Q1 2023 A O Smith Corp Earnings Call

April 27, 2023

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I would like to hand, the conference over to your speaker today Helen cohort.

Helen Please go ahead.

Thank you Eleanor <unk>.

Good morning, and welcome to the a O Smith first quarter conference call I'm, Helen Gerhold, Vice President Investor Relations and financial planning and analysis.

Joining me today are Kevin Wheeler, Chairman, and Chief Executive Officer, and Chuck Lauber, Chief Financial Officer.

In order to provide improved transparency into the operating results of our business. 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 impairment charges non operating non cash pension expenses as well as legal judgment income and terminated acquisition related expenses.

We also provide total segment earnings.

Reconciliations from GAAP measures to non-GAAP measures are provided in the appendix at the end of this presentation and on our website.

Affirm 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 it in our more this morning press release among others.

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.

We will be using slides as we move through today's call you.

You can access them on our website at investor that 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 Alan and good morning, everyone.

Amongst slide four ill review a few highlights of our first quarter results.

Our team delivered record first quarter adjusted EPS from 94.

Driven by strong performance in North America, with sales up 3% due to higher commercial and residential water heater volumes and.

In addition, we saw margin expansion across our water heating boiler.

And water treatment product categories due to a more favorable price cost relationship.

Our rest of World segment delivered consistent performance in the first quarter.

Headwinds in the economy and currency exchange in China.

In India, our sales grew 28% local currency in the first quarter due to strong demand for our water heating and water treatment products.

Please turn to slide five.

North America water heater sales grew 3% in the first quarter of 2023, as we believe we outperformed the market and experience resilient demand for our commercial and residential water heater products.

Sales of commercial electric products were strong in the quarter as demand returned to pre 2022 levels.

Last year commercial industry shipments were negatively impacted by a regulatory change for commercial electric products greater than 55 gallons.

Our North America boiler sales grew 2% driven by previously announced price increases to offset higher costs.

Residential boiler volumes decrease year over year, primarily driven by elevated channel inventory levels coming off a particularly strong fourth quarter of 2022.

We believe inventory levels have normalized by the end of the quarter.

Demand for our commercial high efficiency condensing boilers, particularly our health care crest boilers with <unk> technology remains strong.

North America water treatment sales were flat in the first quarter of 2023 compared to a tough comp in 2022 as higher direct to consumer and E. Commerce sales were offset by lower sales in our dealer, especially wholesale channels.

Sales in the first quarter of 2022 benefited from strong shipments as supply chain constraints improve and we work down our order backlog.

We believe the majority of our dealers and wholesale customers exited the first quarter with normal inventory levels.

In China first quarter sales decreased 10% local currency compared to their first quarter of 2022, primarily due to weakened consumer demand.

We have seen sequential improvement through April and expect that improvement to continue through the year.

We believe it will take time for the Chinese economy, and consumer confidence to improve.

We saw favorable price mix in the quarter, particularly in our water treatment as we recently introduced our large flow products that have been well received by the market.

I'm now on slide six.

A O Smith has recently been named a 2023 energy star partner of the year sustained excellence winter by the EPA in the U S Department of energy.

The Energy Star Award is given to companies that haven't made a long term commitment to energy management through their products or services.

This is the fifth consecutive energy star partner of the year Award a O. Smith has received in the third time being named a sustained excellence partner.

These awards are a direct result of our strategic objective objective to expand and enhance our high efficiency product portfolio, including heat pumps as evidenced by the recent launch of our <unk> heat pump water here.

We are committed to continued development of sustainable water heating and water treating technology.

I'll now turn the call over to Chuck who will provide more details on our first quarter performance.

Thank you, Kevin and good morning, everyone I'm on slide seven.

Record first quarter sales in the North America segment rose to $753 million, a 3% increase compared with the same period last year. The increase was primarily driven by higher commercial and residential water heater volumes, partially offset by pricing.

North America segment earnings of $188 6 million.

<unk> increased 22% compared with the first quarter of 2022 opt.

Operating margin of 25, 1% improved 400 basis points from the segment adjusted operating margin in the first quarter of last year.

The higher segment earnings and operating margin are primarily due to higher volumes of commercial and residential water heaters and lower steel costs.

Moving to slide eight.

Rest of the World segment sales of $219 1 million.

<unk>, 14% year over year, and 8% on constant currency basis.

Currency translation unfavorably impacted segment sales by approximately $17 million.

Our sales decrease was primarily driven by lower sales in China as consumer demand was negatively impacted by COVID-19 related headwinds.

We saw a month over month improvement in consumer demand during the quarter.

