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. 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 3.

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 Aquasana 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 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 US 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 1, and the 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 the 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 4.

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 $0.60 per share compared with $52 million, or $0.32 per share in 2020. Please turn to slide 5. 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 US, improved water heater sales in Canada, a 12% growth in water treatment sales, and inflation-related price increases on water heaters in the US were partially offset by lower US 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 6, North America segment earnings of $130 million increased 3% compared with the first quarter of 2020. The impact on earnings from higher sales and inflation-related price increases on water heaters was partially offset by higher material costs, freight costs, and lower water heater volumes in the US. 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 7. 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 8. 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 million 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 million 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.

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 Ashland City and Juarez facilities and resulted in weak 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 US residential heater industry volumes and continue to project full year volume will be down 2% or 200,000 units in 2021, a small retracement from the record volume shipped in 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 effective 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 a 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 $15 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 for mid-single-digit growth to approximately 10% growth based on a strong first quarter, strong backlog, and visibility into quoting 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, and the introduction of a 1 million BTU light-duty commercial Knight 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 point-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 million to $2 million. Please turn to slide 10. We project revenue will increase between 14% to 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 $15 million of benefit from China currency translation. We expect North America segment margin to be between 23% and 23.5% and Rest of World segment margins to be between 7% and 8%. I'm on slide 11. Our operations faced 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 US water heater and boiler volumes. We have a strong brand, a 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 about the opportunity we see in our North America water treatment platform. We have strong cash flow and a 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 returning cash to shareholders. That concludes our prepared remarks, and we are now available for your questions.

We have our first question from the line of Saree 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 issues in the quarter? And 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.

Yes. This is Chuck. Good morning. We did have some interruptions. We've got two plants that were down: Ashland City and Morez were down due to weather for approximately a week each. So that raises the orders that come in from a perspective of it creates a bit of a surge. And when lead times extend a bit due to a temporary interruption, we see more orders, which extend the lead times. We do expect to make that up in the second and third quarters. We would expect that we would get a little more normalization of production throughout the second and third quarters 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 three price increases at once. So as far as the effectuation 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 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 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 that 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, there is a possible upside, yes, but it’s probably just a little too early to project that in late April.

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

Hi, good morning everyone.

Good morning.

Good morning.

So I was just hoping you could 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 could you just help reconcile that disconnect? 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?

I believe Chuck articulated it well when he mentioned the current noise in order entry due to lead times and the upcoming third price increase, which is pulling orders forward. As we process these orders, we anticipate some new construction activity, but it's important to note that our focus is more on completions rather than starts. At this time, we believe that the 200,000 retracement we discussed is likely the most accurate forecast until we clear the backlog and can differentiate between true demand and demand shifted forward by pricing or extended lead times. It's still a bit too early to rely on these figures given the numerous variables we need to manage. We expect to have a clearer understanding by the end of the second quarter or early in the 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. There's a lot of noise we believe, because of the pandemic, and 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, the industry may be behind us 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.

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

Good morning. This is David Tarantino on for Jeff.

Good morning, David.

Hi David.

So on price increases, was there any pre-buy ahead of price increases? And I know you're talking about destocking last quarter. So if any were 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 to a month of production. So there's always a pre-order, I would say that we're seeing. 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 are you seeing on pricing in China?

We are currently facing inflationary challenges worldwide. While I won't go into all the details of our pricing actions, we have implemented price changes across nearly all our businesses, though the specifics vary. China is experiencing different inflationary pressures compared to what we see here. India also presents a unique situation, and Europe varies as well. Our strategy is to take necessary actions to effectively manage these inflationary pressures over time, and we are confident in our ability to tackle these issues given a reasonable timeframe.

And just to add a comment on China, and it's not directly related to pricing, but just mix. And we're pleased that we're kind of looking at it quarter-over-quarter where the 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 Summerville from D.A. Davidson. Your line is now open.

…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 and 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?

Yes, there are many components to consider. You are correct. Let me outline how we perceive the situation at a high level. I've already mentioned when we expect pricing to be reflected. On the cost side, we have observed increases across several categories: freight, corrugated materials, resins, and foam, among others. However, our primary concern is with steel, which we have discussed frequently regarding its rising prices. The impact is starting to be felt, but we benefit from a 90 to 120-day delay in these costs affecting us. Therefore, as we assess the increase in steel costs, we anticipate that they will rise throughout the year. We project that, on average, steel costs will increase by over 70% year-over-year. Regarding the quarterly trend, as you pointed out, we will experience the highest costs in the third and fourth quarters. Consequently, the greatest pressure on margins in North America will occur in the latter half of the year as we confront the full effect of rising costs and see pricing adjustments more fully realized 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 looks like versus sell-through in the quarter? And which product lines you're seeing the most relative strengths currently? Thank you.

