Q1 2022 A O Smith Corp Earnings Call
Good day and thank you for standing by welcome to the first quarter 'twenty blended do earnings call. At this time, all participants are in a listen only mode.
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I would now like to handle conference over to Hal Gerhard Ma'am. Please go ahead.
Thank you Catherine good morning, and welcome to the a O Smith first quarter conference call I'm, Helen Gurgled, Vice President Investor Relations and financial planning and analysis join.
Joining me today are Kevin Wheeler, Chairman, and Chief Executive Officer, and Chuck Lauber, Chief Financial Officer.
In order to provide improved transparency to our operating results. We provide non-GAAP measures free cash flow is defined as cash from operations less capital expenditures.
Adjusted earnings adjusted earnings per share adjusted segment earnings and adjusted corporate expenses exclude the impact of nonoperating noncash pension income and expenses.
Reconciliations from GAAP measures to non-GAAP measures are provided in the appendix at the end of this presentation and on our website.
A friendly reminder, that some of our comments and answers. During this conference call will be forward looking statements that are subject to risks that could cause actual results to be materially different.
Those risks include matters that we described in this morning's press release among others.
Also as a courtesy to others in the question too.
Please limit yourself to one question and one follow up per turn.
You have multiple questions. Please rejoin the queue.
We will be using slides as we move through today's call you can access them on our website at Investor Dot a O Smith dot com.
I'll now turn the call over to Kevin to begin our prepared remarks.
Please turn to the next slide.
Thank you Helen and good morning, everyone. Thank you for joining us today.
I'm on slide four in our first quarter results.
Our team performed extremely well throughout the quarter, despite a turbulent macro environment and delivered strong sales and EPS performance.
First quarter sales improved 27% year over year, driven by our 2021 inflation related price increases.
And acquisition of giant factories.
Last year and international volume growth.
Excluding acquisitions first quarter sales grew 23%.
Our rest of World segment performance was strong with margin improvement of over 440 basis point year over year, driven by China, improving its operating margins to over 11%.
We delivered strong results despite supply chain challenges and component shortages throughout the quarter.
Weather challenges and omicron related labor constraints impacted our north American production in the first half of the quarter. However shipments improved sequentially in the second half of February and in March.
Especially our residential water heater production, where we saw supply chain improvement and as a result improved our lead times to customers.
The acquisition of giant added $32 million to the quarter sales.
And <unk> <unk> to EPS.
We're pleased with the performance of the team and the integration is on track.
Please turn to slide five.
Our global a O Smith's team delivered first quarter 2022, adjusted EPS of <unk> 77.
A 31% increase that was driven in part by a 27% increase in sales compared with the first quarter of 2021.
Our strong first quarter performance resulted from our team's outstanding operational and sales execution. Despite the challenging environment of component shortages continue materials and transportation cost inflation weather impacts and surges and COVID-19.
I continue to take pride in how my fellow <unk> employees are working together to overcome these challenges to meet market demand and deliver for our valued customers.
Excluding the impact of giant North America water heater sales grew 28% in the first quarter of 2022 due to pricing actions implemented in 2000.
In response to rising material and logistic costs.
Our full year outlook of the residential water heater industry remains unchanged as demand continues to track to our expectations.
Our full year outlook for the commercial water heater industry used to be flat to slightly down.
The commercial industry started the year weaker than expected primarily due to a regulatory change that temporarily impacted orders of large electric commercial products greater than 55 gallon.
Our first quarter commercial sales were also impacted by component shortages for certain gas products.
We have seen demand for large electric product improving since early in the quarter and we expect component availability to improve in the second quarter.
Our North America boiler sales grew 24% in the quarter <unk>.
Primarily driven by price increases to offset higher material and transportation cost and demand for our energy efficient products.
We ended the quarter with a record backlog largely composed of commercial condensing boilers.
In April continues to generate strong order rates for these market, leading energy efficient boilers, providing confidence in our outlook for the year.
Our strategy to focus on innovation and de Carbonization contributed to strong demand for our highest efficiency condensing boilers.
North America water treatment sales grew 17% in the first quarter as we continue to pursue additional market share in this attractive market with a total addressable market value that we estimate to be $2 6 billion.
