chinese operations early in the year and affected demand and commercial markets. The company said global manufacturing continued without material disruption, but logistics costs and shipment times increased. North American production lead times stabilized in the fourth quarter.
- The company recorded $7.7 million of pre-tax severance and restructuring expenses in 2020; these actions were completed during the year. The charges reduced after-tax earnings by $6.3 million, or $0.04 per diluted share. Adjusted EPS, excluding these charges, was $2.16, compared with GAAP diluted EPS of $2.12.
- Management forecast 2021 consolidated sales growth of approximately 10% and diluted EPS of $2.40–$2.50. Guidance assumes business conditions do not deteriorate because of further pandemic restrictions or shutdowns and excludes potential acquisitions.
- For 2021, management projected North America segment margin of 23%–23.5%, Rest of World segment margin of 7%–8%, operating cash flow of $450–$475 million and capital expenditures of $85–$90 million. It expected China sales to grow 14%–15% in local currency; the outlook section also cited 20%–21% growth in U.S. dollar terms.
- The board authorized an additional 7 million shares for repurchase in January 2021. The company said it intended to spend approximately $400 million on repurchases in 2021 and expected to repatriate about $190 million of foreign cash for that purpose. FY2020 repurchases were suspended in March amid pandemic uncertainty; $56.7 million was repurchased during the year. Dividends paid were $0.98 per share, up from $0.90.
Risks, contingencies and unusual items
- Key risks include the uncertain course of COVID-19 and its effects on demand, supply and logistics; China’s economic and consumer recovery; intense competition; steel and component price volatility and availability; foreign-exchange movements; and changes in energy-efficiency or emissions regulation.
- China accounted for approximately 24% of 2020 net sales, and approximately 33% of sales were outside the United States. The five largest customers represented approximately 43% of sales. Foreign subsidiaries held $524.2 million in cash and marketable securities at year-end.
- Product warranty liability was $142.3 million, up from $134.3 million. The independent auditor identified valuation of this liability as a critical audit matter, citing judgment in failure-rate and replacement-cost assumptions.
- The company disclosed ordinary-course product-liability, environmental and other claims, but said reserves and insurance were adequate and expected no material effect. A securities class action and related derivative suits were dismissed in 2020 without settlement consideration.
- The company reported no goodwill or indefinite-lived intangible-asset impairment in 2020. Management and the auditor concluded internal control over financial reporting was effective; the financial-statement audit opinion was unqualified.
Important facts for investors to verify
- Whether China sales and profitability recover as projected, and whether the planned shift toward mid-price products continues to weigh on margins.
- How pandemic-related demand, customer inventory changes, commercial-market weakness, logistics and steel costs affect 2021 results and guidance.
- Whether the $400 million repurchase plan and expected foreign-cash repatriation proceed as stated, alongside planned capital spending and dividends.
- Warranty claims and reserve adequacy, given the $142.3 million liability and the auditor’s critical audit matter.
- Customer concentration, foreign-currency exposure and the company’s ability to renew its revolving credit facility, which was scheduled to expire in December 2021.