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Item 2. Management’s Discussion and Analysis

2022-10-28 compared with 2022-07-29 · 147 added, 120 removed, 161 unchanged (62% of the section changed)

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

(Giant), a Canada-based manufacturer of residential and commercial water heaters using a combination of debt and cash.

(Giant), a Canada-based manufacturer of residential and commercial water heaters, in October 2021 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 $31.0 million and $63.0 million of sales in the second quarter and first half of 2022, respectively.

Giant contributed $25.3 million and $88.1 million of net sales in the third quarter and first nine months of 2022, respectively.

Refer to Note 3, "Acquisitions" for additional information.

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 half of 2022.

We also continue to look for opportunities to add to our existing operations 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 nine months 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.

While we saw improvement in our supply chain as we closed out the second quarter, challenges still persist.

In addition, while steel indices moderated in the first half of 2022, commodity prices and availability remain volatile.

While we continued to see improvement in our supply chain as we closed out the third quarter, challenges still persist.

In addition, while steel markets moderated in the first nine months of 2022, 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.

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

We saw softness in residential water heater order rates as we exited the second quarter and into July as customers right sized their inventories.

We believe that commercial water heater industry volumes will decline seven to nine percent in 2022 compared to 2021 primarily due to weakness in the commercial electric water heaters greater than 55 gallons product category.

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 an approximately 25 percent increase in our sales of boilers in 2022 compared to 2021 driven by increased pricing in response to higher input costs and higher demand.

We anticipate sales of our North America water treatment products, inclusive of acquisitions, will increase approximately 15 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 will be flat in local currency compared with 2021.

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

To slow the spread of COVID-19 in China, targeted lockdowns began in certain cities late in the first quarter and persisted through the first half of the year.

While lockdowns have lessened in recent weeks, the situation remains unpredictable.

Combining all of these factors, we expect our consolidated sales to increase between 12 and 14 percent in 2022, which includes our acquisition of Giant adding approximately $100 million in incremental sales.

This guidance excludes the potential impacts from future acquisitions and assumes the COVID-19 related restrictions in China remain at current levels, and that COVID-19 does not significantly impact our operations or our employees, customers or suppliers.

In our North America segment, after approximately eight percent growth in 2021, we expect residential industry water heater volumes will be down approximately 12 to 13 percent in 2022 compared with 2021 as we believe that industry demand will normalize to more historical growth rates.

We saw greater than anticipated softness in residential water heater order rates in the third quarter of 2022 as we believe our customers right-sized their inventories in response to our lead times returning to pre-pandemic levels after being elevated due to COVID-19-related supply chain constraints.

While we expect quarter-over- quarter improvement in the fourth quarter, we expect North America residential water heater volume softness will persist through the remainder of the 2022.

We believe that commercial water heater industry unit volumes will decline approximately 15 percent in 2022 compared to 2021 primarily due to weakness in the commercial electric water heaters greater than 55 gallons product category.

We expect commercial gas water heater unit volumes to be flat to slightly down.

We expect net 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 an approximately 25 percent increase in our net sales of boilers in 2022 compared to 2021 driven by increased pricing in response to higher input costs coupled with higher demand.

We anticipate net sales of our North America water treatment products, inclusive of acquisitions, will increase approximately 10 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 net sales in China will be flat to slightly down in local currency compared with 2021.

Our business in China continues to be negatively impacted by the COVID-19 pandemic.

To slow the spread of COVID-19 in China, targeted shutdowns began in certain cities late in the first quarter of 2022 and persisted through the first nine months of the year.

The situation remains unpredictable.

Combining all of these factors, we expect our consolidated net sales to increase between five and seven percent in 2022, which includes our acquisition of Giant adding approximately $100 million in incremental net sales.

This guidance excludes the potential impacts from future acquisitions and assumes the COVID-19 related shutdowns in China remain at current levels throughout the rest of the year and do not significantly impact our operations or our employees, customers or suppliers.

Results of Operations

(dollars in millions) Three Months Ended

June 30, Six Months Ended

September 30, Nine Months Ended

September 30,

2022 2021 2022 2021

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Net Earnings $ 109.8 $ 131.6 $ 355.8 $ 347.5

Our sales in the second quarter of 2022 were $965.9 million, or 12.3 percent higher than 2021 second quarter sales of $859.8 million.

