A.O. Smith Corp (AOS) — Q2 2018 Earnings Call Transcript

Thank you, Mark. Good morning, ladies and gentlemen, and thank you for joining us on our 2018 second quarter results conference call. With me participating in the call are Ajita Rajendra, Chairman and Chief Executive Officer; Kevin Wheeler, President and Chief Operating Officer; and John Kita, Chief Financial Officer. Before we begin with Ajita's remarks, I would like to remind you that some of the comments that will be made during this conference call, including answers to your questions, will constitute forward-looking statements. These forward-looking statements are subject to risks that could cause actual results to be materially different. Those risks include, among others, matters that we have described in this morning's press release. 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. I will now turn the call over to Ajita, who will begin our prepared remarks on slide 3.

Thank you, Pat, and good morning, ladies and gentlemen. Our 13% sales growth in the second quarter was primarily driven by higher sales of water heaters and boilers in North America, and higher sales in China, including currency gains. Here are a few highlights. We achieved record sales of $833 million. Net earnings of $0.66 per share were 25% higher than our earnings per share in 2017. We continue to review our capital allocation and dedicate a portion of our cash to return to shareholders. We repurchased 1.1 million shares for approximately $70 million through the first half of the year. As a result of continued strong cash flow, our board approved an incremental 2.5 million shares to repurchase at its meeting earlier this month. We plan to continue buying back our shares at the previously stated $135 million annual pace using a 10b5-1 plan and, in addition, opportunistically buy back shares in the open market. We announced a 29% increase to our dividend in January. The five-year compound annual growth rate of our dividend is over 25%. We repatriated nearly $240 million in the first half of 2018 using the proceeds to pay down floating-rate debt and improve the flexibility of our balance sheet. John will now describe our results in more detail beginning with slide number 4.

Sales for the second quarter of $833 million were 13% higher than the same quarter in 2017. Net earnings in the second quarter of $115 million increased 24% from the second quarter in 2017. Second quarter earnings per share of $0.66 increased 25% compared with the same quarter in 2017. Sales in our North America segment of $534 million increased nearly 14% compared with the second quarter of 2017, primarily due to higher volumes of water heaters and boilers in North America and pricing actions related to steel cost increases. North America water treatment sales comprised of Aquasana and Hague, incrementally adding approximately $7 million to our North America segment sales. Rest of World segment sales of $308 million increased 13% compared with the same quarter in 2017. China sales growth was 12%, including a benefit from currency translation of approximately $19 million. China sales grew 4% in local currency. Pricing actions in mid-2017, primarily due to higher steel and installation costs, as well as higher sales of gas tankless water heaters and water treatment products, contributed to higher sales and were partially offset by the decline in air purification products and e-commerce sales compared with the prior year. Our corporate expenses were similar to last year.

Thank you, John. Our outlook for 2018 includes several tailwinds and headwinds. First, our tailwinds. We project U.S. residential water heater industry volumes will increase approximately 350,000 to 400,000 units in 2018 due to continued new construction and expansion of replacement demand. This assumption includes tankless units. Boiler revenues grew 10% in the first half of 2018, driven by solid demand for our commercial boilers and recently introduced products. We expect our boiler sales to grow approximately 10% in 2018. As a result of significantly higher steel prices and inflation in freight and other costs, we announced a price increase effective in early June, which will average approximately 10% on the majority of our U.S. water heater products. We are confident the underlying fundamentals of our China business, including a well-known premium consumer brand and reputation for innovation, reliable products. We expect our average diluted outstanding shares in 2018 to be approximately 173 million.

Before we go on, I want to just summarize and put it all together. 2018 is turning out to be a very solid year for us, with almost 10% top-line growth and 20% EPS growth over last year. We are achieving this without all of our units performing at top levels. And this shows the strength of the portfolio of businesses that we have. And as Kevin said, we're very comfortable with the longer-term 8% organic growth guidance that we've been giving you.

Good morning. And, Ajita, I know that you are not leaving us. But as this is, I'm assuming, your last conference call leading the call, I just want to say congratulations and good luck again, even though I know that you'll still be around. So, I guess, my question will be on China. The slowdown in housing in China has kind of been with us for a while. I'm kind of wondering why all of a sudden is there an inventory channel build as opposed to not having occurred earlier.

I mean, it is kind of a first half/second half, there are different items that have come up. We had talked about the first half being about 4%, and that was due to two reasons. The growth wasn't as much as we expected, but it was the 4% that we had talked about. And it was due to two reasons. One, air purifier's down about $18 million from last year's first half. And the second piece is our online sales are down about 13% when you take out the air purifier portion of that.

Well, that was very clear, John, as far as what's going on this year. I very much appreciate that. I guess I'm hoping the part two of the question is, you guys have expressed – Ajita, your wrap-up comments as well expressed a lot of confidence in your business model in China. And it's understandable.

The longer-term fundamental, I feel very comfortable with, as I said. What's going to happen in 2019? I don't know, because right now what's driving this slowdown in China is the economy in China and the slowdown in housing. Now, we know that that's going to improve at some point.

Thank you for participating in our call this morning. Please take note that we will participate in the D.A. Davidson Industrial Conference on September 20 in Chicago. And please also save the date for our 2018 Analyst Day to be held in Chicago on November 5.