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spk18: This speaker's presentation will be a question and answer session. To ask a question during this session, you'll need to press star 1-1 on your telephone. You will then hear an automated message advising your hand is raised. To withdraw your question, please press star 1-1 again. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your first speaker today, Helen Gorholt. Please go ahead.
spk07: Thank you, Marvin. Good morning, and welcome to the A.O. Smith Second Quarter Conference Call. I'm Helen Gerholtz, 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 plus capital expenditures, adjusted earnings, adjusted earnings per share, Adjusted segment earnings and adjusted corporate expenses exclude the impact of pension settlement income and restructuring and impairment 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 risk 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 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 can access them on our website at investor.aosmith.com. I will now turn the call over to Kevin to begin our prepared remarks.
spk08: Thank you, Helen, and good morning, everyone. I'm on slide four and our second quarter results. I'm very pleased with our second quarter performance and how we are tracking for the year. In the second quarter, our global A.O. Smith team delivered record quarterly sales of $1 billion and an EPS of $1.06, a 5% increase over 2023 adjusted EPS. North American water heater and boiler sales increased 10% due to higher volumes and pricing action. China third-party sales grew 2% in local currency. India achieved double-digit growth in local currency for the 10th consecutive quarter. And last week, we announced that we signed an agreement to acquire PURIT, a leading water purification business in South Asia. We look forward to welcoming the PURIT team to the A.O. Smith family later this year. Please turn to slide five. North America water heater sales grew 10% in the second quarter due to higher residential and commercial volumes and pricing actions. We began shipping our internally developed and manufactured gas tankless products in the quarter, and we are very pleased with market acceptance. Our North American boiler sales grew 10% compared to the second quarter of last year, driven by higher commercial volumes. I am pleased to see a return to growth as channel inventory levels normalized We are on track to achieve our boiler sales forecast of 8% to 10% for the year. Sales of our commercial boilers, particularly our Crest boilers with Hellcat technology, continue to outperform the market. North America water treatment sales increased 8% in 2024 as acquisition-related dealer sales increases were partially offset by weakness in the retail channel. In China, second quarter third-party sales increased 2% in local currency, as a result of sales of kitchen products as well as HVAC products that were partially offset by lower volumes of residential water treatment. While markets for our core products remain challenged, we are pleased with our market share in the premium portion of the water heater and water treatment product categories. However, we have seen pricing and promotion pressures, particularly in the mid-price sector of the market. I'm now on slide six. This year, we are celebrating our 150th anniversary. It's a time to reflect on those 150 years of living our values, of achieving profitable growth, emphasizing innovation, preserving our good name, being a good place to work, and being a good citizen. It is also gratifying to be recognized for the continuation of those values. So far in 2024, our team has received several honors that reflect our employees' dedication to our core values. Early this year, AO Smith was named one of the world's most ethical companies by Ethisphere, a global leader in defining and advancing the standards of ethical business practices. In addition, our commitment to innovation and energy management has resulted in our Nanjing China plant being selected as one of the 2024 Nanjing Environment Protection Model Enterprises in recognition of our waste and emission reduction efforts. We also received a 2024 Energy Star Sustained Excellence Partner of the Year Award from the EPA for the sixth year in a row for our long-term commitment to energy management through our products. In addition, we were named 2024 U.S. News Best Companies to Work For in Manufacturing by U.S. News & World Report. While the reward is the satisfaction our team receives for doing the right thing and living our values, These honors validate our values as a differentiator for our employees and stakeholders. I'll now turn the call over to Chuck, who will provide more details on our second quarter performance.
spk14: Thank you, Kevin, and good morning, everyone. I'm on slide seven. Second quarter sales in the North America segment were $791 million, a 9% increase compared with 2023, driven by higher water heater and boiler volumes, as well as year-over-year pricing actions. North America's segment earnings of $198 million increased 2% compared with 2023 adjusted segment earnings. The higher segment earnings were primarily driven by increased volumes and pricing that were partially offset by higher steel costs and higher selling expenses to support our growth initiatives, including the launch of our gas tankless products. Segment margin was 25.1%, a decrease of 180 basis points year over year. The lower segment margin was due to the reasons I reviewed with regard to segment earnings, which more than offset higher volumes in the quarter. Moving to slide eight, rest of the world segment sales of $245 million were essentially flat to last year and included unfavorable currency translation of approximately $7 million. primarily related to China, as well as inter-segment sales associated with recently launched tankless water heaters. Segment third-party sales increased 3% on a constant currency basis. The increase was partially driven by higher sales of kitchen and HVAC products, partially offset by lower sales of residential water treatment products in China. India sales grew 16% in local currency in the quarter, driven by growth in both water heater and water treatment categories, with particular strengths in our e-commerce, retail, and commercial markets. Rest of the world segment earnings of $26 million decreased slightly compared to segment earnings in 2023, primarily due to the unfavorable product mix and sales promotions in China. Third-party segment operating margin was 11.5%, slightly lower than segment margin in 2023. Please turn to slide nine. We generated pre-cash flow of $119 million during the first half of 2024, a decrease from the same period last year, primarily as a result of higher inventory and accounts receivable balance, as well as higher incentive payments associated with record sales and profits last year, which more than offset higher earnings and higher trade payable balances. Capital expenditures increased $21 million year over year, driven by our expansion projects. Our cash balance totaled $233 million at the end of June, and our net cash position was $93 million. Our leverage ratio was 6.8%, as measured by total debt to total capital. Now let's turn to slide 10. In addition to returning capital to shareholders, we continue to see opportunities for organic growth, innovation, and new product development across all of our product lines and geographies. As Kevin mentioned earlier, we signed an agreement last week to acquire PURIT from Unilever for $120 million. PURIT offers a broad range of residential water purification solutions and has annual sales of approximately 60 million US dollars, primarily in India, The addition of PURE-IT strengthens our leadership position as a global supplier of premium water treatment products and will double our market penetration in South Asia. The acquisition will also support our corporate strategy by enhancing our premium product portfolio and distribution footprint. Please turn to slide 11 and our 2024 earnings guidance and outlook. We narrowed our 2024 EPS outlook to an expected range $3.95 to $4.10 per share. The midpoint of our EPS range has not changed and represents an increase of 6% compared with 2023 adjusted EPS. Our outlook is based on a number of key assumptions, including our guidance assumes that our steel cost in the full year 2024 will be roughly flat 2023. Our outlook assumes non-steel material costs are similar in 2024 as they were in 2023. Our guidance also assumes a relatively stable supply chain environment, similar to what we experienced throughout 2023. We began shipping our internally designed and manufactured gas tankless products in the second quarter. These products are being manufactured in our China facility until our North America capacity is completed in 2025. Associated import tariffs and other launch costs will impact North America margins by approximately 50 basis points in 2024. The tariff will be eliminated when production moves to Juarez, Mexico. For the year, CapEx should be between $105 and $115 million An increase over the last several years due to our capacity expansion projects, including our gas tankless facility in Juarez, expansion of our engineering capabilities in Lebanon, Tennessee, and adding high efficiency commercial water heating manufacturing capacity ahead of the 2026 regulatory changes. We expect to generate free cash flow of between $525 and $575 million. Corporate and other expenses are expected to be approximately $65 million. Our effective tax rate is estimated to be approximately 24%. And we expect to repurchase approximately $300 million of our shares of stock, resulting in outstanding diluted shares of $147 million at the end of 2024. I'll 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 2024 while staying on slide 11. Kevin? Thank you, Chuck.
