A. O. Smith Corporation — Q1 2023 Form 10-Q
Reporting period: Three months ended March 31, 2023; comparisons are with the three months ended March 31, 2022 unless otherwise noted. A. O. Smith manufactures and markets water heaters, boilers, tanks and water treatment products through its North America and Rest of World segments.
Financial performance
| Metric | Q1 2023 | Q1 2022 |
|---|---|---|
| Net sales | $966.4 million | $977.7 million |
| Gross profit / margin | $374.1 million / 38.7% | $341.6 million / 34.9% |
| Operating earnings before interest, other items and taxes | $179.3 million | $161.8 million |
| Net earnings | $126.9 million | $119.8 million |
| Diluted EPS | $0.84 | $0.76 |
| Operating cash flow | $119.9 million | $16.5 million |
| Free cash flow (non-GAAP) | $109.2 million | $3.6 million |
Sales declined 1.2%, while gross margin increased 3.8 percentage points, primarily due to lower steel and other material costs. SG&A rose $7.4 million. The effective tax rate was 25.9%, versus 23.5%, reflecting geographic earnings mix and the Turkey impairment, which received no tax benefit. Adjusted EPS, excluding specified items, was $0.94 versus $0.77.
Segments
- North America: Sales increased to $752.7 million from $730.1 million. Segment earnings were $188.6 million versus $151.8 million; margin rose to 25.1% from 20.8%, mainly on higher water heater volumes and lower steel costs.
- Rest of World: Sales declined to $219.1 million from $256.0 million; segment earnings were $5.3 million versus $24.8 million. Results reflected weaker China sales, about $17 million of unfavorable currency translation, and the Turkey impairment. Excluding the $12.5 million segment impairment, adjusted earnings were $17.8 million and margin was 8.1%.
Financial position and capital allocation
At March 31, 2023, cash and cash equivalents were $406.2 million, marketable securities $89.8 million, total current assets $1.644 billion and current liabilities $895.7 million. Total debt was approximately $340.8 million, including $10.0 million due within one year; debt declined $3.7 million during the quarter. The company had $211.1 million outstanding under its $500 million revolving facility and $288.9 million of available capacity, and was in compliance with its financial covenants. Total debt to total capitalization was 16.0%, versus 16.5% at year-end 2022.
Operating cash flow improved substantially year over year, partly due to higher earnings, lower incentive payments and lower inventory. The company repurchased 821,000 shares for $53.1 million and paid $45.4 million in dividends. It expects approximately $300 million of 2023 repurchases, subject to business and market conditions. The quarterly dividend was raised to $0.30 per share, payable May 15, 2023.
Outlook, commentary and notable items
- 2023 consolidated sales guidance is approximately flat with 2022, within a range of plus or minus 2%; the outlook assumes about a 2% adverse currency impact and excludes potential acquisitions.
- 2023 diluted EPS guidance is $3.20–$3.40; adjusted EPS guidance is $3.30–$3.50. Expected operating cash flow is $650–$700 million and free cash flow is $575–$625 million. Planned capital expenditures are $70–$75 million.
- Management expects North America segment margin of approximately 23%–23.5% and Rest of World adjusted segment margin of approximately 10%. Residential water heater industry volumes in North America are projected roughly flat; commercial water heater volumes are expected to increase mid-single digits. China sales are projected to grow 3%–5% in local currency, with sequential improvement assumed.
- The company committed to sell its Turkey business and recorded a $15.6 million non-cash impairment, including $11.1 million related to anticipated liquidation of cumulative currency translation adjustments. The sale was completed in April 2023; it was not classified as discontinued operations.
- Material risks cited include weaker residential demand or construction, inflation or recession, supply-chain and commodity cost challenges, China’s economic recovery and consumer demand, foreign-exchange movements, tariffs and geopolitical conditions, competition, customer credit events, cybersecurity, regulation and the ability to respond to decarbonization and energy-efficiency trends.
- A contingent inventory repurchase arrangement supporting certain China distributor financing could require gross repurchases of about $2.3 million if all relevant loans default and specified conditions are met; estimated reserves were immaterial. Management reported no material change in legal and environmental matters from its prior annual report.
Important facts for investors to verify
- Whether North America’s margin improvement and lower material costs persist, and whether the full-year segment-margin and EPS guidance remains achievable.
- China demand, the pace of sequential recovery, and the effect of currency translation on Rest of World sales and earnings.
- Completion and financial consequences of the Turkey sale, including any final proceeds, costs or foreign-currency effects.
- Cash conversion and working-capital trends relative to the $650–$700 million operating cash-flow outlook.
- Execution of planned share repurchases and dividends alongside capital investment and liquidity needs.
- Developments in the China distributor financing repurchase exposure and other risks identified in the filing.