What changed in this filing

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Item 2. Management’s Discussion and Analysis

2022-05-02 compared with 2021-10-29 · 174 added, 149 removed, 69 unchanged (82% 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 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 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.

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.

We expect those challenges to continue for the foreseeable future and we remain in close communication with our suppliers.

In our North America segment, we expect residential water heater industry volumes will increase approximately six percent in 2021 compared with 2020, driven by continued growth in replacement demand and new home construction.

We believe that commercial water heater industry volumes will increase approximately ten percent in 2021 as pandemic-impacted businesses continue to re-open and new construction and replacement installations increase.

We continue to experience significant inflation across our supply chain, particularly steel and logistics costs.

In response to continued material and logistics cost increases, we have implemented price increases, including our announced fifth price increase in 2021 on water heaters in September, effective on November 15, 2021.

When fully realized at the end of 2021, the five announced inflation-related price increases on water heaters compound to approximately 50 percent.

We expect our boiler sales to grow by approximately 13 percent 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 approximately 12 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 20 to 22 percent in local currency terms compared with 2020 due to higher volumes and increased consumer demand for our higher priced products across all of our product categories driven by differentiated new products we launched in the last 12 to 24 months.

Our sales in China were negatively impacted by COVID-19 pandemic related shutdowns in 2020.

We assume China currency rates will stay at current levels and add approximately $54 million and $4 million to sales and earnings in 2021, respectively.

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 $32.0 million of sales and approximately $0.02 in earnings per share (EPS) to our results in the first quarter of 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.

Our global supply chain management team continued to navigate through supply chain and logistics challenges in the first quarter of 2022.

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

In addition, while steel indices moderated as we moved into 2022, they have recently risen again, as commodity prices and availability remain volatile.

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 conflict in Ukraine.

Our business also continues to experience impacts from the novel coronavirus (COVID-19) pandemic.

Omicron variant-related absenteeism negatively impacted North American production early in the first quarter.

In addition, to slow the spread of COVID-19 in China, targeted lockdowns began in certain cities late in the first quarter.

In our North America segment, after approximately eight percent growth in 2021, 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 we anticipate that new construction and replacement installations will 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 18 to 20 percent increase in our sales of boilers in 2022 compared to 2021 driven by increased pricing in response to higher input cost and higher demand.

We anticipate sales of our North America water treatment products will increase 13 to 14 percent in 2022, compared to 2021, primarily driven by higher 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 be flat in local currency compared with 2021 as a result of economic headwinds from COVID-19-related lockdowns.

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 14 and 16 percent in 2022.

This guidance excludes the potential impacts from future acquisitions and assumes the COVID-19 related lockdowns in China subside during the second quarter of 2022, and that COVID-19 does not significantly impact our operations or our employees, customers or suppliers.

Results of Operations

THIRD QUARTER AND FIRST NINE MONTHS OF 2021 COMPARED TO 2020

Sales in the third quarter of 2021 were $915 million, or approximately 20 percent higher than sales of $760 million in the third quarter of 2020.

Sales in the first nine months of 2021 were $2,543 million or approximately 23 percent higher than sales of $2,061 million in the same period last year.

Both periods in 2020 were negatively impacted by the COVID-19 pandemic.

Our sales increases in the third quarter and first nine months of 2021 compared to the same periods of the previous year were 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 sales in China also benefited from currency translation of approximately $14 million and $49 million in the third quarter and first nine months of 2021, respectively, due to the appreciation of the Chinese currency against the U.S.

Gross profit margin in the third quarter of 2021 was 37.2 percent compared to gross profit margin of 39.1 percent in the same period last year.

Gross profit margin in the first nine months of 2021 was 37.4 percent compared to the gross profit margin of 38.0 percent in the first nine months of 2020.

The lower gross margin in both periods of 2021 compared to 2020 was primarily due to higher steel and other material costs which outpaced our pricing actions.