<unk> sales grew 28% in local currency in the first quarter compared to 2022 as our new products have been well received by the market.

Rest of the World adjustment segment earnings of $17 $8 million decreased 28% compared to segment earnings in 2022.

Segment adjusted operating margin was eight 1% of.

The decrease of 160 basis points compared to the first quarter of last year.

Primarily as a result of lower volumes in China, partially offset by lower selling costs.

Please turn to slide nine.

We generated free cash flow of $109 million in the first three months of 2023 higher than the same period in 2022 due to higher earnings and lower working capital outlays, primarily related to lower inventory levels and a lower 2022 incentive payments paid in 2023.

Our cash balance totaled $496 million at the end of March and our net cash position was $155 million.

Our leverage ratio was 16% 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> 30 per share, which represents our 80 <unk> consecutive year of dividend payments.

We repurchased approximately 821000 shares of common stock in the first quarter of 2023 for a total of $53 million.

We expect to repurchase $300 million of our shares dollars.

<unk> of our shares in 2023, a $100 million increase from previous guidance.

Let's now turn to slide 10.

In addition to returning capital to shareholders, we continue to see opportunities for organic growth driven by innovation and new product development across all of our product categories and geographies. The strength of our balance sheet allows us to pursue strategic acquisitions, even in times of economic uncertainty.

During the quarter, we committed to selling our business in Turkey, and recognized a noncash impairment charge of $15 6 million.

Primarily in anticipation of the liquidation of the cumulative foreign currency translation adjustment.

The business model in Turkey is more project based than our core consumer and commercial water treatment business and no longer fits our current strategy.

Please turn to slide 11, and our revised 2023 guidance and outlook.

We've increased our 2023 outlet with an expected adjusted EPS range of $3 30, and $3 50 per share the midpoint of our adjusted EPS range represents an increase of 8% compared with 2020 to adjusted EPS.

Our outlook is based on a number of key assumptions, including.

We assume a relatively stable supply chain, while challenges persist disruptions are limited we remain in close contact with our suppliers and logistics providers to manage it resolve supply chain issues as they arise.

We've increased our north American margin guidance from approximately 23% to a range of between 23% and 23, 5%.

On a full year outlook on volumes and price cost relationship.

We have recently seen a meaningful rise in steel index pricing, which will translate into higher input costs.

And relative to the first quarter put pressure on North American margins in the back half of the year.

We forecast that our steel costs in the second half of the year will be approximately 20% higher than the first half of the year.

Our guidance assumes that other costs outside of steel remained relatively flat to our previous guidance with favorable adjustments in our transportation cost outlook.

Offset by moderately higher cost outside of transportation.

We expect to generate free cash flow of between $575 million and $625 million.

The year Capex should be between 70 million and $75 million.

Corporate and other expenses are expected to be approximately $55 million.

Our effective tax rate is estimated to be approximately 24%.

And as I noted earlier, we expect to repurchase approximately $300 million of shares of our stock, resulting in average outstanding diluted shares.

$150 million at the end of 2023.

I'll now turn the call back to Kevin who will provide more cover on our key markets and top line growth outlook and segment expectations for 2023, staying on slide 11.

Kevin.

Thank you Chuck.

We revised our 2023 sales projection to be approximately flat to 2022 at the midpoint with a range of plus or minus 2%, which includes the following assumptions.

Residential water heater demand was resilient in the first quarter and therefore, we are raising our projections for the 2023 residential water heater industry volumes to be approximately flat to last year.

We continue to monitor proactive replacement and new housing completions.

Demand for commercial electric water heaters greater than 55 gallons was strong in the first quarter and orders remained strong in April .

We have raised our guidance for the commercial water heater industry volumes to increase mid single digits compared to 2022.

Our China business performed as expected in the first quarter.

I believe it will take time for consumer confidence to strengthen and for the economy to improve in China.

We reaffirm our guidance that our sales in China will grow 3% to 5% in local currency in 2023.

Our guidance assumes volumes in China.

Improved throughout the year.

Our forecast assumes the Chinese currency devalue approximately 2% in 2023 compared to 2022.

We are adjusting our outlook for our boiler business, we believe channel inventory levels of residential boilers are more elevated coming into 2023 than what we assumed in our prior guidance.

While commercial growth aligns with our previous guidance the amount of inventory in the residential boiler market resulted in sluggish residential boiler sales in the first quarter.

And guys just to an annual growth outlook of mid single digits.

Demand for our energy efficient customer commercial condensing boilers was steady in the first quarter and job quality remains active particularly in the key institutional vertical.

