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(Exact name of registrant as specified in its charter)
________________________________
iDelaware
(State of Incorporation)
i11270
West Park Place, iMilwaukee, iWisconsin
(Address of Principal Executive Office)
i39-0619790
(I.R.S.
Employer
Identification No.)
i53224-9508
(Zip Code)
(i414) i359-4000
(Registrant’s telephone number, including area code)
_________________________________________________
Securities registered pursuant to Section 12(b) of the Act:
Title of Each Class
Trading Symbol
Name of Each Exchange on Which Registered
iCommon
Stock (par value $1.00 per share)
iAOS
iNew York Stock Exchange
Indicate by check mark whether the
registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. ☒iYeso No
Indicate by check mark whether the
registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). ☒iYeso No
Indicate by check mark whether the registrant is a large accelerated
filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,”“accelerated filer,”“smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
iLarge
accelerated filer
☒
Accelerated Filer
☐
Non-accelerated filer
☐
Smaller reporting company
i☐
Emerging
growth company
i☐
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.o
Indicate by check mark whether
the registrant is a shell company (as defined in Rule 12b-2 of the Act.)i☐Yes☒No
Class A Common Stock Outstanding as of April 28, 2021 - i25,989,387
shares
Common Stock Outstanding as of April 28, 2021 - i134,466,854 shares
The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (GAAP) for interim financial information and pursuant to the rules and regulations of the Securities and Exchange Commission (SEC). Accordingly, they do not include all of the information and footnotes required for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three months ended March 31, 2021 are not necessarily indicative of the results expected for the full year. It is suggested the accompanying condensed consolidated financial statements be read in conjunction with the audited consolidated financial statements and the
notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2020 filed with the SEC on February 12, 2021.
i
Recent Accounting Pronouncement
In December 2019, the Financial Accounting Standards Board (FASB) amended Accounting Standards Codification (ASC) 740, Income Taxes
(issued under Accounting Standards Update (ASU) 2019-12, “Simplifying the Accounting for Income Taxes”). This amendment removes certain exceptions to the general principles of ASC 740 and clarifies and amends existing guidance to improve consistent application. The Company adopted the amendment on January 1, 2021, and the adoption of ASU 2019-12 did not have an impact on its consolidated balance sheets, statements of earnings or statements of cash flows.
2.iRevenue
Recognition
Substantially all of the Company’s sales are from contracts with customers for the purchase of its products. Contracts and customer purchase orders are used to determine the existence of a sales contract. Shipping documents are used to verify shipment. For substantially all of its products, the Company transfers control of products to the customer at the point in time when title and risk are passed to the customer, which generally occurs upon shipment of the product. Each unit
sold is considered an independent, unbundled performance obligation. The Company’s sales arrangements do not include other performance obligations that are material in the context of the contract.
The nature, timing and amount of revenue for a respective performance obligation are consistent for each customer. The Company measures the sales transaction price based upon the payment terms associated with the transaction and whether the sales price is subject to refund or adjustment. Sales and value added taxes are excluded from the measurement of transaction price. The Company’s payment terms
for the majority of its customers are i30 to i90 days from shipment.
Additionally, certain customers in China pay the
Company prior to the shipment of products resulting in a customer deposits liability of $i77.7 million and $i90.0 million at
March 31, 2021 and December 31, 2020, respectively. Customer deposit liabilities are short term in nature and deposits are recognized into revenue within one year of receipt. The Company assesses the collectability of customer receivables based on the creditworthiness of a customer as determined by credit checks and analysis, as well as the customer’s payment history. In determining the allowance for doubtful accounts, the Company also considers various factors including the aging of customer accounts and historical write-offs. In addition, the Company monitors other risk factors including forward-looking information when establishing
adequate allowances for doubtful accounts, which reflects the current estimate of credit losses expected to be incurred over the life of the receivables. The Company’s allowance for doubtful accounts was $i5.3 million at March 31, 2021 and $i5.6
million at December 31, 2020.
Rebates and incentives are based on pricing agreements and are tied to sales volume. The amount of revenue is reduced for variable consideration related to customer rebates which are calculated using expected values and are based on program specific factors such as expected rebate percentages based on expected volumes. In situations where the customer has the right to return eligible products, the Company reduces revenue for its estimates of expected product returns, which are primarily based on an analysis of historical experience. Changes in such accruals may be required if actual sales volume differs from estimated sales volume or if future returns differ from historical experience. Shipping and handling costs billed to customers are included in net sales and
the related costs are included in cost of products sold and are activities performed to fulfill the promise to transfer products.
The Company is comprised of itwo
reporting segments: North America and Rest of World. The Rest of World segment is primarily comprised of China, Europe and India. Both segments manufacture and market comprehensive lines of residential and commercial gas and electric water heaters, boilers, tanks and water treatment products. Both segments primarily manufacture and market in their respective regions of the world.
As each segment manufactures and markets products in its respective region of the world, the Company has determined that geography is the primary factor in reporting its sales. The Company further disaggregates its North America segment sales by major product line as each of North America’s major product lines is sold through distinct distribution channels and these product lines may
be impacted differently by certain economic factors. Within the Rest of World segment, particularly in China and India, the Company’s major customers purchase across the Company’s product lines, utilizing the same distribution channels regardless of product type. In addition, the impact of economic factors is unlikely to be differentiated by product line in the Rest of World segment.