Selling, general, and administrative (SG&A) expenses in the third quarter and first nine months of 2021 increased by $18.2 million and $28.1 million, respectively, compared to the prior-year periods.

The increase in SG&A expenses in the third quarter and first nine months of 2021 was primarily due to higher advertising, engineering and selling expenses and higher

management incentive expenses related to higher earnings compared to the same periods last year.

Higher SG&A expenses in both the third quarter and first nine months of 2021 were partially offset by lower spending in China associated with headcount reductions, store closures and other cost-saving measures previously implemented during 2020.

During the third quarter and first nine months of 2020, aligning our business to market conditions, we recognized $1.6 million and $7.7 million, respectively, of pre-tax severance and restructuring expenses.

These expenses were primarily comprised of $1.6 million of severance expenses in the third quarter of 2020 and $6.8 million of severance costs and $0.9 million of other restructuring expenses in the first nine months of 2020.

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

We are providing non-GAAP measures (adjusted earnings, adjusted earnings per share, and adjusted segment earnings) that exclude severance and restructuring 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 compare our performance period over period.

Interest expense in the third quarter of 2021 was $1.0 million compared to $1.6 million in the same period last year.

Interest expense in the first nine months of 2021 was $2.9 million compared to $6.3 million in the same period the previous year.

The decrease in interest expense in the third quarter and first nine months of 2021 compared to the same periods last year was primarily due to lower debt levels.

Other income was $4.7 million in the third quarter of 2021, higher than $2.8 million in the same period last year.

Other income in the first nine months of 2021 was $13.6 million compared to $11.0 million in the first nine months of 2020.

The increase in other income in the third quarter and first nine months of 2021 compared to the same periods last year was primarily due to higher pension income.

The third quarter of 2021 also benefited from higher interest income.

(dollars in millions) Three Months Ended

Net sales $ 977.7 $ 769.0

Cost of products sold 636.1 480.4

Gross profit 341.6 288.6

Gross profit margin % 34.9 % 37.5 %

Selling, general and administrative expenses 179.8 166.5

Interest expense 1.5 1.0

Other expense (income) - net 3.7 (5.0)

Earnings before provision for income taxes 156.6 126.1

Provision for income taxes 36.8 28.4

Net Earnings $ 119.8 $ 97.7

Our sales in the first quarter of 2022 were $977.7 million, or 27.1 percent higher than 2021 first quarter sales of $769.0 million.

Compared to the prior year quarter, our sales increase was primarily driven by inflation-related pricing actions in North America as well as higher sales in China.

Our acquisition of Giant added $32.0 million of incremental sales in 2022.

In addition, our sales in China were favorably impacted by approximately $5 million in the first quarter of 2022 compared to the first quarter of 2021, due to the appreciation of the Chinese currency compared to the U.S.

Our gross profit margin in the first quarter of 2022 was 34.9 percent and declined compared to 37.5 percent in the first quarter of 2021.

The lower gross profit margin in the first quarter of 2022 was primarily due to higher steel and other material costs which outpaced our pricing actions.

Selling, general, and administrative (SG&A) expenses were $179.8 million in the first quarter of 2022 or $13.3 million higher than the first quarter of 2021.

The increase in SG&A expenses was primarily driven by higher selling expenses in North America due to higher sales compared to the prior year period.

Interest expense in the first quarter of 2022 was $1.5 million, and higher compared to $1.0 million in the first quarter of 2021 primarily due to higher debt levels.

Other expense was $3.7 million in the first quarter of 2022 compared to other income of ($5.0) million in the first quarter of 2021.

Pension expense in the first quarter of 2022 was $3.6 million compared to pension income of $2.9 million in the first quarter of 2021.

In 2021, our Board of Directors approved the termination of our largest defined benefit pension plan (the Plan) representing over 95 percent of our pension plan liabilities with a termination date of December 31, 2021.