Sales in the first six months of 2022 were $1,943.6 million, or approximately 19 percent higher than $1,628.8 million in the same period last year.

Compared to the prior year quarter and the first six months of 2021, our sales increase was primarily driven by inflation-related pricing actions implemented in 2021 in North America, partially offset by lower sales in China.

Our acquisition of Giant added $30.8 million and $62.8 million of incremental sales in the second quarter and first half of 2022, respectively.

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

Our gross profit margin in the second quarter of 2022 was 34.6 percent compared to gross profit margin of 37.4 percent in the prior-year period.

Gross profit margin in the first six months of 2022 was 34.8 percent compared to the gross profit margin of 37.5 percent in the first six months of 2021.

The lower gross profit margin in the second quarter and first six months of 2022 compared to the same periods last year was primarily due to higher steel and other material costs, which outpaced our pricing actions.

Selling, general, and administrative (SG&A) expenses in the second quarter of 2022 decreased by $6.4 million compared to the second quarter of 2021.

SG&A expenses increased $6.9 million in the first half of 2022 compared to the prior year period.

The decrease in SG&A expenses in the second quarter of 2022 was primarily due to lower management incentive expenses and lower engineering costs in China.

Higher selling expenses in North America primarily drove the increase in SG&A expenses in the first half of 2022 due to higher sales compared to the prior year period.

Interest expense in the second quarter of 2022 was $2.1 million compared to $0.9 million in the same period last year.

Interest expense in the first half of 2022 was $3.6 million compared to $1.9 million in the same period the previous year.

The increase in interest expense in the second quarter and first six months of 2022 compared to the same periods last year was primarily due to higher debt levels.

Other expense was $0.3 million in the second quarter of 2022 compared to other income of ($3.9) million in the second quarter of 2021.

Other expense was $4.0 million in the first half of 2022 compared to other income of ($8.9) million in the first half of 2021.

Pension expense in the second quarter of 2022 was $3.7 million compared to pension income of ($2.9) million in the second quarter of 2021.

Pension expense in the first half of 2022 was $7.3 million compared to pension income of ($5.8) million in the first half of 2021.

Our net sales in the third quarter of 2022 were $874.2 million, or 4.4 percent lower than 2021 third quarter net sales of $914.6 million.

Net sales in the first nine months of 2022 were $2,817.8 million, or approximately 11 percent higher than $2,543.4 million in the same period last year.

Compared to the prior year quarter, our net sales decrease was primarily driven by lower residential water heater volumes in North America, which more than offset inflation-related pricing actions implemented in 2021.

Our net sales increase in the first nine months of 2022 was primarily driven by inflation-related pricing actions and partially offset by lower residential water heater volumes in North America and lower net sales in China.

In addition, our net sales in China were negatively impacted by approximately $12 million in the third quarter and first nine months of 2022 due to the depreciation of the Chinese currency against the U.S.

Our acquisition of Giant added $25.3 million and $88.1 million of incremental net sales in the third quarter and first nine months of 2022, respectively.

Our gross profit margin in the third quarter of 2022 was 34.9 percent compared to gross profit margin of 37.2 percent in the prior-year period.

Gross profit margin in the first nine months of 2022 was 34.8 percent compared to the gross profit margin of 37.4 percent in the first nine months of 2021.

The lower gross profit margins in the third quarter and first nine months of 2022 compared to the same periods last year were primarily due to higher steel and other material costs and production inefficiencies, which outpaced our pricing actions.

Selling, general, and administrative (SG&A) expenses in the third quarter of 2022 decreased by $22.1 million compared to the third quarter of 2021.

SG&A expenses decreased by $15.2 million in the first nine months of 2022 compared to the prior year period.

The decrease in SG&A expenses in the third quarter of 2022 was primarily due to the recognition of an $11.5 million judgment against a competitor related to its infringement of one of our patents, partially offset by $4.3 million of expenses associated with a terminated acquisition and lower selling expenses.