Yes, Q1 was a tough comparison because it was such a low point. However, looking ahead, our sell-out has been strong, with expectations of 6% to 7% throughout the year. We're pleased to see this trend across all our core categories, including electric water heaters, gas tankless, and water treatment. The mix is shifting towards the premium sector, which is encouraging. We maintained a strong presence in water treatment during the pandemic and have recently seen positive movement in our residential electric and gas tankless products, particularly with the new gas tankless model that is quieter, which is very important to Chinese consumers. Overall, the business is progressing well, and we believe we are well-positioned for growth in the upcoming quarters. I'll let Chuck provide details on our inventory position.

Yes, the channel inventories are in great shape. Lowest point in five years. Very refreshed, I'll say, so that it's all within 90 days basically. So it's in great shape in China from a channel inventory perspective.

Next is Eitan Buchbinder from Citi. Your line is now open.

Hi. Good morning.

Good morning.

Good morning.

Rest of the World segment margin improved significantly from the COVID impact of Q1 last year and incrementals seemed 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?

Yes. This is Chuck. No, we don't expect the same incremental levels in the latter half of the year or the last three quarters of the year in Q2. In China, we're looking at increments around 40%. As we forecast the year in China, we have a unique factor from last year, which was social insurance that contributed about $12 million last year, but we won't see that this year. The timing of that last year provided us the most advantage in Q2 and Q3, with Q1 being very minimal. That will be a challenge as we progress through the year in China. Overall, we are satisfied with the first quarter results in China at just under 6%. That was a solid performance given that it's usually a tough seasonal quarter for us due to festivals and holidays. Our fourth quarter tends to be our strongest. So as we examine China, as Kevin mentioned, we expect the last three quarters of the year to show continuous improvement, with an overall growth rate of around 6% to 7%. By the fourth quarter, we anticipate approaching double-digit operating margins, similar to last year.

That's 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?

I will address the $400 million. At this time, we plan to keep it at $400 million. We do this because we do not want to increase our cash reserves. You're correct that we are having a strong cash generation year as well. We are actively looking at opportunities to deploy our capital through acquisitions. Throughout the year, our focus remains on capital deployment in that area, and we will maintain our repurchase at the current $400 million.

Yes. I would just add on to that. Again, things can change over the next six months 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 ourselves. 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 on how best to move forward with our capital allocation. Yes. I guess I'll add on the organic growth. I mean, we're pleased with the growth we're seeing in North America water treatment, 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 that 6% to 7% for the back three quarters of the year. So, a couple of areas of growth that we're optimistic about.

Yes. I would just add on that. I mean, organic growth across our product businesses right now looks pretty strong. For us to raise our Lochinvar business up to a 10% growth, we're seeing that part of the business, which is a bit surprising us really bounced 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 Maklari from Goldman Sachs. Your line is now open.

Good morning everybody.

Good morning.

Hi.

My first question is about the destocking you mentioned in the first quarter. Can you provide more insight into the current inventory levels in the channel? I understand that you entered the fourth quarter with some excess inventory at the start of this year. Do you think the weather in Texas and the events of the first quarter have helped reduce that inventory? Are you seeing this pull forward as a way for them to return to normal, or are they planning to hold onto more inventory than they typically would have before last year?

Yes, from our perspective, and considering the weather disruptions Kevin mentioned, we believe that our customers' inventory is decreasing. We're making every effort to meet customer needs with our production, but there has been some pressure in that area. For the quarter, we think our customers' inventories have gone down compared to where we started the year. We expect this to normalize as the year progresses and as we reduce lead times. Therefore, we anticipate more stabilization of inventory levels as we close out the year, which aligns with our guidance for the full year outlook for residential.

Yes. 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 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 your customers are catching up on some of the delays and things that were postponed from last year. Are you also seeing any level of increased new construction or projects that are starting to break ground and helping with some of that backlog as well?

We are observing a consistent level of quoting activity, which is similar to last quarter. While the projects may not be as large, they are still active. This reflects a combination of pent-up demand as well as a solid backlog we have. Some of this quoting activity may finalize by the end of this year, but it will likely extend into 2022. On the commercial side, particularly in the higher end of the boiler segment, there has been a slightly stronger recovery than we expected.

