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.

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.

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.

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…

Thank you, John. We project revenue growth to be between 11.5% and 12.5% in local currency term in 2017, and 10% to 11% in U.S. dollar term. We expect Aquasana sales will be approximately $55 million this year and slightly accretive to earnings. Aquasana sales were up nearly 20% for the first six months of this year compared with last year. With a full year of Aquasana sales as part of A. O. Smith, we expect our global water treatment product sales will be over $275 million in 2017. We project that Chinese currency will depreciate slightly from current levels against the U.S. dollar, resulting in a 4% or $38 million revenue headwind compared with the average rate in 2016. Specific to our North America segment, we project the U.S. residential water heater industry volumes will increase approximately 300,000 units in 2017 due to new construction and expansion of replacement demand. We project U.S. commercial water heater industry volumes will be up 5% to 7% with most, if not all, of the growth in electric units. Lochinvar-branded products grew 5% in the first half of 2017, driven by strong demand for water heaters and solid growth in commercial boilers. We expect double-digit full-year boiler sales growth driven by continued market share gain, new product introduction and energy-efficient product growth. We expect the total portfolio of Lochinvar-branded products to grow 8% into 2017. In 2017, steel prices continue to move up. We expect steel costs in the third quarter will be the highest year-to-date. We recently announced the price increase of approximately 4% on the majority of our U.S. water heater products, effective late August. These factors lead us to expect our North American segment operating margin will be between 21.75% and 22% despite the headwind from lower Aquasana EBIT margin…

Thank you. Our first question comes from the line of Scott Graham with BMO Capital Markets. Your line is open.

Hi. Good morning, all.

Good morning.

Hi, Scott.

John, the steel inflation has gotten a little tamer in recent months. But nevertheless, I'm sure we get your point here. Could you kind of, once again, go over how this rolls into the margin, because it seems like the price increase from last summer, which I think was geared toward offsetting inflation two, three quarters down the line, that something in the spot market, I guess, or the percentage of your spot purchases, has been an offset. Is that a reasonable characterization? But I'm just looking for you to sketch that out for us, because I wouldn't have expected steel inflation to continue to offset the price increase from last summer without some kind of impetus from the spot market. Could you help me with that?

I'll try. I will tell you our steel prices have increased every quarter this year. And clearly compared to the prior years, they're up significantly from the prior year. So when we tear apart, for example, North America second quarter, the pricing could not offset the steel increases last year. I mean, the price increase last year did not offset the steel increases in the second quarter. However, as we talked about in our script, commercial water heaters was extremely strong for us in the quarter, as was commercial boilers. So, those were the contributors on why we had a net positive for the quarter. So, I don't know if that answers it, Scott, or not, but we've had continual increase in steel costs.

Well, you know.

Every quarter this year.

No. And I get that, but I'm just trying to differentiate between, three quarters ago when we put this price increase out, that was supposed to be an offset. So obviously, something has happened in the spot market. What are your spot purchases in North America? Maybe that would help.

Well, I'll take that Scott. When we put it in, there was an anticipation that steel prices, and we talked about it on the year-end call that we thought steel prices would level off and maybe decline. We haven't seen that at all, and they've continued to increase. So, I think that's part of the factor on why we're seeing what we're seeing is they continued to increase higher than what we put.

Right, what our assumptions were. Yeah. Internally.

All right. Two other questions, North American residential water heaters not talked about at all in the press release, in your prepared comments. Why was that seemingly softer in the second quarter?

Well, I'd say they weren't talked about because they were flat to the year, prior year. And you saw that certainly in the April and May data. And I'll tell you what we saw in June, it was the same. So, it was very flat with the prior year. And then, when you look, that's down a couple hundred thousand units from the first quarter. But I'll tell you, overall, we're pleased where the industry is. It's up almost 200,000 when you include tankless year-over-year.

Yeah. And I think a part of it is timing because we had a very strong first half.

First quarter.

First quarter, sorry. And so, it's just the timing of the cutoff, I think. If you look at the first half, it's about where we expected it to be.

Okay. Thank you. Last question is on the Amazon agreement last week. I think that there are some, including myself, speculating that the agreement doesn't end here, that it starts to, at some point down the line, one, two, three years, Amazon moves quickly, so, that's probably more like one to two years, starts to impact the water heater and HVAC markets. And purely, what would be a hypothetical, if that does happen, it would seem as if Sears would potentially stand to benefit and they're a large customer. But the flip side is that, has Amazon – has Sears told you about any designs that Amazon might have on private label, which would probably have to be a U.S. manufacturer, which could benefit you or could not benefit you, depending upon – again, this is speculative, but I'm just wondering what Sears has told you, potentially, on the water heater becoming part of that agreement, but also the potential for private label down the line?

