A. O. Smith Corporation (NYSE:AOS) Q2 2023 Earnings Call Transcript

A. O. Smith Corporation (NYSE:AOS) Q2 2023 Earnings Call Transcript July 27, 2023

A. O. Smith Corporation misses on earnings expectations. Reported EPS is $0.82 EPS, expectations were $0.91.

Operator: Good day, and thank you for standing by. Welcome to the A. O. Smith Corporation Q2 2023 Earnings Conference Call. At this time, all participants are in a listen-only mode. [Operator Instructions]. Please be advised that today’s conference is being recorded. Without further ado, I’ll hand the conference over to your first speaker, Helen Gurholt. Helen, please go ahead.

Helen Gurholt: Thank you, Eric, and good morning, everyone, and welcome to the A.O. Smith Second Quarter Conference Call. I’m Helen Gurholt, 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 nonoperating noncash pension income and 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. 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 1 question and 1 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 investors.aosmith.com.

I will now turn the call over to Kevin to begin our prepared remarks. Please turn to the next slide.

Kevin Wheeler: Thank you, Helen, and good morning, everyone. I’m on Slide 4, and we’ll review a few highlights of our second quarter results. Our team delivered record adjusted EPS of $1.01 in the second quarter, driven by strong performance in our operating segment. We saw margin expansion in our North America segment, primarily due to a more favorable price cost relationship as well as robust demand for our commercial and residential water heaters. Our Rest of World segment delivered improved performance in the second quarter even as headwinds in the economy and currency exchange continue in China. Both China and India delivered sales growth of 15% local currency in the second quarter. Please turn to Slide 5. North America water heater sales decreased 2% in the second quarter of 2023 as higher volumes are offset by lower pricing.

We saw continued resilience in residential water heater demand and year-over-year improvement in our commercial water heater business. Our North America boiler sales declined 13% in the second quarter compared to a tough comp last year as lower volumes more than offset the benefits from pricing. Channel inventory levels of residential and light commercial boilers remain elevated in the quarter as a warmer-than-normal winter resulted in lower industry demand. We believe channel inventory levels are approaching normal levels at the end of the quarter. Demand for our custom commercial high-efficiency condensing boilers, particularly our Hellcat Crest boilers with O2 sensing technology were steady in the quarter and continues to gain traction in the market.

North America water treatment sales were down 2% in the second quarter of 2023 compared to another tough comp in 2022 as pricing and strong e-commerce sales were offset by lower sales in our specialty wholesale and dealer channels. Sales in the first half of 2022 benefited from strong shipments as supply chain constraints improved, and we worked out our order backlog. I’m particularly pleased with the margin improvement we have seen this quarter in our North America water treatment business. In China, second quarter sales increased 15% in local currency compared to the second quarter of 2022 which was negatively impacted by COVID-19-related shutdowns. Demand continued to improve for our products, particularly for residential and commercial water treatment products.

Sales of water treatment consumables were particularly strong in the quarter. We also saw a favorable mix in our water treatment and electric water heater product categories this quarter as recently launched products continue to be well received by the market. I’m now on Slide 6. According to our recent national consumer survey, nearly 9 out of 10 Americans have concerns about microplastics in their drinking water. Reducing plastic pollution has long been a priority for our North America water treatment business. Our North America water treatment products filter enough water to potentially eliminate over 1 billion single-use plastic bottles per year. I am pleased to announce that all of our countertop and undersink water filters are now independently certified to remove up to 99.6% of microplastics in addition to over 70 other contaminants, including PFAS and pesticides.

We remain committed to leading the charge in identifying and becoming certified to remove harmful contaminants as they emerge. I’ll now turn the call over to Chuck, who will provide more details on our second quarter performance.

Charles Lauber: Thank you, Kevin, and good morning, everyone. I’m on Slide 7. Second quarter sales in the North America segment were $722 million, up 3% decline from the same period last year. The decrease is primarily driven by higher commercial and residential water heater volumes that were more than offset by lower boiler sales and pricing. Lower volumes contributed to approximately 1/2 of the organic growth decline. North America adjusted segment earnings of $194 million increased 19% compared with the second quarter of 2022. Adjusted operating margin of 26.9% improved 510 basis points from the segment adjusted operating margin in the second quarter of last year. The higher segment earnings and operating margin were primarily due to lower steel costs and higher volumes of commercial and residential water heaters partially offset by lower boiler volumes.

