Good day. Thank you for standing by. Welcome to the 2024 Second Quarter A.O. Smith Earnings Call. At this time, all participants are in listen-only mode. After the speakers presentation there will be a question-and-answer session. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your first speaker today, Helen Gurholt. Please go ahead.

Thank you, Marvin. Good morning, and welcome to the A.O. Smith second quarter conference call. I'm Helen Gurholt, Vice President of 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 pension settlement income and restructuring and impairment expenses. 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.

Thank you, Helen, and good morning, everyone. I'm on Slide 4 and our second quarter results. I'm very pleased with our second quarter performance and how we are tracking for the year. In the second quarter, our global A.O. Smith team delivered record quarterly sales of $1 billion and EPS of $1.06, a 5% increase over 2023 adjusted EPS. North American water heater and boiler sales increased 10% due to higher volumes and pricing action. China third-party sales grew 2% in local currency. India achieved double-digit growth in local currency for the 10th consecutive quarter. And last week, we announced that we signed an agreement to acquire Pureit, a leading water purification business in South Asia. We look forward to welcoming the Pureit team to the A.O. Smith family later this year. Please turn to Slide 5. North America water heater sales grew 10% in the second quarter due to higher residential and commercial volumes and pricing actions. We began shipping our internally developed and manufactured gas tankless products in the quarter, and we are very pleased with market acceptance. Our North America boiler sales grew 10% compared to the second quarter of last year, driven by higher commercial volumes. I am pleased to see a return to growth as channel inventory levels normalize, and we are on track to achieve our boiler sales forecast of 8% to 10% for the year. Sales of our commercial boilers, particularly our CREST boilers with Hellcat Technology, continue to outperform the market. North America water treatment sales increased 8% in 2024 as acquisition-related dealer sales increases were partially offset by weakness in the retail channel. In China, second quarter third-party sales increased 2% in local currency as a result of sales of kitchen products and HVAC products that were partially offset by lower volumes of residential water treatment. While markets for our core products remain challenged, we are pleased with our market share in the premium portion of the water heater and water treatment product categories. However, we have seen pricing and promotion pressures, particularly in the mid-price sector of the market. I'm now on Slide 6. This year, we are celebrating our 150th anniversary. It's a time to reflect on those 150 years of living our values of achieving profitable growth, emphasizing innovation, preserving our good name, being a good place to work, and being a good citizen. It is also gratifying to be recognized for the continuation of those values. So far in 2024, our team has received several honors that reflect our employees' dedication to our core values. Earlier this year, A.O. Smith was named one of the world's most ethical companies by Ethisphere, a global leader in defining and advancing the standards of ethical business practices. In addition, our commitment to innovation and energy management has resulted in our Nanjing China plant being selected as one of the 2024 Nanjing Environment Protection Model Enterprises in recognition of our waste and emission reduction efforts. We also received a 2024 ENERGY STAR Sustained Excellence Partner of the Year Award from the EPA for the sixth year in a row for our long-term commitment to energy management through our products. In addition, we were named 2024 U.S. News Best Companies to Work for in manufacturing by U.S. News & World Report. While the reward is the satisfaction our team receives for doing the right thing and living our values, these honors validate our values as a differentiator for our employees and stakeholders. I'll now turn the call over to Chuck, who will provide more details on our second quarter performance.

