What changed in this filing

/stocks — the workspaceLOADING

Item 7. Management’s Discussion and Analysis

2022-02-11 compared with 2021-02-12 · 194 added, 212 removed, 116 unchanged (78% of the section changed)

3 unchanged sentences

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 manufacture and market comprehensive lines of residential and commercial gas, heat pump 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.

To date, our global manufacturing operations of essential water heating and water treatment products continue without material disruption to our operations.

In January 2020, an outbreak of a novel coronavirus (COVID-19) surfaced in Wuhan, China, which by March 2020 had spread throughout the world and was declared a global pandemic.

Since March 2020 and continuing into 2021, 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.

These important steps, which in certain cases reduce efficiency, include continuous communication and training to our employees on living and working safely in a COVID-19 environment, plant accommodations and reconfigurations to maintain social distancing, masks for all employees, implementation of sanitizing stations, temperature taking and regular, proactive deep cleaning and sanitization of our facilities, among others.

As we receive guidance from governmental authorities, we adjust our safety measures to meet or exceed those guidelines.

The majority of our customers in the U.S.

are also deemed essential under Cybersecurity and Infrastructure Security Agency (CISA) guidance and are operating their businesses under varying state and local governmental guidance.

Our global supply chain management team continues to monitor and manage our ability to operate effectively during the COVID-19 pandemic.

To date, we have not seen any material disruptions to our supply chain, although we have seen an increase in logistics costs and shipment times as a result of pandemic-related capacity reductions.

Ongoing communications with our suppliers to identify and mitigate risk of potential disruptions and to manage inventory levels continue.

water heater manufacturing lead times, which were extended in the second and third quarters due to self-quarantine absenteeism mandated by our COVID-19 prevention measures, stabilized in the fourth quarter of 2020 as a result of adding manufacturing shifts, hiring temporary workers and shifting some production.

While we believe our balance sheet and capital position are strong, proactive management of discretionary spending and cost structure will continue.

On May 1, 2020, the members of our Board of Directors voluntarily reduced the cash component of their board compensation by 25 percent and our chairman and chief executive officer (CEO) voluntarily reduced his base salary by 25 percent.

Our CEO’s staff, which includes our other named executive officers, also volunteered a 15 percent reduction in base salary.

Full compensation of our Board of Directors, our CEO and our CEO’s staff was reinstated on October 1, 2020.

We estimate that between 80 to 85 percent of our water heater and boiler units sold in the U.S.

relate to replacement business.

While we expect that our replacement business in both water heating and boilers will provide a buffer in any economic downturn resulting from COVID-19 in a similar manner to what we have seen historically, the impacts of the pandemic on consumer spending are difficult to predict.

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 in early 2021 as our lead times have improved and continue to improve.

We believe that commercial water heater industry volumes will further decline approximately four percent in 2021 as COVID-19 pandemic-impacted businesses delay or defer new construction and discretionary replacement installations.

We expect to see a mid-single digit increase to our boiler sales in 2021 compared to 2020 due to industry growth of three to four percent driven by 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 14 to 15 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 $47 million and $3 million to sales and earnings in 2021, respectively.

In addition, we project that our mix of products sold in China is shifting to more mid-price range products from our historical mix of higher priced products.

We also continue to focus on aligning our cost structure in China through headcount reductions, store closures, cuts in advertising

and other cost saving measures.

Our 2020 headcount reductions and restructuring actions we took were largely completed as of the end of the third quarter of 2020.

Combining all of these factors, we expect our consolidated sales to increase approximately ten 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 in 2021 to what we are experienced in recent months and does not deteriorate as a result of further restrictions or shutdowns due to the COVID-19 pandemic.

Our stated acquisition strategy includes a number of our water-related strategic initiatives.

We will seek to continue to grow our core residential and commercial water heating, boiler and water treatment businesses throughout the world.

We will also continue to look for opportunities to add to our existing operations in high growth regions demonstrated by our introduction of water treatment products in India and Vietnam and range hoods and cooktops in China.

As we continue to receive guidance from governmental authorities, we adjust our safety measures to meet or exceed those guidelines.

Our global supply chain management team continued to navigate through supply chain and logistics challenges in 2021.

We have seen supply constraints for certain components and raw materials used in our operations, as well as limited container and trucking capacity, and port congestion and delays.

While supply chain issues moderated as we moved into 2022, we remain in close contact with our suppliers and logistics providers to troubleshoot, manage and resolve bottlenecks, as the environment remains unpredictable, particularly with the surge in the Omicron variant of COVID-19.

We seek to continue to grow our core residential and commercial water heating, boiler and water treatment businesses throughout the world.

This includes focusing on acquisitions that are related to our core business.

Consistent with this strategy, we acquired Giant Factories, Inc.

(Giant), a Canada-based manufacturer of residential and commercial water heaters, on October 19, 2021, for $199 million, subject to customary adjustments, using a combination of debt and cash.

The acquisition fits squarely in our core capabilities, supplements our presence in Canada and enhances our capacity and distribution in the region.

Giant contributed $22.9 million of sales and approximately $0.01 in earnings per share (EPS) to our results in 2021 and we expect Giant will contribute approximately $0.06-$0.08 to our EPS in 2022.

We will also continue to look for opportunities to add to our existing operations in high growth regions demonstrated by our previous introductions of water treatment products in India and range hoods and cooktops in China.

In our North America segment, after approximately eight percent growth each year in 2021 and 2020, we expect residential industry water heater volumes will be down approximately two percent in 2022 compared with 2021 as we believe that industry demand will normalize to more historical growth rates.

