UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

______________________________________________________

FORM 10-Q

______________________________________________________

☒ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2022.

or

☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from __________ to __________

Commission File Number 1-475

________________________________

A. O. Smith Corporation

(Exact name of registrant as specified in its charter)

________________________________

Delaware

(State of Incorporation)

11270 West Park Place, Milwaukee, Wisconsin

(Address of Principal Executive Office)

39-0619790

(I.R.S. Employer

Identification No.)

53224-9508

(Zip Code)

(414) 359-4000

(Registrant’s telephone number, including area code)

_________________________________________________

Securities registered pursuant to Section 12(b) of the Act:

Title of Each Class	Trading Symbol	Name of Each Exchange on Which Registered
Common Stock (par value $1.00 per share)	AOS	New York Stock Exchange

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. ☒ Yes o No

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). ☒ Yes o No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer	☒	Accelerated Filer	☐
Non-accelerated filer	☐	Smaller reporting company	☐
		Emerging growth company	☐

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act.) ☐ Yes ☒ No

Class A Common Stock Outstanding as of July 27, 2022 - 25,970,688 shares

Common Stock Outstanding as of July 27, 2022 - 128,477,403 shares

Index

A. O. Smith Corporation

		Page
Part I.	FINANCIAL INFORMATION
	Condensed Consolidated Statements of Earnings - Three and Six Months Ended June 30, 2022 and 2021	3
	Condensed Consolidated Statements of Comprehensive Earnings - Three and Six Months Ended June 30, 2022 and 2021	3
	Condensed Consolidated Balance Sheets - June 30, 2022 and December 31, 2021	4
	Condensed Consolidated Statements of Cash Flows - Six Months Ended June 30, 2022 and 2021	5
	Condensed Consolidated Statements of Stockholders’ Equity - Three and Six Months Ended June 30, 2022 and 2021	6
	Notes to Condensed Consolidated Financial Statements - June 30, 2022	7-19
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	20-27
Item 3.	Quantitative and Qualitative Disclosures about Market Risk	27
Item 4.	Controls and Procedures	27-28
Part II.	OTHER INFORMATION
Item 1.	Legal Proceedings	28
Item 1A.	Risk Factors	28-29
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	29
Item 6.	Exhibits	29
Index to Exhibits		30
Signatures		31

2

PART I - FINANCIAL INFORMATION

ITEM 1 - FINANCIAL STATEMENTS

A. O. SMITH CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS

(dollars in millions, except for per share data)

(unaudited)

	Three Months Ended June 30,				Six Months Ended June 30,
	2022		2021		2022		2021
Net sales	$	965.9	$	859.8	$	1,943.6	$	1,628.8
Cost of products sold	631.5		538.4		1,267.6		1,018.8
Gross profit	334.4		321.4		676.0		610.0
Selling, general and administrative expenses	166.7		173.1		346.5		339.6
Interest expense	2.1		0.9		3.6		1.9
Other expense (income), net	0.3		(3.9)		4.0		(8.9)
Earnings before provision for income taxes	165.3		151.3		321.9		277.4
Provision for income taxes	39.1		33.1		75.9		61.5
Net Earnings	$	126.2	$	118.2	$	246.0	$	215.9
Net Earnings Per Share of Common Stock(1)	$	0.81	$	0.74	$	1.57	$	1.34
Diluted Net Earnings Per Share of Common Stock(1)	$	0.81	$	0.73	$	1.56	$	1.33
Dividends Per Share of Common Stock	$	0.28	$	0.26	$	0.56	$	0.52

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

A. O. SMITH CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE EARNINGS

(dollars in millions)

(unaudited)

	Three Months Ended June 30,				Six Months Ended June 30,
	2022		2021		2022		2021
Net earnings	$	126.2	$	118.2	$	246.0	$	215.9
Other comprehensive (loss) earnings
Foreign currency translation adjustments	(24.6)		4.9		(24.0)		3.5
Unrealized gains (losses) on cash flow derivative instruments, less related income tax (provision) benefit of $(0.7) and $(0.5) in 2022, $(0.3) and $0.4 in 2021	2.1		0.9		1.5		(1.1)
Adjustment to pension liability, less related income tax provision of $(1.3) and $(2.5) in 2022, $(1.3) and $(2.6) in 2021	3.7		3.8		7.5		7.6
Comprehensive Earnings	$	107.4	$	127.8	$	231.0	$	225.9

See accompanying notes to unaudited condensed consolidated financial statements.

3

A. O. SMITH CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS

(dollars in millions)