spk08: We reaffirm our outlook that 2024 sales will grow 3% to 5% compared to 2023, which includes the following assumptions. Our outlook includes previously announced price increases in North America water heating of 4% on most of our water heater products. Price of heat for heat pump products is 8%. We began to see realization of the price increases in the second quarter. We believe that a pre-buy ahead of the price increases pulled forward some demand in the first half of the year for both residential and commercial water heaters. We have seen some softness in our orders in July. Due to normal seasonality in the pre-buy, we maintain our projection that 2024 U.S. residential industry unit volumes will be flat to last year. Our projection that U.S. commercial water heater industry volumes will increase low single digits in 2024 is also unchanged. Our outlook assumes that new residential home construction and proactive replacement will remain at levels similar to last year. In China, we believe the economy and consumer confidence remain weak. We continue to see headwinds in consumer demand. While we are cautious about the second half of the year, we maintain our 2024 third-party sales growth guidance to be between zero and 3% in local currency. Our forecast assumes a negative currency translation impact of approximately 2% for the year. We reaffirm that we expect our boiler sales to grow eight to 10% over last year. Our sales growth guidance from North America Water Treatment of an increase of eight to 10% is also unchanged. Based on our 2024 assumptions, We expect our North America segment margin to be approximately 25%, and the rest of the world third-party segment margin to be approximately 10%. Please turn to slide 12. We are pleased with our performance in the first half of 2024. We saw strong growth in water heaters in the first half of the year, which we believe was partially driven by the pre-buy. We are pleased to see a return to growth in our North America boiler business, as channel inventory levels normalized and we continue to benefit from the transition to higher energy efficiency boilers, particularly in commercial applications. Our three capital expansion projects that will add capacity for key product categories in North America are on track and will position us well for long-term growth. India remains on track for another year of projected double-digit sales growth. We're excited to complete the PURIT acquisition later this year, which will double our sales in the South Asia region Pure's strong brand and strength in the e-commerce channel will complement our premium brand, will make us the number three residential water treatment company in India. Even as we celebrate our 150th anniversary and our rich history of innovation with employees, customers, and partners, we remain focused on meeting the needs of our customers and executing our key strategic priorities to advance our leadership position in heating and treating water around the globe. That concludes our prepared remarks, and we are now available for your questions.
spk18: Thank you. At this time, we'll conduct the question and answer session. As a reminder to ask a question, you'll need to press star 1-1 on your telephone and wait for your name to be announced. To withdraw your question, please press star 1-1 again. Please stand by while we compile the Q&A roster. Our first question comes from the line of Matt Summerville of DA Devis. Your line is now open.
spk21: Thanks. A couple questions. I was hoping maybe you could spend a moment, Chuck, kind of talking about how we should be thinking about the margin cadence in both North America and the rest of the world in the back half of the year, given some of the pluses and minuses you were describing.
spk14: Yeah, good morning, Matt. Happy to. If you look at the cadence for the back half of the year, clearly we had a strong first six months. We mentioned a bit of what we believe to be a pre-buy in the North America market with our price increase. As you look at volumes of North America, look at Q3 as being a bit challenged because of some of that pre-buy, and then Q4 probably looking very similar to Q2. A little bit of headwind and the volumes in Q3 and a little bit of return back to where we were on Q2 in the fourth quarter with continued momentum on the gas tankless product. Margins will follow. The margin cadence in the third quarter will be challenged by the volume headwind in the third quarter. In China, we're coming off what I would say a solid first half of the year. Still see weakness in the economy, as Kevin mentioned. As always, our fourth quarter is expected to be the strongest as we go into the back half of this year. Third quarter also will be a bit challenging on the volume side, we believe. We've seen a bit of weakness, July orders, both within China and in North America. A little bit of a slow start to the third quarter, and that will probably translate into volume headwinds, and it will leave a little bit of an impact on the margins.
spk21: Got it. And then as a follow-up, could you maybe comment on what the channel inventory picture looks like in China? And I think in your prepared remarks, there was a mention about maybe seeing a little bit more price competition in the mid-price point category. Can you elaborate on that a bit?
spk08: Yeah, hi, this is Kevin. Maybe I'll touch base on inventories are pretty much where we expect them to be in that four to six week range. So nothing that meaningful. There's ups and downs as we go forward. What we mentioned is it's a very competitive market. Consumer demand is weaker than it's been. And so the consumers are a bit cautious. So we're seeing a bit more, I would say, promotional activities. We saw it in Q1. And that's kind of carried over into Q2 as well. I think our team's managing it really well. Again, we don't chase every order. We're very selective in how we go to market. And if you look at it overall, going 2% in local currency in a very competitive market, it has some consumer headwinds. I think our team's done a really nice job of balancing those competitive dynamics. I also want to remind people that we also have some areas in China that are growing well. You look at our kitchen, products are doing well, commercial water treatment is doing well, and so is our HVAC part of the business. So being diversified as we are on the water heating side and water treatment, but also having the other adjacencies has helped and made a difference in this difficult market. So overall, I'm very pleased that we're right on China, and we'll keep managing it in the back half of the year.
spk18: Thank you. We'll move it for our next question. Our next question comes from the line of Jeff Hammond of KeyBank Capital Markets. Your line is now open.
spk04: Hey, good morning. Good morning. Maybe just to start on the acquisition, just give us a sense of, you know, kind of profitability of the business or opportunity, you know, from a profitability standpoint. and kind of what the growth rate's been for the business, you know, last five years?
spk08: Well, I'll take the first part of it and just to talk about the acquisition in general. First, I want to go back to our Indian business is performing really well. We have a terrific management team that's been executing for quarter after quarter. And we're looking to scale that business both organically and inorganically. And Pura plays a nice role in that business. It's a solid brand in the market. It complements our India business that we have today. They're stronger in e-commerce, have a nice retail presence that also dovetails with our general trade and our retail presence. So overall, the business is doing well. It's a premium brand. We do overlap, but we're not exactly have products positioned right next to each other. So if you look at it, the overall, the brand, the product positioning, we're excited about bringing the team on. And doubling our business is going to make a big difference. It's going to make a difference in our scale. We're also going to be able to leverage our infrastructure that we have on the ground there, whether it be logistics, manufacturing, you name it. So doubling our business, we're excited in doing it with a premium company like PURIT and a premium brand. really sets up nicely as we go forward after the close.
spk14: And from a financial profile, it looks very similar to our India business today. I mean, pure business is the majority is in India, but it's also in Bangladesh and some shipments outside of the Sri Lanka and Vietnam, but In total, roughly the same size as our business, around $60 million. Profitability-wise, very similar to what our India business has experienced in the last couple of years, meaning low to mid single-digit profitability. Growth-wise, as a premium brand, they've seen also very good growth in the region. Kevin mentioned 10 consecutive quarters of 15-plus percent growth. I believe they've seen very similar growth rates. So we're pleased with the way the financial profile matches up. And as Kevin said, coming together, we would hope to continue that growth momentum on a larger base and look for opportunities to leverage the bottom line as we go forward.
spk04: Okay. And then just on working capital, it seems like you had a much bigger working capital build in the first half versus, you know, maybe... maybe the last couple years. Is that just timing? Do we expect to get a lot of that back in the second half?
spk14: Yeah, we expect to get it back in the second half. It's timing. It's a little bit of tankless water heater inventory being built up, but for the large part, it's timing.
