The A.O. Smith Corporation held a Q2 2023 Earnings Conference Call, which was led by Vice President Helen Gurholt and Chairman and Chief Executive Officer Kevin Wheeler, as well as Chief Financial Officer Chuck Lauber. The call provided non-GAAP measures and reconciliations from GAAP measures to non-GAAP measures. Forward-looking statements were also discussed, and participants were asked to limit themselves to one question and one follow-up per turn. Slides were also available on the company's website.

In the second quarter of 2023, the team delivered record adjusted EPS of $1.01 driven by strong performance in their operating segment. North America water heater sales decreased 2%, but residential water heater demand remained resilient. Boiler sales declined 13%, due to a warmer-than-normal winter, and water treatment sales were down 2% due to lower sales in specialty wholesale and dealer channels. Custom commercial high-efficiency condensing boilers, particularly Hellcat Crest boilers with O2 sensing technology, saw steady demand in the quarter.

In the first half of 2022, sales benefited from improved supply chain constraints and working out order backlogs, resulting in margin improvement in the North America water treatment business. In China, second quarter sales increased 15% in local currency compared to the second quarter of 2022. Demand for water treatment products was strong, particularly for residential and commercial water treatment products and consumables. North America water treatment products filter enough water to potentially eliminate over 1 billion single-use plastic bottles per year and all of their countertop and undersink water filters are now certified to remove up to 99.6% of microplastics and other contaminants. In the second quarter, North America segment sales were $722 million, a 3% decline from the same period last year.

In the second quarter of 2023, North America adjusted segment earnings increased 19% and operating margin improved 510 basis points compared to the second quarter of 2022 due to lower steel costs and higher volumes of commercial and residential water heaters. Rest of World segment sales increased 6%, driven by higher consumer demand and favorable mix in China, and segment earnings increased 56% due to higher volumes of water treatment products. In the first half of 2023, free cash flow was higher than the first half of 2022 due to higher earnings and lower working capital cash outlays. The cash balance totaled $410 million at the end of June, and the net cash position was $204 million.

The company has committed to returning capital to shareholders through repurchases and dividends, and is pursuing organic growth through innovation and strategic acquisitions. They have increased their 2023 earnings outlook and North American margin guidance, while expecting higher steel costs in the second half of the year.

CapEx is expected to be between $70 million and $75 million, corporate and other expenses should be around $55 million, the effective tax rate is estimated to be 24%, and $300 million of shares of the company's stock will be repurchased, resulting in an average outstanding diluted shares of $151 million. For 2023, the company revised its sales projection to be a range of flat to up 2%. This includes an assumption that residential water heater demand will be flat to up 2% compared to the previous year, commercial electric water heaters greater than 55 gallons will increase mid-teens, sales in China will grow 3-5% in local currency, and the boiler business will be down high single digits.

The company has seen strong demand for its commercial and residential water heaters in the first half of 2023, resulting in a higher adjusted operating margin in the second quarter. The company's China business also performed well in the second quarter, with sales growth of 15% and operating margins of over 12%. The company is also in dialogue with the U.S. Department of Energy regarding its proposed minimum energy efficiency standards for residential water heaters, which is targeted to be affected in 2029.

A. O. Smith is well positioned to meet the DOE requirements and meet customer needs. There are three main factors that will affect the margin compression in North America for the first half of the year: steel costs being up 20%, residential water heater making up 52.5-53% of the year in the first half, and less mix on higher end commercial boilers.

In the second quarter, sellout in China was double digits and inventories were only 1-2 months. Water treatment products, such as hot water purifiers and consumables, were well received by consumers and performed well, up over 20%. Water heating and electrics have been under pressure due to new housing foundations, but the electric side performed well due to products introduced last year. Overall, the company was up 50% in Q2 despite the challenges the economy is facing.

Charles Lauber explains that the 20% decrease in margins in the back half of the year is due to a 90-120 day lag in steel pricing, as well as decreased demand for boilers and water heating. Additionally, there is pressure from the anniversary of last year's pricing on boilers and water heating.

The team at the filtration business is doing an excellent job with cost reductions and vertically integrating, which has helped improve margins for the North American water treatment business. The pricing put in place last year, relief on transportation costs, and a strong direct-to-consumer business contributed to the 12% margins for the second quarter. Volume is in line with expectations, and growth is expected to be between 5-7% for the year.

Charles Lauber discussed inventory levels for boilers and noted that the larger commercial product does not have any inventory headwinds. He believes that the company has largely worked through the inventory issues with the lower, smaller, and lighter commercial boilers and residential boilers. He also mentioned that the company will have better visibility into inventory levels when the heating season begins next year. Lastly, he addressed the potential impact of changes in demand and steel costs on prices.

Charles Lauber summarizes that their price/cost relationships have improved, driving an increase in demand. Susan Maklari then asks about the sustainability of the current level of demand in the industry and for Rheem. Kevin Wheeler breaks down the demand into replacement, proactive, new construction, and new builders. Overall, the demand is up over 2019, but is in line with the industry's long-term CAGR of 1.5-2%, and is expected to remain steady in 2021 and 2022.

Kevin Wheeler states that the commercial water heater industry is resilient, with strong growth in mid-single digits in gas units and a backlog of orders. The industry has been bolstered by the return of greater than 55-gallon electric units following a regulatory change, as well as increased demand from restaurants, hotels, and other businesses. Wheeler believes that the industry will continue to experience normalized growth in the next 12-24 months, depending on interest rates and the economy.

Charles Lauber of the industry is pleased with the results of Q2 in China, which had a 12% margin. He expects Q3 to be fine but not have a lot of volume, with Q4 being the big online shopping quarter. There is no concern about competitive pressure or supply chain headwinds, but they are investing behind the growth in Q4 to keep margins in line with 10%-11%.

Charles Lauber, CEO of the company, spoke about capital allocation and M&A opportunities. He said that the company will continue to invest in new product developments, plant automation, and efficiency. The company will also declare a dividend and repurchase $300 million of shares this year. He mentioned that they are actively looking to acquire companies in the water treatment, commercial space, and other markets globally. Lastly, he spoke about pricing in the second quarter in North America for the 3 product categories of water heaters, boilers, and water treatment.

Charles Lauber and Kevin Wheeler of A. O. Smith discussed the pricing of boilers and water treatment, noting that there has been year-over-year improvement in North America margins. They also discussed the company's approach to pricing, which is to keep customers competitive while also selling on A. O. Smith's value, quality, and delivery. Lastly, they commented on the normal demand for residential water heaters.

Kevin Wheeler and Charles Lauber discussed the potential for 1-2% growth in the industry and the potential of new construction in the multifamily sector. They also discussed the incentives in the IRA Act, such as for heat pump water heaters and high-efficiency water heaters, but noted that there has not been much traction in terms of consumers making the decision to upgrade to more energy-efficient products. They concluded by noting that material price formulas may flip into the second half with the increase in steel prices.

Charles Lauber and Kevin Wheeler discuss the industry numbers for the year, with an expected CAGR of 1.5%. They also mention that material prices have a 90-120 day lag and that this is factored into their guidance. Lastly, they mention that the water treatment business is expected to be flat to slightly down in the first half due to tough comps.

A.O. Smith had a record second quarter performance and EPS. The North America water treatment business had an 18% growth in Q2 of 2022 and the 5 core channels show positive growth. The underlying water quality concerns are expected to continue to grow and A.O. Smith has solutions to address them. The company will be presenting at 3 conferences this quarter and hosting an Investor Day in November in Chicago, Illinois.

Invitations for an event will be sent out in September and the conference call has now ended.

This summary was generated with AI and may contain some inaccuracies.