Scott, let me answer the question from a practical perspective, because I don't want to get into too much speculation. The white goods that are distributed by Sears go out of about approximately 200 different DCs around the country. Okay? The water heaters that are distributed by Sears go out of about six DCs around the country. So, the distribution network is nowhere near as close. The second point is that in most places, a water heater needs a licensed plumber to install it; whereas, a lot of white goods is plug-and-play. So, from a practical perspective, leaving aside the big, bulky, heavy, relatively low-value water heaters, moving these around one at a time just becomes economically not feasible. So, we're not speculating too much or don't see too much of an impact coming from this.

And the private label, is that something that Sears has mentioned that maybe Amazon has spoken with them about within appliances?

I mean, we private label for Sears under the Kenmore brand.

Right.

We've been doing that for many, many, many years. And...

Well, I...

I don't see that changing.

Certainly, no, I do understand that. But what I was talking about was maybe a new private label brand.

We have had no indications of that at all.

Yeah, I know. This is only a speculative question. I get it. It's hard one, and I appreciate it.

It would be, in this it will be very difficult to really execute on something like that.

Is a good point. Thank you, Ajita. Thank you, John.

Thank you. And our next question comes from the line of Charley Brady with SunTrust Robinson Humphrey. Your line is open.

Hi. Thanks. Good morning, guys. Good morning, Pat.

Good morning.

Good morning.

Good morning.

Hey. Just on the price increases that relates to steel and the new one that's going through. Are you anticipating that that new pricing will fully offset or is there still a net negative headwind on pricing despite the price increase?

Well, obviously, it depends where steel goes, but we would expect it will offset.

Well, assuming that steel stays flat from where it is today, it would offset it, correct?

Yeah.

Okay. And then, in terms of the China, the drop or the pull back in advertising expense, is that something that we should expect from a longer-term perspective, or is it a temporary or transitory issue just kind of in the back half of the year, and in 2018, it needs to pick back up again?

No, I would say, it probably doesn't need to pick up in 2018. You always have a situation where in the first half of the year, and we experienced that in the second quarter, you have some pretty significant trade shows, where we spent, gosh, $2.5 million, $3 million at the appliance and electronics shows in the second quarter at the Aquatech Show, at the Boiler Show, et cetera. So, we wouldn't – that's not going to repeat itself in the second half. But obviously, we've said all along, advertising is a key component of our SG&A expense as we maintain the brand and build the brand in some of our water treatment and air purification and combi businesses. But I think given some of those expenses in the first half that won't repeat themselves, we're comfortable advertising being down first half year to second half year.

Okay. And just one more for me then. In terms of geographies where you really don't play in right now, you've talked previously about potential areas you can go into and the other areas where it doesn't make a whole lot of sense. Can you kind of update on opportunities to expand beyond where you are geographically today?

Yeah. This is Ajita. We're building a business in Vietnam, which is primarily water treatment, and there's potential for water heater to follow; wherein India, we are exporting into South America and other markets. So, from the point of view – and also we have now in addition to the U.S. exports, which have been established and been there a while, we have two other low-cost country manufacturing locations which we can export from; primarily India and also China, although China capacity is a little more limited – available for export. From that perspective, you could see us exporting from our current manufacturing bases to other countries. In terms of setting up factories in other countries, we don't see anything in the near future just because the scale isn't there to support a manufacturing location.

Great. Thanks for the color.

Our next question comes from the line of Jeff Hammond with KeyBanc Capital. Your line is open.

Hey. Good morning, guys.

Good morning.

Good morning.

Good morning.

Just back on the Rest of World margins, can you just talk about the – I mean, it seems like first half, you were running sub-12% and you're saying 14% for the year. So, maybe just bridge us first half to second half on kind of getting there.