In April 2022, we received a determination letter from the IRS that allowed us to proceed with the termination process for the Plan.

In 2022, we expect to annuitize the remaining Plan 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 approximately $1.73 per share, 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 resulted in a lower expected rate of return on pension investments and accordingly, higher pension expenses in 2022, compared to previous years.

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 expense (income) are reflected in other expense (income).

We are providing non-U.S.

Generally Accepted Accounting Principles (GAAP) measures (adjusted earnings, adjusted EPS, adjusted segment earnings and adjusted corporate expense) that exclude the impact of pension settlement expenses and non-operating pension income and expenses.

Reconciliations from GAAP measures to non-GAAP measures are provided in the financial information included in this filing.

We believe that the measures of adjusted earnings, adjusted EPS, adjusted segment earnings and adjusted corporate expense 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 that we do not consider to be a component of our core operating performance.

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.

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 3.00 percent in 2022 compared to 6.25 percent in 2021.

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 third quarter and first nine months of 2021 was $2.9 million and $8.7 million, respectively, compared to $1.8 million and $5.9 million in the third quarter and first nine months of 2020, 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 rates for the third quarter and first nine months of 2021 were 20.9 percent and 21.7 percent, respectively.

Our effective income tax rates for the third quarter and first nine months of 2020 were 23.2 percent and 23.0 percent, respectively.

Our effective income tax rates in the third quarter and first nine months of 2021 were lower than the effective income tax rates in the same periods of 2020 primarily due to a change in geographic earnings mix as well as a favorable tax impact of 4.2 million related to amending a previously filed tax return.

We estimate that our annual effective income tax rate for the full year 2021 will be approximately 22.0 percent.

North America

Sales in the North America segment were $658 million in the third quarter of 2021, or $114 million higher than sales of $544 million in the third quarter of 2020.

Sales in the first nine months of 2021 were $1,815 million or $258 million higher than sales of $1,557 million in the same period last year.

The increases in sales in the third quarter and first nine months 2021 compared to the prior-year periods were primarily due to the impact of pricing actions, largely on water heaters, implemented to offset higher steel, other material and logistics costs, as well as higher water heater, boiler, and water treatment volumes.

North America segment earnings were $151.8 million in the third quarter of 2021, or approximately 14 percent higher than segment earnings of $133.1 million in the same period of 2020.

Segment earnings in the first nine months of 2021 were $423.9 million, or approximately 16 percent higher than segment earnings of $365.6 million in the first nine months of 2020.

Segment margin of 23.1 percent in the third quarter of 2021 was lower than segment margin of 24.5 percent in the same period last year.

Segment margin of 23.4 percent in the first nine months of 2021 was slightly lower than segment margin of 23.5 percent in the same period last year.

Adjusted segment earnings and adjusted segment margin in the third quarter of 2020 were $133.6 million and 24.6 percent, respectively.

Adjusted segment earnings and adjusted segment margin in the first nine months of 2020 were $368.3 million and 23.6 percent, respectively.

Higher segment earnings in the third quarter and first nine months of 2021 compared to the prior-year periods were primarily driven by inflation-related price increases implemented to offset higher costs as well as higher volumes, partially offset by higher material and freight costs.

Segment earnings and margin in the prior-year periods were also 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 $1.1 million and $6.6 million for the three and nine months ended 2020, respectively.

We expect 2021 full-year segment margin to be between 22.75 and 23.0 percent.

Adjusted segment earnings and adjusted segment margin in the third quarter and first nine months of 2020 exclude $0.5 million and $2.7 million, respectively, of pre-tax severance and restructuring expenses associated with an initiative to align our business to market conditions.

Rest of World

Sales in the Rest of World segment were $263 million in the third quarter of 2021, $42 million higher than sales of $221 million in the third quarter of 2020.

Sales in the first nine months of 2021 were $749 million, $228 million higher than sales of $521 million in the first nine months of 2020.