We believe that commercial water heater industry volumes will be flat to slightly down in 2022 compared to 2021 as new construction and replacement installations level off.

We expect sales in 2022 will benefit from our 2021 price increases, which had a cumulative effect on our water heater prices of approximately 50 percent.

We expect to see a ten percent increase in our sales of boilers in 2022 compared to 2021 due to industry growth of three to four percent, our expectation that the transition to higher-efficiency boilers will continue as well as our new product introductions.

We anticipate sales of our North America water treatment products will increase 13 to 14 percent in 2022, compared to 2021, primarily driven by consumer demand for our point of use and point of entry water treatment systems.

In our Rest of World segment, after strong growth in 2021, we expect 2022 sales in China to increase approximately five percent in local currency compared with 2021 driven by demand for our residential and commercial water treatment products, including our replacement filters, as well as rangehoods and cooktops.

We assume China currency rates will stay at levels similar to 2021.

Combining all of these factors, we expect our consolidated sales to increase between 16 and 18 percent in 2022.

Our guidance excludes the potential impacts from future acquisitions and assumes the recent surge of the Omicron variant subsides during the first quarter of 2022 and does not have a significant impact on our productivity or significantly impact the end markets that we serve.

RESULTS OF OPERATIONS

Our sales in 2020 were $2,895 million, a decline of 3.3 percent compared to our 2019 sales of $2,993 million.

Compared to 2019, our sales decline in 2020 was primarily driven by lower sales in China and lower commercial water heater volumes, and reduced boiler sales in North America.

The decreased sales in 2020 compared to the prior year more than offset higher water treatment volumes including incremental sales of $16 million from Water-Right, acquired on April 8, 2019 and higher residential water heater volumes in North America.

In addition, our sales in China were favorably impacted by currency translation of approximately $9 million in 2020 compared to 2019, due to the appreciation of the Chinese currency compared to the U.S.

Our sales in 2019 were $2,993 million, a decline of 6.1 percent compared to our 2018 sales of $3,188 million.

The decrease in 2019 sales was primarily due to a 23 percent decline in China sales in U.S.

dollar terms, which was largely a result of weaker end-market demand in the region, year over year channel inventory shifts, and a higher mix of sales of mid-price products versus premium price products than in the prior year.

Excluding the unfavorable impact from currency translation, China sales declined 19 percent in 2019.

The sales reduction in China in 2019 compared to 2018, more than offset the benefits of higher sales in North America, which were primarily a result of higher sales of water treatment products, including incremental sales from our Water-Right acquisition, and water heater pricing actions related to steel and freight cost increases.

The increase in North America sales in 2019 compared to 2018, was partially offset by lower residential water heater volumes.

Our gross profit margin in 2020 of 38.3 percent declined compared to our gross profit margin of 39.5 percent in 2019 primarily due to the lower sales volumes.

Our gross profit margin in 2019 of 39.5 percent declined compared to our gross profit margin of 41.0 percent in 2018, primarily due to the lower sales volumes in China and a higher mix of mid-price products, which have lower margins, in that region.

Selling, general, and administrative (SG&A) expenses were $660.3 million in 2020 or $55.3 million lower than 2019.

SG&A expenses were $715.6 million in 2019 or $38.2 million lower than in 2018.

The decrease in SG&A expenses in both 2020 and 2019 was primarily due to lower selling and advertising expenses in China.

To align our business to current market conditions, we recognized $7.7 million of pre-tax severance and restructuring expenses in 2020.

Charges recognized were comprised of $6.8 million severance costs and $0.9 million of other restructuring expenses.

On March 21, 2018, we announced a plan to transfer water heater, boiler and storage tank production from our Renton, Washington plant to our other U.S.

The majority of the consolidation of operations occurred in the second quarter of 2018.

As a result of the relocation of production, we incurred pre-tax restructuring and impairment expenses of $6.7 million in the first quarter of 2018, primarily related to employee severance, building lease exit costs, and the impairment of assets.

These activities are reflected in "severance, restructuring, and impairment expenses" in the accompanying financial statements.

We provide non-U.S.

Generally Accepted Accounting Principles (GAAP) measures (adjusted earnings, adjusted earnings per share, and adjusted segment earnings) that exclude severance, restructuring, and impairment expenses.

Reconciliations to measures on a GAAP basis are provided later in this section.

We believe that the measures of adjusted earnings, adjusted EPS, and adjusted segment earnings provide useful information to investors about our performance and allow management and our investors to better understand our performance between periods without regard to items we do not consider to be a component of our core operating performance.

Interest expense was $7.3 million in 2020, compared to $11.0 million in 2019 and $8.4 million in 2018.

The decrease in interest expense in 2020 was primarily due to lower debt levels and lower interest rates than the prior year.

The increase in interest expense in 2019 compared to 2018 was primarily due to higher debt levels utilized to fund the acquisition of Water-Right and share repurchase activity.

Other income was $11.0 million in 2020 compared to $18.0 million in 2019 and $21.2 million in 2018.

The decrease in other income in 2020 compared to 2019 was primarily due to lower interest income.

The decrease in other income in 2019 compared to 2018 was primarily due to lower non-service cost-related pension income and lower interest income.

Pension income in 2020 was $5.1 million compared to $6.2 million in 2019 and $8.7 million in 2018.

In this section, we discuss the results of our operations for 2021 compared with 2020.

