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A.O Smith Corporation (AOS)

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A. O. Smith Corp. (AOS)

Q2 2017 Earnings Call

July 26, 2017 10:00 am ET

Executives

Patricia K. Ackerman - A. O. Smith Corp.

Ajita G. Rajendra - A. O. Smith Corp.

John J. Kita - A. O. Smith Corp.

Analysts

R. Scott Graham - BMO Capital Markets (United States)

Charles Brady - SunTrust Robinson Humphrey, Inc.

Jeffrey Hammond - KeyBanc Capital Markets, Inc.

Alvaro Lacayo - Gabelli & Company

Matt J. Summerville - Alembic Global Advisors LLC

Ryan Michael Connors - Boenning & Scattergood, Inc.

Robert Aurand - Longbow Research LLC

Larry T. De Maria - William Blair & Co. LLC

Bhupender Bohra - Jefferies LLC

Presentation

Operator

Good morning, ladies and gentlemen, and welcome to the A. O. Smith Corporation Second Quarter 2017 Earnings Call. As a reminder, this conference call is being recorded.

I would now like to turn the call over to your host for today's conference, Ms. Pat Ackerman, Vice President, Investor Relations and Treasurer. Ma'am, you may begin.

Patricia K. Ackerman - A. O. Smith Corp.

Thank you, Bridget. Good morning, ladies and gentlemen, and thank you for joining us on our 2017 second quarter results conference call. With me participating in the call are Ajita Rajendra, Chairman and Chief Executive 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 his remarks on slide 3.

Ajita G. Rajendra - A. O. Smith Corp.

Thank you, Pat, and good morning, ladies and gentlemen. Our double-digit sales growth in the second quarter was driven continued strong demand for our consumer products in China and positive end markets for our commercial water heaters and boilers in the U.S. and Canada.

Here are a few highlights. Sales grew nearly 11% to $738 million. Excluding the impact from the strengthening U.S. dollar against the Chinese currency, our sales grew 12.5% in the quarter. China sales were up 20% in local currency. A. O. Smith branded water treatment sales grew over 40% in local currency and air purification product revenue quadrupled. Record-setting net earnings of $0.53 per share were 8% higher than our earnings per share in 2016.

We continue to review our capital allocation and dedicate a portion of our cash to return to shareholders. Through the first half of 2017, we repurchased approximately 1.3 million shares for $66 million. We announced a 17% increase to our dividend earlier this year. The five-year compound annual growth rate of our dividend is over 25%.

Many of you are aware that A. O. Smith joined the S&P 500 Index this morning. We are honored to join this prestigious group of U.S. company. Our inclusion is a significant milestone in our company's very rich history and a testament to the 15,000 men and women around the globe who work very hard every day, living our values and contributing to our success. Today marks a significant accomplishment for all of us.

John will now describe our results in more detail, beginning with slide 4.

John J. Kita - A. O. Smith Corp.

Thanks, Ajita. Sales for the second quarter of $738 million were 11% higher than the previous year. Net earnings in the second quarter of $92 million increased 6% from 2016. Second quarter earnings per share of $0.53 increased 8% compared with 2016. Sales in our North America segment of $471 million increased 9% compared with the second quarter of 2016. The increase in sales was primarily due to higher volumes of commercial water heaters and boilers in the U.S. and pricing actions in August 2016 related to steel cost increases and inflationary pressure on other costs. Aquasana, acquired in August of 2016, added $13 million to our North America segment sales.

Rest of World segment sales of $273 million increased 14% compared with 2016. China sales increased 20% in local currency, driven by higher demand for our consumer products in the region, led by water treatment and air purification products, and pricing actions due to higher steel and other costs, which were announced earlier this year.

On slide 6, North America segment earnings of $109 million were 5% higher than segment earnings in the prior year. The favorable impact from higher sales of commercial water heaters and boilers and the pricing actions in the U.S. were partially offset by significantly higher steel costs. Second quarter segment margin declined to 23.2% from 24.1% one year ago due to higher steel costs. The margin on our Aquasana products is lower than the segment average, which also contributed to the margin decline.

Rest of World earnings of $32.5 million were essentially the same as one year ago. Higher China sales, including the price increase, were more than offset by higher steel costs, increased selling, general and administrative expenses and a less profitable sales mix in China.

Advertising to support brand building and expansion of water treatment and air purification retail outlets in Tier 2 and 3 cities were the primary drivers of higher SG&A in China. Currency translation reduced China earnings by approximately $2 million compared with the prior year. As a result of these factors, second quarter segment margin was 11.9% compared with 13.8% last year.

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