spk18: Thank you. One moment for our next question. Our next question comes from the line of Susan McClary of Goldman Sachs. Your line is now open.
spk05: Thank you. Good morning, everyone.
spk18: Good morning, Susan.
spk06: My first question is, you know, you mentioned that boilers saw some growth or reverted back to growth in the quarter. Can you talk about, you know, what's driving that and the sustainability of it? Just any comments on the comps that you face in the back half and how you're thinking about the path from here?
spk08: Well, if you look at it, it's mainly on the commercial side of our business, Susan. And we came off a pretty difficult quarter last year, but still our quoting has been active. That transition from kind of standard models to high efficiency continues. So overall, We're about where we thought we would be. Our new products are doing well. I mean, the Crest Boiler has always done well, but you add the Hellcat technology on top of that, and that's just being really well received in the market. Order rates have been good. They continue to be good. Backlog is strong. So overall, I just think the commercial segment is doing well. The overall industry is slightly up. We're doing better than the industry. And even on the residential side of the business, that's also a positive. Again, 8 to 10 coming off some easier comps, but the overall macro environment is good, and it plays really well into lock and bar and our high-efficiency focus that we've had over the years, and we're seeing some real benefits from that.
spk14: And just to comment on cadence on the comps, I mean, we're up 8% this quarter, but the comps get easier quarter over quarter when we get to the third and fourth quarters, so we feel very comfortable with the 8 to 10% growth.
spk06: Okay, that's helpful. And then turning to steel, we've seen that come down quite a bit recently. How do you think about the flow through of that to the business? You know, perhaps any impact there to North America over the coming quarters and just, you know, overall the trend for pricing?
spk14: Yeah, I mean, the steel has come down a little bit. By the way, boilers grew at 10%. I said 8%, so I'll just correct that. It's a 10% growth for the second quarter. As we look at steel, we're thinking our outlook has steel roughly flat year over year. As we mentioned, steel went up in the second quarter compared to first quarter by about 20%. It was about 25% higher than Q2 last year. you know, there was a bit of a ramp up. We've seen some softening in steel. As you recall, our lag is 90 to 120 days. So as we kind of look at the back half of the year, we see, you know, quarter over quarter Q2 to Q3, a little bit of relief. And then as we look into the fourth quarter, you know, with that lag, you know, we haven't baked in all of our indexes because they haven't all been issued. As you know, it's a monthly index that sets The pricing, as you look, 90 to 120 days out. So we do expect a little bit of relief in the fourth quarter, and it pegs kind of our outlook very similar to what the index was issued for the month of June.
spk18: Thank you. One moment for our next question. Our next question comes from the line of Sari Brodowski of Jeff Breeze. Your line is now open.
spk17: Good morning. Thanks for taking our question. You know, you cited some softer orders in July on the water heater side. Could you just quantify this at all? And then does your guidance assume that demand stays in line with this softer July rate?
spk08: Yeah, and just to mention, we always give you an outlook, you know, for the month we're in on the call. But if you look, we talked about a pre-buy. We do believe there was a pull ahead. And we started to see a bit of softness in May and June into July. But I think July is also one of our weaker months, and really the third quarter is one of our weaker months because of the summer and the heat and so forth. So that's why we do think it's going to... return as we get into August and September. And that's why we're holding a flat rate for the US residential tank type market through the balance of the year. So it's a temporary low that I think just gets us back to where our forecast has been for the entire year.
spk17: Thank you. And then turning to tankless, you started to ship some in the second quarter. What are you seeing from a demand perspective there? And then just on the modeling, what is the impact from tankless to China sales this year? And does this create a challenging segment comp when you do ship production to North America next year?
spk08: Well, I would tell you, again, we're coming from a low, kind of a mid-single-digit market share. So we've had a very good launch. And I don't want to give you any numbers because They would sound really high, and they are for us. We're very pleased with the adoption by our customers. And again, we launched the high-end condensing model first, and that's been well received by a number of customers, and it's easily hitting our expectations as we start to launch this product going forward. Again, we'll have two more products coming in by the end of the year, which will complete the line, and then our factory in Juarez is on track, maybe a bit ahead of schedule, and we'll start to do some assembly and manufacturing towards Q4 and get ready in 2025. Maybe I'll have Chuck touch on that, but having the tariff go away at the start of 2025 is gonna make a big difference in how we view this from a margin perspective going forward.
spk14: Right, I mean, Sri, from a comp perspective, You know, it's all positive when we move to Juarez. We relieve ourselves of the 25% tariff. We take away the long logistics lead time and some of the costs associated with bringing the product all the way back to North America from China. So we're really viewing when we start up production at Juarez, it's a very positive upside to our tankless category.
spk18: Thank you. One moment for our next question. Our next question comes from a line of Andy Kapowitz of Citigroup. Your line is now open.
spk20: Good morning, everyone.
spk03: Good morning, Andy. Good morning.
spk20: So you mentioned lingering pricing promotion pressure in China. I think you talked about margin there a little bit, but you obviously kept your guidance for rest of the world margin at 10%. My question is how difficult is it to maintain that margin sort of guidance moving forward? What cost actions or anything else are you doing to sort of offset lingering price pressure?
spk08: Yeah, I'll touch on it first, and then maybe Chuck will jump in. You know, it's a tough market, and as we said, we're cautious about even our guidance, but Our team's doing a terrific job balancing not only price and promotion, but also the cost of our business. You know, we talked way back when, when we went through the pandemic, a lot of our costs are now more variable than they are fixed. And so we're just balancing it again. We're a premium brand. So, um, we're in a different part of the market in a different clientele, but overall it's still a tough environment. And most of the pressures that we're receiving are kind of in that mid to upper mid level, not on the, on the higher level. And our team's evaluating it. Again, I think we're taking a targeted approach. It's not going to be easy, but we're confident in our China management that they can navigate the way through the second half of the year.
spk14: Yeah, we took quite a few cost actions within the COVID timeframe in China. And like Kevin said, to change some of our cost structure to more variable, take costs out of the business. close some very, you know, less profitable store footprints and feel pretty good about our position to be flexible as volumes challenge us a bit. So, you know, we'll continue to watch it. Right now, I think we've got China at about 11% for the year, very similar to last year. We anticipate being able to kind of work through it and continue to focus on cost and be at that percentage.
spk08: yeah and it will introduce funeral products in the back half of the year check i mentioned q4 is our strongest quarter and again we're building some momentum in in commercial water treatment we're building momentum in our hbac site so again putting the combination together uh challenging but we think it's very doable got it i just want to maybe ask the same question on north america again like in terms of the margin like just make sure i understand it so
spk20: You steal slightly better, you know, you're saying flattish versus a modest headwind, I think is what you previously said. But you also talked about Q3, you know, maybe being a little light or lighter in sort of volume. And I guess that's the incremental margin headwind holding you back. Is there anything else, like launch costs and decimals a little higher than expected? I know you said the 50 days point, so any color would be helpful.
spk14: I mean, nothing new, I don't think, that we haven't talked about before. I'll just mention that the tankless launch does cause some pressure on margins at 50 basis points. It's sort of spread to the full year margin projection of 25%. So clearly, as we launch it, it's heavier weighted into Q2, Q3, and Q4. That's probably the only other area of a little bit of headwind on margins that I would say to take into account as you're thinking about the back half of the year.