Taken an omnichannel approach our strategy is to grow our market share through innovation product development and acquisition opportunities are independent water quality dealers continue to play an important role in our growth by outperforming the market and gaining market share.
And China sales increased 12% in local currency compared to the first quarter of 2021, primarily due to favorable mix as our new product offerings continued to be well received as well as higher sales of commercial water treatment products and replacement filters.
During the first quarter, we proactively work with our distributors to ship product into the market in advance of potential COVID-19, disruptions, which most recently is impacting transportation in certain regions.
While our customers have ample inventory in place our tracking of consumer demand in April across our portfolio and geographies is indicating a year over year reduction of 35% to 40%.
Our outlook assumes that COVID-19 related shutdowns in China subside during the second quarter of 2022.
Despite the economic headwinds to our business in China, I'm very pleased with the quarterly performance of our China team.
A great steps to rightsize the business manage discretionary spend while investing in new product development.
On slide six please.
I'd like to highlight two of our products in China that demonstrate our continued focus on innovation and product development.
The Red Top award ceremony in Tianjin, China, a O Smith earned two of the coveted high end appliance awards.
For the quiet, Chris range Hood, and saltwater heating hot water boiler.
Under the guidance with China household electric appliances Association, our products were among hundreds of products evaluated for the awards every year with a focus on advanced technology Industrial design marketing influence energy conservation and environmental protection and user experience.
We take great Pride in this recognition is yet. Another example of how our products set us apart as the innovative leader in the market.
I'll now turn the call over to Chuck will provide more details on our first quarter performance. Thank you Kevin Good morning, everyone I'm on slide seven.
First quarter sales in North America segment rose to $730 million or 32% increase compared to 2021 pricing.
Pricing actions largely on water heaters represented approximately 89% of the increase.
Sales in the quarter also benefited from higher volumes of boilers and water treatment products.
Wherever the sales increases were partially offset by lower volumes of commercial water heaters.
<unk> acquired on October 19, 2021 added $32 million to North America sales.
North America adjusted segment earnings of $154 million increased 21% compared with the same period of 2021.
The earnings benefit of inflation related increases was partially offset by higher material and freight costs and lower commercial volumes.
Adjustments adjusted segment operating margin of 21, 1% decline compared with 2021 margin performance sequentially improved each month through the quarter as COVID-19 related absenteeism and supply chain constraints ease through the quarter.
North America operating margin exited the quarter at the top end of our full year margin outlook for North America.
Moving to slide eight.
Rest of the World segment sales of $256 million.
Increased 15% year over year favorable mix from new product introductions in the premium segment of the market, particularly our slim line electric wall hung water heaters and water treatment products that deliver hot and ambient filtered water as well as higher sales of commercial water treatment products and water treatment filters.
Contributing to sales gains.
As Kevin noted sales in the first quarter were positively impacted by proactive measures to distribute product into the market in advance of potential COVID-19 disruptions in China.
India continues to perform well and sales grew 36% in the first quarter compared to 2021, we view, India as a long term growth opportunity given its attractive growth characteristics and changes in demographics.
Rest of the World segment earnings of $25 million increased significantly over segment earnings in the first quarter of 2021 in China, the benefits from favorable mix higher volumes and lower advertising and selling expenses drove rest of the world segment margin to nine 7%.
Free cash flow of $4 million during the first quarter decreased from the first quarter of 2021 due to higher 2022 earnings that were more than offset by higher incentive payments due to record 2021 sales and earnings and higher cash outlets outlays for higher levels of safety.
Stock on higher cost inventory.
Historically, we generate the majority of our cash in the second half of the year.
Our cash balance totaled $579 million at the end of March and our net cash position was $284 million, our leverage ratio was 14% as measured by total debt to total capital.
Our strong annual free cash flow and solid balance sheet enable us to focus on capital allocation priorities and return cash to shareholders earlier. This month, our board approved our next quarterly dividend of <unk> 28 per share, which represents our eighth consecutive year of dividend payments.
We purchased one 5 million shares of common stock in the first quarter for a total of $108 million.
Let's now turn to slide 10.
In addition to returning capital to shareholders, we see opportunities for organic growth innovation and new product development across all of our product lines and geographies. We continue to target strategic acquisitions with a focus on water heating and water treating assets that meet our financial metrics of accretive to earnings in the first year and return on.