Thank you, Kevin, and good morning, everyone. I'm on Slide 7. Second quarter sales in the North America segment were $791 million, a 9% increase compared with 2023, driven by higher water heater and boiler volumes as well as year-over-year pricing actions. North America segment earnings of $198 million increased 2% compared with 2023 adjusted segment earnings. The higher segment earnings were primarily driven by increased volumes and pricing that were partially offset by higher steel costs and higher selling expenses to support our growth initiatives, including the launch of our gas-tankless products. Segment margin was 25.1%, a decrease of 180 basis points year-over-year. The lower segment margin was due to the reasons I reviewed regarding segment earnings, which more than offset higher volumes in the quarter. Moving to Slide 8, Rest of the World segment sales of $245 million were essentially flat to last year and included unfavorable currency translation of approximately $7 million, primarily related to China, as well as intersegment sales associated with recently launched tankless water heaters. Segment third-party sales increased 3% on a constant currency basis. The increase was partially driven by higher sales of kitchen and HVAC products, partially offset by lower sales of residential water treatment products in China. India sales grew 16% in local currency in the quarter, driven by growth in both water heater and water treatment categories, with particular strength in our e-commerce, retail, and commercial end markets. Rest of the World segment earnings of $26 million decreased slightly compared to segment earnings in 2023, primarily due to the unfavorable product mix and sales promotions in China. Third-party segment operating margin was 11.5%, slightly lower than segment margin in 2023. Please turn to Slide 9. We generated free cash flow of $119 million during the first half of 2024, a decrease from the same period last year, primarily as a result of higher inventory and accounts receivable balances, as well as higher incentive payments associated with record sales and profits last year, which more than offset higher earnings and higher trade payable balances. Capital expenditures increased $21 million year-over-year driven by our expansion projects. Our cash balance totaled $233 million at the end of June, and our net cash position was $93 million. Our leverage ratio was 6.8% as measured by total debt to total capital. Now let's turn to Slide 10. In addition to returning capital to shareholders, we continue to see opportunities for organic growth, innovation, and new product development across all of our product lines and geographies. As Kevin mentioned earlier, we signed an agreement last week to acquire Pureit from Unilever for $120 million. Pureit offers a broad range of residential water purification solutions and has annual sales of approximately US$60 million, primarily in India. The addition of Pureit strengthens our leadership position as a global supplier of premium water treatment products and will double our market penetration in South Asia. The acquisition will also support our corporate strategy by enhancing our premium product portfolio and distribution footprint. Please turn to Slide 11 and our 2024 earnings guidance and outlook. We narrowed our 2024 EPS outlook to an expected range of $3.95 to $4.10 per share. The midpoint of our EPS range has not changed and represents an increase of 6% compared with 2023 adjusted EPS. Our outlook is based on a number of key assumptions, including our guidance assumes that our steel costs in the full year 2024 will be roughly flat to 2023. Our outlook assumes non-steel material costs that are similar in 2024 as they were in 2023. Our guidance also assumes a relatively stable supply chain environment, similar to what we experienced throughout 2023. We began shipping our internally designed and manufactured gas-tankless products in the second quarter. These products are being manufactured in our China facility until our North America capacity is completed in 2025. Associated import tariffs and other launch costs will impact North America margins by approximately 50 basis points in 2024. The tariff will be eliminated when production moves to Juárez, Mexico. For the year, CapEx should be between $105 million and $115 million, an increase over the last several years due to our capacity expansion projects, including our gas-tankless facility in Juárez, the expansion of our engineering capabilities in Lebanon, Tennessee, and adding high-efficiency commercial water heating manufacturing capacity ahead of the 2026 regulatory changes. We expect to generate free cash flow of between $525 million and $575 million. Corporate and other expenses are expected to be approximately $65 million. Our effective tax rate is estimated to be approximately 24%. And we expect to repurchase approximately $300 million of our shares of stock, resulting in outstanding diluted shares of 147 million at the end of 2024. I'll now turn the call back over to Kevin, who will provide more color on our key markets and top line growth outlook and segment expectations for 2024, while staying on Slide 11.