We discuss our cash flows and current financial condition under “Liquidity and Capital Resources.” For a discussion related to 2020 compared with 2019, please refer to Item 7 of Part II, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K for the Year Ended December 31, 2020, which was filed with the United States Securities and Exchange Commission (SEC) on February 12, 2021, and is available on the SEC's website at www.sec.gov.

Years Ended December 31,

(dollars in millions) 2021 2020 2019

Net sales $ 3,538.9 $ 2,895.3 $ 2,992.7

Cost of products sold 2,228.0 1,787.1 1,812.0

Gross Margin 1,310.9 1,108.2 1,180.7

Gross margin % 37.0 % 38.3 % 39.5 %

Selling, general and administrative expenses 701.4 660.3 715.6

Severance and restructuring expenses — 7.7 —

Interest expense 4.3 7.3 11.0

Other income - net (20.4) (11.0) (18.0)

Earnings before provision for income taxes 625.6 443.9 472.1

Provision for income taxes 138.5 99.0 102.1

Net Earnings $ 487.1 $ 344.9 $ 370.0

Our sales in 2021 were $3,538.9 million, or 22.2 percent higher than 2020 sales of $2,895.3 million.

Compared to 2020, which was negatively impacted by the COVID-19 pandemic, our sales increase in 2021 was primarily driven by inflation-related pricing actions and higher water heater, boiler, and water treatment volumes in North America as well as higher sales in China.

Our acquisition of Giant added $22.9 million of sales in 2021.

In addition, our sales in China were favorably impacted by approximately $58 million in 2021 compared to 2020, due to the appreciation of the Chinese currency compared to the U.S.

Our gross profit margin in 2021 of 37.0 percent declined compared to 38.3 percent in 2020.

The lower gross margin in 2021 was primarily due to higher steel and other material costs which outpaced our pricing actions.

Selling, general, and administrative (SG&A) expenses were $701.4 million in 2021 or $41.1 million higher than 2020.

The increase in SG&A expenses in 2021 was primarily due to higher advertising, engineering and selling expenses and higher management incentive expenses related to higher earnings compared to 2020.

Higher SG&A expenses in 2021 were partially offset by lower spending in China associated with headcount reductions, store closures and other cost-saving measures implemented during 2020.

To align our business to market conditions in 2020, we recognized $7.7 million of pre-tax severance and restructuring expenses.

The charges were comprised of $6.8 million severance costs and $0.9 million of other restructuring expenses.

These activities are reflected in "severance and restructuring expenses" in the accompanying financial statements.

Interest expense was $4.3 million in 2021, compared to $7.3 million in 2020.

The decrease in interest expense in 2021 was primarily due to lower average debt levels.

Other income was $20.4 million in 2021 compared to $11.0 million in 2020.

The increase in other income in 2021 was primarily due to higher pension and interest income.

Pension income in 2021 was $12.0 million compared to $5.1 million in 2020.

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 was 22.3 percent in 2020, compared with 21.6 percent in 2019 and 20.4 percent in 2018.

Our effective income tax rate in 2020 and 2019 was higher compared to the prior years primarily due to a change in geographic earnings mix.

North America

Sales in our North America segment were $2,118 million in 2020 or $34 million higher than sales of $2,084 million in 2019.

Compared to 2019, the increased 2020 sales were primarily due to higher volumes of residential water heaters and a 25 percent increase in water treatment product sales, including $16 million of incremental sales from Water-Right.

This increase was partially offset by lower U.S.

commercial water heater volumes, lower boiler sales and a water heater sales mix composed of more electric models which have a lower selling price.

Our effective income tax rate was 22.1 percent in 2021, compared with 22.3 percent in 2020.

Our lower effective income tax rate in 2021 was primarily due to a change in geographic earnings mix as well as a favorable tax impact related to amending a previously filed tax return.

We estimate that our annual effective income tax rate for the full year of 2022 will be between 23.5 and 24 percent.

North America Segment

Years ended December 31 (dollars in millions) 2021 2020

Net Sales $ 2,529.5 $ 2,118.3

Segment Earnings 590.8 503.5

Segment Margin 23.4 % 23.8 %

Sales in our North America segment were $2,529.5 million in 2021 or $411.2 million higher than sales of $2,118.3 million in 2020.

The increase in sales in 2019 compared to 2018 was primarily due to the incremental Water-Right sales of $44 million, water heater pricing actions related to steel and freight cost increases, and higher sales of water treatment products, which were partially offset by lower residential water heater volumes.

North America segment earnings were $503.5 million in 2020 compared to segment earnings of $488.9 million and $464.1 million in 2019 and 2018, respectively.

Segment margins were 23.8 percent, 23.5 percent and 22.7 percent in 2020, 2019 and 2018, respectively.

Adjusted segment earnings and adjusted segment margin, which exclude severance, restructuring, and impairment expenses, were $506.2 million and 23.9 percent, respectively, in 2020, and $470.8 million and 23.0 percent, respectively, in 2018.

The higher adjusted segment earnings and adjusted segment margin in 2020 compared to 2019 segment earnings and segment margin were primarily driven by higher residential water heater volumes, higher water treatment product sales, which included incremental profit from Water-Right, and lower material costs.

This was partially offset by lower volumes of commercial water heaters and lower boiler sales.

During 2020, segment earnings and margin were adversely impacted by certain costs related to the pandemic.

These costs included temporarily moving production from Mexico to the U.S., paying employees during temporary plant shutdowns, proactively deep cleaning facilities, paying benefits during employee furloughs, and other costs, which were approximately $6.6 million in 2020.