Cost of capital in three years, we have a proven track record of developing innovative new technologies, and making prudent and focused acquisitions to drive shareholder value.
Please turn to slide 11, and our 2022 full year earnings guidance and outlook.
We reaffirm our 2022 outlook with an expected EPS range of $1 56 to $1 76 per share and our adjusted EPS range of $3 35 to $3 55 per share.
Our outlook is based on a number of key assumptions, which include no further significant surges of Covid cases in the U S and that Covid related shutdowns in China subside during the second quarter of 2022, and do not significantly impact our operations, our employees customers or suppliers.
Steel indices began to stabilize at the end of 2021 and steel fell briefly early in the first quarter of 2022.
However, due to the international uncertainty on commodity commodities availability and prices in part due to the conflict in Ukraine steel market prices have risen again in recent weeks.
Our guidance assumes that steel pricing in 2022 on an annual basis will approximate steel market pricing as mid April as of mid April .
We continue to see increases in non materials.
Non steel materials and transportation costs.
Supply chain challenges persisted in the first quarter, we remain in close contact with suppliers logistics providers to troubleshoot manage and resolve bottleneck.
Environment remains unpredictable.
Our outlook our outlook assumes we continue to see the benefit from multiple 2021 price increases.
Compounding to approximately 50% for water heaters and continued resiliency in demand in North America for our water heating product categories, driven by replacement demand and new construction spending.
As for other housekeeping assumption assumptions, we expect to generate free cash flow of between $500 million and $525 million.
For the year, capex should be between $75 million and $80 million.
Corporate and other expenses are expected to be approximately $55 million.
Our effective tax rate is estimated to be between 23, 5% to 24%.
And we expect to repurchase approximately $400 million.
With the shares of our stock, resulting in an outstanding diluted shares of $156 million at the end of 2022.
Based on these assumptions the midpoint of our adjusted EPS range represents an increase of 17% compared with 2021.
I will now turn the call back over to Kevin who will provide more color on our key markets and top line growth outlook and segment expectations for 2022, all while staying on slide 11.
Got it.
Alright, Thank you Chuck.
We project revenue growth for 2022 of 14% to 16%, which is lower than our outlook in January as a result of volume headwinds in China, and a slower start to commercial water heater.
Our sales assumptions include.
Approximately 8% growth in each of the last two years, which is well above the historical average growth rate, we estimate U S residential water heater industry unit volumes will be down approximately 2% from last year as industry demand normalizes.
While the commercial water heater industry demand has started the year slower than expected our guidance assumes improvement in the remainder of the year as we projected commercial industry volumes will be flat to slightly down compared to last year.
We have reduced our sales growth protection in China from 5% growth in local currency to be flat compared to last year. As a result of economic headwinds we are experiencing from COVID-19 related restrictions.
We have increased our North America boiler sales growth projection from 10% to 18% to 20% sales growth driven by increasing increase pricing in response to higher input costs.
Our outlook for North America water treatment sales growth of 13% to 14% for 2022 has not changed.
Based on these factors along with the full impact of our 2021 price increases we expect our North America segment margin to be between 22, 5% and 23% and.
In rest of World segment margins to be approximately 95%, 10% or 50 to 100 basis points higher in 2021.
Please turn to slide 12.
2022 continues to present challenges for our global teams and we're meeting them head on we believe a O Smith is a compelling investment for numerous reasons.
We have leading share position in our major product categories.
We estimate replacement demand represents approximately 80% to 85% of U S water heater and boiler volumes.
We have a strong premium brand in China, a broad product offering in key product categories.
Tenths of distribution and a reputation for quality and innovation in that region.
We have rationalized the cost structure of our China business streamline their stores in tier one and tier two cities and strengthened and extended our product offering in both the premium and upper mid priced sectors of the markets. We serve we.
We are well positioned to maximize favorable demographics in China to enhance shareholder value.
We continue to be very excited for the opportunity we see in our North America water treatment business.
We have strong cash flow and balance sheet supporting our ability to continue to invest for the long term in automation.
Innovation and new products.
As well as acquisitions and return cash to shareholders.
We remain focused on serving our customers and continuing to meet their needs are strong brands across the portfolio combined with investing in technology to drive innovation and new product development will further enhance our market leadership.
We are confident in our ability to capitalize on opportunities as we continue to execute our strategy.
