Good day and thank you for standing by. Welcome to the A. O. Smith Second Quarter 2022 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question-and-answer session. [Operator Instructions] Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Helen Gurholt. Ma'am, please go ahead.

Good morning and welcome to the A.O. Smith second quarter conference call. I'm 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 in the operating results for our business, we provided 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 on non-operating, non-cash pension income and expenses. Reconciliation from GAAP measures to non-GAAP 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 risk 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 for return. 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@investor.aosmith.com. I will now turn the call over to Kevin to begin our prepared remarks. Please turn to the next slide.

Thank you. Helen. And good morning, everyone. Thank you for joining us today. I'm on slide 4 and our second quarter results. Our team performed well throughout the quarter despite an uncertain macro environment to deliver strong sales and EPS performance. Second quarter sales improved 12% year-over-year driven by our 2021 equation related pricing actions. The acquisition of Giant Factories late last year as well as Water Treatment Boiler and Commercial Water Heater volume growth in North America. Our Rest of World segment performance decreased 30% year-over-year, driven by COVID-19 related lockdowns in China. However, we experienced sequential sales improvement in China through the quarter as restrictions began to ease. The acquisition of Giant Factories added $31 million to quarterly sales and $0.01 to EPS. We are pleased with the performance of the team and our integration is on track. We saw quarter-over-quarter improvement in our supply chain in the second quarter was led to higher boiler and commercial water heater volumes. Please turn to slide 5. Our global A. O. Smith team delivered second quarter of 2022 adjusted EPS of $0.82, a 14% increase that was driven in part by 12% increase in sales, compared with the second quarter of 2021. Our strong second quarter performance resulted from our team's outstanding execution. Despite the backdrop of an uncertain macro environment, COVID-19 related lockdowns in China and softness in the residential water heater industry. I am proud of how my A. O. Smith colleagues work together to overcome many challenges to deliver value to our customers across the globe. Excluding the impact of Giant, North America Water Heater sales grew 19% in the second quarter of 2022 due to pricing actions implemented in 2021, and response to rising material and logistics. Lower sales of residential water heaters partially offset sales…

Thank you, Kevin and good morning everyone. I'm on slide 7, second quarter sales in the North America segment rose to $744 million, a 23% increase compared with 2021. Pricing actions largely on water heaters represented approximately 89% of the increase. Sales in the quarter also benefited from higher volumes of water treatment products, boilers and commercial water heaters. That more than offset -- that was more than offset by lower volumes of residential water heaters. Giant acquired in October 2021, added $31 million to North America sales. North America’s adjusted segment earnings of $163 million increased 17% compared with the same period in 2021. The earnings benefit of inflation related price increases was partially offset by higher material and freight cost and lower residential water heater volumes. Adjusted segment operating margin of 21.8% decline compared with the 2021 primarily due to higher material and logistic costs, plants in production and efficiencies and the inclusion of Giant which has lower margins than our legacy water heater business. Moving to slide 8, rest of the world segment sales of $230 million decreased 13% year-over-year, lower sales volumes primarily driven by consumer demand headwinds in China related to COVID-19 related restrictions. Currency translation of China's sales unfavorably impacted sales by approximately $5 million. Sales in India grew 79% in the second quarter of 2022 on strong demand compared to last year, which was negatively impacted by the pandemic. We view India as a long-term growth opportunity given its attractive growth characteristics and changes in demographics. Rest of the World segment earnings of $18 million decreased 18% compared to segment earnings in the second quarter of 2021. In China, the impact of lower volumes was partially offset by lower selling, advertising and engineering expenses. Rest of the World segment margin was 7.9%, down…

Thank you, Chuck. We project revenue growth for 2022 of 12% to 14%, which is lower than our outlook in April as a result of softening demand in residential and commercial water heating. Our sales assumptions include after approximately 8% growth in each of the last two years, which is well above the historical average growth rate. We estimate US residential water heater industry unit volumes will be down approximately 4% to 6% from last year as industry demand normalizes. We project that commercial gas water heater industry shipments will be flat to slightly down for the year. However, we revised our full year outlook for the commercial water heater industry to be down 7% to 9% primarily due to weakness in the large electric grid greater than 55 gallons. The commercial industry started the year weaker than expected primarily due to a regulatory change that temporarily impacted orders in that product category. COVID-19 related restrictions paid out as we expected in the quarter. Therefore, we maintain our sales projection in China to be flat in local currency compared to last year. As a result of the economic headwinds we are experiencing from COVID related restrictions. Due our strong backlog and stable order rates, we have increased our full year boiler sales growth projection from 18% to 20% to 25% sales growth, driven by increased pricing in response to higher input costs and higher demand for our energy efficient products. We project North America Water Treatment sales growth, inclusive of acquisitions to be approximately 50% in 2022 due to strong water quality dealer performance. Based on these factors, along with the full impact of our 2021 price increases, we expect our North America segment margin to be between 22.5% and 23%. And Rest of World segment margin is to be…

[Operator Instructions] And our first question comes from the line of Mike Halloran with Baird.