	(unaudited) June 30, 2022		December 31, 2021
Assets
Current Assets
Cash and cash equivalents	$	359.4	$	443.3
Marketable securities	100.0		188.1
Receivables	621.5		634.4
Inventories	493.0		447.7
Other current assets	57.3		39.1
Total Current Assets	1,631.2		1,752.6
Property, plant and equipment	1,346.3		1,343.2
Less accumulated depreciation	(753.6)		(736.5)
Net property, plant and equipment	592.7		606.7
Goodwill	627.4		627.8
Other intangibles	357.5		364.8
Operating lease assets	31.1		32.5
Other assets	81.5		90.0
Total Assets	$	3,321.4	$	3,474.4
Liabilities
Current Liabilities
Trade payables	$	624.5	$	745.9
Accrued payroll and benefits	66.6		113.4
Accrued liabilities	165.3		181.8
Product warranties	65.1		70.9
Debt due within one year	6.8		6.8
Total Current Liabilities	928.3		1,118.8
Long-term debt	291.6		189.9
Product warranties	114.9		113.5
Long-term operating lease liabilities	23.0		22.3
Other liabilities	171.1		197.7
Total Liabilities	1,528.9		1,642.2
Stockholders’ Equity
Class A Common Stock, $5 par value: authorized 27,000,000 shares; issued, 26,101,181 and 26,104,441	130.5		130.5
Common Stock, $1 par value: authorized 240,000,000 shares; issued 164,606,413 and 164,603,153	164.7		164.7
Capital in excess of par value	553.1		545.2
Retained earnings	2,984.6		2,826.6
Accumulated other comprehensive loss	(346.4)		(331.4)
Treasury stock at cost	(1,694.0)		(1,503.4)
Total Stockholders’ Equity	1,792.5		1,832.2
Total Liabilities and Stockholders’ Equity	$	3,321.4	$	3,474.4

See accompanying notes to unaudited condensed consolidated financial statements.

4

A. O. SMITH CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(dollars in millions)

(unaudited)

	Six Months Ended June 30,
	2022		2021
Operating Activities
Net earnings	$	246.0	$	215.9
Adjustments to reconcile net earnings to cash provided by (used in) operating activities:
Depreciation and amortization	38.3		39.0
Stock based compensation expense	9.0		8.9
Net changes in operating assets and liabilities:
Current assets and liabilities	(233.9)		(50.0)
Noncurrent assets and liabilities	(5.0)		(17.8)
Cash Provided by Operating Activities	54.4		196.0
Investing Activities
Capital expenditures	(30.7)		(30.7)
Acquisitions of businesses	(8.0)		—
Investments in marketable securities	(16.9)		(98.3)
Net proceeds from sale of marketable securities	96.5		79.0
Cash Provided by (Used in) Investing Activities	40.9		(50.0)
Financing Activities
Long-term debt incurred (repaid)	101.7		(6.8)
Common stock repurchases	(190.4)		(198.1)
Net (payments) proceeds from stock option activity	(2.6)		14.5
Dividends paid	(87.9)		(83.9)
Cash Used in Financing Activities	(179.2)		(274.3)
Net decrease in cash and cash equivalents	(83.9)		(128.3)
Cash and cash equivalents - beginning of period	443.3		573.1
Cash and Cash Equivalents - End of Period	$	359.4	$	444.8

See accompanying notes to unaudited condensed consolidated financial statements.

5

A. O. SMITH CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

(dollars in millions)

(unaudited)

	Three Months Ended June 30,				Six Months Ended June 30,
	2022		2021		2022		2021
Class A Common Stock
Balance at the beginning of period	$	130.5	$	130.6	$	130.5	$	130.8
Conversion of Class A Common Stock	—		—		—		(0.2)
Balance at end of period	$	130.5	$	130.6	$	130.5	$	130.6
Common Stock
Balance at the beginning of period	$	164.7	$	164.7	$	164.7	$	164.6
Conversion of Class A Common Stock	—		$	—	—		$	0.1
Balance at end of period	$	164.7	$	164.7	$	164.7	$	164.7
Capital in Excess of Par Value
Balance at the beginning of period	$	550.9	$	528.7	$	545.2	$	520.4
Conversion of Class A Common Stock	—		—		—		0.2
Issuance of share units	(0.2)		(0.1)		(6.0)		(5.4)
Vesting of share units	—		(0.1)		(2.4)		(1.8)
Stock based compensation expense	1.2		1.1		8.9		8.3
Exercises of stock options	—		4.4		0.4		7.0
Stock incentives	1.2		1.0		7.0		6.3
Balance at end of period	$	553.1	$	535.0	$	553.1	$	535.0
Retained Earnings
Balance at the beginning of period	$	2,902.2	$	2,565.1	$	2,826.6	$	2,509.6
Net earnings	126.2		118.2		246.0		215.9
Cash dividends on stock	(43.8)		(41.7)		(88.0)		(83.9)
Balance at end of period	$	2,984.6	$	2,641.6	$	2,984.6	$	2,641.6
Accumulated Other Comprehensive Loss (see Note 16)	$	(346.4)	$	(311.2)	$	(346.4)	$	(311.2)
Treasury Stock
Balance at the beginning of period	$	(1,611.8)	$	(1,219.3)	$	(1,503.4)	$	(1,155.9)
Exercise of stock options	—		5.7		(2.9)		7.6
Stock incentives and directors’ compensation	0.3		0.2		0.3		0.2
Shares repurchased	(82.5)		(131.1)		(190.4)		(198.1)
Vesting of share units	—		0.1		2.4		1.8
Balance at end of period	$	(1,694.0)	$	(1,344.4)	$	(1,694.0)	$	(1,344.4)
Total Stockholders’ Equity	$	1,792.5	$	1,816.3	$	1,792.5	$	1,816.3

See accompanying notes to unaudited condensed consolidated financial statements.

6

A. O. SMITH CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2022

(unaudited)

1. Basis of Presentation

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (GAAP) for interim financial information and pursuant to the rules and regulations of the Securities and Exchange Commission (SEC). Accordingly, they do not include all of the information and footnotes required for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three and six months ended June 30, 2022 are not necessarily indicative of the results expected for the full year. It is suggested the accompanying condensed consolidated financial statements be read in conjunction with the audited consolidated financial statements and the notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2021 filed with the SEC on February 11, 2022.