Thank you, Chuck. We reaffirm our outlook that 2024 sales will grow 3% to 5% compared to 2023, which includes the following assumptions. Our outlook includes previously announced price increases in North America water heating of 4% on most of our water heater products. Prices for heat pump products increase by 8%. We began to see realization of the price increases in the second quarter. We believe that a pre-buy ahead of the price increases pulled forward some demand in the first half of the year for both residential and commercial water heaters. We have seen some softness in our orders in July. Due to normal seasonality in the pre-buy, we maintain our projection that 2024 U.S. residential industry unit volumes will be flat to last year. And our projection that U.S. commercial water heater industry volumes will increase low single digits in 2024 is also unchanged. Our outlook assumes that new residential home construction and proactive replacement will remain at levels similar to last year. In China, we believe the economy and consumer confidence remain weak. We continue to see headwinds in consumer demand. While we are cautious about the second half of the year, we maintain our 2024 third-party sales growth guidance to be between 0% and 3% in local currency. Our forecast assumes a negative currency translation impact of approximately 2% for the year. We reaffirm that we expect our boiler sales to grow 8% to 10% over last year. Our sales growth guidance for North America water treatment of an increase of 8% to 10% is also unchanged. Based on our 2024 assumptions, we expect our North America segment margin to be approximately 25%. And the Rest of World, third-party segment margin to be approximately 10%. Please turn to Slide 12. We are pleased with our performance in the first half of 2024. We saw strong growth in water heaters in the first half of the year, which we believe was partially driven by the pre-buy. We are pleased to see a return to growth in our North America boiler business as channel inventory levels normalize and we continue to benefit from the transition to higher energy efficiency boilers, particularly in commercial applications. Our three capital expansion projects that will add capacity for key product categories in North America are on track and will position us well for long-term growth. India remains on track for another year of projected double-digit sales growth, and we're excited to complete the Pureit acquisition later this year, which will double our sales in the South Asia region. Pureit's strong brand and strength in the e-commerce channel will complement our premium brand and will make us the number three residential water treatment company in India. Even as we celebrate our 150th anniversary and our rich history of innovation with employees, customers, and partners, we remain focused on meeting the needs of our customers and executing our key strategic priorities to advance our leadership position in heating and treating water around the globe. That concludes our prepared remarks, and we are now available for your questions.

Thank you. Our first question comes from the line of Matt Summerville of D.A. Davidson. Your line is now open.

Thanks. A couple of questions. I was hoping maybe you could spend a moment, Chuck, kind of talking about how we should be thinking about the margin cadence in both North America and Rest of the World in the back half of the year, given some of the pluses and minuses you were describing?

Yes. Good morning, Matt. Happy to. If you look at the cadence for the back half of the year, clearly, we had a strong first six months. We mentioned a bit of what we believe to be a pre-buy in the North America market with our price increase. So as you kind of look at volumes of North America, we look at Q3 as being a bit challenged because of some of that pre-buy. And then Q4 probably looking very similar to Q2. So a little bit of headwind in the volumes in Q3 and a little bit of return back to where we were on Q2 in the fourth quarter with continued momentum on the tankless gas, tankless product. Margins will follow. The margin cadence in the third quarter will be challenged by the volume headwind in the third quarter. In China, we're coming off what I would say, a solid first half of the year, still see weakness in the economy, as Kevin mentioned. As always, our fourth quarter is expected to be the strongest as we go into the back half of this year. The third quarter also will be a bit challenged on the volume side, we believe. We've seen a bit of weakness, July orders, both in China and in North America. So a little bit of a slow start to the third quarter, and that will probably translate into volume headwinds and it will leave a little bit of an impact on the margins.

Got it. And then as a follow-up, could you maybe comment on what the channel inventory picture looks like in China? And I think in your prepared remarks, there was a mention about maybe seeing a little bit more price competition in the mid-price point category. Can you elaborate on that a bit?

Yeah, hi. This is Kevin. Maybe I'll touch base on. Inventories are pretty much where we expect them to be in that 4 to 6-week range. So nothing that meaningful. There's ups and downs as we go forward. What we mentioned is it's a very competitive market. Consumer demand is weaker than it's been. And so the consumers are a bit cautious. So we're seeing a bit more, I would say, promotional activities. We saw it in Q1, and that's kind of carried over into Q2 as well. I think our team is managing it really well. Again, we don't chase every order. We're very selective on how we go to market. And if you look at it overall, growing 2% in local currency in a very competitive market has some consumer headwinds. I think our team has done a really nice job of balancing those competitive dynamics. I also want to remind people that we have some areas in China that are growing well. You look at our kitchen products, which are doing well, our commercial water treatment is doing well and so is our HVAC part of the business. So being diversified as we are on the water heating side and water treatment, but also having the other adjacencies has made a difference in this difficult market. So overall, I'm very pleased that we're in China, and we'll keep managing it in the back half of the year.