The North America segment major product lines are defined as the following:
Water heaters The Company’s water heaters are open water heating systems that heat potable water. Typical applications for water heaters include residences,
restaurants, hotels and motels, office buildings, laundries, car washes and small businesses. The Company sells residential and commercial water heater products and related parts through its wholesale distribution channel, which includes more than i1,200 independent wholesale plumbing distributors. The Company also sells residential water heaters and related parts through retail and maintenance,
repair and operations (MRO) channels. A significant portion of the Company’s water heater sales in the North America segment is derived from the replacement of existing products.
Boilers The Company’s boilers are closed loop water heating systems used primarily for space heating or hydronic heating. The Company’s boilers are primarily used in applications in commercial settings for hospitals, schools, hotels and other large commercial buildings while residential boilers are used in homes, apartments and condominiums. The Company’s boiler distribution channel is comprised primarily
of manufacturer representative firms, with the remainder of its boilers distributed through wholesale channels. The Company’s boiler sales in the North America segment are derived from a combination of replacement of existing products and new construction.
Water treatment products The Company’s water treatment products range from point-of-entry water softeners, solutions for problem well water, and whole-home water filtration products to on-the-go filtration bottles and point-of-use carbon and reverse osmosis products. Typical applications for the Company’s water treatment products include residences, restaurants, hotels and offices. The
Company sells water treatment products through its retail and wholesale distribution channels, similar to water heater products and related parts. The Company’s water treatment products are also sold through independent water quality dealers as well as directly to consumers including through internet sales channels. A portion of the Company’s sales of water treatment products in the North America segment is comprised of replacement filters.
i
The
following table disaggregates the Company’s net sales by segment. As described above, the Company’s North America segment sales are further disaggregated by major product line. In addition, the Company’s Rest of World segment sales are disaggregated by China and all other Rest of World:
The Company’s lease portfolio consists of operating leases for buildings and equipment, such as forklifts and copiers, primarily in the United States and China. The Company defines a lease as a contract
that gives the Company the right to control the use of a physical asset for a stated term. The Company pays the lessor for that right, with a series of payments defined in the contract and a corresponding right of use operating lease asset and liability are recorded. The Company has elected not to record leases with an initial term of 12 months or less on its condensed consolidated balance sheet. To determine balance sheet amounts, required legal payments are discounted using the Company’s incremental borrowing rate as of the inception of the lease. The
incremental borrowing rate is the rate of interest that the Company would incur if it were to borrow, on a collateralized basis, an amount equal to the value of the leased item over a similar term, in a similar economic environment. Variable lease components not based on an index or rate are excluded from the measurement of the lease asset and liability and expensed as incurred for all asset classes.
Certain leases include one or more options to renew or terminate. Renewal terms can extend the lease term from one to ifive
years and options to terminate can be effective within ione year. The exercise of lease renewal or termination is at the Company’s discretion and when it is determined to be reasonably certain to renew or terminate, the option is reflected in the measurement of lease asset and liability. The Company’s lease agreements do not contain any material residual value guarantees or material restrictive covenants or material subleases. Cash flows associated
with leases are materially consistent with the expense recorded in the condensed consolidated statement of earnings.
i
Supplemental balance sheet information related to leases is as follows:
The Company offers warranties on the sales of certain of its products with terms that are consistent with the market and records an accrual for the estimated future claims. iThe following table presents the Company’s warranty liability activity:
The Company had a $i500 million multi-year multi-currency revolving credit agreement with a group of inine
banks, which would have expired on December 15, 2021. The facility had an accordion provision which allowed it to be increased up to $i700 million if certain conditions (including lender approval) were satisfied. Borrowings under bank credit lines and commercial paper borrowings were supported by the $i500
million revolving credit agreement. At its option, the Company either maintained cash balances or paid fees for bank credit and services. The Company did not have borrowings on this facility during the three months ended March 31, 2021.
On April 1, 2021, the Company renewed and amended the $i500 million
revolving credit facility with the new expiration date of March 31, 2026. The renewed and amended facility has an accordion provision which allows it to be increased up to $i850 million if certain conditions (including lender approval) are satisfied.
The numerator for the calculation of basic and diluted earnings per share is net earnings. iThe
following table sets forth the computation of basic and diluted weighted-average shares used in the earnings per share calculations:
Denominator
for basic earnings per share - weighted average shares
i161,526,733
i161,871,788
Effect
of dilutive stock options and share units
i1,258,590
i1,025,817
Denominator
for diluted earnings per share
i162,785,323
i162,897,605
8. iStock
Based Compensation
The Company adopted the A. O. Smith Combined Incentive Compensation Plan (the Plan) effective January 1, 2007. The Plan was most recently reapproved by stockholders on April 15, 2020. The Plan is a continuation of the A. O. Smith Combined Executive Incentive Compensation Plan which was originally approved by stockholders in 2002. The number of shares available for granting of options or share units at March 31, 2021 was i6,763,257.