The decrease in SG&A expenses in the first nine months of 2022 was primarily due to the judgment discussed above, lower management incentive expenses, and lower engineering costs in China, partially offset by increased selling expenses on higher net sales and the terminated acquisition expenses discussed above.

Interest expense in the third quarter of 2022 was $2.4 million compared to $1.0 million in the same period last year.

Interest expense in the first nine months of 2022 was $6.0 million compared to $2.9 million in the same period the previous year.

The increase in interest expense in the third quarter and first nine months of 2022 compared to the same periods last year was primarily due to higher debt levels.

Other expense was $2.4 million in the third quarter of 2022 compared to other income of $(4.7) million in the third quarter of 2021.

Other expense was $6.4 million in the first nine months of 2022 compared to other income of ($13.6) million in the first nine months of 2021.

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

Pension expense in the first nine months of 2022 was $10.9 million compared to pension income of ($8.7) million in the first nine months 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.

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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 of non-cash, pre-tax pension expenses, or approximately $1.73 per share.

per share after tax.

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.

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.

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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 rates for the second quarter and first six months of 2022 were 23.7 percent and 23.6 percent, respectively.

Our effective income tax rates for the second quarter and first six months of 2021 were 21.9 percent and 22.2 percent, respectively.

Our effective income tax rates in the second quarter and first half of 2022 were higher than the effective income tax rates in the same periods of 2021 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 24.0 percent.

Our effective income tax rates for the third quarter and first nine months of 2022 were 24.1 percent and 23.7 percent, respectively.

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 in the third quarter and first nine months of 2022 were higher than our effective income tax rates in the same periods of 2021 primarily due to a non-recurring $4.2 million favorable tax impact recorded in the prior year periods related to amending a previously filed tax return and a change in geographic earnings mix.

We estimate our annual effective income tax rate for the full year of 2022 will be between 23.5 and 24.0 percent.

We are providing non-U.S.

Reconciliations from GAAP measures to non-GAAP measures are provided below.

North America Segment

(dollars in millions) Three Months Ended

June 30, Six Months Ended

September 30, Nine Months Ended

September 30,

2022 2021 2022 2021

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Segment margin 21.7 % 23.1 % 21.3 % 23.4 %

Sales in our North America segment were $744.1 million in the second quarter of 2022 or $140.5 million higher than sales of $603.6 million in the second quarter of 2021.

Sales in the first six months of 2022 were $1,474.2 million or $317.7 million higher than sales of $1,156.5 million in the same period last year.

Higher sales in the second quarter of 2022 were primarily driven by price increases implemented in 2021, largely on water heaters, which were in response to rising material and other input costs.

The second quarter of 2022 also benefited from higher volumes of water treatment products, boilers and commercial water heaters, partially offset by lower residential water heater volumes.

The increased sales in the first half of 2022 compared to the prior year period were primarily driven by the same price increases discussed above, partially offset by lower residential and commercial water heater volumes.

In addition, our acquisition of Giant added $30.8 million and $62.8 million of incremental sales in the second quarter and first half of 2022, respectively.

North America segment earnings were $159.9 million in the second quarter of 2022, an increase of 13 percent compared to segment earnings of $141.7 million in the second quarter of 2021.

Segment earnings in the first half of 2022 were $311.7 million, an increase of 15 percent compared to segment earnings of $272.1 million in the first half of 2021.

Segment margins were 21.5 percent and 23.5 percent in the second quarter of 2022 and 2021, respectively.

Segment margins were 21.1 percent and 23.5 percent in the first half of 2022 and 2021, respectively.

Higher segment earnings in the second quarter of 2022 compared to the second quarter of 2021 were primarily due to inflation-related price increases, which were partially offset by higher material and logistics costs and lower residential water heater volumes.

Higher segment earnings in the first half of 2022 compared to the prior year period were primarily due to inflation-related price increases which were partially offset by higher material and logistics costs.

Segment margin was lower in the second quarter and the first half of 2022, primarily due to an overall increase in costs, including production inefficiencies, outpacing pricing actions.

Adjusted segment earnings and adjusted segment margin in the second quarter of 2022 were $162.5 million and 21.8 percent, respectively.

