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A. O. Smith Q2 2023 Earnings Call Transcript

Corporate Executives

  • Helen Gurholt
    Vice President, Investor Relations and Financial Planning and Analysis
  • Kevin Wheeler
    Chairman and CEO
  • Chuck Lauber
    Chief Financial Officer
Operator

Good day and thank you for standing by. Welcome to the A. O. Smith First Q2 2023. [Operator Instructions].

Without further adieu, I will hand the conference over to your speaker today, Helen Gurholt. Helen, please go ahead.

Helen Gurholt
Vice President, Investor Relations and Financial Planning and Analysis at A. O. Smith

Thank you, Eric, and good morning, everyone. And welcome to the A. O. Smith second quarter conference call. I am 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, non-operating non-cash 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 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. Please turn to the next slide.

Kevin Wheeler
Chairman and CEO at A. O. Smith

Thank you, Helen, and good morning, everyone. I am on slide four and we will review a few highlights of our second quarter results. Our team delivered record adjusted EPS of a $1.1 in the second quarter, driven by strong performance in our operating segment. We saw margin expansion in our North America segment primarily due to 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 five. North America water heater sales decreased 2% in the second quarter of 2023. As higher volumes were 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 continue 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 am 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 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 am now on slide six. According to our recent national consumer survey nearly 9 out of 10 Americans have concerns about micro-plastics 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 one billion single use plastic bottles per year. I am pleased to announce that all of our countertop and under sink water filters are now independently certified to remove up to 99.6% of micro-plastics, in addition to over 70 other contaminants, including P5 and pesticides. We remain committed to leading the charge in identifying and becoming certified to remove harmful contaminants as they emerge.

I will now turn the call over to Chuck, who will provide more details on our second quarter performance.

Chuck Lauber
Chief Financial Officer at A. O. Smith

Thank you, Kevin, and good morning, everyone.

I am on slide seven. Second quarter sales in the North America segment were $722 million, a 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 one-half 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 margins 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 eight. Rest of the 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 the World segment earnings of $28 million increased 56% compared to segment earnings in 2022. Segment operating margin was 11.6%, 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 nine. 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 175,000 shares of common stock in the first half 2023 for a total of $70 million. We are committed to repurchasing $300 million of our shares for the full year of 2023.

Now I will 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 megatrends of decarbonization and sustainability. The strength of our balance sheet also allows us to pursue strategic acquisitions as we grow organically.

Please turn to slide 11. In our revised 2023 earnings guidance and outlook, we have 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 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, 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 American margins. 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 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.

I will now turn the call back over to Kevin who will provide more color on our key markets and topline growth outlook for 2023, all staying on slide 11. Kevin?

Kevin Wheeler
Chairman and CEO at A. O. Smith

Thank you, Chuck. We revised our 2023 sales projection to be a range of flat up 2% compared with 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 up 2% compared to last year. We continue to monitor proactive replacement and new housing completions, both of which remained 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 strength and 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 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 remained 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 completions and proactive replacement remain robust. Our second quarter 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 US Department of Energy has recently issued its proposal to raise the minimum energy efficient standards for residential water heaters that is targeted to be effective in 2029. As we review the DOE's proposal, we continue to dialog 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.

Operator

Thank you. [Operator Instructions].

Our first question comes from the line of Matt Summerville of D.A. Davidson & Co. Matt, your line is now open, please go ahead.

Matt Summerville
Analyst at D.A. Davidson & Co.

Thanks. Good morning. A couple of questions. As we think about kind of 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.

Chuck Lauber
Chief Financial Officer at A. O. Smith

Good morning Matt, this is Chuck. So when you kind of look at the front half, back half I think of it in terms of three buckets, right so you have got the price cost relationship compressed a bit by steel costs being up about 20%, that is probably the largest piece of the delta between first half and second half. Also the way the year is setting up on residential water heating, we have got the first half, and this is fairly typical, but maybe a little stronger than normal of residential water heating of about 52.5% to 53% of the year and it is 47% to 47.5% in the back half. So there is a little bit of pressure on that because of the decremented 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
Analyst at D.A. Davidson & Co.

