A. O. Smith Corporation — Q1 2024 Form 10-Q
Reporting period: Three months ended March 31, 2024. The company manufactures and markets residential and commercial water heaters, boilers, tanks and water treatment products through North America and Rest of World segments. Unless noted, amounts are in U.S. dollars and millions.
Financial performance
| Metric | Q1 2024 | Q1 2023 |
|---|---|---|
| Net sales | $978.8 | $966.4 |
| Gross profit / margin | $384.7 / 39.3% | $374.1 / 38.7% |
| Operating expenses: SG&A | $192.2 | $187.2 |
| Earnings before tax | $192.7 | $171.3 |
| Net earnings | $147.6 | $126.9 |
| Diluted EPS | $1.00 | $0.84 |
| Operating cash flow | $106.6 | $119.9 |
| Free cash flow (non-GAAP) | $84.6 | $109.2 |
Sales grew 1.3%; management attributed growth primarily to a favorable mix shift toward higher-efficiency commercial water heaters, including heat pumps. Currency depreciation reduced sales by approximately $9 million. Gross margin improved mainly on lower steel costs. GAAP net earnings and EPS comparisons benefited from the absence of the prior-year $15.6 million Turkey business impairment; excluding that impairment, Q1 2023 adjusted EPS was $0.94 versus $1.00 in Q1 2024.
Segments and balance sheet
- North America: Sales of $766.3 million, up from $752.7 million; segment earnings of $198.7 million versus $188.6 million; margin rose to 25.9% from 25.1%. Higher commercial water heater volumes, product mix and lower steel costs helped, partly offset by higher selling and advertising costs.
- Rest of World: Sales of $226.9 million versus $219.1 million; earnings of $17.2 million versus $5.3 million; margin was 7.6% versus 2.4%. The prior-year impairment explains much of the earnings increase; Q1 2023 adjusted segment earnings were $17.8 million. Sales reflected higher China kitchen-product volumes and inter-segment tankless shipments, partly offset by currency translation.
- Liquidity and debt: Cash and cash equivalents were $251.6 million and marketable securities $51.5 million at March 31. Total debt was $119.7 million, down from $127.3 million at year-end; leverage as a share of total capitalization was 6.0%, versus 6.5%. The $500 million revolving facility had no borrowings and $500 million available; the company was in compliance with its covenants.
- Working capital: $578.1 million, up from $555.0 million at year-end, primarily due to higher inventory and lower payables and payroll accruals, partly offset by lower cash.
Cash use and capital allocation
Operating cash flow declined year over year, primarily reflecting higher incentive payments and inventory, partly offset by higher earnings and payables. Investing cash use was $71.2 million, including $22.0 million of capital expenditures, a $21.1 million net cash acquisition payment and net purchases of marketable securities. Financing cash use was $120.6 million, including $74.5 million of share repurchases and $47.3 million of dividends. The company repurchased 906,000 shares and had 4,595,462 shares remaining under authorization at quarter-end.
Outlook, risks and notable items
- 2024 consolidated sales growth guidance is 3%–5%; full-year diluted EPS guidance is $3.90–$4.15. Guidance excludes potential future acquisitions. The company expects North America segment margin of approximately 25% and Rest of World margin of approximately 10%.
- Management expects 2024 operating cash flow of $640–$690 million, free cash flow of $525–$575 million, capital expenditures of $105–$115 million and depreciation and amortization of approximately $80 million. These are forward-looking estimates; free cash flow is a non-GAAP measure.
- Management’s market assumptions include flat North American residential water heater volumes and new-home construction, low-single-digit commercial water heater growth, 8%–10% growth in North American boiler and water treatment sales, and China third-party sales flat to up 3% in local currency. The company expects approximately 1% unfavorable currency translation on 2024 sales.
- The company acquired Impact Water Products, a California water treatment business, for $21.1 million net of cash acquired, with contingent payments tied to future sales growth. It also reported exiting Vietnam during Q2 2024; the associated restructuring expense was recorded in Q4 2023.
- The board added 2 million shares to repurchase authorization; management expects approximately $300 million of repurchases in 2024, subject to market, working-capital and investment considerations. A $0.32 quarterly dividend was declared after quarter-end, payable May 15, 2024.
- Key risks cited include weaker residential demand or construction, inflation or recession, supply-chain availability and costs, China demand and housing conditions, foreign-exchange movements, tariffs and geopolitical disruption, customer credit or concentration, competition, acquisition integration, cybersecurity, regulation, and the ability to respond to energy-efficiency and decarbonization trends.
- The company reported no material change in legal matters from its 2023 Form 10-K. Potential losses under China distributor inventory repurchase arrangements were reserved at an immaterial amount; the provider is required to indemnify the company. The estimated 2024 effective tax rate is 24%–24.5%; the Q1 rate was 23.4%.
Important facts for investors to verify
- Whether sales, EPS and segment-margin guidance is supported by actual end-market demand, especially in North America and China, and how currency movements affect results.
- Whether working-capital and incentive-payment trends allow management to meet its operating cash flow and free cash flow targets.
- The distinction between reported and adjusted comparisons, particularly the prior-year Turkey impairment and the non-GAAP free cash flow measure.
- Progress integrating Impact Water Products, the contingent acquisition payments, and the stated Vietnam exit.
- Execution of the planned repurchases and capital spending while maintaining liquidity and covenant compliance.