Thank you. One moment for our question. Our next question comes from the line of Jeff Hammond of KeyBanc Capital Markets. Your line is now open.

Hey, good morning.

Morning, Jeff.

Good morning.

Maybe just to start on the acquisition. Just give us a sense of kind of profitability of the business or opportunity from a profitability standpoint and kind of what the growth rate has been for the business in the last 5 years?

I will address the acquisition by first highlighting our Indian business, which is performing exceptionally well. We have an outstanding management team that has consistently delivered strong results. Our aim is to grow this business both organically and through acquisitions, and Pureit plays an important role in that strategy. It is a strong brand that complements our existing operations in India. Pureit excels in e-commerce and has a solid retail presence, aligning well with our overall trade and retail operations. Overall, the performance of the business is encouraging. Pureit is a premium brand, and while there is some overlap, we are not in direct competition. The brand and product positioning look promising, and we are eager to welcome their team on board. Doubling our business with a respected company like Pureit will significantly enhance our scale. We will also be able to take advantage of our existing infrastructure there, including logistics and manufacturing. Partnering with a premium brand like Pureit positions us well for future growth after the acquisition closes.

Yes. And from a financial profile, it looks very similar to our India business today. I mean, the Pureit business is the majority is in India, but it's also in Bangladesh and some shipments outside of the region, including Sri Lanka and Vietnam. But in total, roughly the same size of their business around $60 million. Profitability-wise, very similar to what our India business has experienced in the last couple of years, meaning low to mid-single-digit profitability. Growth-wise, as a premium brand, they've seen also very good growth in the region. Kevin mentioned 10 consecutive quarters of 15-plus percent growth, and I believe they've seen very similar growth rates. So we're pleased with the way the financial profile matches up. And as Kevin said, coming together, we would hope to continue that growth momentum on a larger base and look for opportunities to leverage the bottom line as we go forward.

Okay. And then just on working capital, it seems like you had a much bigger working capital build in the first half versus maybe the last couple of years. Is that just timing? Do we expect to get a lot of that back in the second half?

Yes, we expect to get it back in the second half. It's timing. And it's a little bit of tankless water heater inventory being built up for the large part, it's timing.

Thank you. One moment for our next question. Our next question comes from the line of Susan Maklari of Goldman Sachs. Your line is now open.

Thank you. Good morning, everyone.

Good morning, Susan.

My first question is, you mentioned that boilers saw some growth or reverted back to growth in the quarter. Can you talk about what's driving that and the sustainability of it? Just any comments on the comps that you face in the back half and how you're thinking about the path from here?

If you look at it, it's mainly on the commercial side of our business, Susan. And we came off a pretty difficult quarter last year, but still our quoting has been active. That transition from standard models to high efficiency continues. So overall, we're about where we thought we would be. Our new products are doing well. I mean, the CREST boilers have always done well, but you add the Hellcat Technology on top of that. And that's just been really well received in the market. Order rates have been good. They continue to be good. Backlog is strong. So overall, I just think the commercial segment is doing well. The overall industry is slightly up, and we're doing better than the industry. And even on the residential side of the business, that's also a positive. So again, 8% to 10% coming off some easier comps, but the overall macro environment is good, and it plays really well into Lochinvar and our high efficiency focus that we've had over the years, and we're seeing some real benefits from that.

And just to comment on cadence on the comps, I mean, we were up 8% this quarter, but the comps get easier quarter-over-quarter when we get to the third and fourth quarter. So we feel very comfortable with the 8% to 10% growth.

Okay. That's helpful. And then turning to steel. We've seen that come down quite a bit recently. How do you think about the flow-through of that to the business, perhaps any impact there to North America over the coming quarters? And just overall, the trend for pricing?