The higher segment earnings and segment margin in 2019 compared to 2018 adjusted segment earnings and adjusted segment margin were primarily a result of pricing actions, lower steel costs, and higher sales of water treatment products, including incremental volumes from our acquisition, Water-Right.

These increases were partially offset by the unfavorable impact from lower residential water heater volumes.

We estimate our 2021 North America segment margin will be between 23 and 23.5 percent.

Adjusted segment earnings and adjusted segment margin in 2020 exclude $2.7 million of pre-tax severance and restructuring and impairment expenses.

These expenses were associated with an initiative to align our business to current market conditions.

Adjusted segment earnings and adjusted segment margin in 2018 exclude $6.7 million of pre-tax severance, restructuring and impairment expenses.

These expenses were associated with our transfer of our water heater, boiler and storage tank production from our Renton, Washington plant to our other U.S.

Rest of World

Sales in our Rest of World segment were $800 million in 2020 or $136 million lower than sales of $936 million in 2019.

Compared to 2019, our sales in China decreased by 15 percent in U.S.

dollar terms and 16 percent in local currency in 2020.

In addition, our 2020 sales in China were favorably impacted by currency translation of approximately $9 million compared to 2019, due to the appreciation of the Chinese currency compared to the U.S.

The decrease in Rest of World sales in 2020 was primarily due to COVID-19 pandemic-related lockdowns, weak end-market demand in China, primarily in the first half of 2020, a higher mix of mid-price products which have a lower selling price and year over year channel inventory shifts.

Sales in our Rest of World segment in 2019 were $936 million or $238 million lower than sales of $1,174 million in 2018.

Lower sales in 2019 compared to 2018 were largely a result of decreased China sales, which declined 23 percent in U.S.

dollar terms and 19 percent in local currency terms.

The decline in China sales was primarily due to weaker end-market demand, elevated channel inventory levels for the first three quarters of 2019 that returned to a more normal range of two to three months by the end of 2019, and a higher mix of mid-price products versus premium-priced products.

In addition, the weaker Chinese currency unfavorably impacted translated sales by approximately $39 million.

Sales in India grew approximately 13 percent in 2019 compared to 2018.

The Rest of World segment was breakeven in 2020 compared to segment earnings of $40.2 million and $149.3 million in 2019 and 2018, respectively.

The increased sales in 2021 were driven primarily by price increases, largely on water heaters, which were implemented in response to rising material and transportation costs.

Higher sales were also driven by increased volumes across all product lines, including $22.9 million of incremental sales from Giant.

North America segment earnings were $590.8 million in 2021, an increase of 17 percent compared to segment earnings of $503.5 million in 2020.

Segment margins were 23.4 percent and 23.8 percent in 2021 and 2020, respectively.

Adjusted segment earnings and segment margin, which exclude severance, restructuring, and impairment expenses, were $5.0 million and one percent, respectively, in 2020.

Compared to 2019, the absence of segment earnings in 2020 was driven by the unfavorable impact from lower sales in China and a higher mix of mid-price products, which have lower margins than our historical mix of higher-priced products, and which were partially offset by the benefits from lower selling, advertising, and administrative costs and temporary social insurance exemptions.

Currency translation increased segment earnings by approximately $3.6 million in 2020 compared to 2019.

The decline in 2019 segment earnings and margin compared to 2018 was primarily due to lower sales in China and a higher mix of mid-price products, which have lower margins, that when combined, more than offset benefits to profits from lower SG&A expenses and material costs in that region.

Currency translation reduced segment earnings by approximately $3.0 million in 2019 compared to 2018.

We expect full-year segment margin to be between seven percent and eight percent in 2021.

Adjusted segment earnings and adjusted segment margin in 2020 exclude $5.0 million of pre-tax severance and restructuring and impairment expenses.

These expenses were associated with an initiative to align our business to current market conditions.

Higher segment earnings in 2021 were primarily due to inflation-related price increases and higher volumes, partially offset by higher material and logistics costs.

Segment margin was lower in 2021 primarily due to the rise in costs outpacing pricing actions.

In 2020 segment earnings and margin were adversely impacted by certain costs related to the pandemic.

Those costs included temporarily moving production from Mexico to the U.S., paying employees during temporary plant shutdowns, proactively deep cleaning facilities, paying benefits during employee furloughs, and other costs, which were approximately $6.6 million in 2020.

We estimate our 2022 North America segment margin will be between 22.25 and 22.75 percent.

Rest of World Segment

Years ended December 31 (dollars in millions) 2021 2020

Net Sales $ 1,036.5 $ 800.3

Segment Earnings 91.4 —

Segment Margin 8.8 % — %

Sales in our Rest of World segment were $1,036.5 million in 2021 or $236.2 million higher than sales of $800.3 million in 2020.

Sales in China increased by 32 percent in U.S.

dollar terms and 24 percent in local currency in 2021 compared to 2020.

In addition, our sales in China were favorably impacted by approximately $58 million in 2021 compared to 2020, due to the appreciation of the Chinese currency compared to the U.S.

The increase in 2021 sales was primarily due to growth in our major product categories in China, including electric and gas tankless water heaters, and residential and commercial water treatment products, including replacement filters.

Sales in China were also positively impacted by lower channel inventory reductions in 2021 compared to 2020.

Channel inventory levels in China at the end of 2021 were at their lowest level in the last five years.

Products with higher selling prices, including super-quiet gas tankless water heaters and water treatment products that deliver filtered water at a faster flow rate, contributed to sales gains.