Our outlook for the North America water treatment sales growth of 5% to 7% for 2023 has not changed.

Based on these factors, we expect our North America segment margin to be between 23% and 23, 5% and.

In rest of World segment margins to be approximately 10%.

Please turn to slide 12.

We're very pleased with our performance early in 2023.

Demand for commercial electric water heaters rebounded to three 2022 levels.

We saw resilient demand for our residential water heaters.

Our first quarter 2020, North America operating margins of 25, 1% will drive significant full year margin improvement, even as steel costs rise.

In China, we saw sequential monthly improvement in our sales through April and we expect that to continue through the year.

We are pleased with our free cash flow through March and we expect a strong rebound in free cash flow for the full year as China emerges from COVID-19 related disruptions and our dedicated focus on inventory reduction across our North America operations.

Our focus remains on meeting the needs of our customers as well as executing our key strategic objectives to advance our position as a leader in heating and treating water globally.

Our strong brands across the portfolio combined with technology, driven innovation in new product development will enhance our market leadership.

And with our strong balance sheet, 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.

Okay.

Thank you at this time, we will conduct a question and answer session.

A reminder to ask a question you will need to press star one on your telephone and wait for your name to be announced.

To withdraw your question. Please press star one again please.

Please standby, while we compile the Q&A roster.

Our first question comes from the line.

Michael Halloran.

Baird.

Hey, good morning, everyone. Good morning, Mike Good morning.

Can you can you walk through what Youre seeing on the water heater volume side North America, obviously, a lot of variability here you had the the destock period to last year you look at December January February volumes or at least with the dry says.

Those are tracking above $9 million annualized at this point units.

A little hot maybe relative to what the run rate we've been talking about previously looked like so maybe maybe help understand what you think is going on underneath the hood or there is some element of restocking do you expect some variability in those demand trends and how do you think about that working through the year.

Yes, Mike Hi, it's Kevin Hey, listen I'm going to put it into four buckets for you.

First our.

Our emergency replacement demand is always going to be there. The one KOL shallow rule, our supplies and that will continue.

What we've seen though is proactively placement continues to be above our normal levels. We've just got some updated on that just recently so that's above.

Above average so providing some additional volume.

New construction completions were strong in Q1, so that also gave us a bump.

And you mentioned about customers, we believe some not all a few customers maybe cut their inventories a little bit too low and there was some replenishment going on with some of our customers. So you put those four together that kind of drives our Q1 and then our forward looking guidance of getting back to <unk>.

That to last year.

We do expect Q1 to be down.

We expect it to be down probably double digits, it's probably going to be that low to single low single digit category.

Just remember that Q1 was a very strong quarter. It was the strongest quarter that we had and particularly March was the strongest month, so but overall.

Please lift the volume pleased with the industry and look for a kind of a flat 2023.

Thanks for that and then maybe also on the North American margins and how to think about modeling for the remainder of the year 'twenty through 'twenty three 5% implies decent drawdown as we work through the year is that all back half weighted.

<unk> more comparable to <unk> and <unk>.

Are there offsets to that decline and do you think one H two H.

That you're envisioning, whether incremental pricing or something else that might might help that profile.

Yes.

See steel cost.

Kind of two sides of the lowest in the first half of the year and they're going to be about 20% higher in the back half of the year.

<unk>.

So while we started it started the year, which.

Very pleased with our first quarter North American margins in our price cost relationship.

Steel by itself is going to be kind of a weight on the back half of the year. So we will we will see margins lower in the back half and then for the year 'twenty three 'twenty.

23, 5% operating margins, we kind of we see volumes.

Flitting splitting the year.

The typical cadence is stronger than the first half and a little weaker in the back half 52%, maybe it's typical in the front half and 48 in the back we're a little stronger on our outlook here based on the strong Q1.

We're probably more in the $53 47, and as you're aware, we've got a little bit easier comps in the second and third quarter based on kind of the Destocking last year.

Material costs, we see relatively flat so kind of the puts and takes on margins would be strong first half give back a bit in the second half and end up in that 23% to 23 and a half.

Still good range. Thanks, Chuck really appreciate it thanks, Kevin.

Yes.

Please standby for our next question.

Our next question comes from the line of Brian .

With Jefferies.

Please standby.

The margin commentary you talked about this being driven by higher steel costs in the back half.

Within your guidance are you baking in additional automatic retail pricing for this.

So that offset that.

We haven't we haven't changed any as Theresa good morning, Sherri. This is Chuck we haven't changed any of our pricing policy. So we do have some formula pricing thats out there and that will that will flow kind of on the same lag as we've talked about before as steel costs go up and down so haven't changed.