Sales in China increased approximately 19 percent in U.S.

dollar terms and 12 percent in local currency in the third quarter of 2021 and increased approximately 46 percent in U.S.

dollar terms and 36 percent in local currency in the first nine months of 2021 compared to the same periods last year.

The increase in Rest of World sales in the third quarter and first nine months of 2021 was primarily due to sales growth in each of our major product lines in China compared to the same periods last year.

In addition, sales in China benefited from currency translation of approximately $14 million and $49 million in the third quarter and first nine months of 2021, respectively, compared to the same periods last year, due to the appreciation of the Chinese currency compared to the U.S.

Rest of World segment earnings were $26.8 million in the third quarter of 2021, compared to earnings of $16.7 million in the third quarter of 2020.

Segment earnings in the first nine months of 2021 were $60.9 million, compared to losses of $31.3 million in the first nine months of 2020.

Segment margin was 10.2 percent and 8.1 percent in the third quarter and first nine months of 2021, compared to 7.5 percent in the third quarter of 2020 and negative margin in the first nine months of 2020.

Adjusted segment earnings in the third quarter of 2020 were $17.8 million and adjusted segment losses were $26.3 million in the first nine months of 2020.

Higher segment earnings and segment margin in the third quarter and first nine months of 2021 compared to the prior-year periods were primarily driven by higher volumes that were partially offset by higher employee incentive costs and brand building-related advertising costs in China compared to the same periods last year.

In both periods in 2021, higher segment earnings and margins were partially offset by the absence of social insurance waivers, which we received in China in the prior-year periods.

We expect full-year segment margin to be approximately eight percent in 2021.

Adjusted segment earnings in the third quarter and first nine months of 2020 exclude $1.1 million and $5.0 million, respectively, of pre-tax severance and restructuring expenses associated with an initiative to align our business to market conditions.

Excluding the impact of our recent acquisition of Giant Factories, Inc.

(Giant), we expect our consolidated sales to grow between 20 and 21 percent in 2021 on inflation-related pricing actions and strong China, North America water heater, water treatment and boiler volumes.

Our sales growth projection includes approximately $54 million of benefit from China currency translation.

We increased the midpoint of our EPS guidance for 2021 and we believe we will achieve full-year net earnings of between $2.86 and $2.90 per share.

Our 2021 guidance excludes the potential impacts from future acquisitions.

The discount rate used to determine net periodic pension costs increased to 2.72 percent in 2022 from 2.45 percent in 2021.

Our effective income tax rate was 23.5 percent in the first quarter of 2022, compared with 22.5 percent in the first quarter of 2021.

Our higher effective income tax rate was primarily due to a change in geographic earnings mix.

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

(dollars in millions) Three Months Ended

Net Sales $ 730.1 $ 552.9

Segment Earnings 151.8 130.4

Segment margin 20.8 % 23.6 %

Sales in our North America segment were $730.1 million in the first quarter 2022 or $177.2 million higher than sales of $552.9 million in the first quarter of 2021.

The increased sales in the first quarter of 2022 were driven primarily by price increases, largely on water heaters, which were implemented in response to rising material and transportation costs.

The first quarter of 2022 also benefited from higher volumes of boilers and water treatment products.

Those increases were partially offset by lower commercial water heater volumes.

In addition, our acquisition of Giant added $32.0 million of incremental sales in 2022.

North America segment earnings were $151.8 million in the first quarter of 2022, an increase of 16 percent compared to segment earnings of $130.4 million in the first quarter of 2021.

Segment margins were 20.8 percent and 23.6 percent in the first quarter of 2022 and 2021, respectively.

Adjusted segment earnings and adjusted segment margin in the first quarter of 2022 were $154.4 million and 21.1 percent, respectively.

Adjusted segment earnings and adjusted segment margin in the first quarter of 2021 were $127.8 million and 23.1 percent, respectively.

Higher segment earnings in the first quarter of 2022 were primarily due to inflation-related price increases, partially offset by higher material and logistics costs.