Upon stock option exercise or share unit vesting, shares are issued from treasury stock.
Total stock based compensation expense recognized in the three months ended March 31, 2021 and 2020 was $i7.4 million and $i9.0
million, respectively.
Stock Options
The stock options granted in the three months ended March 31, 2021 and 2020 have iithree
year/ pro rata vesting from the date of grant. Stock options are issued at exercise prices equal to the fair value of the Company’s Common Stock on the date of grant. For active employees, all options granted in 2021 and 2020 expire iiten
years/ after the date of grant. The Company’s stock options are expensed ratably over the iithree
year/ vesting period; however, included in stock option expense for the three months ended March 31, 2021 and 2020 was expense associated with the accelerated vesting of stock option awards for certain employees who either are retirement eligible or become retirement eligible during the vesting period. Stock based compensation expense attributable to stock options in the three months ended March 31, 2021 and 2020 was $i3.6
million and $i4.5 million, respectively.
i
Changes in options, all of which
relate to the Company’s Common Stock, were as follows for the three months ended March 31, 2021:
The weighted-average fair value per option at the date of grant during the three months ended March 31, 2021 and 2020 using the Black-Scholes option-pricing model was $i14.01
and $i8.15, respectively. iAssumptions
were as follows:
The
expected lives of options for purposes of these models are based on historical exercise behavior. The risk-free interest rates for purposes of these models are based on the U.S. Treasury yield curve in effect on the date of grant for the respective expected lives of the option. The expected dividend yields for purposes of these models are based on the dividends paid in the preceding four quarters divided by the grant date market value of the Common Stock. The expected volatility for purposes of these models are based on the historical volatility of the Common Stock.
Restricted Stock and Share Units
Participants may also be awarded shares of restricted stock or share units under the Plan. Share units vest ithree
years after the date of grant. The Company granted i100,153 and i169,407
share units under the plan in the three months ended March 31, 2021 and 2020, respectively. The share units were valued at $i6.1 million and $i7.2
million at the date of issuance in 2021 and 2020, respectively, based on the price of the Company’s Common Stock at the date of grant. The share units are recognized as compensation expense ratably over the ithree-year vesting period; however, included in share unit expense in the three months ended March 31, 2021 and 2020 was expense
associated with accelerated vesting of share unit awards for certain employees who either are retirement eligible or will become retirement eligible during the vesting period. Stock based compensation expense attributable to share units of $i3.8 million and $i4.5
million was recognized in the three months ended March 31, 2021 and 2020, respectively. Certain non-U.S.-based employees receive the cash value of the share price at the vesting date in lieu of shares. Unvested cash-settled awards are remeasured at each reporting period.
i
A summary of share unit activity under the plan is as follows for the three months ended March 31, 2021:
The
service cost component of net periodic benefit cost is presented within cost of products sold and selling, general and administrative expenses within the condensed consolidated statements of earnings while the other components of pension income are reflected in other income. The Company was not required to and did inot make a contribution to its U.S. pension plan in 2020. The
Company is inot required to make a contribution in 2021.
10. iSegment
Results
The Company is comprised of itwo reporting segments: North America and Rest of World. The Rest of World segment is primarily comprised of China, Europe and India. Both segments manufacture and market comprehensive lines of residential and commercial gas and electric water heaters, boilers, tanks, and water treatment products. Both segments primarily manufacture and market in their respective regions of the world. The
Rest of World segment also manufactures and markets in-home air purification products in China.
i
The following table presents the Company’s segment results:
ASC 820, Fair Value Measurements, among other things, defines fair value, establishes a consistent framework for measuring fair value and expands disclosure for each major asset and liability category measured at fair value on either a recurring basis or nonrecurring basis. ASC 820 clarifies that fair value is an exit price, representing the amount that would be received to sell an asset or
paid to transfer a liability in an orderly transaction between market participants. As such, fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or liability. As a basis for considering such assumptions, ASC 820 establishes a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value as follows: (Level 1) observable inputs such as quoted prices in active markets; (Level 2) inputs, other than the quoted prices in active markets, that are observable either directly or indirectly; and (Level 3) unobservable inputs in which there is little or no market data, which require the reporting entity to develop its own assumptions. Assets and liabilities measured at fair value are based on the market approach which are prices and other relevant information generated by market transactions involving identical or comparable assets or liabilities.
i
The
following table presents assets (liabilities) measured at fair value on a recurring basis (dollars in millions):
Quoted prices in active markets for identical assets (Level 1)
$
i87.0
$
i116.5
Significant
other observable inputs (Level 2)
(i3.0)
(i4.3)
/
Items
measured at fair value were comprised of the Company’s marketable securities (Level 1) and derivative instruments (Level 2). There were no changes in the Company’s valuation techniques used to measure fair values on a recurring basis during the three months ended March 31, 2021.
12. iDerivative
Instruments
The Company utilizes certain derivative instruments to enhance its ability to manage currency exposure as well as raw materials price risk. Derivative instruments are entered into for periods consistent with the related underlying exposures and do not constitute positions independent of those exposures. The Company does not enter into contracts for speculative purposes. The contracts are executed with major financial institutions with no credit loss anticipated for failure of the counterparties to perform.