With that we conclude our prepared remarks, and we are now available for your questions.
Alright, Thank you Sir.
To ask a question you will need to press star one on your telephone keypad.
<unk>. Your question you May press the pound key.
Please standby, while we compile the Q&A roster.
And we have our first question from Matt Summerville.
D. A Davidson you may ask your question.
Thanks morning.
First maybe could you guys comment on what you think the market actually did from a volume standpoint in the U S for <unk> and commercial water heaters in Q1, and how you feel you performed relative to the market just given.
But you guys experienced some COVID-19 absenteeism et cetera, I would assume your competitors did as well, but if you could comment on that that would be helpful. And then I have a follow up.
Yes, Matt.
This is Kevin I'll comment on that.
We believe the markets.
It's going to be coming in on the residential side around that 2% range plus 2% <unk>.
Commercial will be down.
Thinking somewhere in the 20% range.
So and there are some reasons for that that we outlined with regards to a regulatory change.
So thats, how the market, we see coming in the first quarter in the U S. How we did.
We certainly get our fair share of both those markets. We performed again, we started out the year again with a lot of Covid and weather.
So as we outlined in our remarks that first month and a half were pretty tough we had a really strong finish, particularly our residential teams did very well on the.
Back half and particularly in March so we feel we did well maybe.
A bit better than the market, but overall, we certainly get our fair share both the residential and the commercial business.
And then just a follow up on China, I think you mentioned.
Sales tracking down 30%, 35%, thus far in April is your guidance assuming an.
Well I guess, what assumption do you think is most appropriate for us to be thinking about in Q2 have you seen that 30% to 35 start to improve or is it getting worse I guess I'm trying to think about how to frame up China for.
The second quarter specifically.
To get to the full year kind of flat.
Okay, Hey, Matt its Chuck.
Yes, China so.
35% to 40% down in China consumer demand just to kind of frame that that's April is what we're seeing in April which is sequentially worse than what we saw in the first quarter.
The way, we think about it is and by the way that that sector of what we're measuring here is consumers. So that's about 75% of our business. The commercial side does not fall into that metric. It's more of the consumer spend that were referencing there.
<unk> really seen a change to that is as we kind of look through the month of April it's been fairly steady at that rate.
In the first quarter it was down in about the 10% range, though sequentially. It was worth the way we think about it.
So pretty pretty heavy lockdowns right now in April so our assumption in our guidance is that that does subside as we go through the year.
Does improve.
As we get towards the end of the second quarter and sequentially, maybe the third quarter looks something like that.
The first quarter as far as consumer demand and then kind of get gets more back to normal in the fourth quarter. So Q2 will certainly be the lowest quarter of the year for us when you think sequentially.
In Q4 once again as it normally is should be the best quarter of the year in China.
Got it thank you guys yet.
And we have our next question from Scott Graham of Loop capital markets. You May ask your question.
Good morning, Scott.
Good morning, Thanks for taking my question.
So I can understand some of the puts and takes here on Europe .
Slide 11.
And essentially if we were to take out the adjustment for the pension.
Your guidance is just it's necessary just a little bit lower I mean, that's just the math and like if you had to say.
What are the larger swing factors in that would you essentially say.
China and slower start to the year in North America, or how would you frame that for us.
Yes.
Scott I'd say our guidance our outlook on the adjusted EPS has that has not changed so we're kind of staying track right on that kind of the puts and takes on that is.
Certainly we're seeing the headwind in China. So we've got to China, where we were saying, 5% up in local currency being roughly flat.
And.
China for the first quarter starts out pretty strong so first quarter. As we mentioned we are proactively put product into the channels. So that is expected to stay in the channel for the majority of the year just kind of protection make sure product is out there if there were any transportation interruptions.
Also discretionary spending in China ran pretty well they are able to flex a bit better and be a little bit more nimble on spending since that taken some cost out and restructured the business. So that we expect that positive SG&A spending to be a lever we can pull going forward. So volume on the volume side, it's really largely China offset.
By a bit of spend that China can do in North America. When we look at North America, we improved their margins 25 basis points on North America. The way, we're thinking about that is.
Our.
We're coming out of the quarter at about that run rate in March when residential production kind of hits a better pace. When we've got components, we can perform pretty well. So the puts and takes are we got China, a little bit of headwind on sales to get a little bit better margin in North America.
