A.O. Smith Corporation

Good day and thank you for standing by. Welcome to the A.O. Smith First Quarter 2021 Earnings Call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question and answer session. To ask a question during the session, you will need to press star 1 on your telephone. If you require any further assistance, please press star 0. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Ms. Patricia Ackerman. Please go ahead.

Thank you, May. Good morning, ladies and gentlemen, and welcome to the A.O. Smith First Quarter Results Conference Call. I am Pat Ackerman, Senior Vice President, Investor Relations, Corporate Responsibility and Sustainability, and our Treasurer. Joining me today are Kevin Wheeler, Chairman and Chief Executive Officer, and Chuck Lauber, Chief Financial Officer. Before we begin with Kevin's remarks, I would like to remind you that some of the comments that will be made during this conference call, including answers to your questions, will constitute forward-looking statements. These forward-looking statements are subject to risks that could cause actual results to be materially different. Those risks include, among others, matters that we have described in this morning's press release. Also as a courtesy to others in the question queue, please limit yourself to one question and one follow-up per turn. If you have multiple questions, please rejoin the queue. I will now turn the call over to Kevin, who will begin our prepared remarks on slide three.

Thank you, Pat. Our global A.O. Smith team delivered first quarter EPS of $0.60 on a 21% increase in sales, demonstrating solid execution despite pandemic and weather-related challenges in our supply chain and operations. along with rapidly rising material costs. I greatly appreciate the diligence of our team to keep each other healthy and safe. Outside of India, where COVID-19 cases have recently surged, I am pleased that we have experienced steady improvement in this area since the beginning of the year. North America water treatment grew 12%, driven by continued consumer demand for home improvement products, which provide safe drinking water in the home. The direct-to-consumer channel with our Aquasano brand and the dealer channel contributed to solid growth to start 2021. Boiler sales grew 12% as we have seen strong demand, particularly within commercial boilers, as a result of completed projects carried over from 2020, as well as a resilient replacement demand. Our volumes of US tank residential water heaters declined in the first quarter due to weather disruptions at our facility supply chain constraints, which limited production. If not for limited production, based on our surge in customer orders in the quarter, our U.S. residential shipments would have increased compared with 2020. Strong orders in the quarter were largely due to extended lead times, our second price increase, which was effective April 1st, and announced third price increase effective in June. Due to continued pandemic-related disruptions in restaurant and hospitality new construction and replacement demand, our commercial water heater volumes declined in the first quarter, largely in line with our expectations coming into the year. In China, sales increased over 100% in local currency, driven by higher consumer demand, and an easy comparison compared with the pandemic-disrupted first quarter of 2020. I will now turn the call over to Chuck, who will provide more details on our first quarter, beginning on slide four.

Thank you, Kevin. First quarter sales of $769 million increased 21% compared with 2020, largely due to significantly higher China sales. As a result of higher sales, first quarter net earnings increased 89% to $98 million or 60 cents per share, compared with $52 million or 32 cents per share in 2020. Please turn to slide five. Sales in the North America segment of $553 million increased 4% compared with the first quarter of 2020. Higher commercial boiler, service parts, and tankless water heater sales in the U.S., improved water heater sales in Canada, a 12% growth in water treatment sales, and inflation-related price increases on water heaters in the U.S. were partially offset by lower U.S. residential and commercial water heater volumes. Rest of the world segment sales of $222 million increased over 100% from the first quarter of 2020, driven by stronger consumer demand in each of our major product categories in China. Pandemic-related lockdowns and weak end market demand in the first quarter of 2020 provided an easy comparison for the first quarter of 2021. Currency translation of China sales favorably impacted sales by approximately $14 million. On slide six, North America's segment earnings of $130 million increased 3% compared with the first quarter of 2020. The impact of earnings from higher sales and inflation-related price increases on water heaters was partially offset by higher material costs and freight costs and lower water heating volumes in the U.S. Segment operating margin of 23.6% was slightly lower than the first quarter of 2020. Rest of the world segment earnings of $12 million increased significantly compared with the first quarter of 2020, which was negatively impacted by the pandemic. In China, higher volumes and lower selling and administrative costs contributed to higher segment earnings. As a result, segment operating margin of 5.3% improved significantly from negative 38.3% in the first quarter of 2020. Our corporate expenses of $15 million were similar to the first quarter of 2020. Our effective tax rate of 22.5% was 110 basis points lower than the prior year, largely due to geographical differences in pre-tax income. Please turn to slide seven. Cash provided by operations of $104 million during the first quarter was higher than the first quarter of 2020, primarily as a result of higher earnings in 2020 compared with the prior year. Our cash balances totaled $660 million at the end of the first quarter, and our net cash position was $559 million. Our leverage ratio was 5%, as measured by total debt to total capital at the end of the first quarter. We completed refinancing our $500 million revolver credit facility on April 1st of this year. We currently have no borrowings on this facility. During the first quarter, we repurchased approximately 1.1 million shares of common stock for a total of $67 million. Please turn to slide eight. We upgraded our 2021 EPS guidance this morning with a range of between $2.55 and $2.65 per share. The midpoint of our range represents an increase of 20% compared with the 2020 adjusted results. We expect cash flow from operations in 2021 to be between $475 and $500 million, compared with $560 million in 2020. We expect higher earnings in 2021 will be more than offset by higher investments in working capital than in our prior year. Our 2021 capital spending plans are between $85 and $90 million, and our depreciation and amortization expense is expected to be approximately $80 million. Our corporate and other expenses are expected to be approximately $52 million, which is similar to 2020. Our effective tax rate is assumed to be approximately 23% in 2021. Average outstanding diluted shares of $160 million assumes $400 million worth of shares are repurchased in 2021. I will now turn the call over to Kevin, who will summarize our guidance assumptions beginning on slide nine. Kevin?