Hey, good morning, everyone. Couple questions here. First, on the China side, the margins and I think the demand proven relatively resilient, versus the magnitude of the lockdowns, maybe just a little under the hood, how you think about the inventory levels there? How that track through the quarter, how you position in the back half of the year? And then just to comment on the capacity side, and the resiliency, the incremental space?

Sure. Good morning, Mike. This is Chuck. Yes, we're really pleased now China perform for the quarter. We, on our last call talked a little bit about consumer demand being down 35% to 40%, in April, and as you recall that was really the hardest and the severe lockdowns in Shanghai and Beijing. But what we saw in consumer demand for the course of the quarter was consumer demand and it was down about 20%. First quarter was down around 10%. So second quarter average are down around 20%. And as we came out of the second quarter, and what we're seeing in July is we're down about 5% to 10%. So the consumer demand went through pretty well to kind of back to the first quarter. So we're -- then our assumption and guidance is that it stays at that level, kind of for the rest of the year. Inventories, they're flat to down a little bit in the channel, from the first quarter to the second quarter. So they are in a really good position. There's about three to four weeks in the inventory -- in the channel. And that's pretty normal for us, it's at a decently low point. And I'd say we're pleased with 9% in operating margins for the quarter on that lower volume. Some of that was helped by discretionary spending, as we mentioned, that's probably $3 million or so of help on discretionary spending. I'm talking about promotions, advertising, and very little travel for the quarter, as you can imagine in the lockdown situation. And we would expect through the second quarter or third quarters, similar ability to kind of demonstrate this controlling discretionary spending, probably back to spending in the fourth quarter. As that's our largest typical quarter in China. And probably, our projection is to turn that back on. And we would hope for a strong fourth quarter similar to last year.

Great, super helpful. And then Kevin, I think you were talking about the last couple years being awfully strong in the North America, residential water heater side. And it makes a lot of sense that the volume side is down for this year against your comparison. What's the house view on what that run rates going to look like from an industry perspective? We're running high 9 million-ish kind of units right now. Do you guys have a sense from an industry perspective on where that settles in from a downside? And what that might look like?

Well, I think, as we talked about where we're forecasting the 4% to 6% downturn, and we truly believe, and we saw quite a bit of that in June, where we saw many of our customers can bring in inventories down. And, again, as we go forward, this year we look at it's starting to normalize beginning into August, September and the rest of the year. Where it goes forward, I think it's going to depend upon some new construction, but it's slowed down, but we think is going to come back. And but it is going to normalize somewhere down towards the lower level of that 9 million I think over time. It's just a matter of working through kind of some of the inventories and some of the economic disruptions that we're going through today. But still, you look at it still going to be 80%, 85% replacement emergency is going to be very resilient. And there's always going to be potential upside on the new construction if we can kind of get through this supply chain interest rate issue that we're kind of navigating through today as a country.

Yes, just a little more color on the tough comp, right. So that Q2 shipments last year were and I think Kevin mentioned on the call record, but that's inclusive of 2006. So really strong 2021 Q2.

And our next question comes line of Nathan Jones with Stifel.

Good morning, everyone. Maybe just following up on Mike's question on the resi heated business in North America and related to the channel inventories, and you talked about customers taking their inventory down. Do you think that inventory is corrected? How long do you think it takes to correct?

Well, I think it's in the correction right now. Certainly, we believe there was a big correction in June. We're seeing some of it in July. And you step back right now you look at overall in the industry, production has improved, lead times are down. So it's becoming a much more predictable environment. And so with that, I think all of our customers are going to reevaluate. I still think it'll take part of July and maybe a little bit of August, and then kind of normalize as we go through the balance of the year.

Yes, just quantifying the lead times too because we came into the year at 25 day lead times, and we're pretty much on the residential side back to normal 15 day lead time. So kind of progression through the quarter, we went from 25 to 20, in Q1, and then at the end of Q2, two were at 15 day range. So those normalizations have happened in the first half of the year.

Make sense. People would need less inventory under those circumstances. I guess my follow up question is going to be around steel prices and how that could impact the pricing on your products overall. Prices on water heaters are up a lot. They needed to be because steel was up a lot. Cold rolls and hot roll that down probably about 50% from peak prices now. Can you talk about your expectations for how price goes from here, obviously, it'll go on a lag that should be accretive to margins, just any comments you can have on how you're expecting that to go. If steel prices kind of stable from where they are now.

Yes, I mean just a little background color on this steel pricing, because, yes, you're right, your reference of kind of the peak to where they've gone is a pretty big Delta on steel pricing, but kind of the mechanics of what we see. And what we see in cost is not necessarily the peak, it's kind of a weekly average, monthly average, quarterly average that we see 90 to 100 days later. So we're never really at the peak, we're probably never really at the trough. So those are a bit muted from kind of the highlights top and bottom end. And then we see that 90 to 120 day lag. So Q1, we had our highest cost, some of the improvement we saw in Q2 was the result of this little improved steel cost, steel pricing. And we do expect that to, as you noted, we've seen indexes come down, we pretty much know what steel will be for Q3 and we projected in Q4 it will be down a bit too, so we do expect to see some benefit on the steel pricing. It's a little muted from those peaks and troughs, and comes a little delayed. And as far as pricing, we always consider the competitive nature in the marketplace and kind of look at abate in some pressure, not just for steel for other costs. And I'll just say kind of the other cost we're experiencing have been pretty resilient, pretty stable, that are still out there, including freight, logistics and delay.