Moving to Slide 8. Rest of World segment sales of $244 million increased 6% year-over-year and 12% on a constant currency basis. Currency translation unfavorably impacted segment sales by approximately $14 million. Our sales increase was primarily driven by higher consumer demand and favorable mix in China, particularly for residential and commercial water treatment products. India sales grew 15% in local currency in the second quarter compared to last year. Rest of World segment earnings of $28 million increased 56% compared to segment earnings in 2022. Segment operating margin was 11.6%, and an increase of 370 basis points compared to the second quarter of last year, primarily as a result of higher volumes of water treatment products and positive mix.

Please turn to Slide 9. We generated free cash flow of $236 million in the first half of 2023, higher than the first half of 2022 due to higher earnings and lower working capital cash outlays primarily related to lower inventory levels and lower 2022 incentive payments paid in 2023. Our cash balance totaled $410 million at the end of June, and our net cash position was $204 million. Our leverage ratio was 9.8% 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 of cash to shareholders. Earlier this month, our Board approved our next quarterly dividend of $0.30 per share. We repurchased approximately 1,075,000 shares of common stock in the first half of 2023 for a total of $70 million.

We are committed to repurchasing $300 million of our shares for the full year of 2023. 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 lines and geographies. We believe that our technology leadership and culture of innovation puts us in a strong position to capitalize on the mega trends of decarbonization and sustainability. The strength of our balance sheet also allowed us to pursue strategic acquisitions as we grow organically. Please turn to Slide 11 in our revised 2023 earnings guidance and outlook. We’ve increased our 2023 outlook with an expected adjusted EPS range of $3.45 and $3.60 per share.

The midpoint of our adjusted EPS range represents an increase of 12% compared with 2022 adjusted EPS. Our outlook is based on a number of key assumptions, including our outlook assumes a relatively stable supply chain with limited disruption. We remain in close contact with our suppliers and logistics providers to manage and resolve supply chain issues as they arise. We have increased our North America full year margin guidance to a range of between 24% and 24.25% based on our full year outlook on volumes and price cost relationship. We will have higher steel costs in the back half of the year, which will put some pressure on North America margin. We forecast that 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 remain at current levels. Our Rest of the World margin guidance of approximately 10% remains unchanged. We expect to generate free cash flow of between $550 million and $600 million. For 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 we expect to repurchase approximately $300 million of shares of our stock, resulting in an average outstanding diluted shares of $151 million at the end of 2023. We I’ll now turn the call back over to Kevin, who will provide more color on our key markets and top line growth outlook for 2023, all staying on Slide 11.

Kevin?

Kevin Wheeler: Thank you, Chuck. We revised our 2023 sales projection to be a range of flat to up 2% compared to 2022, which includes the following assumptions. Residential water heater demand was resilient in the first half of the year. Therefore, we project 2023 residential water heater industry volumes to be flat to up 2% compared to last year. We continue to monitor proactive replacement and new housing completions, both of which remain strong. Demand for commercial electric water heaters greater than 55 gallons was strong in the first half of the year, which leads us to raise our guidance for commercial water heater industry volumes to increase mid-teens compared to 2022. We maintain our guidance that our sales in China will grow 3% to 5% in local currency in 2023.

We believe it will take time for consumer confidence to strengthen and for the economy to improve in China. Our forecast assumes that the Chinese currency will devalue approximately 5% in 2023 compared to 2022. We have decreased our outlook for our boiler business from being up mid-single digits to being down high single digits compared to last year. Last year, our boiler business grew 28% compared to 2021 partially driven by our backlog reduction during the year. We believe channel inventory levels of residential and light commercial boilers were elevated coming into 2023. The mild winter and warm spring resulted in lower demand coming out of the heating season, which slowed channel inventory reduction efforts. Orders for our energy-efficient custom commercial condensing boilers remain steady.