Sales in India increased approximately 31% compared to 2020, which was significantly impacted by the pandemic.

Rest of World segment earnings were $91.4 million in 2021 compared to breakeven in 2020.

Segment margin was 8.8 percent in 2021.

Compared to 2020, which was significantly impacted by the pandemic, earnings in 2021 increased primarily due to higher volumes in China, which was partially offset by higher employee incentives and brand-building-related advertising costs, as well as the absence of the social insurance waivers received in 2020 that did not repeat in 2021.

Higher segment operating margin of 8.8% was primarily a result of increased operating leverage from higher volumes.

We expect full-year segment margin to be approximately 10 percent in 2022.

LIQUIDITY AND CAPITAL RESOURCES

Our working capital was $731.7 million at December 31, 2020 compared with $733.9 million and $853.2 million at December 31, 2019 and December 31, 2018, respectively.

An increase in cash, cash equivalents and marketable securities was offset by higher accounts payable balances and payroll accruals in 2020 compared to 2019.

We repatriated approximately $190 million in foreign cash and marketable securities in 2020 and utilized it to repay floating rate debt.

The decline in cash, cash equivalents and marketable securities and sales related decreases in accounts receivable partially offset by lower accounts payable balances led to the majority of the decline in working capital in 2019.

Approximately $165 million in foreign cash, cash equivalents and marketable securities was repatriated in 2019 and utilized to repay floating rate debt, pay dividends and repurchase shares.

Our working capital was $633.8 million at December 31, 2021 compared with $731.7 million at December 31, 2020.

A majority of the change to working capital was driven by higher accounts payable, payroll related accruals and lower cash balances than 2020, which were partially offset by higher inventory and sales related accounts receivable balances.

We repatriated approximately $168 million of foreign cash and marketable securities in 2021 and utilized it to repurchase shares of our common stock.

We expect to repatriate approximately $100 million in 2022 and use the proceeds for common stock repurchases.

Cash provided by operating activities in 2020 was $562.1 million compared with $456.2 million during 2019 and $448.9 million during 2018.

The improvement in operating cash flows in 2020 was primarily due to lower outlays of working capital including higher accounts payable balances in China, which include receipts of cash deposits in advance of sales from certain customers, that more than offset lower earnings.

The increase in cash flows in 2019 compared with 2018 was primarily due to lower outlays for working capital which offset lower earnings in 2019.

We expect cash provided by operating activities to be $450 million to $475 million in 2021.

We continue to monitor developments on an on-going basis and have taken proactive measures to focus on cash, manage working capital, and reduce costs.

Our capital expenditures were $56.8 million in 2020, $64.4 million in 2019 and $85.2 million in 2018.

Included in 2018 capital expenditures were approximately $13 million related to capacity expansion in China.

We project our 2021 capital expenditures to be between $85 and $90 million and expect depreciation and amortization will be approximately $80 million.

We have a $500 million multi-currency credit facility with a group of nine banks, which expires in December 2021.

The facility has an accordion provision, which allows us to increase it up to $700 million if certain conditions (including lender approval) are satisfied.

Years ended December 31 (dollars in millions) 2021 2020

Cash provided by operating activities $ 641.1 $ 562.1

Cash (used in) provided by investing activities (349.9) 11.8

Cash used in financing activities (421.0) (374.8)

Cash provided by operating activities in 2021 was $641.1 million compared with $562.1 million during 2020.

The improvement in operating cash flows in 2021 was primarily due to increased earnings and lower outlays of working capital, including higher accounts payable balances in China, due to receipts of cash deposits in advance of sales from certain customers, and higher incentive related accruals.

This was partially offset by higher inventory balances due to increased on hand quantities to ensure product availability and higher accounts receivable balances from higher sales.

Our free cash flow in 2021 and 2020 was $566 million and $505 million, respectively.

We expect free cash flow to be between $500 million to $525 million in 2022.

Free cash flow is a non U.S.

Generally Accepted Accounting Principles (GAAP) measure and is described in more detail in the Non-GAAP Measures section below.

We continue to monitor developments on an ongoing basis and have taken proactive measures to focus on cash, manage working capital, and reduce costs.

Our capital expenditures were $75.1 million in 2021 and $56.8 million in 2020.

Included in 2021 capital expenditures was approximately $11 million related to the purchase of our previously leased Lloyd R.

Smith Corporate Technology Center in Milwaukee, WI.

We project our 2022 capital expenditures will be between $75 and $80 million and expect depreciation and amortization will be approximately $80 million.

During the second quarter of 2021, we renewed and amended our $500 million revolving credit facility, which now expires on April 1, 2026.

The renewed and amended facility, with a group of nine banks, has an accordion provision that allows it to be increased up to $850 million if certain conditions (including lender approval) are satisfied.

Borrowing rates under the facility are determined by our leverage ratio.

The facility requires 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 December 31, 2020.

We expect to complete a renewal of our credit facility in the first half of 2021.

The facility requires 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 December 31, 2021 and expect to be in compliance for the foreseeable future.

The facility backs up commercial paper and credit line borrowings.

As a result of the long-term nature of this facility, our commercial paper and credit line borrowings, as well as drawings under the facility, are classified as long-term debt as of December 31, 2019.

At December 31, 2020, we had no borrowings under the facility and an available borrowing capacity of $500 million.

At December 31, 2021, we had $50 million outstanding under the facility and an available borrowing capacity of $450 million.

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 declined from $284.0 million at December 31, 2019, to $113.2 million at December 31, 2020.