Recent Accounting Pronouncement

In November 2021, the Financial Accounting Standards Board (FASB) amended ASC 832, Government Assistance (issued under Accounting Standards Update (ASU) 2021-10, "Disclosures by Business Entities about Government Assistance"). This amendment requires disclosures that are expected to increase the transparency of transactions with a government accounted for by applying a grant or contribution accounting model by analogy, including (1) the types of transactions, (2) the accounting for those transactions, and (3) the effect of those transactions on an entity’s financial statements. The Company adopted the amendment on January 1, 2022, and the adoption of ASU 2021-10 is not expected to materially impact its annual disclosures, consolidated balance sheets, statements of earnings or statements of cash flows.

2. Revenue Recognition

Substantially all of the Company’s sales are from contracts with customers for the purchase of its products. Contracts and customer purchase orders are used to determine the existence of a sales contract. Shipping documents are used to verify shipment. For substantially all of its products, the Company transfers control of products to the customer at the point in time when title and risk are passed to the customer, which generally occurs upon shipment of the product. Each unit sold is considered an independent, unbundled performance obligation. The Company’s sales arrangements do not include other performance obligations that are material in the context of the contract.

The nature, timing and amount of revenue for a respective performance obligation are consistent for each customer. The Company measures the sales transaction price based upon the payment terms associated with the transaction and whether the sales price is subject to refund or adjustment. Sales and value added taxes are excluded from the measurement of the transaction price. The Company’s payment terms for the majority of its customers are 30 to 90 days from shipment.

Additionally, certain customers in China pay the Company prior to the shipment of products resulting in a customer deposits liability of $100.7 million and $155.2 million at June 30, 2022 and December 31, 2021, respectively. Customer deposit liabilities are short term in nature, recognized into revenue within one year of receipt, and recorded in Trade payables within the condensed consolidated balance sheets. The Company assesses the collectability of customer receivables based on the creditworthiness of a customer as determined by credit checks and analysis, as well as the customer’s payment history. In determining the allowance for credit losses, the Company also considers various factors including the aging of customer accounts and historical write-offs. In addition, the Company monitors other risk factors including forward-looking information when establishing adequate allowances for credit losses, which reflects the current estimate of credit losses expected to be incurred over the life of the receivables. The Company’s allowance for credit losses was $10.6 million at June 30, 2022 and $9.5 million at December 31, 2021.

Rebates and incentives are based on pricing agreements and are tied to sales volume. The amount of revenue is reduced for variable consideration related to customer rebates which are calculated using expected values and are based on program specific factors such as expected rebate percentages based on expected volumes. In situations where the customer has the right to return eligible products, the Company reduces revenue for its estimates of expected product returns, which are primarily based on an analysis of historical experience. Changes in such accruals may be required if actual sales volume differs from estimated sales volume or if future returns differ from historical experience. Shipping and handling costs billed to customers are included in net sales and the related costs are included in cost of products sold and are activities performed to fulfill the promise to transfer products.

7

2. Revenue Recognition (continued)

Disaggregation of Net Sales

The Company is comprised of two reporting segments: North America and Rest of World. The Rest of World segment is primarily comprised of China, Europe and India. Both segments manufacture and market comprehensive lines of residential and commercial gas and electric water heaters, boilers, tanks and water treatment products. Both segments primarily manufacture and market in their respective regions of the world.

As each segment manufactures and markets products in its respective region of the world, the Company has determined that geography is the primary factor in reporting its sales. The Company further disaggregates its North America segment sales by major product line as each of North America’s major product lines is sold through distinct distribution channels and these product lines may be impacted differently by certain economic factors. Within the Rest of World segment, particularly in China and India, the Company’s major customers purchase across the Company’s product lines, utilizing the same distribution channels regardless of product type. In addition, the impact of economic factors is unlikely to be differentiated by product line in the Rest of World segment.

The North America segment's major product lines are defined as the following:

Water heaters The Company’s water heaters are open water heating systems that heat potable water. Typical applications for water heaters include residences, restaurants, hotels, office buildings, laundries, car washes and small businesses. The Company sells residential and commercial water heater products and related parts through its wholesale distribution channel, which includes more than 1,100 independent wholesale plumbing distributors. The Company also sells residential water heaters and related parts through retail and maintenance, repair and operations (MRO) channels. A significant portion of the Company’s water heater sales in the North America segment is derived from the replacement of existing products.

Boilers The Company’s boilers are closed loop water heating systems used primarily for space heating or hydronic heating. The Company’s boilers are primarily used in applications in commercial settings for hospitals, schools, hotels and other large commercial buildings while residential boilers are used in homes, apartments and condominiums. The Company’s boiler distribution channel is comprised primarily of manufacturer representative firms, with the remainder of its boilers distributed through wholesale channels. The Company’s boiler sales in the North America segment are derived from a combination of replacement of existing products and new construction.