Cash Flow Hedges
With the exception of its net investment hedges, the Company designates all of its hedging instruments as cash flow hedges. For derivative instruments that are designated and qualify as a cash flow hedge (i.e., hedging the exposure to variability in expected future cash flows that is attributable to a particular risk), gains or losses on the derivative instrument are reported as a component of other comprehensive loss, net of tax, and are reclassified into earnings in the same line item associated with the forecasted transaction and in the same period or periods during which the hedged transaction affects earnings.
The
Company is exposed to foreign currency exchange risk as a result of transactions in currencies other than the functional currency of certain subsidiaries. The Company utilizes foreign currency forward purchase and sale contracts to manage the volatility associated with foreign currency purchases, sales and certain intercompany transactions in the normal course of business. Principal currencies for which the Company utilizes foreign currency forward contracts include the British pound, Canadian dollar, Euro and Mexican peso.
Gains
and losses on these instruments are recorded in accumulated other comprehensive loss, net of tax, until the underlying transaction is recorded in earnings. When the hedged item is realized, gains or losses are reclassified from accumulated other comprehensive loss to the consolidated statement of earnings. The assessment of effectiveness for forward contracts is based on changes in the forward rates. These hedges have been determined to be effective. The majority of the amounts in accumulated other comprehensive loss for cash flow hedges are expected to be reclassified into earnings within one year.
The following table summarizes, by currency, the contractual amounts of the Company’s foreign currency forward contracts that are designated as cash flow hedges:
In addition to entering into supply arrangements in the normal course of business, the Company also enters into futures contracts to fix the cost of certain raw material purchases, principally steel, with the objective of minimizing changes in cost due to market price fluctuations. The hedging strategy for achieving this objective is to purchase steel futures contracts on the New York Metals Exchange (NYMEX) and copper futures contracts on the open market of the London
Metals Exchange (LME) or over the counter contracts based on the LME.
With NYMEX, the Company is required to make cash deposits on unrealized losses on steel derivative contracts.
Net Investment Hedges
The Company enters into certain foreign currency forward contracts to hedge the exposure to a portion of the Company’s net investments
in certain non-U.S. subsidiaries against the effect of exchange rate fluctuations on the translation of foreign currency balances to the U.S. dollar. For the derivative instruments that are designated and qualify as net investment hedges, gains and losses are reported in other comprehensive loss where they offset gains and losses recorded on the Company’s net investments in its non-U.S. subsidiaries. These hedges are determined to be effective. The Company recognized $— and $i0.8
million of after-tax gains associated with hedges of a net investment in non-U.S. subsidiaries in currency translation adjustment in other comprehensive income in the three months ended March 31, 2021 and 2020, respectively. The contractual amount of the Company's foreign currency forward contracts that are designated as net investment hedges is $i50.0
million as of March 31, 2021.
i
The following tables present the impact of derivative contracts on the Company’s financial statements.
Fair value of derivatives designated as hedging instruments under ASC 815:
The Company’s effective income tax rate for the three months ended March 31, 2021 was i22.5
percent compared to i23.6 percent for the three months ended March 31, 2020. The lower effective income tax rate for the three months ended March 31, 2021 compared to the effective income tax rate for the three months ended March 31, 2020 was primarily due to a change in geographical earnings mix. The
Company estimates that its annual effective income tax rate for the full year 2021 will be approximately i23 percent.
As of March 31, 2021, the Company had $i9.0
million of unrecognized tax benefits of which $i0.5 million would affect its effective income tax rate if recognized. The Company recognizes potential interest and penalties related to unrecognized tax benefits as a component of income tax expense. The Company’s U.S. federal income tax returns for 2017-2021 are subject to audit. The
Company is subject to state and local income tax audits for tax years 2002-2021. The Company is subject to non-U.S. income tax examinations for years 2015-2021.
14. iCommitments and Contingencies
The
Company maintains a commercial relationship with a supply-chain service provider (the Provider) in connection with the Company’s business in China. In this capacity, the Provider offers order-entry, warehousing and logistics support. The Provider also offers asset-backed financing to certain of the Company’s distributors in China to facilitate their working capital needs. To facilitate its financing support business, the Provider has collateralized lending facilities in place with multiple Chinese banks under which the Company has agreed to repurchase inventory if both requested by the banks and certain defined conditions are met, primarily related to the aging of the distributors’ notes.
The
Provider is required to indemnify the Company for any losses the Company would incur in the event of an inventory repurchase under these arrangements. Potential losses under the repurchase arrangements represent the difference between the repurchase price and net proceeds from the resale of product plus costs incurred in the process, less related distributor rebates.
Before considering any reduction of distributor rebate accruals of $i4.9
million and $i5.4 million as of March 31, 2021 and December 31, 2020, respectively, and from the resale of the related inventory, the gross amount the Company would be obligated to repurchase, which would be contingent on the default of all of the outstanding loans, was approximately $ii6.5/
million as of both March 31, 2021 and December 31, 2020. The Company’s reserves for estimated losses under repurchase arrangements were immaterial as of March 31, 2021 and December 31, 2020.