Adjusted segment earnings and adjusted segment margin in the second quarter of 2021 were $139.1 million and 23.0 percent, respectively.

Adjusted segment earnings and adjusted segment margin in the first half of 2022 were $316.9 million and 21.5 percent, respectively.

Adjusted segment earnings and adjusted segment margin in the first half of 2021 were $266.9 million and 23.1 percent, respectively.

We estimate our 2022 North America adjusted segment margin will be between 22.5 and 23.0 percent.

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

Adjusted segment earnings and adjusted segment margin in the first half of 2022 and 2021 exclude $5.2 million and ($5.2) million of pension expense (income), respectively.

Net sales in our North America segment were $652.9 million in the third quarter of 2022 or $5.3 million lower than net sales of $658.2 million in the third quarter of 2021.

Net sales in the first nine months of 2022 were $2,127.1 million or $312.4 million higher than net sales of $1,814.7 million in the same period last year.

Lower net sales in the third quarter of 2022 were primarily driven by lower residential water heater volumes which more than offset price increases implemented in 2021, largely on water heaters, which were in response to rising material and other input costs.

The increased net sales in the first nine months of 2022 compared to the prior year period were primarily driven by the price increases discussed above which were partially offset by lower residential water heater volumes.

In addition, our acquisition of Giant added $25.3 million and $88.1 million of incremental net sales in the third quarter and first nine months of 2022, respectively.

North America segment earnings were $141.8 million in the third quarter of 2022, a decrease of approximately seven percent compared to segment earnings of $151.8 million in the third quarter of 2021.

Segment earnings during the first nine months of 2022 were $453.5 million, an increase of approximately seven percent compared to segment earnings of $423.9 million during the first nine months of 2021.

Segment margins were 21.7 percent and 23.1 percent in the third quarter of 2022 and 2021, respectively.

Segment margins were 21.3 percent and 23.4 percent during the first nine months of 2022 and 2021, respectively.

Lower segment earnings in the third quarter of 2022 compared to the third quarter of 2021 were primarily due to lower residential water heater volumes, higher material costs, and production inefficiencies, partially offset by price increases implemented in 2021 as discussed above and the $11.5 million patent infringement judgment referenced above.

Higher segment earnings in the first nine months of 2022 compared to the prior year period were primarily due to the price increases and the judgment referenced above, partially offset by higher material and logistics costs.

Segment margin was lower in the third quarter and the first nine months of 2022 primarily due to an overall increase in costs, including production inefficiencies, outpacing pricing actions.

Adjusted segment earnings and adjusted segment margin in the third quarter of 2022 were $132.9 million and 20.4 percent, respectively.

Adjusted segment earnings and adjusted segment margin in the third quarter of 2021 were $149.2 million and 22.7

percent, respectively.

Adjusted segment earnings and adjusted segment margin in the first nine months of 2022 were $449.8 million and 21.1 percent, respectively.

Adjusted segment earnings and adjusted segment margin in the first nine months of 2021 were $416.1 million and 22.9 percent, respectively.

We estimate our 2022 North America adjusted segment margin will be approximately 21.5 percent, excluding legal judgment income and pension expense.

Adjusted segment earnings and adjusted segment margin in the third quarter of 2022 and 2021 exclude $2.6 million and ($2.6) million of pension expense (income), respectively, and the recognition of the $11.5 million patent infringement judgment.

Adjusted segment earnings and adjusted segment margin in the first nine months of 2022 and 2021 exclude $7.8 million and ($7.8) million of pension expense (income), respectively, and the recognition of the $11.5 million patent infringement judgment.

Rest of World Segment

(dollars in millions) Three Months Ended

June 30, Six Months Ended

September 30, Nine Months Ended

September 30,

2022 2021 2022 2021

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Segment margin 9.5 % 10.2 % 9.0 % 8.1 %

Sales in the Rest of World segment were $229.9 million in the second quarter of 2022, or $33.3 million lower than sales of $263.2 million in the second quarter of 2021.

Sales in the first six months of 2022 were $485.9 million, essentially flat to the first six months of 2021.