Our outlook for North America water treatment sales growth of 5% to 7% for 2023 has not changed. We project that our sales in India will grow 15% compared to last year. Please turn to Slide 12. We are very pleased with our performance in the first half of 2023. Demand for our commercial water heaters was strong. We saw resilient demand for our residential water heaters as new housing completion and proactive replacement remain robust. Our second quarter ’23 — 2023 North America adjusted operating margin of 26.9% was driven by improved price cost relationship and will lead to a full year margin improvement even as our steel costs rise in the second half of the year. Our China business performed well in a weak economy in the second quarter with sales growth of 15% and operating margins of over 12%.

Market-leading products such as our high flow and hot water purifiers as well as dual tank electric water heaters led to a positive mix in the quarter. India continues to outperform the industry as our innovative new products drive market share gains. As a final note, the U.S. Department of Energy has recently issued its proposal to raise the minimum energy efficiency standards for residential water heaters that is targeted to be affected in 2029. As we review the DOE’s proposal, we continue to dialogue with the DOE and other industry participants to offer guidance from our unique market leadership perspective to ensure the final proposal considers all factors that may impact consumers, including affordability, installation challenges, market adoption and consumer awareness as well as state and local electrification regulations.

As a leader in energy-efficient water heater solutions, we believe A. O. Smith is well positioned to deliver a broad range of products that will meet or exceed the DOE requirements. And finally, our focus remains on meeting the needs of our customers as we continue to execute key strategic objectives to advance our position as a global water technology leader. With that, we conclude our prepared remarks, and we are now available for your questions.

Q&A Session

Operator: [Operator Instructions]. And our first call comes from Matt Summerville with D.A. Davidson.

Matt Summerville: A couple of questions. As we think about kind of the first half, second half margin cadence in North America, how should we be thinking about how much margin compression is going to come from steel versus maybe some of the mix headwinds you might have given the change in your boiler outlook for North America? And then I have a follow-up.

Charles Lauber: Matt, this is Chuck. So when you kind of look at the front half, back half, I think of it in terms of 3 buckets, right? So you’ve got the price cost relationship to be compressed a bit by steel costs being up about 20%. That’s probably the largest piece of the delta between first half and second half. Also the way the year is setting up on residential water heater, we’ve got the first half, and this is fairly typical, but maybe a little stronger than normal of residential and water heating at about 52.5% to 53% of the year, and then it is 47% to 47.5% in the back half. So there’s a little bit of pressure on that because of the detriment of some volume on the residential side. And then the smallest piece, I would say, is kind of related to boilers in the mix, a little bit less mix on the higher end commercial boilers.

Matt Summerville: Got it. And then as a follow-up, just with respect to China, can you talk about the sustainability of water treatment demand there that you saw in the second quarter, perhaps maybe why the water heater business may be lagging a bit? And maybe also comment on sell-in versus sell-through and inventory levels overall in China.

Kevin Wheeler: That was quite a question, there’s 4 of them in there. But let me just take the sellout. Sellout was good. It was double digits. We saw sellout improve in each of the months. And so that was a positive trend. Inventories are between that 1% and 2%.

Charles Lauber: One to 2 months.

Kevin Wheeler: One to 2 months, excuse me. Thank you, Chuck. 1 to 2 months and maybe just a tab but nothing out of the ordinary. And as far as going back to water treatment, we just have some terrific products out there that we’ve introduced, and we mentioned it in our remarks on the hot water purifiers that we have in the high flow. They just continue to be well received in the market. Clean water is a priority for the Chinese consumer. So we see that continuing. And then you throw on top of that, our consumables that were really strong, up over 20-plus percent. And each time we sell a water treatment product, we have that potential of the ongoing consumable for the next several years. So that’s gone really well. We continue to see that being a priority for the consumer going into the back half of the year.

And as far as water heating and water treatment and electrics, they are tighter bit to some new housing foundations. So that’s been under pressure for a while. But the electric side performed well, particularly some of our product that we introduced last year, and that continues to move in the right direction. So overall to be up the 50% in Q2 considering the challenges that the economy is having there, I think, is a positive statement of our premium products and how they’re viewed in the market. And maybe the last thing is, if you look at the back half, there is talk about China with some targeted stimulus that’s going forward. They’ve also kind of pulled back on homes as not being able to buy them for speculation. So Q3 may be a little bit tougher, but there’s still some positive momentum in a number of areas, not only with our products, but hopefully, with some of the economic stimulus that should take effect in the back half of maybe Q3 and part of Q4.