Unrealized
net gain (loss) on cash flow derivatives
Balance at beginning of period
i0.6
i0.2
Other
comprehensive (loss) gain before reclassifications
(i2.2)
i0.9
Realized
losses (gains) on derivatives reclassified to cost of products sold (net of income tax (benefit) provision of $(i0.1) and $i0.2 in 2021 and 2020,
respectively)
i0.2
(i0.6)
Balance
at end of period
(i1.4)
i0.5
Pension
liability
Balance at beginning of period
(i273.7)
(i282.3)
Amounts
reclassified from accumulated other comprehensive loss:(1)
i3.8
i3.6
Balance
at end of period
(i269.9)
(i278.7)
Accumulated
other comprehensive loss, end of period
$
(i320.8)
$
(i362.4)
(1)
Amortization of pension items:
Actuarial losses
$
i5.2
(2)
$
i4.9
(2)
Prior
year service cost
(i0.1)
(2)
(i0.1)
(2)
i5.1
i4.8
Income
tax benefit
(i1.3)
(i1.2)
Reclassification
net of income tax benefit
$
i3.8
$
i3.6
(2)These
accumulated other comprehensive loss components are included in the computation of net periodic pension cost. See Note 9 - Pensions for additional details.
ITEM 2 - MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
OVERVIEW
Our
company is comprised of two reporting segments: North America and Rest of World. Our Rest of World segment is primarily comprised of China, Europe and India. Both segments manufacture and market comprehensive lines of residential and commercial gas and electric water heaters, boilers, tanks, and water treatment products. Both segments primarily manufacture and market in their respective region of the world.
In January 2020, an outbreak of a novel coronavirus (COVID-19) surfaced in Wuhan, China. As a result of the outbreak, the Chinese government required businesses to close and restricted certain travel within the country. In cooperation with the government authorities, our operations in China closed for approximately four weeks before resuming production before the end of the first quarter. In March 2020, COVID-19 was declared a global pandemic and we experienced impacts to our business and other markets worldwide. As
a result of the COVID-19 pandemic and in support of continuing our manufacturing efforts, we have undertaken numerous and meaningful steps to protect our employees, suppliers, and customers. As we receive guidance from governmental authorities, we adjust our safety measures to meet or exceed those guidelines.
Our global supply chain management team continues to monitor and manage our ability to operate effectively despite pandemic and weather-related challenges. Ongoing communications with our suppliers to identify and mitigate potential disruptions and manage inventory levels continue. Bottlenecks in our global supply chain, largely due to the pandemic and severe weather, along with shipping delays, weather-related plant closures, absenteeism and self-quarantine related to the pandemic have further extended our water heater lead times in the first quarter of 2021.
The first
quarter of 2021 was particularly challenging for our North America water heater business as severe weather disruptions at our facilities and supply chain constraints limited production. If not for the limited production, based on a surge in customer orders in the first quarter of 2021, we believe our U.S. residential water heater shipments would have increased compared to the same quarter last year.
In our North America segment, we expect industry residential water heater volumes will be down approximately two percent in 2021 compared with 2020, which is driven by our belief that customers may have added inventory in 2020 due to industry extended lead times. We believe that some de-stocking by our customers will occur as our lead times improve throughout 2021. The timing of the de-stocking is difficult to predict, as we have announced three price increases that will go into effect in the first half of 2021, which typically
generate pre-buy orders in advance of the price increases. We continue to experience inflation across our supply chain, particularly steel and logistics costs. The cost of steel has increased 25 percent since late January when we announced our second water heater price which is effective April 1, 2021. Due to rapidly rising material costs and a continued need to expedite freight to overcome shipping delays, we announced our third price increase on water heaters in late March, which is effective on June 1, 2021. When fully implemented, the cumulative impact of our three announced price increases is 24 to 27 percent based on the type of water heater. We believe that commercial water heater industry volumes will further decline approximately four percent in 2021 as COVID-19 pandemic-impacted businesses continue to delay or defer new construction and discretionary replacement
installations. We expect to see a low-double-digits increase in our boiler sales in 2021 compared to 2020 due to pandemic-related pent-up demand as well as our new product introductions. We expect sales of our North America water treatment products to increase by 13 to 14 percent in 2021, compared to 2020, primarily driven by consumer demand for our point of use and point of entry water treatment systems.
In our Rest of World segment, we expect China sales in 2021 to increase 18 to 20 percent in local currency compared with 2020 due to increased consumer demand. We assume China currency rates will stay at current levels and which would add approximately $50 million and $3 million to sales and earnings in 2021, respectively. In addition, we believe that our mix of products sold in China is shifting to more mid-price range products from our historical mix of higher-priced products.
Combining
all of these factors, we expect our consolidated sales to increase by between 14 and 15 percent in 2021. Our guidance excludes the potential impacts from future acquisitions and assumes the conditions of our business environment and that of our suppliers and customers are similar throughout 2021 to what we have experienced in recent months and does not deteriorate as a result of further restrictions, supply chain bottlenecks or shutdowns.