Water treatment products The Company’s water treatment products range from point-of-entry water softeners, solutions for problem well water, and whole-home water filtration products to on-the-go filtration bottles and point-of-use carbon and reverse osmosis products. Typical applications for the Company’s water treatment products include residences, restaurants, hotels and offices. The Company sells water treatment products through its retail and wholesale distribution channels, similar to water heater products and related parts. The Company’s water treatment products are also sold through independent water quality dealers as well as directly to consumers including through internet sales channels. A portion of the Company’s sales of water treatment products in the North America segment is comprised of replacement filters.

The following table disaggregates the Company’s net sales by segment. As described above, the Company’s North America segment sales are further disaggregated by major product line. In addition, the Company’s Rest of World segment sales are disaggregated by China and all other Rest of World:

(dollars in millions)	Three Months Ended June 30,				Six Months Ended June 30,
	2022		2021		2022		2021
North America
Water heaters and related parts	$	613.9	$	498.1	$	1,229.7	$	955.8
Boilers and related parts	70.4		55.5		127.9		102.0
Water treatment products	59.8		50.0		116.6		98.7
Total North America	744.1		603.6		1,474.2		1,156.5
Rest of World
China	$	201.5	$	238.8	$	429.8	$	438.0
All other Rest of World	28.4		24.4		56.1		47.5
Total Rest of World	229.9		263.2		485.9		485.5
Inter-segment sales	(8.1)		(7.0)		(16.5)		(13.2)
Total Net Sales	$	965.9	$	859.8	$	1,943.6	$	1,628.8

8

3. Acquisitions

On October 19, 2021, the Company acquired 100 percent of the shares and related assets of Giant Factories, Inc. (Giant), a Canada-based manufacturer of residential and commercial water heaters for $198.6 million, net of cash acquired. The purchase price increased by $2.5 million during the three months ended June 30, 2022 as a result of final working capital adjustments. The Company incurred acquisition costs of approximately $1.3 million in 2021.

Under the purchase agreement for the Giant acquisition, an escrow of approximately $8 million was set aside from the purchase price to satisfy any potential obligations of the former owners of Giant, should they arise. Goodwill decreased by $2.3 million during the three months ended June 30, 2022 due to the net impact of a measurement period adjustment, primarily related to income tax matters, partially offset by the final working capital adjustment. The purchase price allocation remains preliminary and subject to final valuation adjustments that will be completed within the one year period following the acquisition date. The addition of Giant increases the Company's North America market penetration, creating additional capacity and enhancing the Company's distribution capabilities. Giant is included in the North America segment.

The following table summarizes the preliminary allocation of fair value of the assets acquired and liabilities assumed at the date of acquisition. Of the $53.8 million of acquired identifiable intangible assets, $43.9 million has been assigned to trademarks that are not subject to amortization and $9.2 million has been assigned to customer relationships which are amortized over 22 years, and the remaining $0.7 million has been assigned to non-compete agreements which are amortized over five years. The excess of the acquisition purchase price over the fair value assigned to the assets acquired and liabilities assumed was recorded as goodwill.

The following table summarizes the estimated fair values of Giant's assets acquired and liabilities assumed at the date of acquisition:

October 19, 2021 (dollars in millions)
Current assets, net of cash acquired	$	60.1
Property, plant and equipment	55.8
Intangible assets	53.8
Goodwill	77.6
Total assets acquired	247.3
Current liabilities	(39.2)
Long Term liabilities	(9.5)
Net assets acquired	$	198.6

In addition, during the second quarter of 2022, the Company acquired a privately-held water treatment company. The Company paid an aggregate cash purchase price of $5.5 million, net of cash acquired. The addition of the company acquired expands the Company's water treatment platform and is included in the North America segment for reporting purposes.

As required under ASC 805 Business Combinations, results of operations have been included in the Company’s consolidated financial statements from the date of their acquisition.

4. Leases

The Company’s lease portfolio consists of operating leases for buildings and equipment, such as forklifts and copiers, primarily in the United States and China. The Company defines a lease as a contract that gives the Company the right to control the use of a physical asset for a stated term. The Company pays the lessor for that right, with a series of payments defined in the contract and a corresponding right of use operating lease asset and liability are recorded. The Company has elected not to record leases with an initial term of 12 months or less on its condensed consolidated balance sheet. To determine balance sheet amounts, required legal payments are discounted using the Company’s incremental borrowing rate as of the inception of the lease. The incremental borrowing rate is the rate of interest that the Company would incur if it were to borrow, on a collateralized basis, an amount equal to the value of the leased item over a similar term, in a similar economic environment. Variable lease components not based on an index or rate are excluded from the measurement of the lease asset and liability and expensed as incurred for all asset classes.

Certain leases include one or more options to renew or terminate. Renewal terms can extend the lease term from one to five years and options to terminate can be effective within one year. The exercise of lease renewal or termination is at the Company’s discretion and when it is determined to be reasonably certain to renew or terminate, the option is reflected in the measurement of lease asset and liability. The Company’s lease agreements do not contain any material residual value

9

4. Leases (continued)

guarantees or material restrictive covenants or material subleases. Cash flows associated with leases are materially consistent with the expense recorded in the condensed consolidated statement of earnings.