Operator: And we have Michael Halloran from Baird.

Michael Halloran: So just some help on the margins in North America here. If you look at the implied assumption in the back half of the year is kind of a historically high pullback in the margin levels and the steel assumptions that you laid out seem a little steep relative to what the market pricing is today. So maybe just help add some context to why there’s that magnitude after all, it was an awfully impressive front half of the year on the margin side. And how we should think about that normalizing for you?

Charles Lauber: Yes. I mean the 20% increase in the back half compared to the front half, it’s a lag. So just to kind of remind you and everybody that there is kind of a 90 to 120-day lag on that pricing. And so even though steel costs have come down a little bit from the peak, they really are — we’re really being measured on those costs, particularly in the third quarter from kind of the February time frame for the next couple of months. So even though they’ve moderated a bit, we’re going to see that headwind. I think the other piece on the mix side and taking the boiler outlook down a little bit, maybe causing a little more pressure, a little more pressure than what you might be accounting for. And I think also if you kind of think about just the volume side and what I mentioned earlier, that’s causing a bit of a mark.

We’ve got back half of the year pricing on boilers and water heating last year that [indiscernible] anniversary, right? So there was improvement year-over-year for the first half. from a comp perspective, but we won’t be seeing that in the back half. Hope that helps.

Michael Halloran: Okay. Yes, it does. And then second one is, I think Kevin in the prepared remarks, you squeezed any idea that you guys are pretty happy with the progression on the margins for your filtration business, water filtration business in the U.S. Just like some context there, is that scale, mix, operations, what are the moving pieces there?

Charles Lauber: Yes. So I mean, we are pleased with the second quarter results for North America water treatment margins for the quarter are right around 12%. There’s a couple of pieces of that. One is pricing that we put in last year that’s now in place. That helps a bit. There’s still some pressure on costs for the water treatment business, but a little relief on transportation is helping a bit. And our direct-to-consumer business was strong in the quarter. So we had a strong direct-to-consumer business that helped a bit on the margin side. So pleased with that. The volume, just recall that last year, we were working through — we’re working through getting our backlog down and got a little bit of benefit there. So pleased with the operating performance. Volume is kind of right where we expect and we expect 5% to 7% growth for the year.

Kevin Wheeler: And maybe just throw in, the team is also doing an excellent job in vertically integrating and cost reductions. And that’s going to continue as we go forward as well. We’re — if you recall, we’ve been a cause of some acquisitions. We’re pulling the water treatment business together in 1 company and in 1 water treatment business and be able to leverage each of the locations and put production where it’s the best cost for us. So overall, all the things that Chuck mentioned, and just a real strong focus on driving cost and continuous improvement has really benefited the organization. And I look at that continuing over the next 6, 7 months as well.

Operator: We have David MacGregor with Longbow Research.

Joseph Nolan: This is Joe Nolan on for David. I just have one quick follow-up on boilers. I think you talked about inventories approaching normalized levels kind of towards the end of the quarter. I guess if you could just talk a little bit more about order patterns and just when we might see those inventory levels officially get back to normalized levels and how you’re thinking about approaching inventories in the back half of the year?

Charles Lauber: Yes. I mean, we exited the second quarter — or we exited this quarter now feeling like the inventories are approaching or we’re probably putting in a good space on normal. Let me kind of break that into 2 pieces, though, on the boiler side. So there’s our larger commercial product that’s not really an inventory item. So that larger commercial product, and we mentioned — Kevin mentioned the Crest 02 sensing product that is doing well. Those orders are steady, larger product really doesn’t have any headwind in any way on kind of the inventory build, where we get the inventory product, and I’d say the lower, smaller, lighter commercial boilers, along with residentials where we’re seeing some of that. But we do believe we’re largely through that. And as we get into the heating season next year, we’ll kind of have better visibility into kind of where we are on inventories, but we do believe we’ve kind of worked through that.

Operator: Okay. Our next question comes from Susan Maklari with Goldman Sachs.