RESULTS OF OPERATIONS
FIRST THREE MONTHS OF 2021 COMPARED TO 2020
Sales in the first quarter of 2021 were $769 million, approximately 21 percent higher than sales of $637 million in the first quarter of 2020. The increase in our first quarter of 2021 sales
compared to the same period last year was primarily due to a 119 percent increase in sales in China and higher sales of boilers, water heaters in Canada, and water treatment products in North
America. Our sales in China also benefited from currency translation of approximately $14 million in the first quarter of 2021 due to the Chinese currency's appreciation against the U.S. Dollar.
First quarter gross profit margin of 37.5 percent in 2021 was slightly lower than the gross profit margin of 37.6 percent in the prior-year period.
Selling, general, and administrative
(SG&A) expenses in the first quarter of 2021 were $166.5 million or $7.3 million lower than SG&A expenses of $173.8 million in the first quarter of 2020. The decrease in SG&A expenses in 2021 was primarily due to lower selling expenses and advertising costs in China, resulting from headcount reductions, store closures, cuts in advertising, and other cost-saving measures implemented during 2020.
Interest expense in the first quarter of 2021 was $1.0 million compared to $2.2 million in the first quarter of 2020. The decrease in interest expense in the first quarter of 2021 was primarily due to lower debt levels than the prior-year period.
Other income was $5.0 million in the first quarter of 2021, up from $4.2 million in the same period last year. The increase in other income was primarily due to higher currency translation gains and pension income than in the first quarter
of 2020 and partially offset by lower interest income.
Our pension costs and credits are developed from actuarial valuations. The valuations reflect key assumptions regarding, among other things, discount rates, expected return on plan assets, retirement ages, and years of service. We consider current market conditions, including changes in interest rates, in making these assumptions. Our assumption for the expected rate of return on plan assets is 6.25 percent in 2021 compared to 6.75 percent in 2020. The discount rate used to determine net periodic pension costs decreased to 2.45 percent in 2021 from 3.18 percent in 2020. Pension income for the first quarter of 2021 and 2020 was $2.9 million and $2.1 million, respectively. The service cost component of our pension income is reflected in cost of products sold and SG&A expenses. All other components of our pension income are reflected in other income.
Our
effective income tax rate for the first quarter of 2021 was 22.5 percent compared to 23.6 percent in the same period last year. Our effective income tax rate in the first quarter of 2021 was lower than the effective income tax rate in the first quarter of 2020 primarily due to a change in the geographic earnings mix. We estimate that our effective income tax rate for the full year 2021 will be approximately 23 percent.
North America
Sales in our North America segment were $553 million in the first quarter of 2021 or $20 million higher than sales of $533 million in the first quarter of 2020. Increased sales in the first quarter of 2021 were primarily due to higher boiler, service parts and tankless water heater sales in the U.S., improved water heater sales in Canada, a twelve percent growth in water treatment sales and inflation-related price increases on water heaters in the U.S.,
which were partially offset by lower U.S. residential and commercial tank-type water heater volumes.
North America segment earnings were $130.4 million in the first quarter of 2021, which was higher than segment earnings of $127.1 million in the same period of 2020. Segment margin was 23.6 percent in the first quarter of 2021 compared to 23.9 percent in the first quarter of 2020. Increased earnings from higher sales and inflation-related price increases on water heaters were partially offset by higher material and freight costs and lower water heater volumes in the U.S. We expect our full-year 2021 North America segment margin to be between 23 and 23.50 percent.
Rest of World
Sales in the Rest of World segment were $222 million in the first quarter of 2021 or $112 million higher than sales of $110 million in the first quarter of 2020.
Sales in China increased $108 million, or 119 percent in U.S. dollar terms, compared to the prior-year period and benefited from currency translation of approximately $14 million in the first quarter of 2021 due to the Chinese currency's appreciation against the U.S. Dollar. Stronger consumer demand in the first quarter of 2021 in each of our major product lines in China more than doubled sales compared to the first quarter of 2020 which was impacted by pandemic-related lockdowns and weak end-market demand.
Rest of World segment earnings were $11.8 million in the first quarter of 2021 compared to $42.2 million of losses in the first quarter of 2020. Segment margin was 5.3 percent in the first quarter of 2021 compared to a negative margin of 38.3 percent in the same period last year. In China, stronger consumer demand drove higher sales volumes across our major product lines. Lower SG&A expenses, due to lower selling
expenses and advertising costs in China, resulting from headcount reductions, store closures, cuts in advertising expenditures, and other cost-saving measures implemented during 2020, contributed to higher segment earnings in the first quarter of 2021 compared to the first quarter of 2020. We expect our full-year 2021 Rest of World segment margin to be between seven and eight percent.
We expect our consolidated sales to grow between
14 and 15 percent in 2021 on strong North America water treatment, boiler and China sales, enhanced by pricing actions, and more than offset expected weaker North America water heater volumes. Our sales growth projection includes approximately $50 million of benefit from China currency translation. We have increased the midpoint of our EPS guidance for 2021 and we believe we will achieve full-year net earnings of between $2.55 and $2.65 per share. Our 2021 guidance excludes the potential impacts from future acquisitions and assumes that the conditions of our business environment and those of our suppliers and customers are similar for the remainder of the year to what we have experienced in recent months and do not deteriorate as a result of further restrictions, supply chain bottlenecks or shutdowns.