Our businesses continue to navigate through supply chain and logistic challenges. The first quarter was particularly challenging for our North America water heater business. Severe weather impacted our Aspen City and Juarez facilities and resulted in a week out of production at each plant in the quarter. Supply chain constraints limited our ability to make up the lost production within the quarter. As a result of a surge in orders approximately 30% higher than the first quarter last year, our lead times have further extended. We are working with customers on managing orders along with our operations and supply chain teams, working diligently to meet demand. However, we expect to be catching up throughout the second quarter and into the third quarter. Our outlook for 2021 includes the following assumptions. We have not changed our outlook for full-year U.S. residential heater industry volumes and continue to project a full-year volume will be down 2% or 200,000 units in 2021. a small retracement from the record volume shifted 2020. We expect commercial industry water heater volumes will decline approximately 4% as pandemic impacted business delay or defer new construction and discretionary replacement installation. We continue to experience inflation across our supply chain, particularly steel and logistics costs. Steel has increased 25% since we announced our April 1st water heater price increase. We announced a third price increase in late March on water heaters, affected June 1 at a blended rate of 8.5%. In China, it is encouraging to see sales of our products continue to remain strong through April. Our strategy continues to expand distribution to Tier 4 through 6 cities is on track. We see improvement in consumer trends towards trading up for higher-priced products across all product categories, driven by differentiated new products launched in the last 12 to 24 months. We expect year-over-year increase in local currency sales between 18% to 20% in China. We assume China currency rates will remain at current levels, adding approximately $50 million and $3 million to sales and profits over the prior year, respectively. We have nearly doubled our growth projections and our outlook for our North America boiler sales from mid-single-digit growth to approximately 10% growth based on a strong first quarter, strong backlog, and visibility into courting activity. Our expectations are based on several growth drivers. We believe pent-up demand from the declines last year will drive growth. The transition to higher energy efficient boilers will continue, particularly as commercial buildings improve their overall carbon footprint. In 2020, condensing boilers were 39% of the commercial boiler industry. that represents our addressable market, which provides continued opportunity for our leading market share commercial condensing boilers. New product launches, including improvements to our flagship Crest commercial condensing boiler with a market differentiating oxygen sensor, which continuously measures and optimizes boiler performance. An introduction of a 1 million BTU light duty commercial night FTXL. We continue to project 13 to 14% full-year sales growth in our North America water treatment products, similar to that which we have seen in the first quarter. We believe the megatrends of healthy and safe drinking water, as well as a reduction of single-use plastic bottles, will continue to drive consumer demand for our point-of-use and port-of-entry water treatment systems. We believe margins in this business could grow by 100 to 200 basis points higher than the nearly 10% margin achieved in 2020. In India, first quarter 2021 sales were nearly double the prior year. While India is challenged with recent COVID case resurgence, we project 2021 full-year sales to increase over 20% compared with 2020 to incur a smaller loss of $1 to $2 million. Please turn to slide 10. We project revenue will increase between 14% and 15% in 2021. As strong North America water treatment, boiler, and China sales enhanced by pricing action more than offset expected weaker North America water heater volumes. Our sales growth projections include approximately $50 million of benefit from China currency translation. We expect North America's segment margin to be between 23% and 23.5%, and rest of the world's segment margins to be between 7% and 8%. I'm on slide 11. Our operations face continued challenges in the first quarter, and while we expect continued headwinds in supply chain and logistics in the near term, I have confidence in our teams to continue to navigate through this environment. Along with the strength of our people, I believe A.O. Smith is a compelling investment for numerous reasons. We have leading share positions in our major product categories. We estimate replacement demand represents 80% to 85% of U.S. water heater, and boiler volumes. We have a strong brand, premium brand in China, a broad product offering in our key product categories, broad distribution, and a reputation for quality and innovation in that region. Over time, we are well positioned to maximize favorable demographics in both China and India to enhance shareholder value. We are excited for the opportunity we see in our North America water treatment platforms. We have strong cash flow and balance sheet supporting the ability to continue to invest for the long term with investments in automation, innovation, and new products, as well as acquisitions and return cash to shareholders. That concludes our prepared remarks, and we are now available for your questions.