Any of that in.

Along with kind of the steel price going up some of that natural natural pricing through formulas will.

File either up or down as it moves it does it has historically, yes, I would say when you look at our pricing is but what we expected it.

And Chuck just mentioned, we haven't changed the way that.

Our process works within our company.

I go back to we will continue to monitor it as we always do and claw back. So we have a pretty good track record of adjusting if necessary.

So within your current guidance do you bake in any additional price increases or would you stay at current levels.

Yes.

We're not going to comment on future price increases just to commentary on pricing in total and just to remind maybe remind everybody that our last announced price increase was this November of 2021.

So we've kind of got a comp where full year 'twenty two pricing is in place and so that just.

Just kind of wanted to remind everybody that that's out there for the full year last year and it's been we've anniversaried that price increase last fall that was our <unk>.

Final announced price increase.

Okay.

Just to be clear I know, we're not commenting on additional price increases going forward.

So we can assume that additional price increases are not guidance at this point is that fair.

We're just we just don't comment on pricing and forward looking.

At this time.

And then just one last question you mentioned, China, improving sequentially through the demand how does this trend in April and how you think about the cadence of growth through the year. Thank you.

Yes.

We've talked about in our prepared remarks, China really kind of played out to what we thought we did see January is always a very tough month with the Chinese new year, and so forth and particularly coming out of Covid and opening up but we saw a month over month improvement.

April was playing out really well we're seeing.

Our sellout improve over March so the way we view it.

We should see month over month quarter over quarter, and remember that the fourth quarter is our strongest month there. So.

But it's playing out the way, we thought and as things settle in and consumers get a bit more comfortable.

We're comfortable with our guidance of growth of 3% to 5% local currency being.

Being down in the first quarter, but we do expect quarter over quarter, we would be up each of the quarters going forward.

Please standby for our next question.

Our next question comes from the line.

Macquarie with Goldman Sachs. Your line is now open.

Thank you good morning, everyone.

Good morning.

My first question is around.

As you think about steel moving higher.

And does the potential.

For some pricing come through do you think there was any pull forward that is happening in the market today or in the first quarter and some of your customers, perhaps try to position themselves.

Yeah.

I guess, we can speculate a little bit but as I outlined.

Recently of how the quarter played out in the buckets that we saw.

I really don't feel talking with our businesses that there was much pull forward I think it was people one taking care of their customers and number two maybe balance out their inventory that was a bit light, which cuts from our customers.

But overall I don't think there was any pull forward with regards to steel.

Okay. Okay. That's helpful and then.

Can you give a bit more color on what youre seeing on the commercial side. There's obviously been some cross currents. There as you think about the underlying markets. I know you mentioned that you expect the volumes to be up mid single digits. There so but for the industry. How are you. What are you seeing on the ground there any more color you can give.

Yes, I would tell you it's one the overall commercial market was up but.

But it was really driven by the commercial electric in the greater than 55 gallon.

That really we thought that would not bounce back to pre 2002 levels and quite frankly, it did so that's driving much of the growth, but we're also seeing.

Growth, let's say low single digits and the gas side of the business. So commercial held up well and Thats what gives us the comfort to move it up to that mid single digit growth rate.

One moment for our next question.

Our next question comes from the line of Matt Summerville of D. A Davidson your line is now open.

Thanks.

Couple of questions can you talk about.

Context.

Your M&A pipeline and action ability, they're in and what the step up in repurchase activity, maybe says or maybe does can say about the.

The outlook for a O Smith with first with respect to M&A, specifically and then I have a follow up.

Yes, terrific I'll take the M&A I'll, let Chuck comment on the repurchase.

They're really not connected with regards to why we moved them up M&A pipeline.

Continues to be.

I would say active particularly on the on the water treatment side of the business, but in other areas. So that hasnt changed and we continue to stay in close contact with our targets and looking for the right opportunities.

Bob.

So that's moving much like we thought it would be and we'll we hope we were able to deploy some capital in the near term.

Yeah with respect to the repurchase moving up a $100 million.

We gave.

<unk> our outlook in January we talked about our $200 million buyback outlook and we also talked about $400 million being authorized by the board and we wouldn't kind of watch that through the year based upon our strong cash operations in Q1 and outlook for the year. We went ahead and moved that up to $300 million. So we felt very comfortable.

Well with that.

Got it.

With respect to China can you talk about more recent market share trends in both water heaters and water treatment and what youre seeing from a mix perspective, and then how you would characterize inventory levels. Thank you.