Susan Maklari: When we think about the change in the guide, especially as it relates to the boilers, is there anything also in there as it relates to price especially as you think about some of the changes in demand and perhaps some of the shifts in the steel costs over the last few quarters?

Charles Lauber: Our assumption, I’ll just kind of summarize it is overall, our price/cost relationships a bit improved, and that’s driving a piece of that increase.

Susan Maklari: Okay. And then I guess if we think about the residential water heater demand, and the levels that it’s been running for the industry and for yourselves through May, Europe really nicely versus 2019 even with the level of demand that we saw during the pandemic. Can you just on a higher level, perhaps talk about what are some of the core strengths of that demand, and how do you think about the sustainability of the current level of volumes of the industry and that yourselves are seeing in here as we look out over the next, call it, 12 or even 24 months?

Kevin Wheeler: Well, let’s just maybe break that down into, again, the replacement side. It’s always going to be resilient. The emergency replacement that continues. When we look at right now where it’s at, on the proactive side of the business, people are — we look at — renovation is still a priority for current homeowners and people are going to be staying in their homes, protecting their mortgage interest rates. So we think that’s part of it as it continues to move forward, and we remain an important component of our volume. And then new construction, if you look at just completions have been pretty steady and moving up as well. So and then you look at new builder new builders are confident going forward. So overall, yes, we’re up over the 2019, but we had a CAGR of 1.5% to 2% CAGR that you have to put on the 2019 number.

And as you start to look at where we’re ending up this year, what we think we’re going to end up, it’s going to be fairly in line with where the industry would have benefit. We didn’t go through the ups and downs of the pandemic. So I think we get — we had a little mixed up in 2021 and ’22. And now we’re starting to see things more normalize and the economy has been good, housing’s been good, our renovations have been good. So if you look out in the next 12 to 24 months, I think we’ll start to see more of the normalized growth rate coming out of our water heater business. And maybe just a tad more depending on where interest rates go and how the economy continues to progress.

Operator: Thanks. And our next question comes from Andrew Kaplowitz with Citigroup.

Andrew Kaplowitz: Can you talk about the strength you continue to see in commercial water heaters here in North America, maybe the durability of that strength. You raised your forecast a little bit for the year. You’ve had easy comps, obviously, given the regulatory situation. But could you talk about, as financing costs have been slowly moving up, it still seems like the demand is quite strong in that business.

Kevin Wheeler: On the commercial water heater side, and again, that’s different from boilers because it has the same profile as a residential with emergency replacements and so forth that remains strong. And again, the comps get a little bit difficult because of the greater than 55-gallon electrics. So there was a regulatory change that caused it to downturn in the quarter of 2020 in first quarter. And now we’re starting to really stabilize — and it looks like the greater than 55-gallon electrics going to kind of come back in to where it was prior to that regulatory change. We’re also seeing good mid-single growth on commercial gas as well. And from our perspective, we still have a backlog. And we’re still working through it.

It’s — we’re making progress on it. But the industry seems to be resilient. I look at restaurants and the areas that we sell quite a bit of prior to restaurants, hotels, those things are still coming back and our units are being exercised more. So that’s been a plus for us. So overall, it looks like the industry is again kind of coming back to a normal level of volume coming off, if you remember, in ’21, we were up, I think, 11%, in ’22, we were down 17%, and now we’re moving up to mid-teens. But I think when you level it all out, we’re getting back to a normal cadence. And again, from our perspective, we’ve been outperforming the market in both our residential and commercial products in 2023.

Andrew Kaplowitz: That’s helpful. And then you didn’t change your Rest of World assumption for margin for the year, but you did see a nice step up in Q2, which I think you predicted. But I think you also suggested that you would see incremental margin improvement as the year went on. And again, you didn’t change your overall year guidance. So are you seeing any incremental competitive pressure given the tough China market or incremental supply chain headwinds? Or is it just kind of conservatism given the good Q2 results?