As a reminder, to ask a question, you will need to press R1 on your telephone. To draw your question, press the pound key. Please stand by while we compile the Q&A roster. We have our first question from the line of Sari Boroditsky from Jefferies. Your line is now open.

So you mentioned the surge in orders on the residential water heater side. Could you help quantify the impact of the weather and supply chain issues in the corridor? Do you expect those orders to come through in 2Q? And then just when you have a large backlog of orders, will those come in at the older prices? Thanks.

Yeah, this is Chuck. Good morning. You know, we did have some interruptions. We've got two plants that were down. Ashland City and Juarez were down due to weather for approximately a week each. So that, you know, that does a couple things. One, it raises kind of the orders that come in from a perspective of it creates a bit of a surge in, you know, when lead times extend a bit due to a temporary interruption, we see more orders which extend the lead times. So that quantification, we do expect to make that up in the second and third quarters. we would expect that we would get a little bit more normalization of production throughout the second and third quarter, and those orders would come in. Now, to quantify the surge in orders, it's a bit difficult. There's a lot of noise in the marketplace from the interruption I just described, as well as, you know, three price increases at once. So not all at once, but February, April, and June, and that just creates a bit of noise. So As far as the effectuation of kind of the pricing on those, we work to manage the orders that come through on a more normalized basis. But the extended lead times do push that realization on price out slightly. So, you know, an April 1st price increase, for example, is going to be extended a bit. But when we look at all of our pricing, we would expect that the full impact would be – would be implemented when we get into the third quarter.

That's really helpful. And then you still expect to see a decline in commercial water heater volumes, but there's been a more positive outlook for restaurants and travel. So could you just talk through how you're thinking about demand in that market?

I think it's still a little early. We would agree with you as COVID and vaccines become more prevalent and things start to open up, that certainly is an opportunity going forward. It's probably a bit early here in April to change our outlook. We still believe there's going to be a modest decline, as we mentioned, about 4%. But overall, it's a possible upside, yes, but probably just a little too early to project that in late April.

We have our next question from the line of Damian Karras from UBS. Your line is now open.

Hi, good morning, everyone. Good morning. Good morning. So, I was just hoping you could maybe clarify a little bit on the residential water heaters outlook. I mean, so you're still expecting the market down 2% this year, but it sounds like you're incrementally positive on the demand environment, and you noted that 30% surge in orders. So, you know, could you just help kind of reconcile that disconnect? You know, do you think this demand is short-lived and you're going to, therefore, see a fall-off in the back half of the year?

Yeah, I think what Chuck outlined really well is that there's just a lot of noise in order of entry now because of lead times, because, again, we're working on a third price increase. And so that just pulls orders forward. And so as we think about it, we'll work through those orders. There's certainly going to be some new construction activity, but just remember that we really come into play in completions, not starts. So right now, we just think that the 200,000 retracement we talked about is probably the best forecast we can have until we work through this backlog and get to the other side to really understand what was true demand versus just normal demand brought forward by pricing or extended lean time. So it's, again, you'll probably hear us say this a little bit, it's just a little too early to take these numbers considering there's so many variables that we're going to have to work through. But, you know, we'll have a better, clearer picture probably in the second quarter, early third quarter.