spk18: Thank you. One moment for our next question. Our next question comes from the line of David McGregor of Longbow Research. Your line is now open.
spk13: Good morning, everyone, and thanks for taking my questions. I guess I wanted to focus in on the increased selling expense in North America. I'll talk about how that North American selling expense compared year over year when you exclude the gas tank. Let's roll out. Also, I guess how we should be modeling that through the second half.
spk14: It really tracks closely with volumes. Our cost structure on selling expense is largely based on a commission basis. So as we sell, you know, more product, we're going to have a higher selling expense. We also emphasize different products, you know, with a different commission level to drive initiatives from time to time. So somewhat variable, I think, is the best way to look at it and tracks closer to volumes than it does just kind of flat out expenses. We do mention, you know, the launch of Tankless products. So we've got some initiatives within you know, a launch of the tankless products that's driving that number just a little bit higher?
spk08: Yeah, I'll just add, I mean, we're excited about our tankless offering being that it's internally designed. It's going to be manufactured in North America. And we're going to own the category from our own perspective rather than from partnering with somebody. we're going to spend some, you know, we're going to promote this product for the first part of the year, make sure we get everybody to understand what the product does, training, some promotional activities. All those are really important for us to get that product in the market, make sure people understand the features and benefits and how they really can benefit them going forward and how we can compete long term in this category. So, you know, this is a...
spk13: one-time expense but it's one that we're going to kind of lean into to make sure that we get the product off and and off to a good start got it thanks for that and then as a follow-up on the boiler business i mean you've guided to up eight to ten percent for the year what's the right way to think about how profitability compares with last year and what you may have in your guidance
spk14: Well, volumes being up certainly helps us. You know, when you look at the boiler business, it's largely commercial product that we're talking about being increased 8% to 10%. So, you know, it's an improvement when you've got growth in that product category.
spk18: Thank you. One moment for our next question. Our next question comes from the line of Scott Graham of Seaport Research Partners. Your line is now open.
spk09: Hey, good morning. Thanks for taking the questions. Hey, so the no change in the U.S. resi water heater industry, thinking of flat, you know, I know we talked about in quarters past, a couple quarters, that second half comparisons get a little bit tougher, so you want to be careful with that number. you know, the first half year to date is up in resi, maybe even a little unexpectedly, certainly from this point of view, is your thinking on flat now maybe a little bit more leaning into the, maybe the market is in fact weakening given your, you know, last couple of months sales volumes, or are you kind of going to hold the course with, you know, flat because the comps are tougher and there's really, and you're not trying to message anything.
spk08: Yeah, I don't think we're really trying to message. We've always thought we came off a pretty strong year last year. And going forward, if you look, you look at our MRSA replacement, which is always going to stay the same, proactive, new construction. Again, whether it's single-family or multi-family, we felt that was going to be relatively flat. You know, interest rates would probably keep it flat. We saw that the pre-buy, we're a little surprised when the 4% pulled forward a bit more than we had thought. But when you step back now and you kind of look at how we started the year, kind of trending down to maybe give some back, and then you look forward the next five months, we're just very comfortable as a flat year with strong growth in gas tankless, and we're going to see some good growth in heat pump, both residential and maybe even some commercial as well.
spk09: just trying to get back on track where we really think the market is and and we're very comfortable with that flat residential outlook just based coming off a very strong year thank you kevin so similar question on the north american segment margin you kind of you didn't change that either yet you're kind of calling for um some spot weakness here in the third quarter no pun intended um i'm just wondering is that that is the no change in that margin because maybe you left some wiggle room in there and or that you're actually seeing things that are making you more bullish on the fourth quarter margin and if so what no i wouldn't say we're more bullish i mean we we still believe 25 is going to be you know where we are well where we'll end up we were about at that in q2 on some really nice volumes
spk14: So Q3 will be a little more challenged on that because we will give back some of the volumes, at least in our outlook, and then back to volumes that would drop to the bottom line. A little lower steel than our last assumption. So there is a little bit of opportunity on the steel side when we look at our guidance from a quarter ago. But we're still feeling 25% is kind of the midpoint of where we think we'll end up.
spk18: Thank you. One moment for our next question. Again, as a reminder to ask a question, you'll need to press star 11 on your telephone. Our next question comes from the line of Damien Karras of UBS. Your line is now open.
spk12: Hi. Good morning, everyone. Good morning. Good morning, Damien.
spk16: I was wondering if you might be able to give us a little bit of an update on what you're seeing for heat pump water heaters. You know, I think we've seen states like New York and some others finalize their IRA allocations, a lot of those kind of really ramping up. So could you tell us, you know, what you've been seeing with the heat pump product, how it's been trending and kind of expectations through the rest of the year into next year?
spk08: yeah i would tell you that one i always want to start with is just a calibrate shape it's still two percent of the market but it is a growing category and it's very specific you just mentioned new york california other parts that are really promoting it uh that continues to grow um pretty nicely i mean we've kind of forecasted you know a 25 to 30 percent growth over the next several years but um we were north of that in q2 so It still gets momentum. We have a great product line. We're having more and more distributors and retailers stock it in a broader variety, so that's a good thing. Availability is everything. So overall, the category continues to grow, albeit in certain states, but again, it's well above our growth that we've had, and we see it continuing. It's a great product. We have a great product line. It has a nice payback story. It's just one that needs to be planned. And so far, in the markets that are subsidizing it and putting money up front and helping with the purchase, it's growing quite well. So again, 25%, 30% going forward next several years. And we had a nice Q2 that was several points above that.
spk16: Great. That's good to hear. And then maybe we could touch back just on the North American tank list. Congrats on getting that product rolled out. Now, I know a lot of your wholesale distributors across the country for your tank products have relied on other manufacturers such as Renai, Navi, and Rheem for tankless in the past. Could you just talk a little bit more about what you're seeing and hearing from your distributors? Are they... you know, kind of sampling in your product? Or is it sort of more of an, you know, an all or none type of switch that they would have to make? Any color you could give us just kind of on the receptivity and what your conversations have been like?
spk08: Well, I would tell you, you described the market pretty well. And so I think what we're hearing from our distributors, they like some optionality and they would like to buy from us. When you look at, The commitments we have and the long-term relationships that we have with our distribution and be able to sell not only tank type and commercial, but also put tankless on there, I think is really important. We still have to meet the market and be competitive and so forth, and we are. So, you know, overall, do I expect every one of our distributors to drop their current product lines? The answer is no. But I do look forward to adding a very competitive gas tankless product line to their inventory and then let us compete in the market. And I think we're going to do very well. It's going to take us several years to move that forward. But, again, we control our own destiny now. We have great support from our distributors. I look forward to what's going to happen with our gas tankless line as, you know, the next few years kind of develop.
spk18: Thank you. I'm showing no further questions at this time. I would now like to turn it back to Helen Gorhold for closing remarks.
spk07: Thank you, everyone, for joining us today. Let me conclude by reminding you that our global A.O. Smith team delivered record sales and strong EPS in the second quarter. We look forward to updating you on our progress in the quarters to come. In addition, please mark your calendars to join our presentations at three conferences this quarter. Seaport on August 20th, Stiefel on September 4th, and DA Davidson on September 19th. Thank you and have a great day.