Segment margin was lower in the first quarter of 2022 primarily due to the rise in costs outpacing pricing actions and lower commercial volumes.

We estimate our 2022 North America segment margin will be between 22.5 and 23.0 percent, excluding pension expense.

Adjusted segment earnings and adjusted segment margin in the first quarter of 2022 and 2021 exclude $2.6 million and ($2.6) million of pension expense (income), respectively.

Rest of World Segment

(dollars in millions) Three Months Ended

Net Sales $ 256.0 $ 222.3

Segment Earnings 24.8 11.8

Segment margin 9.7 % 5.3 %

Sales in our Rest of World segment were $256.0 million in the first quarter of 2022 or $33.7 million higher than sales of $222.3 million in the first quarter of 2021.

Sales in China increased by 15 percent in U.S.

dollar terms and 12 percent in local currency in the first quarter of 2022 compared to the first quarter of 2021.

Higher sales in China were primarily driven by favorable mix in water heaters and water treatment products and higher sales for commercial water treatment products and replacement filters compared to the first quarter of 2021.

Sales were also positively impacted by measures to distribute product into the market in advance of potential COVID-19 lockdowns in China, which have temporarily impacted transportation between impacted regions.

In addition, our first quarter of 2022 sales in China were favorably impacted by approximately $5 million, due to the appreciation of the Chinese currency compared to the U.S.

Rest of World segment earnings were $24.8 million in the first quarter of 2022, an increase of $13.0 million compared to segment earnings of $11.8 million in the first quarter of 2021.

Segment margin was 9.7 percent in the first quarter of 2022, higher than segment margin of 5.3 percent in the prior year period.

Higher segment earnings and segment margin compared to the prior year period were primarily driven by favorable mix, higher volumes and lower advertising and selling expenses in China.

We expect full-year segment margin to be between 9.5 and 10 percent in 2022.

We expect our consolidated sales in 2022 to increase between 14 to 16 percent compared to 2021.

Our higher expected sales are driven by pricing actions implemented in 2021 in North America and expected 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 adjusted EPS between $3.35 and $3.55 per share.

Our 2022 guidance excludes the potential impacts from future acquisitions and assumes the COVID-19 related lockdowns in China subside during the second quarter of 2022, and that COVID-19 does not significantly impact our operations or our employees, customers or suppliers.

Liquidity & Capital Resources

Working capital of $756 million as of September 30, 2021, was $24 million higher than at December 31, 2020.

The change in working capital was driven by sales-related increases to accounts receivable balances and higher inventories that were partially offset by higher accounts payable balances.

As of September 30, 2021, approximately $520 million of our $685 million of cash, cash equivalents, and marketable securities was held by our foreign subsidiaries.

In the first nine months of 2021, we repatriated approximately $160 million of cash from our foreign subsidiaries.

We used the proceeds to repurchase shares of our common stock.

Cash provided by operations in the first nine months of 2021 was $376.8 million compared with $330.4 million during the same period last year.

The impact of higher earnings was partially offset by higher investments in working capital compared with the same period in 2020.

For the full year 2021, we expect cash provided by operating activities will be between $550 and $575 million, similar to 2020 cash provided by operating activities of $562 million primarily due to higher earnings in 2021 being offset by higher investments in working capital compared to last year.

Capital expenditures totaled $45.3 million in the first nine months of 2021, compared with $36.7 million in the year-ago period.

We project 2021 capital expenditures will be between $70 and $75 million, and full-year depreciation and amortization expense 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.

Our working capital was $719.3 million at March 31, 2022 compared with $633.8 million at December 31, 2021.

A majority of the increase in working capital was driven by lower accounts payable and payroll related accruals and higher inventory balances than at December 2021, which was partially offset by lower accounts receivables and cash balances.

We expect to repatriate approximately $100 million in 2022 and use the proceeds to pay down debt balances and repurchase our common stock.