Supplemental balance sheet information related to leases is as follows:

(dollars in millions)	June 30, 2022		December 31, 2021
Liabilities
Short term: Accrued liabilities	$	9.7	$	11.7
Long term: Operating lease liabilities	23.0		22.3
Total operating lease liabilities	$	32.7	$	34.0
Less: Rent incentives and deferrals	(1.6)		(1.5)
Assets
Operating lease assets	$	31.1	$	32.5

Lease Term and Discount Rate	June 30, 2022
Weighted-average remaining lease term	6.7 years
Weighted-average discount rate	2.87%

The components of lease expense were as follows:

(dollars in millions)		Three months ended June 30,
Lease Expense	Classification	2022(1)		2021(2)
Operating lease expense	Cost of products sold	$	1.0	$	1.0
	Selling, general and administrative expenses	4.4		4.1

(1)2022 includes short-term and variable lease expenses of $0.6 million and $0.9 million, respectively.

(2)2021 includes short-term and variable lease expenses of $0.5 million and $0.6 million, respectively.

(dollars in millions)		Six Months Ended June 30,
Lease Expense	Classification	2022(1)		2021(2)
Operating lease expense	Cost of products sold	$	2.0	$	2.0
	Selling, general and administrative expenses	8.3		8.1

(1)2022 includes short-term and variable lease expenses of $1.1 million and $1.7 million, respectively.

(2)2021 includes short-term and variable lease expenses of $1.0 million and $1.2 million, respectively.

Maturities of lease liabilities were as follows:

(dollars in millions)	June 30, 2022
2022	$	5.9
2023	8.1
2024	6.6
2025	4.5
2026	2.8
After 2026	9.2
Total lease payments	37.1
Less: Imputed interest	(4.4)
Present value of operating lease liabilities	$	32.7

10

5. Inventories

The following table presents the components of the Company’s inventory balances:

(dollars in millions)	June 30, 2022		December 31, 2021
Finished products	$	174.3	$	190.2
Work in process	50.0		42.0
Raw materials	346.3		286.3
Inventories, at FIFO cost	570.6		518.5
LIFO reserve	(77.6)		(70.8)
	$	493.0	$	447.7

6. Product Warranties

The Company offers warranties on the sales of certain of its products with terms that are consistent with the market and records an accrual for the estimated future claims. The increase in the reserve for product warranties as of June 30, 2022 compared to June 30, 2021 was primarily due to increased steel prices and the acquisition of Giant. Refer to Note 3, "Acquisitions", for additional information regarding the acquisition of Giant.

The following table presents the Company’s warranty liability activity:

(dollars in millions)	Three Months Ended June 30,
	2022		2021
Balance at April 1,	$	182.9	$	141.6
Expense	14.7		15.3
Claims settled	(17.6)		(12.0)
Balance at June 30,	$	180.0	$	144.9

(dollars in millions)	Six Months Ended June 30,
	2022		2021
Balance at January 1,	$	184.4	$	142.3
Expense	28.6		27.9
Claims settled	(33.0)		(25.3)
Balance at June 30,	$	180.0	$	144.9

7. Debt

In 2021, the Company renewed and amended its $500 million multi-year multi-currency revolving credit agreement with a new expiration date of April 1, 2026. The facility has an accordion provision that allows it to be increased up to $850 million if certain conditions (including lender approval) are satisfied. Borrowings under bank credit lines and commercial paper borrowings are supported by a $500 million revolving credit agreement. As a result of the long-term nature of this facility, the Company’s commercial paper and credit line borrowings are classified as long-term debt at June 30, 2022. At its option, the Company either maintains cash balances or pays fees for bank credit and services. The facility requires the Company to maintain two financial covenants, a leverage ratio test and an interest coverage test. The Company was in compliance with the covenants as of June 30, 2022.

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8. Earnings per Share of Common Stock

The numerator for the calculation of basic and diluted earnings per share is net earnings. The following table sets forth the computation of basic and diluted weighted-average shares used in the earnings per share calculations:

	Three Months Ended June 30,		Six Months Ended June 30,
	2022	2021	2022	2021
Denominator for basic earnings per share - weighted average shares	155,692,240	160,241,814	156,351,739	160,880,724
Effect of dilutive stock options and share units	939,432	1,490,159	1,118,514	1,374,828
Denominator for diluted earnings per share	156,631,672	161,731,973	157,470,253	162,255,552

9. Stock Based Compensation

The Company adopted the A. O. Smith Combined Incentive Compensation Plan (the Incentive Plan) effective January 1, 2007. The Incentive Plan was most recently reapproved by stockholders on April 15, 2020. The Incentive Plan is a continuation of the A. O. Smith Combined Executive Incentive Compensation Plan which was originally approved by stockholders in 2002. The number of shares available for granting of options or share units at June 30, 2022 was 7,144,796. Upon stock option exercise or share unit vesting, shares are issued from treasury stock.

Total stock based compensation expense recognized in the three months ended June 30, 2022 and 2021 was $1.4 million and $1.5 million, respectively. Total stock based compensation expense recognized in the six months ended June 30, 2022 and 2021 was $9.0 million and $8.9 million, respectively.

Stock Options

The stock options granted in the six months ended June 30, 2022 and 2021 have three year pro rata vesting from the date of grant. Stock options are issued at exercise prices equal to the fair value of the Company’s Common Stock on the date of grant. For active employees, all options granted in 2022 and 2021 expire ten years after the date of grant. The Company’s stock options are expensed ratably over the three year vesting period; however, included in the stock option expense for the six months ended June 30, 2022 and 2021 was expense associated with the accelerated vesting of stock option awards for certain employees who either are retirement eligible or become retirement eligible during the vesting period. Stock based compensation expense attributable to stock options in the three months ended June 30, 2022 and 2021 was $0.6 million and $0.5 million, respectively. Stock based compensation expense attributable to stock options in the six months ended June 30, 2022 and 2021 was $4.5 million and $4.1 million, respectively.