spk18: Thank you for your participation in today's conference. This does conclude the program. You may now disconnect. Thank you. Thank you. Thank you. Thank you. Thank you for watching. I'm going to add a new layer. I'm going to add a new layer. Good day. Thank you for standing by. Welcome to the 2024 Second Quarter A.L. Smith Earnings Call. At this time, all participants are in listen-only mode. After this speaker's presentation, there will be a question and answer session. To ask a question during this session, you'll need to press star 1-1 on your telephone. You will then hear an automated message advising your hand is raised. To withdraw your question, please press star 1-1 again. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your first speaker today, Helen Gerholt. Please go ahead.
spk07: Thank you, Marvin. Good morning, and welcome to the A.O. Smith Second Quarter Conference Call. I'm Helen Gerholt, 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 plus capital expenditures. Adjusted earnings, adjusted earnings per share, adjusted segment earnings, and adjusted corporate expenses exclude the impact of pension settlement income and restructuring and impairment 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 queue, please limit yourself to one question and one follow-up for turn. If 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.aosmith.com. I will now turn the call over to Kevin to begin our prepared remarks.
spk08: Thank you, Helen, and good morning, everyone. I'm on slide four and our second quarter results. I'm very pleased with our second quarter performance and how we are tracking for the year. In the second quarter, our global A.O. Smith team delivered record quarterly sales of $1 billion and an EPS of $1.06, a 5% increase over 2023 adjusted EPS. North American water heater and boiler sales increased 10% due to higher volumes and pricing action. China third-party sales grew 2% in local currency. India achieved double-digit growth in local currency for the 10th consecutive quarter. And last week, we announced that we signed an agreement to acquire PURIT, a leading water purification business in South Asia. We look forward to welcoming the PURIT team to the A.O. Smith family later this year. Please turn to slide five. North America water heater sales grew 10% in the second quarter due to higher residential and commercial volumes and pricing actions. We began shipping our internally developed and manufactured gas tankless products in the quarter and we are very pleased with market acceptance. Our North American boiler sales grew 10 percent compared to the second quarter of last year, driven by higher commercial volumes. I am pleased to see a return to growth as channel inventory levels normalized. We are on track to achieve our boiler sales forecast of 8 to 10 percent for the year. Sales of our commercial boilers, particularly our Crest boilers with Hellcat technology, continue to outperform the market. North America water treatment sales increased 8% in 2024 as acquisition-related dealer sales increases were partially offset by weakness in the retail channel. In China, second quarter third-party sales increased 2% in local currency as a result of sales of kitchen products as well as HVAC products that were partially offset by lower volumes of residential water treatment. While markets for our core products remain challenged, We are pleased with our market share in the premium portion of the water heater and water treatment product categories. However, we have seen pricing and promotion pressures, particularly in the mid-price sector of the market. I'm now on slide six. This year, we are celebrating our 150th anniversary. It's a time to reflect on those 150 years of living our values, of achieving profitable growth, emphasizing innovation, preserving our good name, being a good place to work, and being a good citizen. It is also gratifying to be recognized for the continuation of those values. So far in 2024, our team has received several honors that reflect our employees' dedication to our core values. Early this year, A.O. Smith was named one of the world's most ethical companies by Ethisphere, a global leader in defining and advancing the standards of ethical business practices. In addition, our commitment to innovation and energy management has resulted in our Nanjing China plant being selected as one of the 2024 Nanjing Environment Protection Model Enterprises in recognition of our waste and emission reduction efforts. We also received a 2024 Energy Star Sustained Excellence Partner of the Year Award from the EPA for the sixth year in a row for our long-term commitment to energy management through our products. In addition, we were named 2024 U.S. News Best Companies to Work For in Manufacturing by U.S. News & World Report. While the reward is the satisfaction our team receives for doing the right thing and living our values, these honors validate our values as a differentiator for our employees and stakeholders. I'll now turn the call over to Chuck, who will provide more details on our second quarter performance.
spk14: Thank you, Kevin, and good morning, everyone. I'm on slide seven. Second quarter sales in the North America segment were $791 million, a 9% increase compared with 2023, driven by higher water heater and boiler volumes, as well as year-over-year pricing actions. North America segment earnings of $198 million increased 2% compared with 2023 adjusted segment earnings. The higher segment earnings were primarily driven by increased volumes and pricing that were partially offset by higher steel costs and higher selling expenses to support our growth initiatives, including the launch of our gas tankless products. Segment margin was 25.1%, a decrease of 180 basis points year over year. The lower segment margin was due to the reasons I reviewed with regard to segment earnings, which more than offset higher volumes in the quarter. Moving to slide eight, rest of the world segment sales of $245 million were essentially flat to last year and included unfavorable currency translation of approximately $7 million, primarily related to China as well as inter-segment sales associated with recently launched tankless water heaters. Segment third-party sales increased 3% on a constant currency basis. The increase was partially driven by higher sales of kitchen and HVAC products, partially offset by lower sales of residential water treatment products in China. India sales grew 16% in local currency in the quarter, driven by growth in both water heater and water treatment categories, with particular strengths in our e-commerce, retail, and commercial end markets. Rest of the world segment earnings of $26 million decreased slightly compared to segment earnings in 2023, primarily due to the unfavorable product mix and sales promotions in China. Third-party segment operating margin was 11.5%, slightly lower than segment margin in 2023. Please turn to slide nine. We generated free cash flow of $119 million during the first half of 2024, a decrease from the same period last year, primarily as a result of higher inventory and accounts receivable balance, as well as higher incentive payments associated with record sales and profits last year, which more than offset higher earnings and higher trade payable balances. Capital expenditures increased $21 million year over year, driven by our expansion projects. Our cash balance totaled $233 million at the end of June, and our net cash position was $93 million. Our leverage ratio was 6.8%, as measured by total debt to total capital. Now let's turn to slide 10. In addition to returning capital to shareholders, we continue to see opportunities for organic growth, innovation, and new product development across all of our product lines and geographies. As Kevin mentioned earlier, We signed an agreement last week to acquire PURIT from Unilever for $120 million. PURIT offers a broad range of residential water purification solutions and has annual sales of approximately 60 million US dollars, primarily in India. The addition of PURIT strengthens our leadership position as a global supplier of premium water treatment products and will double our market penetration in South Asia. The acquisition will also support our corporate strategy by enhancing our premium product portfolio and distribution footprint. Please turn to slide 11 and our 2024 earnings guidance and outlook. We narrowed our 2024 EPS outlook to an expected range of $3.95 to $4.10 per share. The midpoint of our EPS range has not changed and represents an increase of 6% compared with 2023 adjusted EPS. Our outlook is based on a number of key assumptions, including our guidance assumes that our steel costs in the full year 2024 will be roughly flat to 2023. Our outlook assumes non-steel material costs are similar in 2024 as they were in 2023. Our guidance also assumes a relatively stable supply chain environment, similar to what we experienced throughout 2023. We began shipping our internally designed and manufactured gas tankless products in the second quarter. These products are being manufactured in our China facility until our North America capacity is completed in 2025. Associated import tariffs and other launch costs will impact North America margins by approximately 50 basis points in 2024. The tariff will be eliminated when production moves to Juarez, Mexico. For the year, CapEx should be between $105 and $115 million, an increase over the last several years due to our capacity expansion projects, including our gas tankless facility in Juarez, expansion of our engineering capabilities in Lebanon, Tennessee, and adding high efficiency commercial water heating manufacturing capacity ahead of the 2026 regulatory changes. We expect to generate free cash flow of between $525 and $575 million. Corporate and other expenses are expected to be approximately $65 million. Our effective tax rate is estimated to be approximately 24%. And we expect to repurchase approximately $300 million of our shares of stock, resulting in outstanding diluted shares of $147 million at the end of 2024. I'll 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 2024 while staying on slide 11.