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 talked 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. Thank you.

Kevin Wheeler
Chairman and CEO at A. O. Smith

That was quite a question there [Voice Overlap] with four of them in there, but let me just take the -- the sell-out -- sell-out was good, it was it was double digits. We saw solid improved in each of the months, and so that was a positive trend. Inventories are between 1% and 2%.

Chuck Lauber
Chief Financial Officer at A. O. Smith

One or two months.

Kevin Wheeler
Chairman and CEO at A. O. Smith

One or two months excuse me. Thank you Chuck. One or two months and maybe up 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 have 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 the 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 electric, they are tide a bit to some new housing formation. So it has been under pressure for a while, but the electric side performed well, particularly some of our [Indecipherable] product that we introduced last year and that continues to move in the right direction. So overall to be up the 15% 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 is going forward,they've also kind of pulled back on homes as not being able to buy them for speculation. So Q3 maybe a little bit tougher, but there is 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.

Matt Summerville
Analyst at D.A. Davidson & Co.

Thank you.

Operator

Okay standby for our next caller and we have Michael Halloran from Baird. Michael, your line is open. Please go ahead.

Michael Halloran
Analyst at Robert W. Baird

Good morning, everyone. So just some help on the margins in North America here, you look at the implied assumption in the back half of the year it is kind of 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 does that magnitude after what was awfully impressive front half of the year on the margin side, and how we should think about that normalizing for you.

Chuck Lauber
Chief Financial Officer at A. O. Smith

Yeah I mean the 20% increase in the back half compared to the front half, it is -- it's a lag, so just to kind of remind -- remind you and everybody that there is kind of a 90 to a 120 day lag on that pricing. So even though steel costs have come down a little bit from the peak, they really are -- we are really being measured on those cost particularly in the third quarter from kind of the February timeframe for the next couple of -- next couple of months. So even though they have moderated a bit, we are going to see that headwind. I think -- I think the other piece on the mix side and taking the Wheeler outlook down a little bit is may be causing a little more pressure -- a little more pressure than what you might be -- might be accounting it for and I think also if you kind of think about just the volume side and what I mentioned earlier that -- that's causing a bit of a mark. We have got back half of the year pricing on boilers and water heating last year, the anniversary, right, so there was improvement year-over-year for the first half from a comp perspective, but we would not be seeing that in the back half. Hope that helps.

Michael Halloran
Analyst at Robert W. Baird

Yeah it does. Thanks for that Chuck. And then second one is Kevin in prepared remarks you squeezed in the idea that you guys are pretty happy with the progression, the margins for your water filtration business in the US. Just like some context there, the scale mix operations, what are the moving pieces there.

Kevin Wheeler
Chairman and CEO at A. O. Smith

We are pleased with the second quarter results for North America water treatment and margins for the quarter are right around 12%. It is just a couple of pieces of that, one is pricing that we put in last year that is now in place that helps a bit, 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, if you just recall that last year we were 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 5% to 7% growth for the year. The teams is also doing an excellent job in vertically integrating in cost reductions and that is going to continue as we go forward as well. If you recall we have been a [Indecipherable] of some acquisitions [Indecipherable] the water treatment business together as one company and -- and one water treatment business and be able to leverage each of the locations and put production where it -- 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 benefit the organization and I look at it continuing over the next six to seven months as well.

Michael Halloran
Analyst at Robert W. Baird

Thanks everyone. Appreciate it.

Kevin Wheeler
Chairman and CEO at A. O. Smith

Thanks, Mike.

Operator

Stand by for our next caller. And we have David MacGregor with Longbow Research. David, your line is open. Please go ahead

David MacGregor
Analyst at Longbow Research

Hey Good morning. This is Joe Nolan on for David.

Kevin Wheeler
Chairman and CEO at A. O. Smith

Good morning.

David MacGregor
Analyst at Longbow Research

Good morning. 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 are thinking about approaching inventories in the back half of the year.