(dollars in millions) Three Months Ended

Cash provided by operating activities $ 16.5 $ 104.4

Cash provided by investing activities 2.1 12.5

Cash used in financing activities (56.1) (111.5)

Cash provided by operating activities in the first quarter of 2022 was $16.5 million compared with $104.4 million in the first quarter of 2021.

Higher earnings in the first quarter of 2022 compared with the prior year was more than offset by higher incentive payments in 2022 due to record 2021 sales and earnings and working capital cash outlays for higher levels of safety stock on higher cost inventory, led to lower cash provided by operating activities.

Our free cash flow in the first quarter of 2022 and 2021 was $3.6 million and $87.3 million, respectively.

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

Free cash flow is a non-GAAP measure and is described in more detail in the Non-GAAP Measures section below.

Our capital expenditures were $12.9 million in the first quarter of 2022 and $17.1 million in the first quarter of 2021.

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

In 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 September 30, 2021.

We did not have borrowings on this facility as of September 30, 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 March 31, 2022 and expect to be in compliance for the foreseeable future.

The facility backs up commercial paper and credit line borrowings.

At September 30, 2021, we had an available borrowing capacity of $500 million under this facility.

At March 31, 2022, we had $155.0 million outstanding under the facility and an available borrowing capacity of $345.0 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 decreased by $6.8 million from $113.2 million at December 31, 2020 to $106.4 million at September 30, 2021.

Our leverage, as measured by the ratio of total debt to total capitalization, calculated excluding operating lease liabilities, was 5.3 percent at September 30, 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.

Our total debt increased by $98.7 million from $196.7 million at December 31, 2021 to $295.4 million at March 31, 2022.

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

Our leverage, as measured by the ratio of total debt to total capitalization, calculated excluding operating lease liabilities, was 14.0 percent at March 31, 2022, compared with 9.7 percent at December 31, 2021.

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

We were not required to make a contribution to our pension plan in 2021.

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.

In the first quarter of 2022, our Board of Directors approved adding 3,500,000 shares of common stock to our existing discretionary share repurchase authority.

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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 nine months of 2021, we repurchased 3,177,467 shares of our stock at a total cost of $212.0 million.

As of September 30, 2021, we had 5,436,357 shares remaining on the share repurchase authority.

After a black out period on share repurchase activity in the third quarter related to the Giant acquisition, we plan to resume our repurchase program in early November.

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 repurchases in the open market.

On October 11, 2021, our Board of Directors increased the rate of our quarterly cash dividend of $0.28 per share on our Common Stock and Class A common stock.

The dividend is payable on November 15, 2021, to shareholders of record on October 29, 2021.

On October 19, 2021, we acquired Giant, a Canada-based manufacturer of residential and commercial water heaters for approximately $192 million 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.

Giant had trailing twelve-month annual sales of approximately $105 million.

During the first quarter of 2022, we repurchased 1,486,500 shares of our stock at a total cost of $107.9 million.

At March 31, 2022, we had 5,539,857 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 2022 through a combination of our Rule 10b5-1 automatic trading plan and open market repurchases.

On April 11, 2022, our Board of Directors declared a regular quarterly cash dividend of $0.28 per share on our Common Stock and Class A common stock.

The dividend is payable on May 16, 2022, to shareholders of record on April 29, 2022.

Non-GAAP Financial Information

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.

We provide non-GAAP measures of free cash flow, adjusted earnings, adjusted EPS, adjusted segment earnings and adjusted corporate expense.