spk08: Thank you, Chuck. We reaffirm our outlook that 2024 sales will grow 3 to 5 percent compared to 2023, which includes the following assumptions. Our outlook includes previously announced price increases in North America water heating of 4 percent on most of our water heater products. Price increase for heat pump products is 8 percent. We began to see realization of the price increases in the second quarter. We believe that a pre-buy ahead of the price increases pulled forward some demand in the first half of the year for both residential and commercial water heaters. We have seen some softness in our orders in July. Due to normal seasonality in the pre-buy, we maintain our projection that 2024 U.S. residential industry unit volumes will be flat to last year. And our projection that U.S. commercial water heater industry volumes will increase low single digits in 2024 is also unchanged. Our outlook assumes that new residential home construction and proactive replacement will remain at levels similar to last year. In China, we believe the economy and consumer confidence remain weak. We continue to see headwinds in consumer demand. While we are cautious about the second half of the year, we maintain our 2024 third-party sales growth guidance to be between zero and 3% in local currency. Our forecast assumes a negative currency translation impact of approximately 2% for the year. We reaffirm that we expect our boiler sales to grow 8% to 10% over last year. Our sales growth guidance from North America Water Treatment of an increase of 8% to 10% is also unchanged. Based on our 2024 assumptions, we expect our North America segment margin to be approximately 25%. and the rest of the world third-party segment margin to be approximately 10%. Please turn to slide 12. We are pleased with our performance in the first half of 2024. We saw strong growth in water heaters in the first half of the year, which we believe was partially driven by the pre-buy. We are pleased to see a return to growth in our North America boiler business as channel inventory levels normalize and we continue to benefit from the transition to higher energy efficiency boilers particularly in commercial applications. Our three capital expansion projects that will add capacity for key product categories in North America are on track and will position us well for long-term growth. India remains on track for another year of projected double-digit sales growth. We're excited to complete the PURIT acquisition later this year, which will double our sales in the South Asia region. Pure's strong brand and strength in the e-commerce channel will complement our premium brand and make us the number three residential water treatment company in India. Even as we celebrate our 150th anniversary and our rich history of innovation with employees, customers, and partners, we remain focused on meeting the needs of our customers and executing our key strategic priorities to advance our leadership position in heating and treating water around the globe. That concludes our prepared remarks, and we are now available for your questions.
spk18: Thank you. At this time, we'll conduct the question and answer session. As a reminder to ask a question, you'll need to press star 1-1 on your telephone and wait for your name to be announced. To withdraw your question, please press star 1-1 again. Please stand by while we compile the Q&A roster. Our first question comes from the line of Matt Summerville of DA Devis. Your line is now open.
spk21: Thanks. A couple questions. I was hoping maybe you could spend a moment, Chuck, kind of talking about how we should be thinking about the margin cadence in both North America and the rest of the world in the back half of the year, given some of the pluses and minuses you were describing.
spk14: Yeah, good morning, Matt. Happy to. You know, if you look at the cadence for the back half of the year, clearly we had a strong first six months. We mentioned a bit of what we believe to be a pre-buy in the North America market with our price increase. So as you kind of look at volumes of North America, look at Q3 as being a bit challenged because of some of that pre-buy. And then Q4 probably looking very similar to Q2. A little bit of headwind and the volumes in Q3 and a little bit of return back to where we were on Q2 in the fourth quarter with continued momentum on the gas tankless product. Margins will follow. The margin cadence in the third quarter will be challenged by the volume headwind in the third quarter. In China, we're coming off what I would say a solid first half of the year. Still see weakness in the economy, as Kevin mentioned. As always, our fourth quarter is expected to be the strongest as we go into the back half of this year. Third quarter also will be a bit challenged on the volume side, we believe. We've seen a bit of weakness, July orders, both on China and both within China and in North America. A little bit of a slow start to the third quarter, and that'll probably translate into volume headwinds, and it'll leave a little bit of an impact on the margins.
spk21: Got it. And then as a follow-up, could you maybe comment on what the channel inventory picture looks like in China? And I think in your prepared remarks, there was a mention about maybe seeing a little bit more price competition in the mid-price point category. Can you elaborate on that a bit?
spk08: Yeah, hi, this is Kevin. Maybe I'll touch base on inventories are pretty much where we expect them to be in that four to six week range. So nothing that meaningful. There's ups and downs as we go forward. What we mentioned is it's a very competitive market. Consumer demand is weaker than it's been. And so the consumers are a bit cautious. So we're seeing a bit more, I would say, promotional activities. We saw it in Q1. And that's kind of carried over into Q2 as well. I think our team's managing it really well. Again, we don't chase every order. We're very selective in how we go to market. And if you look at it overall, going 2% in local currency in a very competitive market, it has some consumer headwinds. I think our team's done a really nice job of balancing those competitive dynamics. I also want to remind people that we also have some areas in China that are growing well. You look at our kitchen, products are doing well, commercial water treatment is doing well, and so is our HVAC part of the business. So being diversified as we are on the water heating side and water treatment, but also having the other adjacencies has helped and made a difference in this difficult market. So overall, I'm very pleased that we're right on China, and we'll keep managing it in the back half of the year.
spk18: Thank you. We'll move it for our next question. Our next question comes from the line of Jeff Hammond of KeyBank Capital Markets. Your line is now open.
spk04: Hey, good morning. Good morning. Maybe just to start on the acquisition, just give us a sense of, you know, kind of profitability of the business or opportunity, you know, from a profitability standpoint. and kind of what the growth rate's been for the business, you know, last five years?
spk08: Well, I'll take the first part of it and just to talk about the acquisition in general. First, I want to go back to our Indian business is performing really well. We have a terrific management team that's been executing for quarter after quarter. And we're looking to scale that business both organically and inorganically. And Pura plays a nice role in that business. It's a solid brand in the market. It complements our India business that we have today. They're stronger in e-commerce, have a nice retail presence that also dovetails with our general trade and our retail presence. So overall, the business is doing well. It's a premium brand. We do overlap, but we're not exactly have products positioned right next to each other. So if you look at it, the overall, the brand, the product positioning, we're excited about bringing the team on. And doubling our business is going to make a big difference. It's going to make a difference in our scale. We're also going to be able to leverage our infrastructure that we have on the ground there, whether it be logistics, manufacturing, you name it. So doubling our business, we're excited in doing it with a premium company like PURIT and a premium brand. really sets up nicely as we go forward after the close.
spk14: And from a financial profile, it looks very similar to our India business today. I mean, period business is the majority is in India, but it's also in Bangladesh and some shipments outside of the Sri Lanka and Vietnam, but In total, roughly the same size as our business, around $60 million. Profitability-wise, very similar to what our India business has experienced in the last couple of years, meaning low to mid single-digit profitability. Growth-wise, as a premium brand, they've seen also very good growth in the region. Kevin mentioned 10 consecutive quarters of 15-plus percent growth. I believe they've seen very similar growth rates. So we're pleased with the way the financial profile matches up. And as Kevin said, coming together, we would hope, you know, to continue that growth momentum on a larger base and look for opportunities to leverage the bottom line as we go forward.
spk04: Okay. And then just on working capital, it seems like you had a much bigger working capital build in the first half versus, you know, maybe... maybe the last couple years. Is that just timing? Do we expect to get a lot of that back in the second half?