Okay.

When we look at China overall, we've talked about this there's not a great market share.

Outlet for us to we may have to put pieces together, but when we look at our retail business, we look at our specialty store business and overall.

We're very comfortable that we're still one of the leaders in the market and we're getting our fair share.

<unk>.

Of the business.

Yes, the channel inventory is.

It's in a normal range kind of in that four to six weeks.

And coming back just about the mix the mix is holding pretty well our premium mix in all of our categories still continues to be moving up slightly and most of the categories. We.

We talked a bit about our water treatment and how we introduced a new high flow product, which is in the premium sector. So.

It's been it's been interesting to watch, but the premium side of the mix in their premium customers continue to buy our products.

And we see that continuing through the rest of the year.

One moment for our next question please.

Our next question comes from the line of Damien Carrick of UBS. Your line is now open.

Hey, good morning, everyone. Congrats on the quarter good morning.

So I wanted to ask you about.

Your comments on channel inventory with North America pretty much being at normal levels exiting the quarter.

You are already there for water heaters heading into <unk>, but it sounds like maybe boiler and water treatment costs, you a bit by surprise.

With respect to the inventory levels out there could you just maybe help us understand a little bit better on what youre seeing or hearing that gives you confidence.

Some of these more recent Destocking is in fact, yes.

Flushed out.

Although let me, let me start with that and Chuck can jump in.

Boilers, I would say a bit of a surprise.

We kind of missed that.

A strong fourth quarter.

And so that.

That was a bit of a surprise.

We had to sell through the.

Water treatment I would say no we knew there is still <unk>.

Some inventory in the channel, particularly with our dealers and our specialty wholesalers and that worked itself out but the way I look at it right now all of our channels I think inventories are right, where they really need to be quite frankly, and the only area that may have a little bit of a gap and we'll take care of that hopefully in Q2 will be on our commercial side of the.

Business.

But overall other than the boilers I think we.

We saw inventories, where we thought they should be with our customers.

Okay great.

And I wanted to ask you about.

Heat pumps, which is a.

Topical subject matter at the moment and I know, Kevin you mentioned in the past are not expecting heat pumps. They take over the water heater market anytime soon there is still some cost and installation challenges.

But I will say I've seen quite a bit of incentives out there related to <unk> re buy rebates on on heat pump water heaters. So I'm curious if you started seeing any notable pickup in activity or maybe any changes in <unk>.

And customer buying decisions as a result.

I'm not sure I would qualify it as many any major changes <unk> been out there they've been stated in local.

Certainly there is a federal side of this now.

No.

What I would tell you that heat pump continues to grow its coming off a very small base as we've talked is less than 2% of the overall water heaters sold but it's growing at that double digits pretty regularly each quarter.

The future is going to continue to grow.

It's a very good high efficiency.

<unk> product that I think has a place long term and so but it's going to keep continue to grow at a modest pace, even with the incentives, we're probably going to need regulatory to really drive.

<unk>.

<unk> increase in volume, but you can expect.

To grow month over month quarter over quarter.

For the foreseeable future, we're very high on heat pumps, both on the residential side and on the commercial side of the business.

I'm not sure I would qualify it as is.

They are expensive they do take a little bit too to install but from a consumer from a commercial standpoint, they provide really good payback in a really good value proposition long term of the consumer or the business owner.

Maybe any major changes rebates have been out there they've been state and local.

Theres a petrol side of this now so what I would tell you that heat pump continues to grow its coming off a very small base as we've talked is less than 2% of the overall water heaters sold.

Yeah.

Please standby for our next question.

But it's growing at that double digits pretty regularly each quarter.

Our next question comes from the line of Andrew Kaplowitz of Citigroup. Your line is now open.

The future is going to continue to grow.

It's a very good high efficiency green product that I think has a place long term and so but it's going to keep continue to grow at a modest pace, even with the incentives, we're probably going to need regulatory to really drive.

Hey, good morning, everyone.

Good morning, good evening.

Talk about margin performance and rest of the World I know you didn't change the margin guide in the segment for the year, but it was a little low in Q1 was that just sort of a weaker start to the year in China as you talked about already.

Fast increase in volume, but you can expect it to grow month over month quarter over quarter.

Think you had mentioned that youre going to spend more money on marketing advertising did you do that in Q1.

Yes.

For the foreseeable future.

Q1, as it aligns with our expectations, it's a little lower than last year I would say last year was a bit oversized and you kind of look at our history and our Q1 Q1 in China is always a bit of a challenge.

Hi, and heat pumps, both on the residential side and on the commercial side of the business.