Sales in China decreased approximately 16 percent in U.S.

dollar terms and 14 percent in local currency in the second quarter of 2022 and approximately two percent in U.S.

dollar terms and local currency in the first six months of 2022 compared to the same period last year.

Lower sales in China in the second quarter of 2022 were primarily driven by lower consumer demand due to COVID-19 related lockdowns.

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

Sales in India increased 79 percent in the second quarter of 2022 on strong demand, compared to the prior year quarter, which was negatively impacted by the COVID-19 pandemic.

Rest of World segment earnings were $18.1 million in the second quarter of 2022, compared to $22.3 million in the second quarter of 2021.

Segment earnings in the first six months of 2022 were $42.9 million, compared to $34.1 million in the first half of 2021.

Segment margins were 7.9 percent and 8.5 percent in the second quarter of 2022 and 2021, respectively.

Segment margins were 8.8 percent and 7.0 percent in the first half of 2022 and 2021, respectively.

Lower segment earnings in the second quarter of 2022 compared to the prior year period were largely driven by lower volumes in China, due primarily to COVID-19 related lockdowns, partially offset by lower selling, advertising, and engineering expenses.

Higher segment earnings and margin in the first half of 2022 compared to the prior year period were primarily driven by favorable mix 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 to increase between 12 and 14 percent in 2022, which includes our acquisition of Giant adding approximately $100 million in incremental sales.

Our higher expected sales are driven by pricing actions implemented in 2021 in North America, partially offset by lower volumes of residential water heaters.

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 half of 2022, and that COVID-19 does not significantly impact our operations or our employees, customers or suppliers.

Net sales in the Rest of World segment were $230.2 million in the third quarter of 2022, or $32.9 million lower than net sales of $263.1 million in the third quarter of 2021.

Net sales during the first nine months of 2022 were $716.1 million, or $32.5 million lower than net sales of $748.6 million during the first nine months ended of 2021.

Net sales in China decreased approximately 15 percent in U.S.

dollar terms and 10 percent in local currency in the third quarter of 2022 and approximately six percent in U.S.

dollar terms and five percent in local currency in the first nine months of 2022 compared to the same period last year.

Lower net sales in China in the third quarter and first nine months of 2022 were primarily driven by lower consumer demand due to COVID-19 related shutdowns.

In addition, our net sales in this segment were negatively impacted by approximately $16 million and $22 million in the third quarter and first nine months, respectively of 2022 compared to the same periods last year, due to the depreciation of foreign currencies compared to the U.S.

Net sales in India increased approximately 16 percent in the third quarter of 2022 on strong demand for our water heater and water treatment products compared to the prior year quarter.

Rest of World segment earnings were $21.8 million in the third quarter of 2022, compared to $26.8 million in the third quarter of 2021.

Segment earnings during the first nine months of 2022 were $64.7 million, compared to $60.9 million during the nine months of 2021.

Segment margins were 9.5 percent and 10.2 percent in the third quarter of 2022 and 2021, respectively.

Segment margins were 9.0 percent and 8.1 percent during the first nine months of 2022 and 2021, respectively.

Lower segment earnings in the third quarter of 2022, were driven by lower volumes in China, partially offset by lower selling and advertising expenses.

The decline in segment operating margin in the third quarter of 2022 was primarily due the impact of negative currency, partially offset by the increase in China operating margins.

Higher segment earnings and margin in the first nine months of 2022 compared to the prior year period were primarily driven by favorable mix and lower engineering, advertising and selling expenses in China.

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

We expect our consolidated net sales to increase between five and seven percent in 2022, which includes our acquisition of Giant adding approximately $100 million in incremental net sales.

Our expected higher net sales are driven by pricing actions implemented in 2021 in North America, partially offset by lower volumes of residential water heaters in North America.

We expect to achieve full-year earnings of between $1.29 and $1.39 per share and adjusted earnings of between $3.05 and $3.15 per share.

Our 2022 guidance excludes the potential impacts from future acquisitions and assumes the COVID-19 related shutdowns in China remain at current levels throughout the rest of the year and do not significantly impact our operations or our employees, customers or suppliers.