spk14: Yeah, we expect to get it back in the second half. It's timing. It's a little bit of tankless water heater inventory being built up, but for the large part, it's timing.
spk18: Thank you. One moment for our next question. Our next question comes from the line of Susan McClary of Goldman Sachs. Your line is now open.
spk05: Thank you. Good morning, everyone.
spk18: Good morning, Susan.
spk06: My first question is, you know, you mentioned that boilers saw some growth or reverted back to growth in the quarter. Can you talk about, you know, what's driving that and the sustainability of it? Just any comments on the comps that you face in the back half and how you're thinking about the path from here?
spk08: Well, if you look at it, it's mainly on the commercial side of our business, Susan. And we came off a pretty difficult quarter last year, but still our quoting has been active. That transition from kind of standard models to high efficiency continues. So overall, We're about where we thought we would be. Our new products are doing well. I mean, the Crest Boiler has always done well, but you add the Hellcat technology on top of that, and that's just being really well received in the market. Order rates have been good. They continue to be good. Backlog is strong. So overall, I just think the commercial segment is doing well. The overall industry is slightly up. We're doing better than the industry. And even on the residential side of the business, that's also a positive. Again, 8 to 10 coming off some easier comps, but the overall macro environment is good, and it plays really well into lock and bar and our high-efficiency focus that we've had over the years, and we're seeing some real benefits from that.
spk14: And just to comment on cadence on the comps, I mean, we're up 8% this quarter, but the comps get easier quarter over quarter when we get to the third and fourth quarters, so we feel very comfortable with the 8 to 10% growth.
spk06: Okay, that's helpful. And then turning to steel, we've seen that come down quite a bit recently. How do you think about the flow through of that to the business? You know, perhaps any impact there to North America over the coming quarters and just, you know, overall the trend for pricing?
spk14: Yeah, I mean, the steel has come down a little bit. By the way, boilers grew at 10%. I said 8%, so I'll just correct that. It's a 10% growth for the second quarter. As we look at steel, we're thinking our outlook has steel roughly flat year over year. As we mentioned, steel went up in the second quarter compared to first quarter by about 20%. It was about 25% higher than Q2 last year. you know, there was a bit of a ramp up. We've seen some softening in steel. As you recall, our lag is 90 to 120 days. So as we kind of look at the back half of the year, we see, you know, quarter over quarter Q2 to Q3, a little bit of relief. And then as we look into the fourth quarter, you know, with that lag, you know, we haven't baked in all of our indexes because they haven't all been issued. As you know, it's a monthly index that sets The pricing, as you look, 90 to 120 days out. So we do expect a little bit of relief in the fourth quarter, and it pegs kind of our outlook very similar to what the index was issued for the month of June.
spk18: Thank you. One moment for our next question. Our next question comes from the line of Sari Brodowski of Jeff Briefs. Your line is now open.
spk17: Good morning. Thanks for taking our question. You know, you cited some softer orders in July on the water heater side. Could you just quantify this at all? And then does your guidance assume that demand stays in line with this softer July rate?
spk08: Yeah, and just to mention, we always give you an outlook, you know, for the month we're in on the call. But if you look, we talked about a pre-buy. We do believe there was a pull ahead. And we started to see a bit of softness in May and June into July. But I think July is also one of our weaker months, and really the third quarter is one of our weaker months because of the summer and the heat and so forth. So that's why we do think it's going to... return as we get into August and September. And that's why we're holding a flat rate for the US residential tank type market through the balance of the year. So it's a temporary low that I think just gets us back to where our forecast has been for the entire year.
spk17: Thank you. And then turning to Tankless, you started to ship some in the second quarter. What are you seeing from a demand perspective there? And then just on the modeling, what is the impact from Tankless to China sales this year? And does this create a challenging segment comp when you do ship production to North America next year?
spk08: Well, I would tell you, again, we're coming from a low, kind of a mid-single-digit market share. So we've had a very good launch. And I don't want to give you any numbers because They would sound really high, and they are for us. We're very pleased with the adoption by our customers. And again, we launched the high-end condensing model first, and that's been well received by a number of customers, and it's easily hitting our expectations as we start to launch this product going forward. Again, we'll have two more products coming in by the end of the year, which will complete the line, and then our factory in Juarez is on track, maybe a bit ahead of schedule, and we'll start to do some assembly and manufacturing towards Q4 and get ready in 2025. Maybe I'll have Chuck touch on that, but having the tariff go away at the start of 2025 is gonna make a big difference in how we view this from a margin perspective going forward.
spk14: Right, I mean, Sri, from a comp perspective, You know, it's all positive when we move to Juarez. We relieve ourselves of the 25% tariff. We take away the long logistics lead time and some of the costs associated with bringing the product all the way back to North America from China. So we're really viewing when we start up production at Juarez, it's a very positive upside to our tankless category.
spk18: Thank you. One moment for our next question. Our next question comes from a line of Andy Kapowitz of Citigroup. Your line is now open.
spk20: Good morning, everyone.
spk03: Good morning, Andy. Good morning.
spk20: You mentioned lingering pricing promotion pressure in China. I think you talked about margin there a little bit, but You obviously kept your guidance for rest of the world margin at 10%. So my question is how difficult is it to maintain that margin sort of guidance moving forward? What cost actions or anything else are you doing to sort of offset lingering price pressure?
spk08: Yeah, I'll touch on it first, and then maybe Chuck will jump in. You know, it's a tough market, and as we said, we're cautious about even our guidance, but Our team's doing a terrific job balancing not only price and promotion, but also the cost of our business. You know, we talked way back when we went through the pandemic, a lot of our costs are now more variable than they are fixed. And so we're just balancing it. Again, we're a premium brand, so we're in a different part of the market in a different clientele. But overall, it's still a tough environment. And most of the pressures that we're receiving are kind of in that mid to upper mid level, not on the higher level. And our team's evaluating it. Again, I think we're taking a targeted approach. It's not going to be easy, but we're confident in our China management that they can navigate the way through the second half of the year.
spk14: Yeah, we took quite a few cost actions within the COVID timeframe in China. And like Kevin said, to change some of our cost structure to more variable, take costs out of the business. close some very, you know, less profitable store footprints and feel pretty good about our position to be flexible as volumes challenge us a bit. So, you know, we'll continue to watch it. Right now, I think we've got China at about 11% for the year, very similar to last year. We anticipate being able to kind of work through it and continue to focus on cost and be at that percentage.
spk08: yeah and it will introduce funeral products in the back half of the year check i mentioned q4 is our strongest quarter and again we're building some momentum in in commercial water treatment we're building momentum on our hbac site so again putting the combination together uh challenging but we think it's very doable got it i just want to maybe ask the same question on north america again like in terms of the margin like just make sure i understand it so
spk20: You steal slightly better, you know, you're saying flattish versus a modest headwind, I think is what you previously said. But you also talked about Q3, you know, maybe being a little light or lighter in sort of volume. And I guess that's the incremental margin headwind holding you back. Is there anything else, like launch costs and decimals a little higher than expected? I know you said the 50 days point, so any color would be helpful.
spk14: I mean, nothing new I don't think that we haven't talked about before. I'll just mention that the tankless launch does cause some pressure on margins at 50 basis points. It's sort of spread to the full year margin projection of 25%. So clearly as we launch it, it's heavier weighted into Q2, Q3, and Q4. So that's probably the only other area of a little bit of headwind on margins that I would say to take into account as you're thinking about the back half of the year.