Yeah, I'll just add one comment. And when you take a step back and you look at last year, the industry was the highest level it's been since 2006. You know, there's a lot of noise, we believe, because of the pandemic, because of some supply chain constraints pushing lead times out. And we do expect, as we kind of go through the year, and particularly when we get into the third and fourth quarter, that, you know, the industry may be behind that a bit, and that may drive down a little bit of the demand as we get into the back half of the year. as inventories get a little more comfortable.

Okay, that's helpful. And I guess thinking about once we get into the third quarter and the fourth quarter, how best do we think about the you know, the actual financial impact of the 30% or so year-to-date increases in price. I mean, correct me if I'm wrong, but, you know, it doesn't appear that, you know, your expectation is that, you know, sales or revenues are going to go up by, you know, 30% in the back half. So what's, you know, how do we think about the translation of those announced price increases to the top line later this year?

Yeah, well, you're exactly right on kind of thinking about when we look at the three price increases and you kind of look at what we've announced, we're in that 24% to 27% range, we think, you know, as far as you look at a blended byproduct category when you look at the residential and commercial market. So they do come in into really what's going to fall into what I would say, you know, For sure, largest part of that would be expected to come in in the fourth quarter, and we're going to see it feather in a bit in the third quarter. So, you know, you've got to kind of think about the fact that it's not fully implemented probably or fully impacting us in Q3. You know, it kind of feathers in as we go throughout the year.

Next is Jeffrey Hammond from KeyBank Capital Markets. Your line is now open.

Morning. This is David Tarantino on for Jeff. Morning, David. So on price increases, was there any pre-buy ahead of price increases? And I know you were talking about destocking last quarter. So if any, where would be the greatest period of destocking?

Well, we actually believe there's been some destocking in the first quarter just because of some of the constraints that we've had. But when you look at any pre-buy, we normally limit into a month of production. So there's always a pre-order, I would say, that we're seeing, and that's part of our backlog and our surge right now, is that you had April orders that were already put in by our customers in the first quarter. Then, of course, you have June that just came up, and people are getting in line and placing their orders for that increase. So there is always an order pull forward that we have to work through. And, again, we'll work through that most of the second quarter and into the third quarter and hope to have that part of it behind us as we get through July and August.

Okay. And then just as a follow-up, what have you seen or, like, are you seeing on pricing in China?

Well, I will tell you – Just taking in general, we have inflationary issues across the globe. And we don't get into all the specifics that we take price in action, but we've taken price in action in almost every one of our businesses. Some are a bit different than others. China doesn't quite have some of the inflationary pressures that we've seen here. India may be a bit different. Europe's a little bit different. But what we've done is we've taken action to make sure that – Over time, we're able to address these inflationary pressures that we're seeing today, and we believe we have a track record that's going to prove out that we can address these given the appropriate amount of time.

And just to add on a comment on China, and it's not directly related to pricing but just mix, and, you know, we're pleased that we're kind of looking at it quarter over quarter where mix is neutral to positive. So not necessarily pricing, but our mix, we believe, has taken a point where from here through the rest of the year, we forecast it to be kind of a neutral positive, where we had some headwinds last year.

Next is Matt Somerville from D.A. Davidson. Your line is now open. Thank you.

around this a little bit, but I was hoping for a bit more specificity in terms of how we should be thinking about the quarterly revenue and earnings cadence in North America with the moving pieces around the pre-buys, the destocking, the price increases, satisfying these incoming orders you were referring to. Where do you think the high watermark will be on a quarterly basis versus the low watermark?

Yeah, there's a lot of moving parts. You're exactly right. So, you know, let me just try to frame up high level how we think about it. And I've already kind of talked about when pricing would potentially be expected to come in. And when we look at our cost side, right? So if you think about our cost side, and we've seen costs go up in multiple categories, freight, corrugated, you know, our resins, our foam, you know, there's a lot of categories that's gone up. But when you think about our biggest category, which is steel, and we've talked a lot about steel pricing going up, it's, It's coming in. We do have a benefit of a 90- to 120-day lag. So when we think about steel costing us, you know, it progressively gets higher during the year. So year-over-year steel costs, just we expect it to be on average up over 70%. But when you look at the quarter cadence, kind of back to your question, we get hit with the highest costs in the third and fourth quarter. So the most pressure on margins in North America will be in the back half of the year as we feel the full impact of some of the higher price increases that we're seeing on cost side and see some of the pricing being more fully implemented in the fourth quarter.