Yes. I mean the steel has come down a little bit. By the way, boilers grew at 10%, I said 8%. So I'll just correct that. It's a 10% growth for the second quarter. As we look at steel, our outlook has still roughly flat year-over-year. As we mentioned, steel went up in the second quarter compared to the first quarter by about 20%. It was about 25% higher than Q2 last year. So there was a bit of a ramp-up. We've seen some softening in steel. As you recall, our lag is 90 to 120 days. So as we kind of look at the back half of the year, we see quarter-over-quarter, Q2 to Q3, a little bit of relief. And then as we look into the fourth quarter, with that lag, we haven't baked in all of our indexes because they haven't all been issued. As you know, it's a monthly index that sets the pricing as you look 90 to 120 days out. So we do expect a little bit of relief in the fourth quarter. And it pegged kind of our outlook very similar to what the index was issued for the month of June.

Thank you. One moment for our question. Our next question comes from the line of Saree Boroditsky of Jefferies. Your line is now open.

Good morning. Thanks for taking our question. You cited some softer orders in July on the water heater side. Could you just quantify this at all? And then does your guidance assume that demand stays in line with this softer July rate?

Yes. We always provide an outlook for the current month during the call. We mentioned a pre-buy and noted a pull ahead, along with some softness in May and June leading into July. July is typically one of our weaker months, and the third quarter generally sees lower performance due to the summer heat. However, we expect a return to normal levels as we move into August and September, which is why we are maintaining a flat rate for the U.S. residential tank market for the remainder of the year. This is just a temporary dip, getting us back on track with our forecast for the year.

Thank you. And then turning to tankless, you started to ship some in the second quarter. What are you seeing from a demand perspective there? And then just on the modeling, what is the impact from tankless on China sales this year? And does this create a challenging segment comp when you do ship production to North America next year?

We are beginning from a mid-single-digit market share, and our launch has been very successful. I won't provide specific numbers because they may seem excessively high, but we are pleased with the customer adoption. We initially launched the high-end condensing model, which has been well received and is meeting our expectations as we continue to roll out this product. We anticipate that two additional products will be introduced by the end of the year, completing our line. Our factory in Juárez is on track, possibly ahead of schedule, and we plan to begin some assembly in Q4 to prepare for 2025. The removal of the tariff at the beginning of 2025 will significantly impact our margins moving forward.

Right. I mean, Saree, from a comp perspective, it's all positive when we move to Juárez as we relieve ourselves of the 25% tariff. We take away the long logistics lead time and some of the costs associated with bringing the product all the way back to North America from China. So we're really viewing when we start up production in Juárez as a very positive upside to our tankless category.

Thank you. One moment for our next question. Our next question comes from the line of Andy Kaplowitz of Citigroup. Your line is now open.

Good morning, everyone.

Good morning, Andy.

Morning.

So you mentioned lingering pricing promotion pressure in China. I think you talked about margin there a little bit, but you obviously kept your guidance for Rest of the World margin 10%. So my question is how difficult it is to maintain that margin sort of guidance moving forward? What cost actions or anything else are you doing to offset lingering price pressure?

Yes, I'll touch on it first, and then maybe Chuck will jump in. It's a tough market. And as we said, we're cautious about even our guidance. But our team is doing a terrific job balancing not only price and promotion, but also the cost of our business. We talked way back when, when we went through the pandemic. A lot of our costs are now more variable than they are fixed. And so we're just balancing it. Again, we're a premium brand. So we're in a different part of the market with a different clientele. But overall, it's still a tough environment. And most of the pressures that we're receiving are in the mid- to upper mid level, not on the higher level. And our team is evaluating it. Again, I think we're taking a targeted approach. It's not going to be easy, but we're confident in our China management that they can navigate their way through the second half of the year.

Yes. We took quite a few cost actions over the COVID time frame in China, like Kevin said, to change some of our cost structure to more variable take costs out of the business. We closed some very less profitable store footprints, and we feel pretty good about our position to be flexible as volumes challenge us a bit. So we'll continue to watch it. Right now, I think we've got China at about 11% for the year, very similar to last year. We anticipate being able to kind of work through it and continue to focus on cost and be at that percentage.