Liquidity &
Capital Resources
Working capital of $722.1 million at March 31, 2021 was $9.6 million lower than at December 31, 2020, primarily due to lower accounts receivable balances. As of March 31, 2021, approximately $540 million of our $666 million of cash, cash equivalents, and marketable securities was held by our foreign subsidiaries. We expect to repatriate approximately $160 million of cash from our foreign subsidiaries in 2021 and use the proceeds to purchase shares of our common stock.
Cash provided by operations in the first quarter of 2021 was $104.4 million
compared with $54.1 million during the same period last year. Higher earnings resulted in higher cash flow from operations in the first quarter of 2021. For the full year 2021, we expect cash provided by operating activities will be between $475 and $500 million, lower than 2020 cash provided by operating activities of $562 million primarily due to higher investments in working capital partially offset by higher earnings compared to the prior year.
Capital expenditures totaled $17.1 million in the first quarter of 2021, compared with $12.8 million in the year ago period. We project 2021 capital expenditures will be between $85 and $90 million and full year depreciation and amortization expense will be approximately $80 million.
We had a $500 million multi-currency credit facility with a group of nine banks, which would have expired in December 2021. The facility had an accordion
provision, which allowed us to increase it up to $700 million if certain conditions (including lender approval) were satisfied. Borrowing rates under the facility were determined by our leverage ratio. The facility required us to maintain two financial covenants, a leverage ratio test and an interest coverage test, and we were in compliance with the covenants as of March 31, 2021. We did not have borrowings on this facility during the quarter ended March 31, 2021. On April 1, 2021, we renewed and amended our $500 million revolving credit facility with the new expiration date of March 31, 2026. The renewed and amended facility has an accordion provision which allows it to be increased up to $850 million if certain conditions (including lender approval) are satisfied.
The
facility backs up commercial paper and credit line borrowings. At March 31, 2021, we had available borrowing capacity of $500 million under this facility. We believe the combination of available borrowing capacity and operating cash flows will provide sufficient funds to finance our existing operations for the foreseeable future.
Our total debt decreased $6.8 million from $113.2 million at December 31, 2020 to $106.4 million at March 31, 2020. Our leverage, as measured by the ratio of total debt to total capitalization, calculated excluding operating lease liabilities, was 5.4 percent at March 31, 2021, compared with 5.8 percent at December 31, 2020.
Our
pension plan continues to meet all funding requirements under ERISA regulations. We are not required to make a contribution and we do not plan to make any voluntary contributions to the plan in 2021.
In the first quarter of 2021, our Board of Directors approved adding 7,000,000 shares of common stock to our existing discretionary share repurchase authority. Under our share repurchase program, we may purchase our common stock through a combination of a Rule 10b5-1 automatic trading plan and discretionary purchases in accordance with applicable securities laws. The stock repurchase authorization remains effective until terminated by our Board of Directors, which may occur at any time, subject to the parameters of any Rule 10b5-1 automatic trading plan that we may then have in effect. During the first quarter of 2021, we repurchased 1,075,200 shares of our stock at a total cost of $67.0 million. At March
31, 2021, we had 7,538,624 million shares remaining on the share repurchase authority. Depending on factors such as stock price, working capital requirements and alternative investment opportunities, we expect to spend approximately $400 million on stock repurchases in 2021 through a combination of our Rule 10b5-1 automatic trading plan and opportunistic repurchase in the open market.
On April 12, 2021, our Board of Directors declared a regular quarterly cash dividend of $0.26 per share on our Common Stock and Class A common stock. The dividend is payable on May 17, 2021, to shareholders of record on April 30, 2021.
We provide a non-GAAP measure, adjusted earnings per share (EPS) that excludes severance and restructuring expenses in 2020. We believe that this measure of adjusted EPS provides useful information to investors about our performance and allows management and our investors to better compare our performance period over period.
A. O. SMITH CORPORATION
2021 EPS Guidance and 2020 Adjusted EPS
(unaudited)
The following is a reconciliation of diluted EPS to adjusted EPS (non-GAAP):
2021 Guidance
2020
Diluted
EPS (GAAP)
$2.55-2.65
$
2.12
Severance and restructuring expenses per diluted share, net of tax
—
0.04
Adjusted EPS
$2.55-2.65
$
2.16
Critical
Accounting Policies
Our consolidated financial statements are prepared in conformity with accounting principles generally accepted in the U.S., which requires the use of estimates and assumptions about future events that affect the amounts reported in the financial statements and accompanying notes. Future events and their effects cannot be determined with absolute certainty. Therefore, the determination of estimates requires the exercise of judgment. Actual results inevitably will differ from those estimates, and such differences may be material to the financial statements. The critical accounting policies that we believe could have the most significant effect on our reported results or require complex judgment by management are contained in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, of our Annual Report on Form 10-K for the year ended December
31, 2020. We believe that at March 31, 2021, there has been no material change to this information.
Recent Accounting Pronouncement
Refer to Recent Accounting Pronouncement in Note 1 – Basis of Presentation in the notes to our condensed consolidated financial statements included in Part 1 Financial Information.