And then with respect to China, can you just talk about what your latest assessment is in terms of channel inventories, what your sell-in looked like versus sell-through in the quarter, and which product lines you're seeing the most relative strengths currently? Thank you.

Yeah, I'll take the – we're seeing – well, Q1 was a terrible comp because it was just such a low point in time. But you look at it going forward, Sellout has been robust. We're looking at a 6% to 7% sellout throughout the year. Very pleased that it's going across all of our core categories. So it's electric water heaters, gas tankless, and water treatment. So that's moving in the right direction. And Chuck just mentioned, it's nice to see our mix leaning towards the premium sector. And we really saw that. We've always... really had it on water treatment throughout the pandemic, but we really saw some nice movement up on our residential electric and gas tankless. I think there's some new products, particularly on the gas tankless, which is a grade one product that has the lowest noise level, which is exceptionally important to the Chinese consumer. So, you know, overall, the business is moving in the right direction. We think we're positioned very well over the next few quarters to – move that business forward.

From the inventory position, I'll let Chuck review that. Yeah, the channel inventories are in great shape, lowest point in five years. You know, very refreshed, I'll say, so that it's all, you know, within 90 days, basically. So it's in great shape in China from a channel inventory perspective.

Next is Aidan Buckpinder from Citi. Your line is now open.

Hi, good morning. Good morning. The rest of the world segment margin improved significantly from the COVID impact of Q1 last year, and incrementals, you know, they seem just about short of 50%. So do you anticipate maintaining this level of incrementals in Q2, which had a less drastic but still steep sales decline in 2020?

Yeah, this is Chuck. No, we don't see the same incremental levels going into the back half of the year, or the back three quarters of the year of Q2. You know, in China, we're kind of looking at incrementals in that, you know, 40% range. And then as you think about kind of how the year plays out in China, we've got, you know, a special item that we had last year, which was social insurance, which helped us for about $12 million last year, which we won't see this year. And the cadence of that by quarter, you know, we got the most benefit last year in Q2 and Q3. So Q1 was very small last year. So that's a bit of a headwind as we go through the rest of the year in China. So, I mean, we're pleased with where the first quarter came out in China, just under 6%. That was a pretty solid quarter for what is always a challenging quarter. seasonal quarter for us with the festivals and the holiday. And the fourth quarter is always our strongest. So as we kind of look at China, and Kevin mentioned it, we would expect the back three quarters of the year to progressively improve overall growth rate in that 6% to 7%. And then when we get into the fourth quarter, you know, approaching double-digit operating margins in the fourth quarter, similar to what we had last year.

That's a very helpful color. And as a follow-up, given your raised expectations for operating cash flow, continued strong balance sheet, and expanded share repurchase authority, what would you need to see to expand 2020's repurchase beyond the current $400 million? And is there any potential for an uptick in the pace of inorganic growth?

Well, I'll address the $400 million. I think at this time, you know, we're going to keep it framed at $400 million. We kind of do that because we don't want to grow cash. And you're right, we're going to have a strong cash generation year this year, too. We're going to keep looking to deploy capital. So, you know, we're very, very actively looking at where we can deploy our capital through acquisition. And so, you know, as we play out the year, we're still focused on, you know, deploying the capital in that area. And we're going to maintain our repurchase at this point. at the $400 million.

Yeah, I would just add on to that. Again, things can change over the next six to nine months. We've talked about it. We've been very active in the M&A side. We think there's some opportunities out there. And we're staying close to those opportunities. And again, it always takes two to close a deal. But we would prefer to deploy our capital in the M&A side and invest back in ourself and And at the end, we'll take a look at it as we get through the balance of this year, and we'll make a determination how best to move forward with our capital allocation.

Yeah, I guess I'll add on on the organic growth. I mean, we're pleased with the growth we're seeing in North America water treatment. You know, growing at 12% to 13% for the rest of the year, that's an area of growth. We like the trends that we're seeing in China, growing at 6% to 7% for the back three-quarters of the year. So, Yeah, a couple areas of growth that we're optimistic about.