Yes. And we'll introduce a few new products in the back half of the year. Chuck mentioned, Q4 is our strongest quarter. And again, we're building some momentum in commercial water treatment. We're building momentum in our HVAC side. So again, putting the combination together is challenging, but we think it's very doable.

Got it. And I just want to maybe ask the same question on North America, again, like in terms of the margin, like just to make sure I understand it. And so steel slightly better. You're saying flattish versus a modest headwind, I think, is what you previously said. But you also talked about Q3 maybe being a little light or lighter in sort of volume. And I guess that's the incremental margin headwind holding you back. Is there anything else like launch costs, investments a little higher than you expected? I know you said the 50 basis points. So any color would be helpful.

I mean nothing new that we've talked about or that we haven't talked about before. I'll just mention that the tankless launch does cause some pressure on margins, and that 50 basis points is sort of spread to the full year margin projection of 25%. So clearly, as we launch it, it's heavier weighted into Q2, 3, and 4. So that's probably the only other area of a little bit of headwind on margins that I would say to take into account as you're thinking about the back half of the year.

Thank you. One moment for our next question. Our next question comes from the line of David MacGregor of Longbow Research. Your line is now open.

Yes. Good morning, everyone, and thanks for taking my questions. I guess I wanted to focus in on the increased selling expense in North America. Can you talk about how that North American selling expense compared year-over-year when you exclude the gas tankless rollout? And also, I guess how we should be modeling that through the second half?

Yes. I mean, it really tracks closely with volumes, right? So our cost structure on selling expense is largely based on a commission basis. So as we sell more product, we're going to have a higher selling expense. We also emphasize different products with a different commission level to drive initiatives from time to time. So somewhat variable, I think, is the best way to look at it, and it tracks closer to volumes than it does just flat out expenses. We do mention the launch of tankless products, so we've got some initiatives within our launch of the tankless products that's driving that number just a little bit higher.

I'm excited about our tankless offering, which is designed in-house and will be manufactured in North America. We plan to take full ownership of this category instead of partnering with another company. In the first part of the year, we will promote this product to ensure everyone understands its features and benefits. Training and promotional activities are essential for getting this product into the market so that people can see how it can help them and how we can compete in this category in the long run. While this will be a one-time expense, it's one we are committed to, as we want to ensure a strong start for the product.

Got it. Thanks for that. And then as a follow-up on the boiler business, I mean you guided to up 8% to 10% for the year. What's the right way to think about how profitability compares with last year and what you may have in your guidance?

Well, volumes being up certainly help us. When you look at the boiler business, it's largely a commercial product that we're talking about being increased by 8% to 10%. So it's an improvement when you've got growth in that segment or in that product category.

Thank you. One moment for our next question. Our next question comes from the line of Scott Graham of Seaport Research Partners. Your line is now open.

Hey, good morning. Thanks for taking the questions.

Hey, Scott.

There has been no change in the U.S. residential water heater industry, which is currently stable. We previously mentioned that comparisons in the second half of the year could be more challenging, so we need to tread carefully with those figures. The first half of the year has shown some unexpected growth in residential sales. Are you now leaning towards a more cautious outlook, considering that the market might be weakening based on your recent sales volumes? Or will you maintain your flat outlook despite the tougher comparisons? You're not trying to convey any particular message with this.

Yes. I don't think we're really trying to message. We've always thought we came off a pretty strong year last year. And going forward, if you look at our merchant replacement, which is always going to stay the same proactive new construction. Again, whether it's single-family or multifamily, we felt that was going to be relatively flat. Interest rates would probably keep it flat. So we saw that the pre-buy, we're a little surprised when the 4% pulled forward a bit more than we had thought. But when you step back now and you look at how we started the year, kind of a trend down to maybe give some back, and then you look forward the next five months. We're just very comfortable as a flat year with strong growth in gas-tankless, and we're going to see some good growth in heat pump both residential and maybe even some commercial as well. So just trying to get back on track where we really think the market is, and we're very comfortable with that flat residential outlook just based on coming off a very strong year.