Our backlog is still strong on the boiler side, Kevin mentioned kind of the boiler condensing.
Product Thats out there larger product good margin product, we've got a little bit the ground to make up on commercial water heating.
So that should help our mix a bit so as you kind of go throughout the year, we would expect that to be a bit of a bit of a help compared to Q1.
We've talked a lot of we've talked a lot in the past and we have noted in our comments the water heater pricing, but if.
If you take outside of water heaters in North America, and think about kind of the pricing on other product categories. We've got announced price increases and I will just make the range, 2% to 12% out there that becomes effective as we go through the year that helps a bit on the margin side as we go kind of in the back half of the quarter, we still see <unk>.
Addity costs high.
Hi.
We can get a little relief on steel, but commodity costs made that up in increased so our outlook.
Really hasnt changed much and costs, we expected that to go up in our January outlook and it has so we're still seeing pressure on the cost side.
I got it Ed Chuck My apologies I am now looking at the quarterly presentation and that pension adjustment is in there.
So guidance does get changed again and thank you for that comprehensive.
Response that was awesome, let me ask you a little bit about the <unk>.
Supply chain and I know that you're always kind of low to one.
Ill comment on price cost, but your wording in North America.
<unk> suggests that you were kind of price cost positive here.
And if you can confirm that great and then secondly, you said the supply chain constraints are getting easier in North America can you explain that a little bit.
Yes.
Let's talk about the supply chain.
First.
As we frame it.
Stable. It has improved we saw our residential.
Components, and so forth to improve in the quarter.
But we also see some improvement coming in the second quarter on a commercial on particular components, so but overall it's been stable.
Those improved particularly on the materials side components are still a bit unpredictable. So it's getting better, but we still wake up every day and it's still.
At times, we'll have issues that we have to work through but again our teams are working very closely with our suppliers. In fact, I think we know our suppliers better than we ever have now last couple of years.
So it is moving forward, we're going to have these sporadic issues, we have to deal with.
I think the key takeaway here is we just don't see any major disruptions.
And before there is even a follow up question just wanted to talk about Ukraine, we have no direct suppliers out of there and we're seeing maybe some transportation issues a small amount in Europe that we have to deal with China I think it's still a little early we stay very close to China.
Of course, we have.
A decent supply base, there, particularly on some of our components.
Nothing in the.
Early term here that we see any issues with and maybe some medium risk down the road, but again no major disruptions in our supply chain that we can forecast at this time, so getting better and all factories are running well and thats in China as well just just to follow up on that.
We will continue to work on some of our backlogs, we have large backlogs and boilers. We have large backlog in commercial water heating, we anticipate that second quarter, we will we'll be able to make a dent in both of those and they are certainly upsides for us as we go through the year as Chuck mentioned.
Again, thank you very much for your comprehensive answers both of you I'll get back in the queue.
And speakers we have our next question from Susan Mcclary of Goldman Sachs. You May ask your question.
Thank you good morning, everyone. Good morning, Hey, good morning.
I guess just staying on commercial for for a bit can you talk a little bit more about the regulatory changes that came through and I know that you mentioned that you do expect that that will incrementally sort of catch up as we move through the next couple of quarters can you just give us some details on the.
Relative changes that you're making there and how to think about some of those.
No details.
Yes. Thank you for asking that question, because I really think it needs some explanation.
The regulatory change were talking about was on the <unk> 55 gallon electric and without getting into the details.
Change brings the kw wattage and requires a different SKU.
What happened, though our industry really did anticipate that going into effect.
We were anticipating the old.
Regulatory.
To be carried over an extended into the first quarter. This year it wasn't.
From our point of view it caught the industry a bit flat footed not so much on the manufacturing side, because we were all prepared.
I think we've just understanding the regulatory change on the distribution side.
So if you look at it we had to get out there.
And kind of.
<unk>, our customers of what the new Skus would be and so forth. So we saw January very slow.
We're working through the regulatory change being implemented.
To our customers we saw February improve and then when I can just speak from our point of view March our run rate on greater than 55 gallon commercial electrics was basically at a run rate from prior year.
So we look at this as kind of a temporary kind of lab.
Gap, if you will that we will close itself and more normalized as we get through the year. So it was just.