spk18: Thank you. One moment for our next question. Our next question comes from the line of David McGregor of Longbow Research. Your line is now open.
spk13: Yes, good morning, everyone, and thanks for taking my questions. I guess I wanted to focus in on the increased selling expense in North America. I'll talk about how that North American selling expense compared year over year when you exclude the gas tankless rollout, and also, I guess, how we should be modeling that through the second half.
spk14: Yeah, I mean, it really tracks closely with volumes, right? So our cost structure on selling expense is, largely based on a commission basis. So as we sell, you know, more product, we're going to have a higher selling expense. We also emphasize different products, you know, with a different commission level to drive initiatives from time to time. So somewhat variable, I think, is the best way to look at it and tracks closer to volumes than it does just kind of flat out expenses. We do mention, you know, the launch of Tankless products. So we've got some initiatives within you know, a launch of the tankless products that's driving that number just a little bit higher?
spk08: Yeah, I'll just add, I mean, we're excited about our tankless offering, being that it's internally designed, it's going to be manufactured in North America, and we're going to own the category from our own perspective rather than from partnering with somebody. We're going to promote this product for the first part of the year, make sure we can get everybody to understand what the product does, training, some promotional activities. All those are really important for us to get that product in the market, make sure people understand the features and benefits and how they really can benefit them going forward and how we can compete long-term in this category.
spk13: one-time expense but it's one that we're going to kind of lean into to make sure that we get the product off and and off to a good start got it thanks for that and then as a follow-up on the boiler business i mean you've guided to up eight to ten percent for the year what's the right way to think about how uh profitability compares uh with last year and um what you may have in your guidance
spk14: Well, volumes being up certainly helps us. You know, when you look at the boiler business, it's largely commercial product that we're talking about being increased 8% to 10%. So, you know, it's an improvement when you've got growth in that product category.
spk18: Thank you. One moment for our next question. Our next question comes from the line of Scott Graham of Seaport Research Partners. Your line is now open.
spk09: Hey, good morning. Thanks for taking the questions. Hey, so the no change in the U.S. resi water heater industry, thinking of flat, you know, I know we talked about in quarters past, a couple quarters, that second half comparisons get a little bit tougher, so you want to be careful with that number. you know, the first half year to date is up in resi, maybe even a little unexpectedly, certainly from this point of view, is your thinking on flat now maybe a little bit more leaning into the, maybe the market is in fact weakening given your, you know, last couple of months sales volumes, or are you kind of going to hold the course with, you know, flat because the comps are tougher and there's really, and you're not trying to message anything.
spk08: Yeah, I don't think we're really trying to message. We've always thought we came off a pretty strong year last year. And going forward, if you look, you look at our emergency replacement, which is always going to stay the same, proactive, new construction. Again, whether it's single-family or multi-family, we felt that was going to be relatively flat. You know, interest rates would probably keep it flat. We saw that the pre-buy, we're a little surprised when the 4% pulled forward a bit more than we had thought. But when you step back now and you kind of look at how we started the year, kind of a trending down to maybe give some back, and then you look forward the next five months, we're just very comfortable as a flat year with strong growth in gas tankless, and we're going to see some good growth in heat pump, both residential and maybe even some commercial as well.
spk09: just trying to get back on track where we really think the market is and and we're very comfortable with that flat residential outlook just based coming off a very strong year thank you kevin so similar question on the north american segment margin you kind of you didn't change that either yet you're kind of calling for um some spot weakness here in the third quarter no pun intended um i'm just wondering is that that is the no change in that margin because maybe you left some wiggle room in there and or that you're actually seeing things that are making you more bullish on the fourth quarter margin and if so what no i wouldn't say we're more bullish i mean we we still believe 25 is going to be you know where we are well where we'll end up we were about at that in q2 on some really nice volumes
spk14: So Q3 will be a little more challenged on that because we will give back some of the volumes, at least in our outlook, and then back to volumes that would drop to the bottom line. A little lower steel than our last assumption. So there is a little bit of opportunity on the steel side when we look at our guidance from a quarter ago. But we're still feeling 25% is kind of the midpoint of where we think we'll end up.
spk18: Thank you. One moment for our next question. Again, as a reminder to ask a question, you'll need to press star 11 on your telephone. Our next question comes from the line of Damian Karras of UBS. Your line is now open.
spk12: Hi. Good morning, everyone. Morning. Morning.
spk16: I was wondering if you might be able to give us a little bit of an update on what you're seeing for heat pump water heaters. I think we've seen states like New York and some others finalize their IRA allocations, a lot of those kind of really ramping up. So could you tell us what you've been seeing with the heat pump product, how it's been trending and kind of expectations through the rest of the year into next year?
spk08: Yeah, I would tell you that one, I always want to start with is just a calibrate shape. It's still 2% of the market, but it is a growing category and it's very specific. You just mentioned New York, California, other parts that are really promoting it. That continues to grow pretty nicely. I mean, we've kind of forecasted, you know, a 25 to 30% growth over the next several years, but we were north of that in Q2. It still gets momentum. We have a great product line. We're having more and more distributors and retailers stock it in a broader variety, so that's a good thing. Availability is everything. So overall, the category continues to grow, albeit in certain states, but again, it's well above our growth that we've had, and we see it continuing. It's a great product. We have a great product line. It has a nice payback story. It's just one that needs to be planned. And so far, in the markets that are subsidizing it and putting money up front and helping with the purchase, it's growing quite well. So again, 25%, 30% going forward next several years. And we had a nice Q2 that was several points above that.
spk16: Great. That's good to hear. And then maybe we could touch back just on the North American tank list. Congrats on getting that product rolled out. Now, I know a lot of your wholesale distributors across the country for your tank products have relied on other manufacturers such as Renai, Navi, and Rheem for tankless in the past. Could you just talk a little bit more about what you're seeing and hearing from your distributors? Are they... you know, kind of sampling in your product or is it sort of more of an, you know, an all or none type of switch that they would have to make? Any color you could give us just kind of on the receptivity and what your conversations have been like?
spk08: Well, I would tell you, you described the market pretty well. And so I think what we're hearing from our distributors, they have some optionality and they would like to buy from us. When you look at The commitments we have and the long-term relationships that we have with our distribution and be able to sell not only tank type and commercial, but also put tankless on there, I think is really important. We still have to meet the market and be competitive and so forth, and we are. So overall, do I expect every one of our distributors to drop their current product lines? The answer is no. But I do look forward to adding a very competitive gas tankless product line to their inventory and then let us compete in the market. And I think we're going to do very well. It's going to take us several years to move that forward. But again, we control our own destiny now. We have great support from our distributors. I look forward to what's going to happen with our gas tankless line as, you know, the next few years kind of develop.
spk18: Thank you. I'm showing no further questions at this time. I would now like to turn it back to Helen Gorhold for closing remarks.
spk07: Thank you, everyone, for joining us today. Let me conclude by reminding you that our global A.O. Smith team delivered record sales and strong EPS in the second quarter. We look forward to updating you on our progress in the quarters to come. In addition, please mark your calendars to join our presentations at three conferences this quarter. Seaport on August 20th, Stiefel on September 4th, and DA Davidson on September 19th. Thank you and have a great day.
spk18: Thank you for your participation in today's conference. This does conclude the program. You may now disconnect.
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