Liquidity & Capital Resources

Our working capital was $702.9 million at June 30, 2022 compared with $633.8 million at December 31, 2021.

Our working capital was $668.7 million at September 30, 2022, and higher 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 31, 2021, due to higher levels of safety stock on higher cost inventory which were partially offset by lower accounts receivable, and cash balances.

In the first half of 2022, we repatriated approximately $120 million of cash from our foreign subsidiaries.

In addition, cash balances as of September 30, 2022 were negatively impacted by $37.4 million due to the effects of changes in foreign currency during the year.

In the first nine months of 2022, we repatriated approximately $120 million of cash from our foreign subsidiaries.

We used the proceeds to pay down outstanding debt balances.

(dollars in millions) Six Months Ended

(dollars in millions) Nine Months Ended

September 30,

Cash provided by operating activities $ 214.7 $ 376.8

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Cash used in financing activities (320.1) (328.5)

Cash provided by operating activities in the first half of 2022 was $54.4 million compared with $196.0 million in the first half of 2021.

Cash provided by higher earnings in the first half of 2022 compared with the prior year was more than offset by lower customer deposits in China, higher incentive payments in 2022 due to record 2021 sales and earnings and additional working capital cash outlays for higher levels of safety stock on higher cost inventory.

Our free cash flow in the first half of 2022 and 2021 was $23.7 million and $165.3 million, respectively.

Cash provided by operating activities in the first nine months of 2022 was $214.7 million compared with $376.8 million in the same period last year.

Cash provided by higher earnings in the first nine months of 2022 compared with the prior year was more than offset by lower customer deposits in China, higher incentive payments in 2022 due to record 2021 net sales and earnings, and additional working capital cash outlays for higher levels of safety stock on higher cost inventory.

Our free cash flow in the first nine months of 2022 and 2021 was $163.8 million and $331.5 million, respectively.

We expect free cash flow to be between $400 million to $425 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 $30.7 million in the first half of 2022 and equal to the first half of 2021.

We project our 2022 capital expenditures, as well as depreciation and amortization, will be approximately $80 million.

Capital expenditures totaled $50.9 million in the first nine months of 2022, compared with $45.3 million in the same period last year.

We project 2022 capital expenditures will be between $70 and $75 million, and full-year depreciation and amortization expense will be approximately $80 million.

In 2021, we renewed and amended our $500 million revolving credit facility, which now expires on April 1, 2026.

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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 June 30, 2022 and expect to be in compliance for the foreseeable future.

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, 2022, and expect to be in compliance for the foreseeable future.

The facility backs up commercial paper and credit line borrowings.

At June 30, 2022, we had $160.0 million outstanding under the facility and an available borrowing capacity of $340.0 million.

At September 30, 2022, we had $152.1 million outstanding under the facility and an available borrowing capacity of $347.9 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 increased by $101.7 million from $196.7 million at December 31, 2021 to $298.4 million at June 30, 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, was 14.3 percent at June 30, 2022, compared with 9.7 percent at December 31, 2021.

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

Our total debt increased by $94.6 million in the first nine months of 2022 and was primarily due to repurchases of our common stock.

Our leverage, as measured by the ratio of total debt to total capitalization, was 14.1 percent at September 30, 2022, compared with 9.7 percent at December 31, 2021.

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

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

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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 half of 2022, we repurchased 2,868,500 shares of our stock at a total cost of $190.4 million.

At June 30, 2022, we had 4,157,857 shares remaining on the share repurchase authority.

During the first nine months of 2022, we repurchased 4,472,500 shares of our stock at a total cost of $282.0 million.

At September 30, 2022, we had 2,553,857 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 July 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 August 15, 2022, to shareholders of record on July 29, 2022.

On October 12, 2022, our Board of Directors declared a regular quarterly cash dividend of $0.30 per share on our Common Stock and Class A common stock, which represents an increase over the amount per share of our most recent dividend.

The dividend is payable on November 15, 2022, to shareholders of record on October 31, 2022.

Non-GAAP Financial Information

1 unchanged sentence

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.