Chuck Lauber
Chief Financial Officer at A. O. Smith

We exit the second quarter -- we exit this quarter now feeling like the inventories are approaching normal probably put in a good space on normal and we kind of break that into two pieces though on the boiler side, so there is -- there is our larger commercial product that is not really an inventoried item. So that larger commercial product and mentioned -- Kevin mentioned the CREST O2 sensing product that is doing well, those orders are steady. Larger product really does not have any headwind in anyway on the kind of the inventory build. Where we get the inventory product and I would say lower, smaller, lighter commercial boilers along with residentials, where we are seeing some of that, but we do believe we are largely through that and as we get into the heating season next year will kind of have better visibility into kind of where we are on inventories, but we do believe we have kind of worked through that.

David MacGregor
Analyst at Longbow Research

Got it, thanks. All right I will pass it on.

Operator

Okay our next question comes from the line of Susan Maklari of Goldman Sachs. Susan, your line is now open. Please go ahead.

Susan Maklari
Senior Analyst at A. O. Smith

Thank you. Good morning.

Kevin Wheeler
Chairman and CEO at A. O. Smith

Good morning.

Susan Maklari
Senior Analyst at A. O. Smith

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.

Chuck Lauber
Chief Financial Officer at A. O. Smith

Our assumption I will just kind of summarize it. Overall, our price cost relationships have bit improved and that is driving a piece of that increase.

Susan Maklari
Senior Analyst at A. O. Smith

Okay. And then I guess if we think about the residential water heater demand and the levels it has been running for the industry and for yourselves through May you are up 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 some of the core strengths of that demand and how do you think about the sustainability of the current level of volumes, the industry and that yourselves are seeing in here as we look out over the next call it 12 or even 24 months.

Chuck Lauber
Chief Financial Officer at A. O. Smith

Well, let us just say maybe break that down into again the replacement side, it is always going to be resilient, the emergency replacement that continues. When we look at it right now where it is at. On the proactive side of the business, people when we look at the 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 is part of it, as it continues to move forward and will 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 builders are confident going-forward. So overall, we are up over the 2019, but we had a CAGR of 1.5% to 2% CAGR that you have to put on that -- on the 2019 number and as you start to look at where we are ending up this year, what we think we are going to end up, it is going to be fairly inline with where the industry would have been if we did not go through the ups and downs of the pandemic. So I think, we got a little mixed up in 2021 and 2022 and now we are starting to see things more normalized and the economy has been good, housing has been good, renovations have been goods. So when you look out the next 12 to 24 months I think we will start to see more of a 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.

Susan Maklari
Senior Analyst at A. O. Smith

Okay, that is helpful color. Thank you and good luck with everything.

Chuck Lauber
Chief Financial Officer at A. O. Smith

Thanks.

Operator

Thank you. And our next question comes from the line of Andrew Kaplowitz with Citigroup.

Andrew Kaplowitz
Managing Director at A. O. Smith

Good morning, everyone.

Chuck Lauber
Chief Financial Officer at A. O. Smith

Good morning, Andrew

Andrew Kaplowitz
Managing Director at A. O. Smith

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

Kevin Wheeler
Chairman and CEO at A. O. Smith

On the commercial water heater side and again that is 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 2022 first quarter. And now we are starting to really stabilize and it looks like the greater than 55 gallon electric is going to kind of come back into where it was prior to that regulatory change. We are also seeing good mid-single growth on commercial gas as well. And from our perspective we still have the backlog and -- and we are still working through it, it's -- we are making progress on it, but the industry seems to be resilient. I look at restaurants in the areas that we -- that we sell quite a bit products to restaurants, hotels, things are still coming back and our units are being exercised more so that -- 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 the volume coming off, if you remember 2021, we were up I think 11%, in 2022 we were down 17% and now we are moving up to mid teens. I think when you level it all out, we are getting back to a normal cadence. And again, from our perspective, we have been outperforming the market in both our residential and commercial products in 2023.

Andrew Kaplowitz
Managing Director at A. O. Smith

That is helpful and then you did not 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, again you did not 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.