They are expensive they do take a little bit to install but from a consumer from a commercial standpoint, they provide really good payback in a really good value proposition long term for the consumer or the business owner.

We really cut back on spending last year in Q1 to help that margin.

But it was.

The margin the margin in rest of the world was aligned with our expectations. This year.

We will though we're calling out to be I think 11% operating margin in China roughly for the year and we expect the year over year growth in next quarters, and we do expect to spend more on SG&A to drive some of that growth. So that's why we're not expanding down a great deal, but we're really pleased that we're kind of back to a growth mode. Once we get out of Q1.

Please standby for our next question.

Our next question comes from the line of Andrew Kaplowitz of Citigroup. Your line is now open.

Hey, good morning Rod.

Good morning, good evening.

Can you talk about margin performance and rest of the world and I know you didn't change the margin guide in the segment for the year, but there is a little low in Q1 was that just sort of a weaker start to the year in China as you talked about already.

That's very helpful and then Kevin or Chuck as rates have continued to come up and given the volatility around the banks in March it doesn't seem like you saw any hiccups, but did you when you're talking to your customers or chat.

I think you had mentioned that youre going to spend more money on marketing advertising did you do that in Q1.

China Partners did you see anything that sort of worried you there either in the sort of core residential or commercial markets.

I would say that you know.

This is anecdotal but it's.

Yes.

Are those concerns right now with rates moving up and what Thats going to mean for the economy, particularly the back half. So everybody has it online, but they're not then that change in behavior, there watching inventories closely but.

We really cut back on spending last year in Q1 to help that margin.

Customer demand still seems to be moving along both residential and commercially but there's this.

Well no I mean, we're calling out to be I think 11% operating margin in China roughly for the year and we expect the year over year growth in next quarters, and we do expect to spend more on SG&A to drive some of that growth. So that's why we're not expanding down a great deal, but we're really pleased that we're kind of back to a growth mode. Once we get out of Q1.

Hints of a backdrop that the interest rates could cause some potential issues as we get into the back half of the year, we'll have to see how that plays out that's more conversation than actually what's happening on the ground today.

Okay.

Please standby for our next question.

Our next question comes from the line.

<unk> of Keybanc capital markets.

Channel Partners did you see anything that sort of worried you there either in the sort of core residential or commercial markets.

Your line is now open hey, good morning.

Hey, Jeff Good morning morning.

So I think you called out lower price in the first quarter.

I would say that.

This is anecdotal but it's.

I just wanted to understand maybe the magnitude one is this all kind of material price formulas or is there something more broad.

Yes.

All those concerns right now with rates moving up and what Thats going to mean for the economy, particularly the back half. So everybody has it online but they are not then that change in behavior, there watching inventories closely but customer demand still seems to be moving along both residential and commercially but there is this <unk>.

Yeah, we're not we're not really going to carve out the details around that and I will say, though I mean, we're up on organic growth for the quarter. So the commercial growth.

Residential growth outweighed the price.

So we're.

Sure.

We're pleased kind of with our margin expansion in Q1, knowing that we're going to see some pressure on steel in the back half of the year.

A backdrop that the interest rates could cause some potential issues as we get into the back half of the year, we'll have to see how that plays out that's more conversation than actually what's happening on the ground today.

Jeff I would just tell you comment just a while back.

Really on the pricing side it played out as we expected quite frankly.

So maybe even a little bit better, but it played out well and we will continue to.

Okay.

Please standby for our next question.

Just continue to evaluate and make sure their customers are competitive, but I've always said that over and over and both channels and commercially.

Our next question comes from the line, Jeff Hammond of Keybanc capital markets.

Your line is now open hey, good.

We're pleased with the quarter and we're pleased with the trends that we have today.

Hey, Jeff Good morning.

So I think you'd called out lower price in the first quarter.

Okay.

Okay, and then I think there was an earlier question about the cadence in North American margins is it is it simply <unk> looks like <unk> and then we get a step down to kind of fall within the guidance.

Just wanted to understand maybe the magnitude one is this all kind of material price formulas or is there something more broad.

Yeah, we're not we're not really going to carve out the details around that and I will say, though I mean, we're up on organic growth for the quarter. So the commercial growth resident.

Yes.

Roughly that.

Really see some of those cost on the steel side that go up 20% in the back half of the year weighing in on Q3 and Q4.

Our residential growth outweighed the price.

We're pleased kind of with our margin expansion in Q1.

Early evening on the quarter at least when we look at it today.

Okay.

Knowing that we're going to see some pressure on steel in the back half of the year.