Our adjusted earnings, adjusted EPS, adjusted segment earnings and adjusted corporate expenses excludes the impact of pension settlement expenses, non-operating pension income and expenses, legal judgment income, and expenses associated with terminated acquisition costs.

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

5 unchanged sentences

Three Months Ended

June 30, Six Months Ended

September 30, Nine Months Ended

September 30,

2022 2021 2022 2021

Net Earnings (GAAP) $ 109.8 $ 131.6 $ 355.8 $ 347.5

Legal judgment income, before tax (11.5) — (11.5) —

Pension expense (income), before tax 3.0 (3.2) 8.9 (9.5)

Tax effect of pension expense (income) (0.7) 0.8 (1.4) 1.6

Terminated acquisition-related expenses, before tax 4.3 — 4.3 —

Tax effect on above items 1.0 0.8 (0.4) 2.4

Adjusted Earnings (non-GAAP) $ 106.6 $ 129.2 $ 357.1 $ 340.4

1 unchanged sentence

$ 0.71 $ 0.82 $ 2.27 $ 2.15

Legal judgment income per diluted share, before tax (0.07) — (0.07) —

Pension expense (income) per diluted share, before tax 0.02 (0.02) 0.06 (0.06)

Tax effect of pension expense (income), per diluted share (0.01) 0.01 (0.01) 0.01

Terminated acquisition-related expenses per diluted share, before tax 0.03 — 0.03 —

Tax effect on above items per diluted share — 0.01 (0.01) 0.02

Adjusted EPS (non-GAAP) (1)

$ 0.69 $ 0.81 $ 2.28 $ 2.11

(1) Earning per share amounts are calculated discretely and, therefore, may not add up to the total due to rounding.

(1) Earnings per share amounts are calculated discretely and, therefore, may not add up to the total due to rounding.

SMITH CORPORATION

3 unchanged sentences

Three Months Ended

June 30, Six Months Ended,

September 30, Nine Months Ended,

September 30,

2022 2021 2022 2021

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Total Segment Earnings (GAAP) $ 163.6 $ 178.5 $ 518.1 $ 484.7

North America pension expense (income) $ 2.6 $ (2.6) $ 5.2 $ (5.2)

North America $ (8.9) $ (2.6) $ (3.7) $ (7.8)

Rest of World — — — —

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Total Adjusted Segment Earnings (non-GAAP) $ 154.7 $ 175.9 $ 514.4 $ 476.9

Additional Information

North America Segment

Pension expense (income), before tax $ 2.6 $ (2.6) $ 7.8 $ (7.8)

Legal judgment income, before tax (11.5) — (11.5) —

Total Adjustments $ (8.9) $ (2.6) $ (3.7) $ (7.8)

SMITH CORPORATION

3 unchanged sentences

Three Months Ended

June 30, Six Months Ended,

September 30, Nine Months Ended,

September 30,

2022 2021 2022 2021

1 unchanged sentence

Corporate pension expense (income) 0.4 (0.6) 1.1 (1.7)

Terminated acquisition-related expenses 4.3 — 4.3 —

Corporate Expense (non-GAAP) $ (11.8) $ (11.7) $ (40.1) $ (39.7)

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

Six Months Ended,

Nine Months Ended,

September 30,

Cash provided by operating activities (GAAP) $ 214.7 $ 376.8

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Pension expense (income) 0.06 (2)

Legal judgment income (0.05) —

Terminated acquisition-related expenses 0.02 —

Adjusted EPS (non-GAAP) $ 3.05 - 3.15 $ 2.96

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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 June 30, 2022, there was no material change to this information.

We believe that at September 30, 2022, there was no material change to this information.

Recent Accounting Pronouncement

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Important factors that could cause actual results to differ materially from these expectations include, among other things, the following:

further softening in U.S.

residential water heater demand resulting primarily from channel inventory destocking;

negative impacts to the Company, particularly the demand for its products, resulting from global inflationary pressures or a potential recession in one or more of the markets in which the Company participates;

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 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;

further weakening in U.S.

residential or commercial construction or instability in the Company's replacement markets;

inability of the Company to implement or maintain pricing actions;

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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 the Company’s replacement markets;

foreign currency fluctuations;

7 unchanged sentences

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