Kevin Wheeler
Chairman and CEO at A. O. Smith

We are really pleased with Q2, right. China's margins were about 12%. We are 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 their results in Rest of the World. Q4 is the big, I will call it holiday shopping online shopping quarter, it is typically when we have our largest sales. We are turning a corner 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 will be fine, but not a ton of volume and then investing behind kind of the growth in Q4, keeps the margins a little bit -- a little bit in line with 10% to 11%. But nothing from a competitive nature that we are concerned about.

Andrew Kaplowitz
Managing Director at A. O. Smith

I appreciate the color.

Operator

Thank you very much. Our next question comes from Nathan Jones with Stifel. Your line is open. Please go ahead.

Nathan Jones
Senior Equity Analyst at A. O. Smith

Good morning, 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 net cash position. What are the priorities put in the stores to the shareholders. Are there any M&A opportunities out there to [Indecipherable] Board?

Kevin Wheeler
Chairman and CEO at A. O. Smith

Good morning. Yeah I mean capital allocation really has not changed. We are going to continue to invest in ourselves, making sure that we are investing in the new product developments, the plant automation and the efficiencies that we know we need to continue to drive. In our dividends, we continue to have an increase in dividend year over year and we have declared the next dividend, so dividends will be a part of that for sure. We have got, from a stock buy back, we certainly are in a good under levered position, so we do expect to repurchase $300 million of shares this year and that is expected to be carried out. From an M&A perspective, I would say it is still active. We have talked in the past about looking at kind of their priorities around water treatment. We still see opportunities to grow geographically in North America. We see opportunities to look through acquire, maybe in the commercial space in water treatment. We also look globally since that is a global technology and global product. Other markets where we can see our positioning in premium space are also of interest. So continue to be active and look to deploy capital.

Nathan Jones
Senior Equity Analyst at A. O. Smith

Thank you for taking my question.

Kevin Wheeler
Chairman and CEO at A. O. Smith

Thanks.

Operator

Standby for our next caller who is Damian Karas with UBS. Damian, your line is open. Please go ahead.

Damian Karas
CFA, Executive Director at A. O. Smith

Hey, good morning, everyone.

Kevin Wheeler
Chairman and CEO at A. O. Smith

Good morning, Damian.

Chuck Lauber
Chief Financial Officer at A. O. Smith

Good morning, Damian.

Damian Karas
CFA, Executive Director at A. O. Smith

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 three product categories, water heaters, boilers and water treatment. If you can maybe just give us sense where pricing is trending and it is kind of the expectation as we get through the rest of the year, maybe a little bit of modest price paid in North America water heaters. Just given kind of steel indexing, but no real formally announced price increases, kind of in the wholesale channels.

Chuck Lauber
Chief Financial Officer at A. O. Smith

Just a couple of comments and you know we do not get into a lot of detail on pricing, but for the quarter, we have got pricing that is year-over-year improvement in boilers and water treatment, because we have 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 had a decrease in organic growth, about half of that is volume. So, you kind of inferred the other half is right around pricing. So if you look at the North America piece in total, it is fairly weighted on organic growth equally and where the pressure is. Back half of the year, we have increased our guidance from where we were for North America margins. So just kind of looking across North America, we are seeing a little bit of improvement and are still our outlook really has not changed.

Kevin Wheeler
Chairman and CEO at A. O. Smith

Yeah, just maybe another comment on this is. Again, we very consistent on how we manage our businesses and our pricing. There is not much difference from Q1 to Q2. We continue to have the underlying goal is to keep our customers competitive, when you look at both the markets that we are in and then the boiler market that has remained very consistent. So not a -- not a big change. Again, We sell on A. O. Smith value, quality, delivery, a number of other things that go forward that has been consistent for a number of years and that has not changing as we enter the back half of the year.

Damian Karas
CFA, Executive Director at A. O. Smith

Understood. And then, Kevin. I think you mentioned kind of getting to know back to normalized demand for resi water heaters. So I am 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 about IRA energy transition, and other factors at play today.