Sure. Well, let's talk about the second quarter first, so you understand what happened, because sales were off and not much dropped to the bottom line. What we had is about two-thirds of our sales increase came from water treatment and air purification. We spent pretty significantly on SG&A and grew the distribution and advertising. So, their profits, even though on two-thirds of the profits – two-thirds of the sales were about flat. Our most profitable major SBU, water heaters, was actually flat in the second quarter which, quite frankly, we expected because of the pre-buy that happened in the first quarter. But we didn't expect is that profits would actually be down and it was a combination of conversion costs, but also some mix. We alluded to mix in the press release and what it was, was some of the high-end electric, fully featured was a smaller percent in the total for the quarter compared to the prior year. So then, we also spent on a new product that we're bringing out, the point of use softener, we spent about $1 million on that, had a loss of $1 million. So, what happened is the higher sales that we got from commercial, that we got from combi, that we got from parts was – parts business is doing very well, kind of offset those losses, so we ended up neutral. Now, when we look to the second half of the year versus the first half of the year, what we have is we're going to get the full benefit of the half-year price increase. And as we alluded to in Ajita's comments, we expanded that price increase in June. And so, we expect to get significantly more price the second half of the year than the first half of the year. If you recall, we basically got nothing in January – I mean, in the first quarter from a price standpoint. And then, two, as we said, SG&A, we expect advertising will be down second half compared to the first half, et cetera. So, that's kind of the major pieces of the bridge from the first half to the second half as well as what happened to the margin in the second quarter.

Okay. Great. And then, Lochinvar, I think you said, Ajita, is up 5% year-to-date. I think you're still saying 8% for the full year. So, what's kind of second half visibility for that step-up?

I think we're seeing the boiler business pick up some of the things we talked about in the first quarter in terms of lots of quoting activity, but the projects being kind of slow. We see that picking up. We are picking up market share, because we were up in the first half. And best information we have is that the market was about flat. And we have some really interesting new products coming out. So, combination of all of that gives us confidence in terms of continuing that growth trend in the second half.

Okay. Thanks for the color, guys.

Our next question comes from the line of Alvaro Lacayo with Gabelli & Company. Your line is open. Alvaro Lacayo - Gabelli & Company: Good morning, everyone.

Good morning.

Good morning. Alvaro Lacayo - Gabelli & Company: Just two quick questions regarding pricing. In North America, the 4%, that's going to be across all the product lines, just wondering, or if it's going to be only specific to certain areas? And then, in China, with the price adjustment that was mentioned on the call, if you can maybe just provide a little more color in terms of is it from a magnitude standpoint or is it going to be extended across other products? And then, I didn't really hear a size, so in terms of how much that price increase or how it'll impact in the second half, that'd be great.

So, I'll start with the China. The China, we did expand it to encompass more products, so it included commercial, it included combi. We also adjusted some of the prices on some of the existing products that we raised in the first quarter. So, to give you a percentage that kind of varies by SBU, I couldn't even give you an average right now. But we did expand it and we also added to some of the existing increases we had in the first quarter. With respect to North America, it would cover the majority of the products, but we did not raise it on things such as tankless and specialty water heaters, such as heat pump, et cetera. So, it was not an increase on that. And as you know, some of our customers have a pass-through for steel, so it didn't affect those. Alvaro Lacayo - Gabelli & Company: Okay. Thank you.

Our next question comes from the line of Matt Summerville with Alembic Global. Your line is open.

Thank you. Just a couple follow-up questions. First, on the commercial side of the business, I think you guys in the Q&A early on gave some color as to what you saw in the residential market in June. I was wondering if you could provide that same color for the commercial market. And then also remind us, sort of between gas and electric, what your relative market share is on the commercial side and, I guess, how that electric side has been progressing post that efficiency standard change?

Well, I'll tell you the first part, which is commercial, June was very strong for us and, we assume, for the market. So, if you look at the first two months of commercial, it was kind of a net flat, but we saw a very strong, and quite frankly, we were up in the first two months even though the market was flat, and then we saw a very strong June. So, that's with respect to commercial water heaters. And as Ajita alluded to, on the boiler side, if you look at our commercial boiler business, it was actually up high teens. The residential boilers were down, partly because of a difficult comp last year, and also as we bring out our new product, getting the heat exchangers is going a little slower than we thought. But we had a very strong commercial boiler business in the second quarter. So, commercial right now, and I know there's mixed signals out there, the Dodge Index is good, the Architectural Index is good, but they're starting to say adjustments could slow in the second half of the year, but we're certainly not seeing it.

Yeah. And just one point of clarification on the residential comp, we brought on a large new customer last year. So, there was a buy-in.