Changes in options, all of which relate to the Company’s Common Stock, were as follows for the six months ended June 30, 2022:

	Weighted- Avg. Per Share Exercise Price		Number of Options	Average Remaining Contractual Life	Aggregate Intrinsic Value (dollars in millions)
Outstanding at January 1, 2022	$	47.73	2,252,498
Granted	74.14		321,600
Exercised	35.80		(25,638)
Forfeited	58.09		(10,094)
Outstanding at June 30, 2022	51.16		2,538,366	7 years	$	19.2
Exercisable at June 30, 2022	46.82		1,716,451	6 years	$	16.0

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9. Stock Based Compensation (continued)

The weighted-average fair value per option at the date of grant during the six months ended June 30, 2022 and 2021 using the Black-Scholes option-pricing model was $17.58 and $14.03, respectively. Assumptions were as follows:

	Six Months Ended June 30,
	2022		2021
Expected life (years)	5.7		5.8
Risk-free interest rate	1.9	%	1.2	%
Dividend yield	1.5	%	1.6	%
Expected volatility	26.8	%	27.4	%

The expected lives of options for purposes of these models are based on historical exercise behavior. The risk-free interest rates for purposes of these models are based on the U.S. Treasury yield curve in effect on the date of grant for the respective expected lives of the option. The expected dividend yields for purposes of these models are based on the dividends paid in the preceding four quarters divided by the grant date market value of the Common Stock. The expected volatility for purposes of these models are based on the historical volatility of the Common Stock.

Restricted Stock and Share Units

Participants may also be awarded shares of restricted stock or share units under the Incentive Plan. Share units vest three years after the date of grant. The Company granted 93,211 and 100,676 share units under the Incentive Plan in the six months ended June 30, 2022 and 2021, respectively.

The share units were valued at $6.9 million and $6.1 million at the date of issuance in 2022 and 2021, respectively, based on the price of the Company’s Common Stock at the date of grant. The share units are recognized as compensation expense ratably over the three-year vesting period; however, included in share unit expense in the three and six months ended June 30, 2022 and 2021 was expense associated with accelerated vesting of restricted stock and share unit awards for certain employees who either are retirement eligible or will become retirement eligible during the vesting period. Stock based compensation expense attributable to share units of $0.8 million and $1.0 million was recognized in the three months ended June 30, 2022 and 2021, respectively. Stock based compensation expense attributable to share units of $4.5 million and $4.8 million was recognized in the six months ended June 30, 2022 and 2021, respectively. Certain non-U.S.-based employees receive the cash value of the share price at the vesting date in lieu of shares. Unvested cash-settled awards are remeasured at each reporting period.

A summary of share unit activity under the Incentive Plan is as follows for the six months ended June 30, 2022:

	Number of Units	Weighted-Average Grant Date Value
Issued and unvested at January 1, 2022	421,138	$	47.28
Granted	93,211	73.70
Vested	(126,631)	49.49
Forfeited	(6,777)	53.93
Issued and unvested at June 30, 2022	380,941	52.98

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10. Pensions

The following table presents the components of the Company’s net pension expense (income):

(dollars in millions)	Three Months Ended June 30,				Six Months Ended June 30,
	2022		2021		2022		2021
Service cost	$	0.3	$	0.4	$	0.7	$	0.8
Interest cost	3.7		3.6		7.3		7.2
Expected return on plan assets	(5.3)		(12.0)		(10.7)		(24.0)
Amortization of unrecognized loss	5.1		5.2		10.2		10.4
Amortization of prior service cost	(0.1)		(0.1)		(0.2)		(0.2)
Defined benefit plan expense (income)	$	3.7	$	(2.9)	$	7.3	$	(5.8)

The service cost component of net periodic benefit cost is presented within cost of products sold and selling, general and administrative expenses within the condensed consolidated statements of earnings while the other components of pension expense (income) are reflected in other expense (income). The Company was not required to and did not make a contribution to its U.S. pension plan in 2021. The Company is not required to make a contribution in 2022.

In 2021, the Company's Board of Directors approved the termination of the Company's largest defined benefit pension plan (the Plan) representing over 95 percent of the Company's pension plan liabilities with a termination date of December 31, 2021. In April 2022, the Plan received a determination letter from the IRS that allowed the Company to proceed with the termination process for the Plan. In 2022, the Company expects to annuitize the remaining pension liability. The Plan settlement, which the Company expects to complete in the fourth quarter of 2022, will accelerate the recognition of approximately $445 million of non-cash, pre-tax pension expenses.