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

Good morning, everyone. Congratulations on the progress in the Rest of the World segment, particularly in China. If we look back, the margins generated in the Rest of the World business were around 13% before challenges arose in China. I would like to discuss the long-term potential for margin generation in China. Are we able to return to the 13% margins? I understand there's been a shift towards a higher concentration of medium price points rather than premium ones, but you mentioned in previous calls that the margins were fairly similar. I'm trying to gauge the potential for Rest of the World margins and if there is room for improvement based on the initiatives you've undertaken.

Yes. I mean, so we 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 right now, 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 a heavier amount of mid-priced 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 when we think about kind of the transition that the business has taken a bit on store count efficiency, the SG&A initiatives that we've done. 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 and the water treatment has been a pretty good category for us, so we'd like to see more trading up. Housing coming back would help us to get some of the volume back up and just consumer confidence in the trading up. So 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.

Could you clarify that for me? I have a second question, but it seems like you’re saying it depends on volume and mix. For the sake of a longer-term perspective, if we were to achieve the needed volume, and if it were to rise to a significantly higher operating rate with some strength on the premium side for both water heaters and water treatment, is there a fundamental reason you can’t return to 13%? Has anything changed, or based on reasonable assumptions, is 15% still a realistic goal?

No. There's not a structural change there. But to your comment, I'd say the largest driver of that is seeing the market move further into the trading up high end of the piece of the market than what it is today. But yes, 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 fairly – 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 our tankless has been up a bit, and it's interesting because in Texas, it's a warmer climate and a lot of the tankless were installed outdoors. And that's fine because there's an electrical part that prevents 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.

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

Great. Thanks for taking my questions. Wanted to talk about competitive dynamics a little bit. And 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 sectors. 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, excluding the weather that I mentioned that impacted our plans, 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 overall, I think we're doing well. We have a terrific operations and supply chain group. And we have terrific suppliers that they're working through their own capacity constraints as they're ramping up or repairing some of the things that were impacted out of the Gulf region. So, I think we're doing well, that's why as we get into Q2 and Q3, we get back to a normalized level. Our factories don't have a week out of production. So overall, I believe anytime 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's concrete yet. But specifically, this proposal of 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 in China in particular?

Yes. 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, 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, 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. If you need a replacement water heater or 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 water heater?

Yes, I will address that. Generally, there isn't a significant amount of trading down occurring in the US residential water heater market. That’s just how it is, and we don't anticipate many changes. The only exception might be with our heat pumps or premium products, which could experience minor impacts; however, that effect is relatively small during inflationary periods. Essentially, as you mentioned, when consumers run out of hot water, they tend to replace it, and availability is the key factor driving their purchasing decisions.

Okay. Thanks for taking my question.

Thank you.

Next is Kevin Hocevar from Northcoast Research. Your line is now open.

Hey. Good morning, everybody. A nice start to the year there.

Thanks.

In terms of coming back to price and the price-cost relationship, it sounds like expectations are that pricing will phase in and by the fourth quarter, it should be fully implemented. Do you think at that point you'll be fully offsetting the inflationary pressures with the pricing actions you've announced, or might you need more in order to do that?

We have implemented three price increases, and with each increase, we have observed a rise in costs afterward. It is challenging to anticipate the direction of costs. Our forecast for the year is based on current costs, especially regarding steel. We will need to see how the year unfolds. By the fourth quarter, based on our assumptions and price increases, we believe we will be at a point where we are covering costs, but we do anticipate some margin pressure.

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

I would not say that this year we would expect SG&A to be the highest percent of sales. 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 again, I wouldn't say that the quarter is going to play out much differently than the back three quarters from a percentage of sales.

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

Hey guys. Just a couple of 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 that. We haven't provided that information, and that data is not made public. In fact, tankless data is not published at all. We haven't specifically addressed that in relation to those product categories.

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

Okay. Fair enough. I wanted to ask about buybacks. Your guidance is slightly better than when you started the year, suggesting potential improvement in residential water heaters depending on future developments. Is there any possibility that you might increase the buyback amount beyond the $400 million you've mentioned for the year?

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

All right. Thanks for that.

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 4, Northcoast on May 11, Goldman on May 13, William Blair on June 1, KeyBanc on June 2, UBS on June 9, and Stifel on June 10. Have a great day. Bye-bye.

This concludes today's conference call. Thank you for participating. You may now disconnect.