One moment for our next question please.

Yes, Jeff I would just tell you a comment just oil back.

Our next question comes from the line of David Macgregor of Longbow Research. Your line is now open.

Really on the pricing side. It played out as we expected quite frankly, and so maybe even a little bit better, but it played out well and we will continue to.

Yeah.

Yes, good morning, everyone.

I'm wondering if you could just go back to China, Yes. Good morning, I Wonder if I could just go back to China and.

Just continue to evaluate and make sure their customers are competitive, but I've always said that over and over and both channels and commercially.

Ask you to just talk about that 3% to 5% guidance for 2023.

We're pleased with the quarter and we're pleased with the trend that we have today.

Separate out price versus volume and help us just understand what's happening trend wise there and then also on China. If you could just talk about the extent to which you are expanding your distribution.

Okay.

At this point and what that might represent in 'twenty three and then I have a follow up question.

Yes, it's mostly volume in China, there is a bit of price, but not nearly what we've seen in other parts of our businesses. So that 3% to 5% is based on what we believe.

Yes.

It's roughly that.

We really see some of those costs in the steel side that go up 20% in the back half of the year weighing in on Q3 and Q4.

The opening in China, and then the Covid policies that we will see a step up we're comfortable kind of with the order rates that came in in April we feel good about that so.

Fairly evening out in the quarter at least when we look at it today.

Okay.

One moment for our next question please.

It's largely volume.

Distribution wise in China, we took we reduced some stores in the during the Covid period of 2020 through 2021, but really distribution points are relatively stable.

Our next question comes from the line of David Macgregor of Longbow Research. Your line is now open.

Yes, good morning, everyone.

Not a lot of change on the distribution points, but we.

I was wondering if you could just go back to China, Yes. Good morning, I Wonder if I could just go back to China and.

We're comfortable with the outlets we have.

Okay, and then just if I could just expand on China for a second I do have a follow up question, but just a.

Ask you to just talk about that 3% to 5% guidance for 2023.

A little further on the China question.

As you look at that volume recovery is it mostly in your medium price point as opposed to a higher price point products mentioned earlier premium was doing well. So I just wanted to get some clarity on that.

At this point and what that might represent in 'twenty three and then I have a follow up question.

No.

I would say that we're going to see a kind of a normal pattern coming out maybe even leaning towards the premium a bit because we do have some new products that have come out.

Yes, it's mostly volume in China, there is a bit of price, but not nearly what we've seen in other parts of our businesses. So that 3% to 5% is based on what we believe.

And it will introduce additional products through the year, So I would say that our purchasing or the consumer purchase purchasing behavior of a O Smith products will be.

With the opening in China in the Covid policies that we will see a step up we're comfortable kind of with the order rates that came in in April we feel good about that so.

Very similar to what we've seen in the past and hopefully maybe a bit of a step up on the premium side as these new products into the market. Yes, we have seen our mix moved to positive based on the premium products introduced in the last call. It 12 months, so that mix on new products is helping a bit on the growth.

It's largely volume.

Distribution wise in China, we reduced some stores in the <unk>.

During the Covid period of 2020 through 2021, but really distribution points are relatively stable.

Not a lot of change on the distribution points, but.

We're comfortable with the outlets we have.

Please standby, while we compile the Q&A roster as a reminder to ask a question you will need to press star one on your telephone.

Okay, and then just if I could just expand on China for a second I do have a follow up question, but just a.

A little further on the China question.

As you look at that volume recovery is it mostly in your medium price point as opposed to your higher price point product mentioned earlier premium was doing well. So I just wanted to get some clarity on that.

No.

Our next question comes from the line of David Macgregor with Longbow Research one moment. Please.

I would say that we're going to see it kind of a normal pattern coming out maybe even leaning towards the premium a bit because we do have some new products that have come out and it will introduce additional products through the year. So I would say that our purchasing or the consumer purchase purchasing behavior of a O Smith products will be.

Hi, there thank you.

Hey, David.

That's helpful.

Welcome back.

Thanks again back in the queue.

Similar to what we've seen in the past and hopefully maybe a bit of a step up on the premium side as these new products into the market. Yes, we have seen our mix moved to positive based on the premium products introduced in the last call. It 12 months, so that mix on new products is helping a bit on the growth.

[laughter] Deja Vu all over again, so I wanted to just ask.

Water treatment and theirs.

There's kind of this is kind of a long conversation we've been having over the last few years about profitability within water treatments and just wanted to get a sense of how youre thinking about the margin outlook and water treatment. This year and just what the factors might be behind your thinking around that.