Charles Lauber: Well, we are really pleased with Q2, right? China’s margins were about 12%. We’re very pleased with the results in China for the quarter. If you look out for the rest of the year and China drives the majority of the results in the Rest of the World, Q3 — I’m sorry, Q4 is the big, I’ll call it, holiday shopping, online shopping quarter. Typically, when we have our largest sales, we are turning a quarter on volume, growing 3% to 5% is our outlook. And it will be important we invest behind that. So some of that is waiting to see how Q3 plays out, which we expect we’ll be fine, but not a ton of volume and then investing behind kind of the growth in Q4 keeps the margins a little bit in line with that 11% — 10%, 11%. But nothing from a competitive nature that we’re concerned about.

Operator: Thank you very much. And our next question comes from Nathan Jones with Stifel.

Adam Farley: This is Adam Farley on for Nathan Jones. Most of my questions have already been answered, but I wanted to ask about your capital allocation, the balance sheet remains very strong net cash position. What are the priorities for putting this to work for shareholders? And are there any M&A opportunities out there to move this capital forward?

Charles Lauber: Yes. I mean capital allocation really hasn’t changed. We’re going to continue to invest in ourselves, making sure that we’re investing in the new product developments, the plant automation and the efficiencies that we know we need to continue to drive. Our dividends, we continue to have an increasing dividend year-over-year, and we’ve declared the next dividend. So dividends would be a part of that for sure. We’ve got from a stock buyback, we certainly are in a good underlevered position. So we do expect to repurchase $300 million of shares this year, and that’s expected to be carry out. From an M&A perspective, I’d say it’s still active. So we’ve talked in the past about looking at kind of our priorities around water treatment.

We still see opportunities to grow geographically in North America. We see opportunities to look to acquire maybe in the commercial space in water treatment. We also looked globally since that’s a global technology and global product, other markets where we can see our positioning in a premium space are also of interest. So continue to be active, and we look to deploy capital.

Operator: Stand by for our next caller who is Damian Karas with UBS.

Damian Karas: So sorry if I missed this, but I was hoping you might be able to give us a sense for pricing in the second quarter in North America, kind of thinking about the 3 product categories, water heaters, boilers and water treatment, if you can maybe just give us a sense where pricing is trending? And is kind of the expectation as we get through the rest of the year, maybe a little bit of modest price fade in North America water heaters, just given kind of steel indexing, but no real formally announced price increases kind of in the wholesale channels?

Charles Lauber: Yes. Just a couple of comments. And we don’t get into a lot of detail on pricing. But for the quarter, we’ve got pricing that’s year-over-year improvement in boilers and water treatment because we’ve got price increases this year that were announced at the end of last year. So a little bit of improvement there. I think if you just look at North America overall in our bridges in our presentation, we show what organic — we had a decrease in organic growth. About half of that is volume. So you kind of infer the other half is right around pricing. So if you look at the North America piece in total, it’s fairly weighted on organic growth equally on where the pressure is. Back half of the year, we’ve increased our guidance from where we were for North America margins. So just kind of looking across North America, we’re seeing a little bit of improvement. Our, still, outlook really hasn’t changed.

Kevin Wheeler: Yes, just maybe another comment on this is, again, we’re very consistent in how we manage our businesses and our pricing. There’s not much difference from Q1 to Q2. We continue to have the underlying goals to keep our customers competitive. We look at both the markets that we’re in and the boiler market, that’s remained very consistent. So not a big change. Again, we sell on A. O. Smith value quality delivery, a number of other things that go forward that’s been consistent for a number of years, and it’s not changing as we enter the back half of the year.

Damian Karas: Understood. And then, Kevin, I think you mentioned kind of getting back to normalized demand for resi water heaters. So I’m just curious how you’re thinking today about what normalized demand is. I think historically, maybe you guys have talked about flattish to up a few points of volumes on an annual basis. plus a few points perhaps of price/mix. But how are you thinking about what that kind of framework is thinking of IRA, energy transition, other factors at play today?

Kevin Wheeler: Yes. I don’t think about some of the industry as a whole has changed a whole lot. That 1% to 2% growth is pretty consistent, and it does move a bit when you have new construction. And again, we’re in this economy right now, I mean the economy is still doing pretty well. GDP came out, still moving in the right direction. Housing were still at a deficit. You’ve heard us say that. I think how many years in a row. There’s quite a bit of work to be done, maybe a few million homes that still need to be built. So I think the case is going to get back to that 1% or 2% and probably the variable will be new construction in multifamily, how that continues to progress over the next couple of years. My guess is probably going to be a bit favorable to the industry and to our company.