11. Segment Results

The Company is comprised of two reporting segments: North America and Rest of World. The Rest of World segment is primarily comprised of China, Europe and India. Both segments manufacture and market comprehensive lines of residential and commercial gas and electric water heaters, boilers, tanks, and water treatment products. Both segments primarily manufacture and market in their respective regions of the world. The following table presents the Company’s segment results:

(dollars in millions)	Three Months Ended June 30,				Six Months Ended June 30,
	2022		2021		2022		2021
Net sales
North America	$	744.1	$	603.6	$	1,474.2	$	1,156.5
Rest of World	229.9		263.2		485.9		485.5
Inter-segment	(8.1)		(7.0)		(16.5)		(13.2)
	$	965.9	$	859.8	$	1,943.6	$	1,628.8
Segment earnings
North America(1)	$	159.9	$	141.7	$	311.7	$	272.1
Rest of World	18.1		22.3		42.9		34.1
Inter-segment	—		—		(0.1)		—
	178.0		164.0		354.5		306.2
Corporate expense(2)	(10.6)		(11.8)		(29.0)		(26.9)
Interest expense	(2.1)		(0.9)		(3.6)		(1.9)
Earnings before income taxes	165.3		151.3		321.9		277.4
Provision for income taxes	39.1		33.1		75.9		61.5
Net earnings	$	126.2	$	118.2	$	246.0	$	215.9
(1)includes pension expense (income) of:	$	2.6	$	(2.6)	$	5.2	$	(5.2)
(2)includes pension expense (income) of:	$	0.4	$	(0.5)	$	0.7	$	(1.1)

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12. Fair Value Measurements

ASC 820, Fair Value Measurements, among other things, defines fair value, establishes a consistent framework for measuring fair value and expands disclosure for each major asset and liability category measured at fair value on either a recurring basis or nonrecurring basis. ASC 820 clarifies that fair value is an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. As such, fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or liability. As a basis for considering such assumptions, ASC 820 establishes a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value as follows: (Level 1) observable inputs such as quoted prices in active markets; (Level 2) inputs, other than the quoted prices in active markets, that are observable either directly or indirectly; and (Level 3) unobservable inputs in which there is little or no market data, which require the reporting entity to develop its own assumptions. Assets and liabilities measured at fair value are based on the market approach which are prices and other relevant information generated by market transactions involving identical or comparable assets or liabilities.

The following table presents assets (liabilities) measured at fair value on a recurring basis (dollars in millions):

Fair Value Measurement Using	June 30, 2022		December 31, 2021
Quoted prices in active markets for identical assets (Level 1)	$	100.0	$	188.1
Significant other observable inputs (Level 2)	2.6		(0.7)

Items measured at fair value were comprised of the Company’s marketable securities (Level 1) and derivative instruments (Level 2). There were no changes in the Company’s valuation techniques used to measure fair values on a recurring basis during the six months ended June 30, 2022.

13. Derivative Instruments

The Company utilizes certain derivative instruments to enhance its ability to manage currency exposure as well as raw materials price risk. Derivative instruments are entered into for periods consistent with the related underlying exposures and do not constitute positions independent of those exposures. The Company does not enter into contracts for speculative purposes. The contracts are executed with major financial institutions with no credit loss anticipated for failure of the counterparties to perform.

Cash Flow Hedges

With the exception of its net investment hedges, the Company designates all of its hedging instruments as cash flow hedges. For derivative instruments that are designated and qualify as a cash flow hedge (i.e., hedging the exposure to variability in expected future cash flows that is attributable to a particular risk), gains or losses on the derivative instrument are reported as a component of other comprehensive loss, net of tax, and are reclassified into earnings in the same line item associated with the forecasted transaction and in the same period or periods during which the hedged transaction affects earnings.

Foreign Currency Forward Contracts

The Company is exposed to foreign currency exchange risk as a result of transactions in currencies other than the functional currency of certain subsidiaries. The Company utilizes foreign currency forward purchase and sale contracts to manage the volatility associated with foreign currency purchases, sales and certain intercompany transactions in the normal course of business. Principal currencies for which the Company utilizes foreign currency forward contracts include the British pound, Canadian dollar, Euro and Mexican peso.

Gains and losses on these instruments are recorded in accumulated other comprehensive loss, net of tax, until the underlying transaction is recorded in earnings. When the hedged item is realized, gains or losses are reclassified from accumulated other comprehensive loss to the consolidated statement of earnings. The assessment of effectiveness for forward contracts is based on changes in the forward rates. These hedges have been determined to be effective. The majority of the amounts in accumulated other comprehensive loss for cash flow hedges are expected to be reclassified into earnings within one year.

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13. Derivative Instruments (continued)

The following table summarizes, by currency, the contractual amounts of the Company’s foreign currency forward contracts that are designated as cash flow hedges:

(dollars in millions)	June 30, 2022				December 31, 2021
	Buy		Sell		Buy		Sell
Canadian dollar	$	—	$	145.5	$	—	$	113.4
Euro	37.6		—		24.2		—
Mexican peso	17.1		—		23.8		—
Total	$	54.7	$	145.5	$	48.0	$	113.4

Net Investment Hedges

The Company enters into certain foreign currency forward contracts to hedge the exposure to a portion of the Company’s net investments in certain non-U.S. subsidiaries against the effect of exchange rate fluctuations on the translation of foreign currency balances to the U.S. dollar. For the derivative instruments that are designated and qualify as net investment hedges, gains and losses are reported in other comprehensive loss where they offset gains and losses recorded on the Company’s net investments in its non-U.S. subsidiaries. These hedges are determined to be effective. The Company recognized $1.7 million and $1.4 million of after-tax gains associated with hedges of net investments in non-U.S. subsidiaries in currency translation adjustment in other comprehensive loss in the three and six months ended June 30, 2022, respectively. The Company recognized $(0.1) million of after-tax losses associated with hedges of a net investment in non-U.S. subsidiaries in currency translation adjustment in other comprehensive loss in both the three and six months ended June 30, 2021. The contractual amount of the Company's foreign currency forward contracts that are designated as net investment hedges is $— million as of June 30, 2022.