Our leverage, as measured by the ratio of total debt to total capitalization, calculated excluding operating lease liabilities, was 5.8 percent at the end of 2020, compared with 14.6 percent at the end of 2019.

Our total debt increased by $83.5 million from $113.2 million at December 31, 2020 to $196.7 million at December 31, 2021.

The increase in debt balances was due to our acquisition of Giant and repurchases of our common stock.

Our leverage, as measured by the ratio of total debt to total capitalization, calculated excluding operating lease liabilities, was 9.7 percent at December 31, 2021, compared with 5.8 percent at December 31, 2020.

pension plan continues to meet all funding requirements under ERISA regulations.

1 unchanged sentence

We forecast that we will not be required to make a contribution to the plan in 2022, and we do not plan to make any voluntary contributions in 2022.

For further information on our pension plans, see Note 13 of Notes to Consolidated Financial Statements.

In the second quarter of 2019, our Board of Directors approved adding 3,000,000 shares of Common Stock to an existing discretionary share repurchase authority.

Under the share repurchase program, our common stock may be purchased through a combination of a Rule 10b5-1 automatic trading plan and discretionary purchases in accordance with applicable securities laws.

For further information on our pension plans, see the Critical Accounting Policies below and Note 13 of Notes to Consolidated Financial Statements.

In 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.

Due to the uncertainty surrounding the impact of the global COVID-19 pandemic, we suspended our share repurchases on March 18, 2020.

During 2021, we repurchased 5,087,467 shares of our stock at a total cost of $366.5 million.

At December 31, 2020, we had 1,613,824 million shares remaining on the board share repurchase authority.

As of December 31, 2021, we had 3,526,357 shares remaining on the share repurchase authority.

After a blackout period on share repurchase activity in the third quarter related to the Giant acquisition, we resumed our repurchases in early November.

On January 25, 2022, the Board of Directors approved adding 3,500,000 shares of common stock to the existing discretionary share repurchase authority.

Including the additional shares, we have approximately 8.6 million shares available for repurchase.

We currently intend to spend approximately $400 million to repurchase common stock in 2021 through a combination of 10b5-1 plans and open market purchases.

Including the additional shares, we have approximately 6.8 million shares available for repurchase as of the date of the Board of Directors' approval.

intend to repurchase approximately $400 million of our common stock in 2022 through a combination of 10b5-1 plans and open market purchases.

On October 19, 2021, we acquired Giant, a Canada-based manufacturer of residential and commercial water heaters for approximately $199 million, subject to customary adjustments, using a combination of debt and cash.

Giant manufactures water heaters at two facilities in Montreal, Canada and sells water heating products under the Giant brand across Canada.

Incremental sales of $23 million were realized in 2021, from the date of acquisition.

We have paid dividends for 82 consecutive years with annual amounts increasing each of the last 30 years.

16 unchanged sentences

Goodwill and Indefinite-lived Intangible Assets

In conformity with U.S.

Generally Accepted Accounting Principles (GAAP), goodwill and indefinite-lived intangible assets are tested for impairment annually or more frequently if events or changes in circumstances indicate that the assets might be impaired.

In conformity with GAAP, goodwill and indefinite-lived intangible assets are tested for impairment annually or more frequently if events or changes in circumstances indicate that the assets might be impaired.

We perform impairment reviews for our reporting units using a fair-value method based on management’s judgments and assumptions.

3 unchanged sentences

Any impairment review is, by its nature, highly judgmental as estimates of future sales, earnings and cash flows are utilized to determine fair values.

However, we believe that we conduct thorough and competent annual valuations of goodwill and indefinite-lived intangible assets and that there has been no impairment in goodwill or indefinite-lived assets in 2020.

However, we believe that we conduct a thorough and competent annual quantitative analysis of goodwill and indefinite-lived intangible assets.

Based on the annual goodwill impairment test, we determined there was no impairment of our goodwill as of December 31, 2021.

The fair value of each of our reporting units significantly exceeded its carrying value and a 10% decrease in the estimated fair value of our reporting units would not have resulted in a different conclusion.

Based on the annual indefinite-lived assets impairment test, we determined there was no impairment of our indefinite-lived assets as of December 31, 2021.

Product Warranty

6 unchanged sentences

While our warranty costs have historically been within calculated estimates, it is possible that future warranty costs could differ significantly from those estimates.

The allocation of the warranty liability between current and

long-term is based on the expected warranty liability to be paid in the next year as determined by historical product failure rates.

At December 31, 2020 and 2019, our reserve for product warranties was $142.3 million and $134.3 million, respectively.

The allocation of the warranty liability between current and long-term is based on the expected warranty liability to be paid in the next year as determined by historical product failure rates.

At December 31, 2021 and 2020, our reserve for product warranties was $184.4 million and $142.3 million,

respectively.

The increase in our reserve for product warranties in 2021 compared to the prior year was primarily due to increased steel prices and the acquisition of Giant.

Product Liability

9 unchanged sentences

At December 31, 2021 and 2020, our reserve for product liability was $35.4 million and $35.3 million, respectively.

If the estimated loss reserves as of December 31, 2021 developed adversely by 10%, the impact on earnings would be approximately $2.9 million.

We have significant pension benefit costs that are developed from actuarial valuations.

5 unchanged sentences

In developing our expected return on plan assets, we evaluate our pension plan’s current and target asset allocation, the expected long-term rates of return of equity and bond indices and the actual historical returns of our pension plan.

