A. O. Smith Corporation — Q1 2021 Form 10-Q
Business context and reporting period: Unaudited results for the three months ended March 31, 2021, compared with the three months ended March 31, 2020. 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.
Key financial results
| Metric | Q1 2021 | Q1 2020 |
|---|---|---|
| Net sales | $769.0 million | $636.9 million |
| Gross profit / gross margin | $288.6 million / 37.5% | $239.5 million / 37.6% |
| Earnings before income taxes | $126.1 million | $67.7 million |
| Net earnings | $97.7 million | $51.7 million |
| Diluted EPS | $0.60 | $0.32 |
| Cash provided by operating activities | $104.4 million | $54.1 million |
| Capital expenditures | $17.1 million | $12.8 million |
Sales rose approximately 21%, while net earnings rose approximately 89%. Gross margin was nearly unchanged. SG&A decreased to $166.5 million from $173.8 million; interest expense fell to $1.0 million from $2.2 million. The effective tax rate was 22.5%, versus 23.6%.
Segment results: North America sales increased to $552.9 million from $532.9 million; segment earnings were $130.4 million versus $127.1 million, and margin was 23.6% versus 23.9%. Rest of World sales increased to $222.3 million from $110.2 million; segment earnings were $11.8 million versus a $42.2 million loss, and margin was 5.3% versus negative 38.3%. China sales increased 119% in U.S. dollar terms, including approximately $14 million of currency-translation benefit; the prior-year quarter was affected by pandemic restrictions and weak demand.
Liquidity, balance sheet and capital allocation
At March 31, 2021, cash and cash equivalents were $578.5 million and marketable securities were $87.0 million, or approximately $666 million combined. About $540 million was held by foreign subsidiaries. Working capital was $722.1 million. Total debt was $106.4 million, down from $113.2 million at December 31, 2020; debt-to-total-capitalization was 5.4%, excluding operating lease liabilities. The company reported $500 million of available capacity under its revolving credit facility and compliance with its financial covenants.
Operating cash flow exceeded the prior-year quarter, principally due to higher earnings. Cash used in financing was $111.5 million, including $67.0 million for share repurchases and $42.2 million of dividends. The company repurchased 1,075,200 shares during the quarter and expected to spend approximately $400 million on repurchases in 2021. The quarterly dividend was $0.26 per share. On April 1, 2021, after quarter-end, the company renewed its $500 million revolving facility through March 31, 2026, with a conditional accordion increase up to $850 million.
Outlook, commentary and risks
Management forecast 2021 consolidated sales growth of 14%–15% and diluted EPS of $2.55–$2.65. It expected operating cash flow of $475–$500 million, capital expenditures of $85–$90 million, and a full-year effective tax rate of approximately 23%. Forecast segment margins were 23%–23.5% for North America and 7%–8% for Rest of World. Other expectations included China sales growth of 18%–20% in local currency, North America water treatment sales growth of 13%–14%, and low-double-digit growth in boiler sales. Management estimated approximately $50 million of 2021 sales benefit from China currency translation.
Management cited pandemic-related and severe-weather supply disruptions, shipping delays, absenteeism and facility interruptions that constrained North America water heater production and extended lead times. Steel costs had risen 25% since late January; three announced water-heater price increases were expected to have a cumulative 24%–27% impact when fully implemented. Management warned that customer inventory de-stocking and the timing of price-related pre-buying were difficult to predict. Guidance assumes business and supply-chain conditions do not deteriorate through the remainder of 2021 and excludes future acquisitions.
Other stated risks include further COVID-19 impacts, prolonged weather or supply-chain bottlenecks, material-cost volatility and inability to realize pricing, China demand or currency changes, weaker construction and replacement markets, tariffs and geopolitical issues, competition, foreign-exchange movements, cybersecurity incidents and regulatory or economic changes. The company uses currency and commodity derivatives to hedge exposures and states that it does not use them speculatively.
Contingencies and unusual items
The company had a conditional China inventory-repurchase arrangement related to distributor financing. The gross potential repurchase amount was approximately $6.5 million if all outstanding loans defaulted and specified conditions were met; the provider indemnifies the company, and reserves for estimated losses were immaterial. The company reported no material changes to previously disclosed legal and environmental matters. It adopted ASU 2019-12 on January 1, 2021, with no reported financial-statement impact. Management reported effective disclosure controls and no material change in internal control over financial reporting.
Important facts for investors to verify
- Whether supply constraints, weather disruptions and freight costs ease enough to support production, margins and the stated sales and EPS outlook.
- How much of China’s exceptional year-over-year sales increase reflects underlying demand versus the pandemic-affected comparison quarter and currency translation.
- Whether announced price increases offset steel, logistics and other input-cost inflation, and how customer pre-buying or de-stocking affects demand.
- Whether the company achieves its cash-flow, capital-expenditure and approximately $400 million share-repurchase plans while maintaining liquidity.
- Potential exposure under the China distributor inventory-repurchase arrangement and the conditions of the renewed revolving credit facility.