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

Our adjusted earnings, adjusted EPS, adjusted segment earnings and adjusted corporate expenses 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 earnings, adjusted EPS, adjusted segment earnings and adjusted corporate expense 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

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Three Months Ended

September 30, Nine Months Ended

September 30,

2021 2020 2021 2020

Net Earnings (GAAP) $ 119.8 $ 97.7

Severance and restructuring expenses, before tax — 1.6 — 7.7

Tax effect of severance and restructuring expenses — (0.3) — (1.4)

Adjusted Earnings $ 131.6 $ 106.7 $ 347.5 $ 231.2

Pension expense (income), before tax 2.9 (3.2)

Tax effect of pension expense (income) (0.7) 0.8

Adjusted Earnings (non-GAAP) $ 122.0 $ 95.3

Diluted EPS (GAAP) $ 0.76 $ 0.60

Severance and restructuring expenses, per diluted share — $ 0.01 — 0.05

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

Adjusted EPS $ 0.82 $ 0.66 $ 2.15 $ 1.42

Pension expense (income) per diluted share, before tax 0.01 (0.01)

Tax effect of pension expense (income), per diluted share — —

Adjusted EPS (non-GAAP) $ 0.77 $ 0.59

SMITH CORPORATION

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Three Months Ended

September 30, Nine Months Ended

September 30,

2021 2020 2021 2020

Segment Earnings (GAAP)

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Total Segment Earnings (GAAP) $ 176.5 $ 142.2

North America (1)

$ — $ 0.5 $ — $ 2.7

North America pension expense (income) $ 2.6 $ (2.6)

Rest of World — —

Inter-segment earnings elimination — —

Total Adjustments $ 2.6 $ (2.6)

Adjusted Segment Earnings

Adjusted Segment Earnings (non-GAAP)

North America $ 154.4 $ 127.8

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Inter-segment earnings elimination (0.1) —

Total Adjusted Segment Earnings $ 178.5 $ 151.4 $ 484.7 $ 341.7

(1) In the third quarter and first nine months of 2020, the Company recognized $0.5 million and $2.7 million of severance and restructuring expenses, respectively.

For additional information, see Note 3 of the notes to the financial statements.

(2) In the third quarter and first nine months of 2020, the Company recognized $1.1 million and $5.0 million of severance and restructuring expenses, respectively.

For additional information, see Note 3 of the notes to the financial statements.

Total Adjusted Segment Earnings (non-GAAP) $ 179.1 $ 139.6

SMITH CORPORATION

2021 EPS Guidance and 2020 Adjusted EPS

The following is a reconciliation of diluted EPS to adjusted EPS (non-GAAP):

Adjusted Corporate Expense

(dollars in millions)

The following is a reconciliation of reported Corporate Expense to adjusted Corporate Expense (non-GAAP):

Three Months Ended

Corporate Expense (GAAP) $ (18.4) $ (15.1)

Corporate pension expense (income) 0.3 (0.6)

Corporate Expense (non-GAAP) $ (18.1) $ (15.7)

SMITH CORPORATION

Free Cash Flow

(dollars in millions)

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

Three Months Ended,

Cash provided by operating activities (GAAP) $ 16.5 $ 104.4

Capital expenditures (12.9) (17.1)

Free cash flow (non-GAAP) $ 3.6 $ 87.3

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 and restructuring expenses per diluted share, net of tax — 0.04

Adjusted EPS $2.86 - 2.90 $ 2.16

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.

Critical Accounting Policies

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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, 2021.

We believe that at September 30, 2021, there has been no material change to this information.

We believe that at March 31, 2022, there was no material change to this information.

Recent Accounting Pronouncement

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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.

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the Company's 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 the Company’s businesses, including demand for its products, particularly commercial products, operations and workforce dislocation and disruption as a result of the severity and duration of the COVID-19 pandemic;

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

inability of the Company 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 the Company’s businesses from international tariffs, trade disputes and geopolitical differences;

negative impact to the Company’s businesses from international tariffs, trade disputes and geopolitical differences, including the conflict in Ukraine;

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

substantial defaults in payment, material reduction in purchases by or the loss, bankruptcy or insolvency of a major customer, including from the result of COVID-19;

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.

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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-Q

Item 2. Management’s Discussion and Analysis