Understood. And then just a follow-up with respect to China. You mentioned sort of the base water heater business was flattish in Q2, likely the result of the pre-buy you saw in Q1, so that's fairly understandable. Have you started to see, three, four weeks into the third quarter, have you started to see that base water heater business, from a volume standpoint, begin to rebound?

One, I don't know and two, I'm not sure we'd really comment if we knew. I mean, I think I'll say we're tracking where we thought where we're going to be in July.

Got it. Thank you.

Our next question comes from the line of Ryan Connors with Boenning & Scatter (sic) [Boenning & Scattergood]. Your line is open. Ryan Michael Connors - Boenning & Scattergood, Inc.: Great. Thank you. I appreciate all the color earlier on the new arrangement with the Sears-Amazon, but wanted to just actually touch on the other shift in channel strategy that you mentioned on the last call, which is the new arrangement with Lowe's. And if you can give us any color there on how that's progressed in terms of sell-through, any competitive update there in terms of how that's impacted the wholesale side, if at all. Just any update there would be great.

That whole changeover is on track. It's gone about as expected. And all the stores have the product and we haven't seen any major shifts. It's kind of as expected, on track.

Yeah. We're comfortable the inventory levels are where they should be. Ryan Michael Connors - Boenning & Scattergood, Inc.: Right.

So, that's a positive. So, they've been able to sell out the old, if you will. And so, the inventory levels are where we want them to be, if you will. Ryan Michael Connors - Boenning & Scattergood, Inc.: Okay. And no sign that there's any impact on the wholesale side in terms of losing the purity there of being a wholesale brand and so forth?

No. Ryan Michael Connors - Boenning & Scattergood, Inc.: Okay. And then, my other quick question was on air purification in China. Really, seems like that is gaining some pretty significant steam here. I know it's a small base, but at this pace, it could be material pretty quickly. So, can you give us an update there in terms of sizing that and whether you envision that now becoming a more significant material contributor to the overall picture in China?

I guess, I'd say it's tracking where we thought. Last year, we sold about $25 million. This year, we expect to sell about $45 million. We did say it was 4 times and that's true, but last year, it was $2.5 million in the second quarter. So, it was about $10 million in the second quarter this year, which is – that's not the prime season. The prime seasons are the fourth quarter and the first quarter. I would tell you, and Ajita may disagree, but the estimates for the growth are not as good as what they are for the water treatment. I think most of them are kind of – estimates are high teens, versus water treatment, clearly, it's 30%-plus. But air purification, we're trying to get a position in the marketplace that we've spent on advertising, et cetera, and to build the brand, and trying to develop products that we think can differentiate it. So, I'd say we're tracking where we thought we were going to be.

Yeah. I think, in terms of just looking out into the future and the potential, it does certainly have the potential to be a much larger business than it is today. But it is a seasonal business. There's about half the year that it sells. There's robust sales, and then during the summertime it isn't as much. Whereas water treatment in comparison, is a year-round product, and just because of the reasonably low household penetration of water treatment products, frankly both products, we see lots of room for both of those businesses to grow. Ryan Michael Connors - Boenning & Scattergood, Inc.: Got it. Well, thanks for your time.

And our next question is from the line of David MacGregor with Longbow Research. Your line is open.

Thank you. Robert Aurand on for David today. Quick question on the pricing in North America, you say it's going to do effect in late August this year. First, I believe, was August 1st last year. How should we think about that gap in terms of profitability here in early 3Q?

I'll try to answer. There is a gap between August and September. We wouldn't expect there would be much pre-buy. It'll happen mostly within the quarter because we'll try to limit it to a month or so. So, we wouldn't expect there will be much pre-buy effect on the quarter. But yeah, there is a gap in the pricing of modeling.

Okay. And then, looking at China, we had maybe heard that some of the domestic manufacturers there are getting more aggressive in the high end of the market. Are you seeing that? And if so, what kind of impact might that have on ASP realizations there?

Your statement is true, but it's not a new phenomenon. It's always been that way. So, from the perspective of any change, we really don't see a change. I've always said China is one of the most competitive markets in the world, because you have every manufacturer in the world there and fighting for space. So, we don't really see a change. It is very competitive.

And I think our competitive advantage of having built up that infrastructure from an engineering standpoint and being first to market with products and with features that the consumer wants, that's still very much in agreement.

Right.

And so, the engineering, the advertising, the brand building, all of that that supports our premium brand position is intact and we keep strengthening it.

All right. Thank you.

