A. O. Smith Corporation — Q2 2021 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2021. A. O. Smith manufactures and markets water heaters, boilers, tanks, and water-treatment products through its North America and Rest of World segments, with China the largest Rest of World market. Dollar amounts below are in millions except per-share data.
Financial performance
| Metric | Q2 2021 | Q2 2020 | Six months 2021 | Six months 2020 |
|---|---|---|---|---|
| Net sales | $859.8 | $663.9 | $1,628.8 | $1,300.8 |
| Gross profit | $321.4 | $247.5 | $610.0 | $487.0 |
| Gross margin | 37.4% | 37.3% | 37.5% | 37.4% |
| Net earnings | $118.2 | $67.8 | $215.9 | $119.5 |
| Diluted EPS | $0.73 | $0.42 | $1.33 | $0.74 |
| Operating cash flow | — | $196.0 | $179.3 |
Quarterly sales rose about 30% and six-month sales about 25% year over year. Earnings increased substantially from the pandemic-affected 2020 comparison periods. SG&A increased $17.2 in Q2 and $9.9 for the first half, largely on engineering, selling, advertising, and incentive costs. Interest expense declined to $0.9 in Q2 and $1.9 for the first half, primarily from lower debt. The 2020 comparison includes $6.1 of severance and restructuring expense; adjusted diluted EPS was $0.45 for Q2 2020 and $0.77 for the first half of 2020, versus GAAP EPS of $0.42 and $0.74.
Segments and material changes
- North America: Sales were $603.6 in Q2 and $1,156.5 for the first half, up from $480.5 and $1,013.4. Segment earnings were $141.7 and $272.1. Margins were 23.5% for both Q2 and the first half, compared with 21.9% and 22.9% in 2020. Growth reflected higher volumes and price increases, partly offset by material and freight inflation.
- Rest of World: Sales were $263.2 in Q2 and $485.5 for the first half, versus $189.7 and $299.9. Segment earnings were $22.3 and $34.1, compared with losses of $5.8 and $48.0 in 2020. China sales growth and lower selling and administrative costs helped results; China currency translation added approximately $20 in Q2 and $34 in the first half to sales.
- Consolidated gross margin was broadly stable year over year despite higher input and logistics costs. Prior-year results were also affected by COVID-related disruptions and $6.1 of restructuring costs.
Liquidity, debt, and capital allocation
At June 30, cash and cash equivalents were $444.8 and marketable securities were $137.1, totaling $581.9; approximately $439 was held by foreign subsidiaries. Cash declined $128.3 from year-end. Working capital was $678.7, down about $53 from December 31, 2020. Six-month operating cash flow was $196.0; capital expenditures were $30.7. Financing used $274.3, including $198.1 of share repurchases and $83.9 of dividends.
Total debt was $106.4, down from $113.2 at year-end; debt to total capitalization, excluding operating leases, was 5.5%. The company had no borrowings on its renewed $500 revolving credit facility, which expires April 1, 2026, and reported $500 of available capacity and compliance with its covenants. The facility may be increased to $850 subject to conditions.
The company repurchased 2.98 million shares for $198.1 in the first half and expected approximately $400 of repurchases for full-year 2021. The board added 7 million shares to repurchase authorization in Q1; 5.64 million remained authorized at June 30. The quarterly dividend was $0.26 per share.
Outlook, risks, and contingencies
Management forecast 2021 sales growth of 17%–18%, diluted EPS of $2.70–$2.76, operating cash flow of $500–$525, capital expenditures of $85–$90, and depreciation and amortization of approximately $80. Guidance excludes future acquisitions and includes about $50 of China currency-translation benefit. Segment margin expectations were 22.75%–23.0% for North America and approximately 8% for Rest of World. Management expected residential water-heater industry volumes in North America to rise about 3%, commercial water-heater volumes about 2%, boiler sales to grow by low double digits, and North America water-treatment sales to grow 13%–14%. China sales were expected to grow 20%–22% in local currency.
Management cited continuing supply-chain, component, raw-material, container, trucking, and port constraints, along with steel and logistics inflation. A fourth North America water-heater price increase, announced in late June, was scheduled to take effect August 1 at 10%–12%, depending on product. Risks include prolonged supply bottlenecks, COVID-19 effects, China demand or currency changes, tariffs and geopolitical issues, commodity-price volatility, inability to realize pricing, construction and replacement-market weakness, competition, cybersecurity events, regulation, and acquisition execution.
Potential China distributor-financing inventory repurchases were approximately $10.3 gross at June 30 if all related loans defaulted, before potential resale proceeds and distributor rebates; the company’s loss reserve was immaterial. The filing reported no material changes in legal or environmental matters from its 2020 Form 10-K. Management estimated the full-year effective tax rate at approximately 23%.
Important facts for investors to verify
- Whether price increases offset ongoing material, freight, and other supply-chain cost inflation, and whether supply constraints persist as management anticipated.
- Whether China growth, currency assumptions, and North America demand support the full-year sales, EPS, and segment-margin guidance.
- Whether working-capital needs affect the operating-cash-flow outlook and planned capital spending.
- How the planned share repurchases, foreign cash balances, and dividend payments affect liquidity and capital allocation.
- Any developments in distributor-financing exposure, tax examinations, or other disclosed contingencies.