Charles Lauber: And just a comment around the IRA Act. I mean, there are incentives in there in the IRA act for heat pump water heaters, high-efficiency water heaters. Certainly, that’s an upside, but we have — we really haven’t seen traction to move the consumer’s decision away from kind of the decisions they make today on replacement, which generally is under an emergency replacement type of environment to trade up to an energy-efficient product with a supplement on some sort of incentive through IRA Act. But certainly a longer-term opportunity as we look at that.

Operator: Thank you very much. And our last call comes from Jeff Hammond with KeyBanc Capital Markets.

Jeffrey Hammond: Just on resi water heaters. So I wanted to come back to price because I think you said it was going to be similar, but I’m just wondering if some of the material price formulas flip into the second half with the steel up. And then just how should we think about your 0 to 2 industry number given that it seems like first half was a little more resilient destocking done and the comps, obviously, in the second half are really easy?

Charles Lauber: Yes. Let me talk about the industry first. And if we kind of look back and look back at our Q1, we talked about coming out of 2022 with inventories normal, and I think they might have been a little low. So we have got a little help in Q1 on volumes, building back some of the inventories in the industry that may have been depleted a bit. So kind of a little bit of help in that category. I think if you look at the full year though, and Kevin kind of described it, if you skip COVID, and you just go to 2019 and the 5 years before, and take an average of where we are in those 5 years and then look at the jumping off point of 2019, take a CAGR of 1.5%. And you’re kind of in the ballpark of where we have the industry this year at flat to up a little bit.

The industry ended last year in the tank side on residential, it may be and change. And if we’re flat to that or a little bit up, that’s a 1.5% CAGR jumping off between 2019. The other part of your question, could you remind me on that?

Jeffrey Hammond: Just material price formulas move…

Charles Lauber: Yes. I mean as steel also follows what we see on anything we have with material price in the steel portion is that there’s a 90- to 120-day lag. So that portion also sees pricing follow.

Kevin Wheeler: Yes. And that’s baked into our guidance.

Jeffrey Hammond: Okay. And then last one, water treatment, I think you’re kind of flat to slightly down first half, you’re saying 5% to 7%. Is that just lapping tough comps? Or what’s driving kind of the [indiscernible] there?

Kevin Wheeler: Well, certainly, it’s lapping a tough comp. I mean, if you look at all of our businesses, Q2 of last year, we were strong. But I’ll give you an example. I mean, the North America water treatment back in Q2 of 2022, it was plus 18%. So it was solid. And but we are seeing some softness in various parts of the market as things start to stabilize. But overall, if you look at our 5 core channels, we still see positive growth in them over time. And so that’s just that 2% of 18% comp, still a pretty good quarter, quite frankly, for our water treatment business. And in every one of those channels, we have some ups and downs. I yet to see all 5 up and I have to see all 5 down. And so — but overall, the business is going well.

I suspect we’ll see our deal or specialty business make and come back in the back half of the year as they were down a little bit in Q2. But overall, the business is in good shape. The overall underlying water quality concerns are going to continue to grow, and that’s the key point. I think when you look at this business, you’re going to have your PFAS and different type of chemicals and the quality of water being questioned by consumers on a regular basis. And we have great solutions, whether they be under the counter or point of use or point of entry. And we’re going to be able to take advantage of that trend as it continues to go forward as we have in the past.

Operator: Since I’m showing no further questions at this time, I will turn the conference back to Helen Gurholt for closing remarks.

Helen Gurholt: Thank you, Eric, and thank you, everyone, for joining us today. Let me conclude by reminding you that our global A.O. Smith team delivered record second quarter performance and record EPS. We look forward to updating you on our progress in the quarters to come. Please mark your calendars to join our presentations at 3 conferences this quarter: North Coast on August 7, Stifel on September 6 and Davidson on September 21. In addition, we are very pleased to announce that we will host an Investor Day on Monday, November 6, in Chicago, Illinois. Invitations to register for our event will be forthcoming in September. Thank you, and enjoy the rest of your day.

Operator: And this does conclude today’s conference call. Thank you for participating. You may now disconnect.