A situation where.
The industry had to kind of recover but the fundamentals of the category. The fundamentals of the business are still there. That's why we're looking in the balance of year for that to stabilize and normalize so that's it.
A quick snapshot of what happened in that regulatory environment.
Yes, no that's very helpful. I appreciate all that color.
And then I guess.
On the residential side with the water heaters appreciating that this is a bit further removed from you, but any commentary on inventories in the channel and just where are those kind of given all the moving parts that the industry and yourselves, obviously faced in the first quarter.
We don't have great.
You into the inventories in the channel so what I'm going to tell you is anecdotal industry experience that type of thing on the commercial side.
We believe the inventory is still a bit light in the channel.
And that's indicated by our backlogs and just the activity that we're seeing there so inventory <unk>.
Commercially a bit light.
We hope to make that up as we improve our production in the upcoming months and quarters and I would just probably add on residential we probably think about.
About where it.
It needs to be it may be even a bit heavy because.
People are hedging themselves customers are hedging this up in case any further disruption. So that's our view again residential probably where it needs to be well heavy commercial is still some room we have.
Take care of some production needs and get some products back into our customers' inventories.
Okay, great. Thank you and good luck with everything.
Good.
And our next question from Nathan Jones of Stifel. You May ask your question.
Good morning, everyone.
Hey, good morning, I'll, just I'll start off following up on the residential inventory there.
Noted that it might be a bit heavy week safety stock.
I think that's going to be one of the questions as we not just the euro business, but for a lot of businesses as we go forward is.
Are customers holding safety stock and how they are going to continue to hold that safety stock.
More permanently or will it normalize.
As customers.
<unk>.
More confidence in the supply chain, just interested DEA year opinion on that and what youre thinking about potential inventory levels.
Moreover, the longtime at your customers.
Well as I mentioned.
I would agree with what you just said quite frankly.
Think.
<unk>.
As lead times come down and things normalize now when that is im not going to predict.
But.
Right now, yes, there could be some but again lead times youre going to have to come down first things you've got to be a lot more stable I don't think its as heavy.
Stock out their safety stock that we think but it is a bit higher than than maybe normal.
But my view, probably most distributors from my talk to will probably be a bit conservative.
And making sure theyre going to lean in on on heavy product inventory to service their customers considering the last year or so they've gone through what we've gone through so that's that's our view.
Again, we can't predict what's going to happen 612 months from now, but thats where were at today.
Thanks for that maybe I could just ask where are your lead times today, where it was a last year or late 2020, when they were at their highest in what would normally be for COVID-19 .
Are you talking North America, or U S. Right now yet, yes, North America residential water heaters, primarily.
Lead times today are about 20 days.
That our goal and what historically, we've targeted <unk>.
And you look out back in the tougher times are partly to ex that or more.
And we've just been able to bring those down.
We ramp up production again.
<unk>.
Materials and components were became more available.
On the commercial side.
We target really the same type of lead times.
Right now our commercial lead times are elevated it.
At least two to three X.
That's great color for me. Thank you very much for taking my questions.
Thanks.
And our next question from Andy Kaplowitz Citigroup you May ask your question.
Morning, everyone. Good morning, Andy.
Maybe just talk a little bit more on China can you give us an update into inventories in the channel I know you said you put product in the channel. How are you thinking about the channel itself given it was sort of coming off five year lows and maybe a little more color around your ability to drive self help in China with new products growing into those tier three to tier two.
I think you mentioned SG&A cost that how much does all that other stuff to sort of help you as you go through this uncertain period.
Yes, so channel inventory in China.
Most of the sales increase for the quarter was putting channel into the inventory so putting inventory into the channel.
The level at the end of Q1 is about a month and a half that's not really out of line compared to it was certainly higher than year end, which was kind of a five year low.
Felt it was prudent to do that make sure we had channel inventory available in case, there is transportation interruptions. So.
The way, we're thinking about that in our outlook for the year is that most of that inventory will stay in the channel were not really bringing it back down to kind of the law.
Low level it was as we exited 2021.
So we expect it to stay there just due to the uncertainty.
Covid potential interruption, even though our outlook projects projects.
Subside a bit as we go through the rest of the year.
Kind of the levers in SG&A and the amount in the first quarter of SG&A discretionary spend that was.