Yeah, I would just add on. I mean, organic growth across our businesses right now looks pretty strong. You know, for us to raise our Lock and Bar business up to a 10% growth, you know, we're seeing that part of the business, which is a bit surprising to us, really bounce back. And so if you look across all our businesses, the organic side of it looks pretty strong as we – go out through the year. We always reserve the right because things can change in this chaotic environment we're in with COVID and so forth. But organically, all our businesses are well positioned.

Next is Susan McClary from Goldman Sachs. Your line is now open.

Good morning, everybody. Good morning. Hi. My first question is, you mentioned that you have seen some desocking in the first quarter. But I guess can you give us some more color on where you think inventories are in the channel? You know, I know that you kind of came into the fourth quarter with some excess inventory. You came into this year with it. Do you think that with the weather in Texas and everything that went on in the first quarter, that that's basically been depleted? And do you think that this pull forward is, in a sense, them just trying to get back to normal, or are they looking to actually carry a bit more inventory maybe than they would have prior to the past year? Sure.

Yeah, I mean, from our perspective and some of the disruptions that Kevin talked about due to the weather, you know, we do believe that we've seen some of our customers' inventories coming down because, you know, we're trying to get production out as best we can and satisfy customer needs, but there's been some stress in that area. So for the quarter, we do believe our customers' inventories have decreased when you look at where we started the year. We would expect that to normalize as we go forward for the remainder of the year, and we bring down lead times. So we kind of expect more normalization to inventory levels as we exit the year, and that kind of plays into the guidance of where we talked about our full-year outlook for residential.

And our teams are really focused on making sure that as we're going through these kind of challenging times when it comes to material shortages and so forth, that we're that we're actually producing products for orders that customers actually need, and we're not just building inventory. So the positive side of this I would like to leave with is that our customers do have stock. They are taking care of their customers, and we're working very closely to make sure that continues over the next quarter or so as we work through this backlog.

Okay, that's helpful. And then on the commercial side, I know that you mentioned that you're clearly catching up on or your customers are catching up on some of the delays and things that were postponed from last year. Are you also seeing that there's any level of increased new construction or projects that are really kind of starting to break ground that are coming through and kind of helping some of that backlog as well?

We're seeing – And we mentioned in the remarks, we are seeing, you know, coding activity remain fairly good. And, again, it's similar to last quarter. We commented that the projects aren't maybe as large, but they're still active. So the combination of, you know, kind of the pent-up demand that we're feeling today and a nice backlog that we have, and then, you know, this coding activity, which could potentially coming at the end of this year, but it will probably carry over to 2022. So it's been on the commercial side of the business, the higher end, kind of the boiler-walking fire side. It's bounced back a bit more than we anticipated.

Next is David McGregor from Longbow Research. Your line is now open.

Yes, good morning, everyone. And I guess, you know, congratulations on some of the progress in the rest of the world segment, China for certain. You know, when we look back on the margins that you would generate in the rest of the world business for a long, long time before things became problematic in China, it was kind of a 13% margin. And I'm just wondering, you know, if we step back here for a second and talk, you know, longer term, how are you thinking about the potential for margin generation in China? Do we go back to 13% numbers? I know there's been a transition to a higher concentration of medium price point versus premium price point, but I think you'd indicated on prior calls that you felt like the margins were relatively equivalent. And so I guess I'm just trying to get a sense of what's the potential on ROW margins? Is there upside based on various initiatives you've undertaken along the way? Help us think longer term about the potential there.

Yeah, so we've framed our rest of the world margins this year in that 7% to 8%. And what we saw last year in the fourth quarter is we were at the double-digit margin percentage, and we get a little bit of volume. And so, you know, right now, you know, 10% is kind of where our target is in the upcoming timeframe, not this year. But as we look at that, that's certainly doable in the current environment where we've got you know, a heavier amount of mid-price products than we historically have. We haven't seen the strength in the trading up on the high end of the market. Even though Kevin had noted in his remarks that we've seen some positive trends in that area, it's not at the same level as what we had in the past. And those margins, while we, on a percentage basis, are similar, they are lower than the high end of the market. So we do get some pressure on that. So You know, when we think about kind of the transition that the business has taken a bit on store count efficiency, the SG&A initiative that we've done, you know, we have taken costs out of the business to grow a bit back into higher margins. We need a little bit more volume. We'd also like to see some trading up outside of the categories. Water treatment has been a pretty good category for us, but we'd like to see more trading up. Housing coming back would help us to get some of the volume backed up and just consumer confidence in the trading up. So, you know, we need a little bit of help in that category to get back to higher margins than what we're experiencing today, but those are some of the areas that we're watching very closely.