Our plan’s target allocation to equity managers is approximately 30 to 60 percent, with the remainder allocated primarily to bond managers, private equity managers and real estate managers.

Our actual asset allocation as of December 31, 2020, was 44 percent to equity managers, 46 percent to bond managers, nine percent to real estate managers, and one percent to private equity managers.

Our plan’s target allocation to bonds managers is between 60 to 95 percent with the remainder allocated primarily to equities, private equity managers and cash.

Our actual asset allocation as of December 31, 2021, was one percent to equity managers, 75 percent to bond managers, one percent to private equity managers, and the remainder allocated to cash.

We regularly review our actual asset allocation and periodically rebalance our investments to our targeted allocation when considered appropriate.

4 unchanged sentences

We will continue to evaluate our actuarial assumptions at least annually, and we will adjust the assumptions as necessary.

We recognized pension income of $5.1 million, $6.2 million, and $8.7 million in 2020, 2019, and 2018, respectively.

We made changes to our pension plan including closing the plan to new entrants effective January 1, 2010, and the sunset of our plan for the majority of our employees on December 31, 2014.

Lowering the expected return on plan assets by 25 basis points would decrease our net pension income for 2021 by approximately $1.8 million.

Lowering the discount rate by 25 basis points would increase our 2021 net pension income by approximately $0.7 million.

As part of our strategy to de-risk our defined benefit pension plan, the qualified defined benefit pension plan purchased a group annuity contract whereby an unrelated insurance company assumed a $23 million and $31 million obligation to pay and administer future annuity payments for certain retirees and beneficiaries in 2020 and 2019, respectively.

Pension Plan Termination

In 2021, our Board of Directors approved the termination of our defined benefit pension plan (the Plan) with a termination date of December 31, 2021.

The Plan has filed for a determination letter from the IRS regarding the qualification of the plan termination.

The Plan represents over 95 percent of our pension plan liability.

In 2022, we expect to annuitize the remaining pension liability.

The Plan settlement, which we expect to complete in the fourth quarter of 2022, will accelerate the recognition of approximately $445 million, or $1.73 of EPS, of non-cash, pre-tax pension expenses.

In addition, to protect the Plan’s funded status, the Plan transferred a significant portion of its assets to lower risk investments in 2021.

The impact of this transition will result in a lower expected rate of return on pension investments and accordingly, higher pension expenses in 2022, compared to previous years.

As part of our strategy to de-risk our defined benefit pension plan, the qualified defined benefit pension plan purchased a group annuity contract whereby an unrelated insurance company assumed $23 million obligation to pay and administer future annuity payments for certain retirees and beneficiaries in 2020.

We recognized pension income of $12.0 million and $5.1 million in 2021 and 2020, respectively.

To provide improved transparency into the operating results of our business in 2022 we will provide a non-GAAP measure (adjusted earnings per share) that excludes the impact of our estimated pension settlement charge and non-operating pension income and expenses.

A reconciliation from GAAP measures to non-GAAP measures is provided in the financial information included in this filing.

Non-GAAP Measures

We provide non-GAAP measures (adjusted earnings, adjusted earnings per share (EPS) and adjusted segment earnings) that exclude severance, restructuring and impairment expenses in 2020 and 2018.

We provide non-GAAP measures of adjusted free cash flow and adjusted EPS.

We define free cash flow as cash provided by operating activities less capital expenditures.

Our adjusted EPS excludes the impact of pension settlement expenses and non-operating pension income and expenses.

We believe that free cash flow provides useful additional information concerning cash flow available to meet future debt service obligations and working capital requirements.

We believe that the measure of adjusted EPS provides useful information to investors about our performance and allows management and our investors to better understand our performance between periods without regard to items we do not consider to be a component of our core operating performance.

SMITH CORPORATION

Adjusted Earnings and Adjusted EPS

(dollars in millions, except per share data)

The following is a reconciliation of net earnings and diluted earnings per share (EPS) to adjusted earnings (non-GAAP) and adjusted EPS (non-GAAP):

Years ended December 31,

2020 2019 2018

Net Earnings (GAAP) $ 344.9 $ 370.0 $ 444.2

Severance, restructuring and impairment expenses, before tax (1)(2)(3)

Tax effect of severance, restructuring and impairment expenses (1.4) — (1.7)

Adjusted Earnings $ 351.2 $ 370.0 $ 449.2

Free Cash Flow

(dollars in millions)

The following is a reconciliation of reported cash flow from operating activities to free cash flow (non-GAAP):

Twelve Months Ended,

Cash provided by operating activities (GAAP) $ 641.1 $ 562.1

Capital expenditures (75.1) (56.8)

Free cash flow (non-GAAP) $ 566.0 $ 505.3

SMITH CORPORATION

2022 Adjusted EPS Guidance and 2021 Adjusted EPS

The following is a reconciliation of diluted EPS to adjusted EPS (non-GAAP) (all items are net of tax):

2022 Guidance 2021

Diluted EPS (GAAP) $ 1.56 - 1.76 $ 3.02

Severance, restructuring and impairment expenses per diluted share (1)(2)(3)

Tax effect of severance, restructuring and impairment expenses per diluted share (0.01) — (0.01)

Adjusted EPS $ 2.16 $ 2.22 $ 2.61

The following is a reconciliation of reported segment earnings to adjusted segment earnings (non-GAAP):

Years ended December 31,

2020 2019 2018

Segment Earnings (GAAP)

North America $ 503.5 $ 488.9 $ 464.1

Rest of World — 40.2 149.3

Inter-Segment earnings eliminations (0.3) — —

Total Segment Earnings (GAAP) $ 503.2 $ 529.1 $ 613.4

North America (1) (2)

$ 2.7 $ — $ 6.7

Rest of World (3)

Inter-Segment earnings eliminations — — —

Total Adjustments $ 7.7 $ — $ 6.7

Adjusted Segment Earnings

North America $ 506.2 $ 488.9 $ 470.8

Rest of World 5.0 40.2 149.3

Inter-Segment earnings eliminations (0.3) — —

Total Adjusted Segment Earnings $ 510.9 $ 529.1 $ 620.1

(1) In 2020, we recognized $2.7 million of severance and restructuring expenses in connection with our alignment of the business to current market conditions.