Please standby, while we compile the Q&A roster as a reminder to ask a question you will need to press star one on your telephone.

Yes.

In the quarter and water treatment is around 10% operating margin and as you know we were we were at 10 and working our way up.

Our goal is still to expand those margins 100 basis points a year, we're a little behind the curve on that and try to play a little bit of catch up because of some of the cost price relationships.

Our next question comes from the line of David Macgregor with Longbow Research one moment. Please.

There, which put a little pressure on operating margin for.

For the year, we're kind of looking at 11% operating margins. So we're looking to be a little bit better as we go through the year.

Hi, there thank you.

Hey, David.

But yes, we have a lot of catch up to do on some cost increases.

That's helpful.

Yeah.

Is it mix of new products to drive that improvement or are you just getting a little more progress around productivity.

Welcome back.

Thanks again, thank you.

Yes.

Again, so I wanted to just ask.

What are the drivers behind that.

Water treatment.

Gradual improvement.

And just kind of this is kind of a long conversation we've been having over the last few years about profitability within water treatment and just wanted to get a sense of how youre thinking about the margin outlook and water treatment. This year and just what the factors might be behind your thinking.

Yes, I think it's a combination of.

What you just mentioned there'll be some productivity there'll be some mix because we are going to introduce some new products, particularly in our retail segment.

So it'll be a combination of productivity mix and a few other things stick to that 100 basis point increase.

On that.

Yes, so for the quarter and water treatment is around 10% operating margin and as you know we were we were at 10 and working our way up.

And then you mentioned in your M&A comments that water treatment the opportunity look perhaps a little more imminent.

Our goal is still to expand those margins 100 basis points a year, we're a little behind the curve on that and try to play a little bit of catch up because of some of the cost price relationships.

Yes, I would just look at water treatment and again I didn't say eminent okay I want to make sure that we're clear on that but when you look at water treatment, it's a very fragmented market.

There, which put a little pressure on operating margin for.

A lot of smaller acquisitions, we think we're going to be part of the roll up and so that area is always a bit more active than maybe some of our core products, but there is always opportunity. There we have to find the right fit not only for us, but also for the people that would want to sell to us.

For the year, we're kind of looking at 11% operating margins. So we're looking to be a little bit better as we go through the year.

But yes, we have a lot of catch up to do an excellent cost increases.

Is it mix of new products that drive that improvement or are you just getting a little more progress around productivity.

I think water treatment is going to be a <unk>.

Primary focus and probably will have the most opportunity over the next few years for us not to say theres not others, but that's why I kind of singled out water treatment.

What are the drivers behind that.

Gradual improvement.

Yes, I think it's a combination of.

What you just mentioned there'll be some productivity there'll be some mix because we are going to introduce some new products, particularly in our retail segment.

At this time I would like to turn it back to Helene.

So it'll be a combination of <unk>.

For any closing remarks.

Productivity mix and a few other things to that 100 basis point increase.

Thank you everyone for joining us today, let me conclude by reminding you that our global <unk> team delivered strong first quarter performance and record first quarter EPS.

And then you mentioned in your M&A comment that water treatment the opportunity look perhaps a little more imminent.

Yes, I just look at Ed water treatment and again I didn't say eminent okay I want to make sure that we're clear on that but when you look at water treatment, it's a very fragmented market.

Look forward to updating you on our progress in quarters to come.

In addition, please mark your calendars to join our presentations at three conferences this quarter.

A lot of smaller acquisitions, we think we're going to be part of the roll up and so that area is always a bit more active than maybe some of our core products, but there's always opportunity. There we have to find the right fit not only for us but also for the people that would want to sell to us, but I think water treatment is going to be a.

Oppenheimer on May 9th Keybank on May 31.

And William Blair on June six.

You and enjoy the rest of your day.

Okay.

Thank you for your participation in today's conference. This does conclude the program you may now disconnect.

Our primary focus and probably will have the most opportunity over the next few years for us not to say theres not others, but that's why I kind of singled out water treatment.

At this time I would like to turn it back to Helene.

For any closing remarks.

Thank you everyone for joining us today, let me conclude by reminding you that our global a O Smith team delivered strong first quarter performance and record first quarter EPS.

I look forward to updating you on our progress in quarters to come in.

In addition, please mark your calendars to join our presentations at three conferences this quarter.

Oppenheimer on May 9th Keybank on May 31, and.

And William Blair on June six.

You and enjoy the rest of your day.

Okay.

Thank you for your participation in today's conference. This does conclude the program you may now disconnect.

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Q1 2023 A O Smith Corp Earnings Call

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