And if I could just clarify on that, because I do have a second question, but it sounds like what I'm hearing you say is, you know, it's dependent upon volume and mix-up. But just for the sake of sort of putting together some longer-term construct here, if you were to get the volume you needed, if the volume moved back up to a much higher level of operating rate, and you were to get a little bit of strength on the premium side of this in both water heaters and water treatment, is there a structural reason why you can't get back to 13%? Has something changed there? Or, you know, based on some reasonable assumptions, I'm not getting ridiculous, but Is 15% still an achievable goal?

No, there's not a structural change there. But, you know, to your comment, I'd say the largest driver of that is seeing the market move further into the trading up, you know, high end of the piece of the market than what it is today. Right. But, yes, you know, structurally there's no reason that we can't get back there with some of the other factors, volume, higher end of the market trading up, along with some of the restructuring we've done.

Okay. My second question is with regard to tankless product in the United States, and can you just talk about category growth, what you're seeing there, and your share, and I guess what would you need to see to commit more capital to that category in the North American market?

Well, I mean, I would start out with the back half of the question. We're already investing capital, and it's part of our offering. I've mentioned many times we're in the hot water business, and so we're Clearly, what we're looking for is the best solution, and at times tankless is the best and other times the tank is. When you look at the business today, we talked a bit about Texas. So tankless has been up a bit, and it's interesting because in Texas, you know, it's a warmer climate, and a lot of the tankless were installed outdoors. And that's fine because there's an electrical part of things that were to freeze that prevent the unit from freezing. But we saw an uptick in Texas because not only did we have cold weather, but we had no electricity as well. And so tankless for us was up in the quarter. And it was just driven by a one-time weather-related item that can happen. But overall, I mean, I don't want to leave. Tankless is still part of our long-term strategy. It's part of our residential product offering. And just like any other products that we have, heat pumps and regular electrics and so forth, and so we're committed to it. And over time, we believe we'll continue to carve out the appropriate share in that product category. Okay.

Next question is from Ryan Connors from Boning Scattergood. Your line is now open.

Great. Thanks for taking my question. I wanted to talk about competitive dynamics a little bit. And, you know, obviously everyone's supply chain is unique and it's been a crazy year on the manufacturing front. And so sometimes these situations create the opportunity for some market share shifts. And we have seen that in some other industrial markets. So how do you think you're coping relative to your peers through all these supply chain issues and are there opportunities to pick up market share, outgrow the market given some of the things going on?

Yeah, I would tell you from excluding the weather that I mentioned that impacted our clients, I think we're coping very well with the supply chain and we're certainly getting our fair share of the raw materials and so forth. So You know, overall, I think we're doing well. We have a terrific operations and supply chain group, and we have terrific suppliers that, you know, they're working through their own capacity constraints as they're ramping up or repairing some of the things that were impacted down in the Gulf region. So I think we're doing well. That's why as we get into, you know, Q2 and Q3, we get back to a normalized level. Our factories don't have a week out of production. So overall, I would tell you from my perspective, any time you have any type of disruption, it's who executes the best. And there are some opportunities there, and those will have to play out over the next maybe Q1 and part of Q3.

Okay. And then my other one just is on kind of tax policy and some of the changes being proposed. I know none of it is concrete yet, but, you know, specifically this proposal of, you know, kind of going after foreign – corporate earnings. Have you looked at that in any detail and any idea or color on how that might or might not impact your rest of world business and China in particular?

Yeah, I mean, it's still being formed, of course, but we have taken a high-level look at that. We don't believe that that's going to impact us in a significant way. Clearly, if the corporate tax rate goes up from 21 to 28 or somewhere in between, that has a much larger impact.

Next is Nathan Jones from Stifel. Your line is now open.

There's also proposed changes in here for increasing the capital gains tax. Are you seeing that potentially motivate some more sellers for properties that you might be interested in domestically?

Well, you know, when there's uncertainty in tax rate and capital gains, I imagine that does get some private owners to think a little bit about when the right timing might be to exit. So, you know, the mosaic of what's happening in M&A is kind of made up of multiple things, and that certainly could be a driver.

