A. O. Smith Corporation — Q3 2021 Form 10-Q
Reporting period: Three and nine months ended September 30, 2021. A. O. Smith manufactures and markets residential and commercial water heaters, boilers, tanks, and water treatment products through North America and Rest of World segments, including China. Results are unaudited; management cautions that interim results are not necessarily indicative of full-year results.
Financial performance
| Metric | Q3 2021 | Q3 2020 | Nine months 2021 | Nine months 2020 |
|---|---|---|---|---|
| Net sales | $914.6m | $760.0m | $2,543.4m | $2,060.8m |
| Gross profit | $340.3m | $297.1m | $950.3m | $784.1m |
| Gross margin | 37.2% | 39.1% | 37.4% | 38.0% |
| Net earnings | $131.6m | $105.4m | $347.5m | $224.9m |
| Diluted EPS | $0.82 | $0.65 | $2.15 | $1.38 |
| Operating cash flow | Not provided for quarter | Not provided for quarter | $376.8m | $330.4m |
Q3 sales rose about 20% and nine-month sales about 23%. Earnings growth reflected higher volumes and pricing, including recovery from pandemic-affected 2020 comparisons. Gross margin declined as steel and other material costs rose faster than pricing actions. Interest expense fell to $1.0m in Q3 and $2.9m year to date, primarily due to lower debt. The effective tax rate was 20.9% for Q3 and 21.7% year to date; a $4.2m benefit from amending a prior tax return contributed to the year-over-year rate decline.
Segments
- North America: Sales were $658.2m in Q3 and $1,814.7m year to date, up from $544.0m and $1,557.4m. Segment earnings were $151.8m and $423.9m, respectively. Margin was 23.1% in Q3 and 23.4% year to date. Growth reflected pricing and higher water heater, boiler, and water treatment volumes; higher materials and freight costs partly offset the gains.
- Rest of World: Sales were $263.1m in Q3 and $748.6m year to date, versus $221.4m and $521.3m. Segment earnings were $26.8m and $60.9m, compared with $16.7m and a $31.3m loss in 2020. China sales benefited from volume growth and currency translation; the prior-year comparison included pandemic disruption and restructuring.
Liquidity, debt, and capital allocation
At September 30, cash and cash equivalents were $486.1m and marketable securities were $199.1m. Working capital was $756m. Total debt was $106.4m, including $6.8m due within one year; debt was $113.2m at year-end 2020. The company reported a 5.3% debt-to-total-capitalization ratio, excluding operating leases. Its $500m revolving facility, renewed through April 1, 2026, was undrawn, leaving $500m available; the company was in compliance with its financial covenants. Approximately $520m of the $685m in cash, cash equivalents, and marketable securities was held by foreign subsidiaries.
Nine-month investing cash use was $135.3m, including $45.3m of capital expenditures and $9.0m for acquisitions, partly offset by marketable-security transactions. Financing cash use was $328.5m, including $212.0m of share repurchases and $125.4m of dividends. Cash declined $87.0m to $486.1m. The company repurchased 3.18m shares year to date and expected approximately $400m of repurchases for 2021, subject to business needs and market conditions. After quarter-end, the board raised the quarterly dividend to $0.28 per share, payable November 15, 2021; Q3 dividends were $0.26 per share.
Outlook, changes, and notable items
- Management projected 2021 sales growth of 20%–21%, excluding Giant, and diluted EPS of $2.86–$2.90. Sales guidance included an estimated $54m benefit from China currency translation. The EPS outlook was increased at the midpoint.
- Full-year 2021 operating cash flow guidance was $550m–$575m; capital expenditures were projected at $70m–$75m. North America segment margin guidance was 22.75%–23.0%; Rest of World segment margin guidance was approximately 8%.
- Management expected supply-chain constraints, logistics delays, and significant materials and freight inflation to persist for the foreseeable future. Five announced 2021 North America water-heater price increases were expected to compound to approximately 50% when fully realized by year-end; pricing recovery may lag cost increases.
- On October 19, 2021, after quarter-end, the company acquired Canadian manufacturer Giant Factories for approximately $192m, subject to customary adjustments, using debt and cash. Giant reported trailing twelve-month sales of approximately $105m. The acquisition was excluded from the stated 2021 sales and EPS guidance.
- The filing identifies risks including material and component price volatility or shortages, supplier concentration, transportation disruption, COVID-19 effects, inability to realize pricing, China market and currency conditions, construction demand, customer credit/defaults, competition, cybersecurity, and acquisition integration. The company uses currency and commodity hedges and states it does not speculate with derivatives.
- Other notable items: warranty liabilities increased to $151.5m from $142.3m at year-end; the allowance for doubtful accounts rose to $10.1m from $5.6m. The filing reports no material change in legal proceedings or internal controls and no material change in previously disclosed market-risk exposure.
Key investor checks
- Whether further pricing actions can offset steel, component, and freight inflation without materially weakening demand or margins.
- Whether supply availability and logistics improve, and whether the company can maintain production and timely customer shipments.
- Whether China growth, currency benefits, and the projected Rest of World margin are sustainable after pandemic-affected comparisons.
- How Giant is integrated and financed, and whether its sales and performance align with expectations; assess any effect beyond guidance that excludes the acquisition.
- Whether working-capital investment permits achievement of cash-flow guidance alongside planned repurchases, dividends, and capital spending.