Forward Looking Statements
This filing contains statements that the
Company believes are “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements generally can be identified by the use of words such as “may,”“will,”“expect,”“intend,”“estimate,”“anticipate,”“believe,”“forecast,”“continue,”“guidance” or words of similar meaning. All forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from those anticipated as of the date of this filing. Important factors that could cause actual results to differ materially from these expectations include, among other things, the following: negative impacts to the Company’s businesses, including demand for its products, particularly commercial products, operations and workforce dislocation and
disruption, supply chain disruption and liquidity as a result of the severity and duration of the COVID-19 pandemic; lengthening or deepening of weather-related supply chain bottlenecks; an uneven recovery of the Chinese economy or decline in the growth rate of consumer spending or housing sales in China; negative impact to the Company’s businesses from international tariffs, trade disputes and geopolitical differences; potential weakening in the high-efficiency boiler segment in the U.S.; significant volatility in material availability and prices; inability of the Company to implement or maintain pricing actions; a failure to recover or further weakening in U.S. residential or commercial construction or instability in the Company’s
replacement markets; foreign currency fluctuations; the Company’s inability to successfully integrate or achieve its strategic objectives resulting from acquisitions; competitive pressures on the Company’s businesses; the impact of potential information technology or data security breaches; changes in government regulations or regulatory requirements; and adverse developments in general economic, political and business conditions in key regions of the world. Forward-looking statements included in this filing are made only as of the date of this filing, and the Company is under no obligation to update these statements to reflect subsequent events or circumstances. All subsequent written and oral forward-looking statements attributed
to the Company, or persons acting on its behalf, are qualified entirely by these cautionary statements.
ITEM 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
As is more fully described in our Annual Report on Form 10-K for the year ended December 31, 2020, we are exposed to various types of market risks, including currency and certain commodity
risks. Our quantitative and qualitative disclosures about market risk have not materially changed since that report was filed. We monitor our currency and commodity risks on a continuous basis and generally enter into forward and futures contracts to minimize these exposures. The majority of the contracts are for periods of less than one year. Our Company does not engage in speculation in our derivative strategies. It is important to note that gains and losses from our forward and futures contract activities are offset by changes in the underlying costs of the transactions being hedged.
ITEM
4 - CONTROLS AND PROCEDURES
Evaluation of disclosure controls and procedures
Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of our disclosure controls and procedures, as such term is defined under Rule13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended (Exchange Act). Based upon this evaluation of these disclosure controls and procedures, our principal executive officer and principal financial officer concluded that the disclosure controls and procedures were effective as of March 31, 2021 to ensure that information required to be disclosed by us in the reports we file or submit under the Exchange Act is recorded, processed, summarized and reported, within the time period specified in the
SEC rules and forms, and to ensure that information required to be disclosed by us in the reports we file or submit under the Exchange Act is accumulated and communicated to our management, including our principal executive and principal financial officers, as appropriate, to allow timely decisions regarding disclosure.
Changes in internal control over financial reporting
There have been no changes in our internal control over financial reporting during the quarter ended March 31, 2021 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
PART II - OTHER INFORMATION
ITEM
1 - LEGAL PROCEEDINGS
There have been no material changes in the legal and environmental matters discussed in Part 1, Item 3 and Note 15 of the Notes to Consolidated Financial Statements in our Annual Report on Form 10-K for the year ended December 31, 2020.
ITEM 2 - UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
In the first quarter of 2021, our Board of Directors approved adding 7,000,000 shares of common stock to the existing discretionary share repurchase authority. Under the share repurchase program, the Common Stock may be purchased through a combination of Rule 10b5-1 automatic trading plan and discretionary purchases in accordance with applicable
securities laws. The number of shares purchased and the timing of the purchases will depend on a number of factors, including share price, trading volume and general market conditions, as well as working capital requirements, general business conditions and other factors, including alternative investment opportunities. The stock repurchase authorization remains effective until terminated by our Board of Directors which may occur at any time, subject to the parameters of any Rule 10b5-1 automatic trading plan that we may then have in effect. In the first quarter of 2021, we repurchased 1,075,200 shares at an average price of $62.35 per share and at a total cost of $67.0 million. As of March 31, 2021, there were 7,538,624 shares remaining on the existing repurchase authorization.
ISSUER
PURCHASES OF EQUITY SECURITIES
Period
Total Number of Shares Purchased
Average Price Paid per Share
Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs
Maximum Number of Shares that may yet be Purchased Under the Plans or Programs
The following materials from A. O. Smith Corporation’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2021 are filed herewith, formatted in XBRL (Extensive Business Reporting Language): (i) the Condensed Consolidated Statement of Earnings for the three months ended March 31, 2021 and 2020, (ii) the Condensed Consolidated Statement of Comprehensive Earnings for the three months ended March
31, 2021 and 2020, (iii) the Condensed Consolidated Balance Sheets as of March 31, 2021, and December 31, 2020 (iv) the Condensed Consolidated Statement of Cash Flows for the three months ended March 31, 2021 and 2020 (v) the Condensed Consolidated Statement of Stockholders’ Equity for the three months ended March 31, 2021 and 2020 (vi) the Notes to Condensed Consolidated Financial Statements.
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has authorized this report to be signed on its behalf by the undersigned.