Mitigated I guess is in that $3 million to $4 million or so.
We've taken out a large number of stores in tier one and tier two over 1000 last year and that reduces the cost makes those store more efficient gives.
It gives us a little more flexibility on how we spend SG&A.
So those those are kind of the inventory levels the SG&A side.
The progress on tier three through six cities to four through six cities is on track.
We continue to very low cost model continue to have.
Think of those again more counter counter space than they are storefronts in the tier one and tier two cities, but.
Largely on track continue to add to those cities.
I appreciate the color and then maybe just a little more color to the strength youre seeing in terms of your North American boiler business, obviously increased guidance there, but how much of the improved outlook as your customers really focusing on these commercial condensing boilers, given their energy efficiency focus and a higher natural gas price environment could you see further inflection is.
Prices stay high.
Well again this will be anecdotal again, we don't have any great data there, but it just would be natural as energy costs have gone up.
And a movement for de carbonization, and reducing your footprint that plays really well into our condensing boilers. So.
We feel there has to be some some impact of that certainly the return on investment now on our condensing boilers.
Today versus the were just months ago are significantly better. So it's playing a role and I think we see that because of just the order.
Right that we have on our condensing boilers coming in I mean, our backlog has been high continues to be high we're shipping.
Activity in the institutional side activity in the hospitality side still activity in the education side is good.
And our coating continues to be good so.
Overall I think there is.
One the market is maybe making up for lost time in the last couple of years to Covid, but I do think there is a.
A swing towards convincing high and efficient product score again paybacks, but just as much we're de carbonization.
I appreciate the color.
And speakers our next question from Damian Karas.
As you May ask your question.
Hi, good morning, everyone.
Good morning.
I wanted to ask you about pricing.
Based on guidance it doesn't seem like you've <unk>.
Taken any further price actions since 2021, but you did mention.
Some of the ongoing freight and other supply chain issues.
So just wondering if there's anything else that you have executed our.
Anything on the pricing front.
It's being planned at the moment.
Yeah, Let me, let me kind of frame our outlook on pricing or the way we were thinking about it back in January we projected that our other material cost would continue to go up.
In the half so our assumptions going out in January were that they would we really have seen that play out on the other material costs. So when we speak of that that's kind of baked in already and it hasnt changed our outlook much. Although we continue to see the pressure on the other material costs freight and logistics.
And the second part of that.
Again I'm sorry.
Does that answer your question or was there a second piece, yes, yes, basically just.
Trying to get a sense if there is any.
Yes.
We did have other pricing. So so when you just kind of park water heaters for a second.
And look at the rest of our businesses in North America, So water treatment Oilers.
We've got a range of price increases on different products.
It's a pretty broad range, but in that 2% to 12% price increases that we've announced.
Beyond 2021 that are just coming into effect and will be effective in the back half of the year, So and it was needed for those other material costs going up so some of those pricings.
Actions, we'll see as we go through the rest of the year.
Okay got it that's helpful.
And then could you maybe just elaborate on the weather impacts that you spoke of maybe quantify that and I don't know it just seems like.
Adverse weather events are normal part of the business thinking about that.
The various floods and tornadoes and other things that have happened over the last.
A few years, but maybe you could just.
Speak to what you experienced.
Yes, I'll touch on that wasn't a pleasant tornados, but.
It really comes down to the cold weather snow freezing rain, it just impacts that impacted our plants, particularly Tennessee and again, if you look at it.
You take a couple three or four days out because of that that has a productive productivity issue for us, but one four so that's part of it we had that happen in Q1 of 2021. It just seemed to spill over to 2022, we manage through that and really I would tell you the quarter there.
<unk> impact we had from a plant standpoint was we had COVID-19 .
And we mentioned that in our January call, we had absenteeism in our factories is about 7%.
At Covid and that again is significant amount of people that we had to overcome.
Again as we got through January people started to recover and get back to work that in February we got back on track so whether it's part of it but I would tell you that COVID-19 was probably the bigger part.
Understood. Thanks for the color best of luck.
Thank you.
And our next question from David Macgregor of Long Beach Longbow Research you May ask your question.
Yes, good morning, everyone.
I guess I just wanted to go back and maybe try and create a little more clarity around the pricing.