Our next question is from the line of Larry De Maria with William Blair. Your line is open. Larry T. De Maria - William Blair & Co. LLC: Hi. Thanks and good morning. As far as the air treatment and water purification, and Rest of World, which is obviously mostly China, can you remind us maybe the profitability either in the quarter or on an annual basis and if they're losing money this year and if they can swing to positive next year as we continue to grow like this given those mid-teens and 30%-plus growth rates you talked about, until we should swing positive next year? Can you just discuss the profitability of those businesses?

Sure. I'll start with air purification, we lost about $5 million last year. We'll lose probably about $2 million this year, but I think our run rate at the end of the year will be breakeven. So, we expect to be breakeven for the year, next year, or profitable in air purification. Water treatment, we are profitable and have been. I think that the litany of our water treatment is a good example of how we try to leverage the high gross margins that we have in this product to ultimately get them to profitability. So when we started the water treatment, we probably lost $10 million, then we lost $6 million, then we made $3 million. And last year, we were at about low-double-digit margins. So, it's a nicely profitable business for us, not at the average for the business, but certainly progressing that way. Larry T. De Maria - William Blair & Co. LLC: That's great. And can you just size that business for us as well, like you do for the treatment business?

Well, I think we said that water treatment will be about $185 million or so in China with the A. O. Smith brand.

And the $275 million I referred to was worldwide.

Yeah. It was worldwide. Larry T. De Maria - William Blair & Co. LLC: Got you. Okay. Very good. Thank you.

Thank you. And our next question is from Bhupender Bohra with Jefferies. Your line is open.

Hey, good morning, guys.

Good morning.

Good morning.

Hey. Congratulations getting the stock into S&P 500 here.

Thank you.

Thank you.

And my question was around the – Ajita, you talked about the retail expansion in the release, you've talked about like Tier 2 and Tier 3, especially on the water treatment side. Could you update us on the retail stores you have in China today? And I don't know if you're doing anything different specific to water treatment, air purification on the retail side?

Go ahead.

Well, to give you an idea, we're over 9,000 stores in the water heater, so about 9,400, 9,500. We would be over 7,000 stores. We've grown that pretty dramatically this year, probably about 900 units or so this year in the water treatment. So, we're over 7,000. In air purification, we're probably at about 3,000 stores or so. Now, again, those last two would probably have a higher percent online. But from a store standpoint, we're continuing to do what we've always done is we'll be the first to tell you there are some underperforming stores. We evaluate those stores quarterly. And ultimately, if we're not comfortable with the forecast of being able to get them to a reasonable level, we'll shut them. And we'll continue to prune stores minus and add stores. So, I think it's a consistent philosophy we've had for the last several years.

And also, in terms of the new categories getting into the stores, it's always an evaluation of the cost of getting in, which is training the people, getting the merchandising, the fixturing and all of that for a new category versus what we expect in terms of revenue and profitability. So, that balance and evaluation that we make whenever you're going to a new store versus not. So, that whole process is an ongoing process.

Okay. And was there any specific portion to Tier 2 and Tier 3 cities? I mean, that's what, I think, you specified in the release here in the quarter.

I think that's where the area of expansion is. That's where the growth in new housing, I'd say, is occurring. And so, we've been moving into that for the last couple of years.

Okay. Got it. And just a follow-on on the Aquasana headwind, I think you mentioned, for this year, it's going to be about like 40 bps. It seems like that's a little bit less than 50 bps on the last quarterly call you mentioned. So, things are progressing well, I guess, on the Aquasana side. Can you give us some color, like how the cost-saving synergies, which you have talked about, are coming through?

Yeah. Well, I think we've said approximately 50 bps.

Less than.

Less than 50 bps. I'd say, I think it's progressing well. Year-to-date, we're up 20% in sales. And the cost synergies that we forecast, I'd say, are probably a little bit ahead.

Yeah, and...

The revenue synergy is probably slightly behind.

Yeah, right.

But overall, we are very happy with the performance and where we are strategically with that acquisition.

And I'd say, their P&L impact has not really changed. They're on plan and meeting the expectations from a P&L standpoint.

Okay. Thanks a lot.

Just one moment while we wait for questions. I'm not showing any further questions. I'll now turn the call back over to Pat Ackerman for closing remarks.

Thank you, all, for joining us today. Please take note that we will participate in the Jefferies Conference in New York City on August 9. Have a wonderful day.

Ladies and gentlemen, this does conclude the program. You may now disconnect.