The following tables present the impact of derivative contracts on the Company’s financial statements.

Fair value of derivatives designated as hedging instruments under ASC 815:

(dollars in millions)	Balance Sheet Location	June 30, 2022		December 31, 2021
Foreign currency contracts	Other current assets	$	4.6	$	1.7
	Accrued liabilities	(1.8)		(1.6)
Total derivatives designated as hedging instruments		$	2.8	$	0.1

The effect of cash flow hedges on the condensed consolidated statement of earnings:

Three Months Ended June 30 (dollars in millions):

Derivatives in ASC 815 cash flow hedging relationships	Amount of gain recognized in other comprehensive loss on derivatives				Location of gain (loss) reclassified from accumulated other comprehensive loss into earnings	Amount of gain (loss) reclassified from accumulated other comprehensive loss into earnings
	2022		2021			2022		2021
Foreign currency contracts	$	3.4	$	0.4	Cost of products sold	$	0.7	$	(0.8)

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13. Derivative Instruments (continued)

Six Months Ended June 30 (dollars in millions):

Derivatives in ASC 815 cash flow hedging relationships	Amount of gain (loss) recognized in other comprehensive loss on derivatives				Location of gain (loss) reclassified from accumulated other comprehensive loss into earnings	Amount of gain (loss) reclassified from accumulated other comprehensive loss into earnings
	2022		2021			2022		2021
Foreign currency contracts	$	2.8	$	(2.5)	Cost of products sold	$	0.8	$	(1.1)

Balance Sheet Hedges

Foreign Exchange Contracts

The Company periodically enters into foreign exchange contracts to mitigate the foreign currency volatility relative to certain intercompany loans. These foreign exchange contracts did not qualify for hedge accounting in accordance with ASC 815 and as such were marked to market through earnings. The fair value of the foreign exchange contracts was a liability of $0.2 million as of June 30, 2022. The fair value of the foreign exchange contracts was a liability of $0.8 million as of December 31, 2021 and recorded in Accrued liabilities within the consolidated balance sheet.

The following table summarizes the contractual amounts of the Company's foreign exchange contracts that are designated as balance sheet hedges:

(dollars in millions)	June 30, 2022				December 31, 2021
	Buy		Sell		Buy		Sell
Canadian dollar	$	—	$	113.9	$	—	$	125.6

The amounts recognized within the consolidated statements of earnings related to the Company's foreign exchange contracts are set forth below.

Three Months Ended June 30 (dollars in millions):

Derivatives not designated as hedging instruments:	Location of loss within the consolidated statements of earnings	2022		2021
Foreign exchange contracts	Other (income) expense - net	$	(0.2)	$	—

Six Months Ended June 30 (dollars in millions):

Derivatives not designated as hedging instruments:	Location of loss within the consolidated statements of earnings	2022		2021
Foreign exchange contracts	Other expense (income) - net	$	1.1	$	—

14. Income Taxes

The Company’s effective income tax rate for the three and six months ended June 30, 2022 was 23.7 percent and 23.6 percent, respectively. The Company estimates that its annual effective income tax rate for the full year 2022 will be between approximately 23.5 and 24.0 percent. The effective income tax rate for the three and six months ended June 30, 2021 was 21.9 percent and 22.2 percent, respectively. The change in the effective income tax rate for the six months ended June 30, 2022 compared to the effective income tax rate for the six months ended June 30, 2021 was primarily due to a change in geographical earnings mix.

As of June 30, 2022, the Company had $14.3 million of unrecognized tax benefits of which $0.5 million would affect its effective income tax rate if recognized. The Company recognizes potential interest and penalties related to unrecognized tax benefits as a component of income tax expense. The Company’s U.S. federal income tax returns for 2017-2022 are subject to audit. The Company is subject to state and local income tax audits for tax years 2008-2022. The Company is subject to non-U.S. income tax examinations for years 2015-2022.

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15. Commitments and Contingencies

The Company maintains a commercial relationship with a supply-chain service provider (the Provider) in connection with the Company’s business in China. In this capacity, the Provider offers order-entry, warehousing and logistics support. The Provider also offers asset-backed financing to certain of the Company’s distributors in China to facilitate their working capital needs. To facilitate its financing support business, the Provider has collateralized lending facilities in place with multiple Chinese banks under which the Company has agreed to repurchase inventory if both requested by the banks and certain defined conditions are met, primarily related to the aging of the distributors’ notes.

The Provider is required to indemnify the Company for any losses the Company would incur in the event of an inventory repurchase under these arrangements. Potential losses under the repurchase arrangements represent the difference between the repurchase price and net proceeds from the resale of product plus costs incurred in the process, less related distributor rebates.

Before considering any reduction of distributor rebate accruals of $2.5 million and $3.9 million as of June 30, 2022 and December 31, 2021, respectively, and from the resale of the related inventory, the gross amount the Company would be obligated to repurchase, which would be contingent on the default of all of the outstanding loans, was approximately $3.5 million as of June 30, 2022 and $