For additional information, see Note 5 of Notes to Consolidated Financial Statements.

(2) In 2018, we recognized $6.7 million of restructuring and impairment expenses in connection with the move of manufacturing operations from our Renton, Washington facility to other U.S.

For additional information, see Note 5 of Notes to Consolidated Financial Statements.

(3) In 2020, we recognized $5.0 million of severance and restructuring expenses in connection with our alignment of the business to current market conditions.

For additional information, see Note 5 of Notes to Consolidated Financial Statements.

We expect our consolidated sales to increase approximately ten percent in 2021.

We believe the Chinese economy will improve in 2021 and expect that sales in China will increase by 20 to 21 percent in U.S.

dollar terms and 14 to 15 percent in local currency terms.

We expect to achieve full-year earnings of between $2.40 and $2.50 per share.

Our 2021 guidance excludes the potential impacts from future acquisitions and assumes that the conditions of our business environment and that 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 or shutdowns due to the COVID-19 pandemic.

Estimated pension settlement charge 1.73 (1)

Pension expense (income) 0.06 (2)

Adjusted EPS (non-GAAP) $ 3.35 - 3.55 $ 2.96

(1) Includes pre-tax pension settlement charges of $378.3 million and $66.7 million, within the North America segment and Corporate expenses, respectively.

(2) Includes pre-tax pension expense of $10.5 million and $1.3 million, within the North America segment and Corporate expenses, respectively.

(3) Includes pre-tax pension income of $10.5 million and $2.6 million, within the North America segment and Corporate expenses, respectively.

As we begin 2022, we expect our consolidated sales to increase between 16 to 18 percent compared to 2021.

Our higher expected sales are driven by pricing actions in North America and increased boiler and water treatment volumes within that region.

We expect to achieve full-year earnings of between $1.56 and $1.76 per share and an adjusted EPS in the range of $3.35 and $3.55 per share.

Our 2022 guidance excludes the potential impacts from future acquisitions and assumes the recent surge of the Omicron variant subsides during the first quarter of 2022 and does not have a significant impact on our productivity or significantly impact the end markets that we serve.

OTHER MATTERS

11 unchanged sentences

Our goal is to manage risks prudently rather than avoid risks.

We can mitigate risks and their impact on the Company only to a limited extent.

A team of senior executives prioritizes identified risks and assigns an executive to address each major identified risk area and lead action plans to manage risks.

We can mitigate risks and their impact on our company only to a limited extent.

A team of senior executives prioritizes identified risks, including decarbonization, disruptive technologies and cyber threats among others, and assigns an executive to address each major identified risk area and lead action plans to manage risks.

Our Board of Directors provides oversight of the ERM process and reviews significant identified risks.

4 unchanged sentences

We are exposed to various types of market risks, primarily currency.

We monitor our risks in such areas on a continuous basis and generally enter into forward contracts to minimize such exposures for periods of less than one year.

We monitor our risks in such areas on a continuous basis and generally enter into forward contracts to minimize such exposures.

We do not engage in speculation in our derivatives strategies.

5 unchanged sentences

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.

This filing contains statements that we believe are “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995.

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 work-force dislocation and disruption,

supply chain disruption and liquidity as a result of the severity and duration of the COVID-19 pandemic;

a failure to recover or a further weakening of the Chinese economy and/or a failure to recover or a further decline in the growth rate of consumer spending or housing sales in China;

negative impact to the Company’s businesses from international tariffs and trade disputes;

potential further weakening in the high-efficiency boiler segment in the U.S.;

significant volatility in raw 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;

our ability to continue to obtain commodities, components, parts and accessories on a timely basis through its supply chain and at expected costs;

negative impacts to demand for our products, particularly commercial products, and its operations and workforce as a result of the severity and duration of the COVID-19 pandemic;

our inability to implement or maintain pricing actions;

an uneven recovery of the Chinese economy or decline in the growth rate of consumer spending or housing sales in China;

negative impact to our businesses from international tariffs, trade disputes and geopolitical differences;

potential weakening in the high-efficiency boiler segment in the U.S.;

substantial defaults in payment by, material reduction in purchases by or the loss, bankruptcy or insolvency of a major customer;

a weakening in U.S.

residential or commercial construction or instability in our 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;

our inability to successfully integrate or achieve its strategic objectives resulting from acquisitions;

competitive pressures on our businesses;

the impact of potential information technology or data security breaches;

1 unchanged sentence

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.

Forward-looking statements included in this filing are made only as of the date of this filing, and we are under no obligation to update these statements to reflect subsequent events or circumstances.

All subsequent written and oral forward-looking statements attributed to us, or persons acting on our behalf, are qualified entirely by these cautionary statements.

ITEM 7A – QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

1 unchanged sentence

Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.

What changed 10-K

Item 7. Management’s Discussion and Analysis