You had talked about 50% price increase in 2021 can you just remind us what the carryover pricing benefit as I realize there's been some additional pricing initiatives in 2022, but just how much of that $2021, 50% carried over into 2022.
Yes.
It's roughly half on the water heating side.
Okay.
Did you get the benefit of that.
Sorry go ahead.
It was 50 50 roughly.
Right and you get the benefit of that just to be clear you get the benefit of that from the beginning of the calendar year through the year.
It is largely at the beginning of the calendar year, yes. It was.
Last one was announced effective November 15th of 2021.
So with lead times, it might be a little spill.
Over into January for the most part it's running pretty much effective.
Okay. Good. Thank you for that and then just on the North American operating margins 21, one.
The 200 basis point decline was due to the lower commercial volumes.
Yes.
For Q1, it's about 50 basis points. So when we kind of look at Q1 50 basis points on commercial water heating and it's about 50 basis points on giant.
Recall in the past Giants, largely residential product and so that's a little bit lower margin. So when you add that.
That brought out a bit.
It was a 100 basis points between the two.
Well, thank you very much.
Great. Thank you.
And again, if you would like to ask a question you May press star one on your Touchtone phone.
And we have our next question from Jeff Hammond.
You May ask your question.
Hey, guys. This is Mitch more on for for Jeff, Hey, Mitch I was just saying.
I was just wondering if you could walk us through your current expectations of margin cadence through the year, given all the moving pieces and if.
If you still have your expectation of one quarter being the trough for margins in 2022.
Well 2022, and this is split at rest of the world separately from North America, and kind of mentioned earlier, China Q2 is going to be we believe in our outlook the toughest quarter because of kind of where we're starting out in April so I would say kind of cadence would be.
China would be a bit challenged in Q2 kind of start to normalize in Q really largely normalized in Q3, and then Q4 would be the best quarter.
North America, if you think about kind of North America, we've got.
Still in the first quarter just to remind everybody is still was highest in the first quarter that we see throughout the outlook. So im a bit of a margin pressure on that 21, 1% in North America is little higher steel.
That kind of rolls off slightly as we go into the next quarters, but as I was mentioning other commodity costs and other costs sort of fill that gap.
Margins for the back half of the year sequentially.
Q3, and Q4 are a little bit stronger and Thats, typically where we have kind of the strength of our boiler business. The back half of the year, we kind of see the cadence of the year playing out fairly normal for the boiler side of the business being kind of Q3 Q4 being a little stronger than the first half.
Okay, Great. That's helpful. And then and then just on supply chain I was wondering if you could give us some color on areas, where where youre seeing supply chain get better and if theres any differences.
Commercial versus residential.
The rest of the world.
Yes, right now, we see our supply chain on the residential side improving.
And that's really on the material side of it.
And commercially.
We expect Q2 to improve.
So really nice line of sight right now on to some of the components that have been causing us some production issues and they look like to be.
That there'll be resolved at least in Q2 as we go forward. So overall again.
Back on our supply chain it is unpredictable.
<unk> our teams managed it really well.
And reaching out to the organizations and the companies that deliver to US and then even our supplier step it up and do it and doing the things. They have so we're getting better because our suppliers are getting better again, we'll work through some of the Ukraine issues and so forth that we talked about but overall I don't see supply chain being an issue for our <unk>.
Business as we go forward, particularly in the second quarter on just by.
Kind of the view that I've had from our procurement and supply chain group.
We're we've managed through most of those challenges and again anything is unpredictable we can always be a change, but we feel pretty good where we're at we don't see any of the supply chain issues, disrupting our production or causing any issues throughout the year.
Okay, great. Thanks for taking my questions.
Thank you.
And speakers there are no more questions on queue. You May proceed.
Thank you Catherine and thank you all for joining US today, let me conclude by reminding you that our global a O Smith team delivered strong sales and earnings in the first quarter. Despite many challenges.
We look forward to updating you on our progress in the quarters to come in.
In addition, please mark your calendars to join our presentations at conferences in the second quarter.
Oppenheimer on May four at Goldman Sachs on May 10th Keybank on June 1st.
Capital on June 2nd William Blair on June 7th and UBS on June eight thank you and enjoy the rest of your day.
Okay.
This concludes today's conference call. Thank you all for joining you may now disconnect.
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