Thanks for that, Kevin. I have a similar question. Regarding the North American segment margin, you haven't made any changes, yet you're anticipating some weakness in the third quarter. I'm curious if the lack of change in that margin indicates that you may have left some room for flexibility, or if there are factors that are actually making you more optimistic about the fourth quarter margin. If so, what are those factors?

No, I would say we're more bullish. I mean we still believe 25% is going to be where we'll end up. We were about at that in Q2 on some really nice volumes. So Q3 will be a little more challenged on that because we will give back some of the volumes, at least in our outlook, and then back to volumes that would drop to the bottom line. A little lower steel than our last assumption. So there is a little bit of opportunity on the steel side when we look at kind of our guidance from a quarter ago. But we're still feeling 25% is kind of the midpoint of where we think we'll end up.

Thank you. One moment for our next question. Our next question comes from the line of Damian Karas of UBS. Your line is now open.

Hi. Good morning, everyone.

Morning.

Morning, Damian.

I was wondering if you might be able to give us a little bit of an update on what you're seeing for heat pump water heaters. I think we've seen states like New York and some others finalize their IRA allocation, a lot of those kind of really ramping up. So could you tell us what you've been seeing with the heat pump product, how it's been trending and kind of expectations through the rest of the year into next year?

Yes. I would tell you that, one, I always want to start with is just a calibration, it's still 2% of the market, but it is a growing category, and it's very specific. You just mentioned New York, California, and other parts that are really promoting it. That continues to grow pretty nicely. I mean, we've kind of forecasted a 25% to 30% growth over the next several years, but we were north of that in Q2. So it still gets momentum. We have a great product line. We're having more and more distributors and retailers stock it in a broader variety. So that's a good thing; availability is everything. So overall, the category continues to grow, albeit in certain states. But again, it's well above our growth that we've had, and we see it continuing. It's a great product. We have a great product line. It has a nice payback story. It's just one that needs to be planned and so forth in the markets that are subsidizing it and putting money up front and helping with the purchase; it's growing quite well. So again, 25%, 30% going forward the next several years, and we had a nice Q2, which was several points above that.

Great. That's good to hear. And then maybe if we could touch back just on the North American tankless. Congrats on getting that product rolled out. Now I know a lot of your wholesale distributors across the country for your tank products have relied on other manufacturers, such as Rinnai, Navien, and Rheem for tankless in the past. Can you just talk a little bit more about what you're seeing and hearing from your distributors? Are they kind of sampling in your product? Or is it sort of more of an all-or-none type of switch that they would have to make? Any color you could give us just on the receptivity and what your conversations have been like?

Well, I would tell you, you described the market pretty well. And so I think what we're hearing from our distributors is they have some optionality and they would like to buy from us. When you look at the commitments we have and the long-term relationships that we have with our distribution and being able to sell not only tank-type and commercial, but also tankless on there, I think is really important. We still have to meet the market and be competitive, and so forth, and we are. So overall, do I expect every one of our distributors to drop their current product lines? The answer is no. But I do look forward to adding a very competitive gas-tankless product line to their inventory and then let us compete in the market. And I think we're going to do very well. It's going to take us several years to move that forward. But again, we control our own destiny now. We have great support from our distributors. And I look forward to what's going to happen with our gas-tankless line as the next few years develop.

Thank you. I'm showing no further questions at this time. I would now like to turn it back to Helen Gurholt for closing remarks.

Thank you, everyone, for joining us today. Let me conclude by reminding you that our global A.O. Smith team delivered record sales and strong EPS in the second quarter. We look forward to updating you on our progress in the quarters to come. In addition, please mark your calendars to join our presentations at three conferences this quarter, Seaport on August 20, Stifel on September 4, and D.A. Davidson on September 19. Thank you, and have a great day.

Thank you for your participation in today's conference. This does conclude the program. You may now disconnect.