Kevin Wheeler
Chairman and CEO at A. O. Smith

I do not think our thoughts on the industry as a whole has changed a whole lot and that 1% to 2% growth is pretty consistent and it does move a bit when you have new construction and again, we are in this economy right now, I mean the economy is still doing pretty well. GDB came out still, still moving in the right direction. Housing, we are still at a deficit, you have heard us say that I think how many years in a row. There is quite a bit of work to be done, maybe a few million homes still need to be built. So I think the key is going to get back to that 1% or 2% and probably the variable we will be new construction and multifamily how that continues to progress over the next couple years. My guess is probably going to be a bit favorable to the industry and to our company.

Chuck Lauber
Chief Financial Officer at A. O. Smith

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

Damian Karas
CFA, Executive Director at A. O. Smith

Makes sense. Thanks for all the color and good luck.

Kevin Wheeler
Chairman and CEO at A. O. Smith

Thanks.

Operator

Thank you very much. Our last call comes from Jeff Hammond with KeyBanc Capital Markets, Inc. Jeff, your line is open. Please go ahead.

Jeff Hammond
Managing Director at A. O. Smith

Hey guys.

Kevin Wheeler
Chairman and CEO at A. O. Smith

Jeff good morning.

Jeff Hammond
Managing Director at A. O. Smith

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 am just wondering if some of the material price formulas flip into the second half with steel up. And then just, how should we think about your zero to two 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.

Chuck Lauber
Chief Financial Officer at A. O. Smith

Let me talk about the industry first and then 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, I think it is 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 five years before and take an average of where we are and those five years and then look at the jumping off point of 2019, take a CAGR of 1.5%, you are kind of -- you kind of in the ballpark of where we have the industry this year at flat up a little bit. The industry ended last year in the tank side, on the residential, maybe 8%, 7% and change and if we are flat to that a little bit up that 1.5% CAGR jumping off between 2019.

Kevin Wheeler
Chairman and CEO at A. O. Smith

The other part of your question, could you remind me on that.

Jeff Hammond
Managing Director at A. O. Smith

Just material price formulas move forward here.

Kevin Wheeler
Chairman and CEO at A. O. Smith

I mean they as steel also follows what we see on anything we have with material price and the steel portion is that there is a 90 days to a 120 days lag. So that portion also sees pricing follow.

Chuck Lauber
Chief Financial Officer at A. O. Smith

Yeah, and that is baked into our guidance.

Kevin Wheeler
Chairman and CEO at A. O. Smith

Yeah

Jeff Hammond
Managing Director at A. O. Smith

Okay and then last one water treatment, I think you kind of flat to slightly down first half, you are saying, five to seven, is that just lapping tough comps or what is driving kind of the re-excel there.

Kevin Wheeler
Chairman and CEO at A. O. Smith

Well, it is certainly it is lapping a tough comp. I mean if you look at all of our businesses, Q2 of last year, we were strong but I gave the example being the North America water treatment back in Q2 of 2022, it was plus 18%, so it was solid, but we are seeing some softness in various parts of the market as things start to stabilize, but overall, if you look at our five core channels we still see positive growth in them overtime and so that is just 2% up 18% is 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, we are yet to see all 5 up and we are yet to all 5 down, and. So but overall the business is going well. I suspect we will see our dealer especially business make a comeback into 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 is the key point, I think when you look at this business, you are going to have your P5 and different type of chemicals and the quality of water being questioned by consumers on a regular basis. We have great solutions, whether they be under the counter or point to use or point of entry and we are going to be able to take advantage of that trend as it continues to go forward as we have in the past.

Jeff Hammond
Managing Director at A. O. Smith

Okay thanks.

Operator

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

Helen Gurholt
Vice President, Investor Relations and Financial Planning and Analysis at A. O. Smith

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 three conferences this quarter, North Coast on August 7th, Stifel on September 6th and Davidson on September 21st. In addition, we are very pleased to announce that we will host an Investor Day on Monday, November 6th in Chicago, Illinois. Invitations to register for our event will be forthcoming in September. Thank you, and enjoy the rest of your day.

Operator

[Operator Closing Remarks].

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