Okay. And then I just had one around pricing. you know, if you need a replacement water heater, a residential water heater, you're going to buy one. And the new construction demand is obviously pretty strong here. So I think the unit demand is pretty good. You guys have been through these inflationary cycles before, maybe not quite to this extent. Do you typically see customers trade down in price point to offset that inflation or does that not have an impact on the way customers are looking at what they're buying in terms of a water heater?

Yeah, I would take that, you know, the vast majority there's not, quite frankly, a lot of trading up within the U.S. residential water heater business. And so, normally speaking, that's just the way it is. And so, we don't see much changes. The only thing I would tell you that you might see during this time is, you know, on our heat pumps or our high-end products, those might be impacted a bit, but it's relatively small changes. impact to us when we go through these kind of inflationary times. Because quite frankly, as you just said, when you're out of hot water, you're going to replace it. And availability is the number one driver for a consumer. Great. Thanks for taking my questions. Thank you.

Next is Kevin Hosibar from North Coast Research. Your line is now open.

Hey, good morning, everybody. And nice start to the year there. Thank you. In terms of going back to price and, you know, the price-cost relationship, it sounds like, you know, expectations are pricing will phase in, and by fourth quarter, you know, it should be fully implemented. Do you think at that point you'll be fully offsetting the inflationary pressures with, you know, with the pricing actions you've announced, or, you know, or might you need more in order to do that?

Well, I mean, we've announced three price increases, and each time we've announced a price increase, we've seen costs go up after that. So, you know, it's hard to predict where costs will go. You know, our forecast for the year assumes that costs are kind of where they are right now, particularly on the steel side. So we'll have to see how the year plays out. When we get to the fourth quarter, you know, when we think about kind of that price cost, I mean, on our assumption and what we've announced and based on what our costs are projected out to be, you know, we, we get to the point where we're covering costs, but there, we do expect some pressure on margin.

Yeah. Okay. And, and, and you guys have done a really good job managing SG&A, uh, you know, here in the quarter and, and really, you know, for the last several, uh, quarters. And, you know, if I look back in recent history, it seems like the first quarter typically has the highest, um, you know, SG&A spend as the percent of sales, uh, So, curious if you expect that dynamic to remain here in 2021 where the first quarter is the highest, SG&A's highest percent of sales or, you know, would there be any reason that would be different this year?

You know, I would not say that this year we would expect SG&A to be the highest percent of sales. I think, you know, I think as I was looking at it for the quarter, Particularly in China, we had a pretty good SG&A quarter. We were watching our costs very closely in China with lower volume. Not a lot of travel in the first quarter this year compared to last year. We'll have to see how that plays out for the rest of the year. But I wouldn't say that the quarter is going to play out much different than any back three quarters from a percentage of sales.

Next is Damian Taras from UBS. Your line is now open.

Hey, guys, just a couple quick follow-ups here. Sorry if I missed this, but did you mention how much Tankless was up in the quarter? And I'm curious how many units you're expecting to push this year for Tankless.

No, we did not mention either one. So, no, we haven't mentioned either one. And that data doesn't get published. Actually, Tankless data doesn't get published at all. And we haven't really addressed that from that specific point. product categories.

Yeah, it was a strong quarter, but we haven't quantified it. It was certainly up for us.

Okay, fair enough. And then, just wanted to ask you about buyback. So, obviously, your guidance is a little bit better than when you, where you came into the year with the potential for a little bit more improvement in RISD water heaters as well, depending on what happens. Just curious if there's any chance you might buy back more than the $400 million that you had they're currently saying for the year?

At this point, we're going to stay at the 400. I mean, you know, we'll see how the year plays out. We really focused in on not growing our cash position and reserving the opportunity to deploy that cash in other productive ways. So, you know, as we stand today, we're going to stay with that 400.

Okay, great. Appreciate all the color. All right, thanks.

No further questions at this time. I turn the call back over to Ms. Patricia Ackerman.

Thank you all for joining us today. We plan to participate in seven virtual conferences in the second quarter. Oppenheimer on May 4th, North Coast on May 11th, Goldman on May 13th, William Blair on June 1st, KeyBank on June 2nd, UBS on June 9th, and Stifel on June 10th. Have a great day. Bye-bye.

This concludes this conference call. Thank you for participating. You may now disconnect.