And our next question comes from a line of Andrew Kaplowitz with Citi.

Quite significantly, from flat down to down 7% and 9%. I think you said last quarter that you are seeing your order volume improvised.

Hey, Andrew.

Yes. Can you hear me, okay?

No. You were you were muted for a while. So could you start over, please?

Yes, I have no problem.

Sorry about that.

Yes, no problem. So you change your outlook for commercial water heater volumes. You are down 7% to 9%, as you said and I think you said last quarter that you were seeing your order volume stabilize after the early regulatory change. So can you give us more color into why the changing guidance? Are you seeing more of a significant change in customer demand there? Or is it just a slow start to the year. Maybe destock there, anymore color will be helpful.

Yes, I'll take that. As we mentioned, we still think commercial gas is going to be flat to slightly down. So that's moving along. But the regulatory change that we experienced in the first quarter, we're seeing our orders normalize. But as we go forward, we believe of the 7% and 9% that we have forecasted being down almost 90% positive, it's going to be in that light service, commercial electric, we just don't see the industry rebounding from a slow start in a quarter. So that's the backdrop of why we're going down, the rest of the commercial businesses quite strong and doing well. And maybe just kind of a reference point that the light service goes into homes and really kind of small businesses. And when you look at our commercial overall business, there's about a 4x or 5x to our commercial overall business, excluding the light service when it comes to price. So it's on the lower end of our pricing curve, but it does drive volume. And we just see now with better visibility, that we need to bring the industry down from a unit standpoint, but feel pretty good about our commercial gas and condensing gas and where that's going.

Got it. That's helpful. And then Kevin or Chuck, maybe just I want to understand the puts and takes, overall, you maintain your EPS guidance, but you did lower your revenue forecast a little bit, maintain margins in North America, China looks pretty good versus expectations. So what are the puts and takes here? Is it -- what's the positives that you're seeing? Is it price versus cost that is the major offset to the lower volumes, any help there?

Yes, I'll start out and Kevin may add on a little bit after that, but I mean, the puts and takes. It’s price versus costa and it's what we are seeing a bit of softening on the steel pricing. So we're getting a little bit of help there. But it's not just the water heating side, it's also pricing that we're going to have implemented in the fourth quarter on both the boiler side of the business and water treatment side of the business. So we've got some second quarter announced price increases that are in the market that should help us a bit in the back half with the margins. Also we had a bit of destabilization during the quarter of water rates on the residential side. And we expect that the plants probably will run a little bit smoother during the back half of the year, during the quarter, our water rates on the residential side, and we expect that the plants probably will run a little bit smoother during the back half of the year. So we would expect a little bit of help there. And then there's a bit of mix opportunity, right, so residential is down in the quarter and residential, we see for the year down 4% to 6%. But as Kevin mentioned, we still feel good about commercial, particularly gas commercial product being strong for the back half of the year. And then boilers and our backlog for boilers is still pretty resilient. And we expect and it's typical that the boilers are strongest in our boiler business is strongest volume in the third quarter. So we would help on the -- we expect help on the mix side also.

Yes, the only thing I might add is even though China has gone through some COVID related lockdowns. We've seen our new products do well. We've seen trade up continue to grow. It's growing for the last couple of years. So we have some positive mix issues here. It's not only in North America, but also we see that also in China.

And our next question comes from the line of Matt Summerville with D.A. Davidson.

Thanks. A couple questions. First on China. If you gave this I apologize. But what is your best estimate on the revenue impact you experienced in the second quarter from the lockdowns? And wherein did you see any sort of difference in out the door demand for water heaters versus water treatment in China? And then I have a follow up.

Yes, I mean, it's hard to call out exactly what's COVID and what's the overall economy in China. So it's really hard to parse that but clearly, we were impacted negatively by COVID. And consumer demand out the door was down about 20%. So that was kind of out the door demand. I would say just kind of within our product categories, certainly the residential products were challenged most so I would say, electric water heaters and water treatment were probably the most challenge during the quarter, commercial water heating, commercial water treatment, the commercial side that's not sold through retail, kind of offset some of that 20% down which viewed as the number for overall sales volume.

Got it and then just with respect to the boiler backlog, can you guys maybe put a finer point on that? How does that compare to prior peaks prior cycles? And can you maybe talk about the magnitude of pricing you're looking for in boilers in treatment to what you just mentioned, a couple of moments ago in the back half. Thank you.

Yes, I'll take the magnitude and maybe Chuck, you can jump in on any of the pricing side of it. Certainly, we haven't seen this type of backlog, we're in the three to four month range, to be honest with you. And it's mainly commercial. So what's important to know here in our backlog is we actually have shift days for the vast majority of all our orders in house. So there may be a put and take that we see where a job gets pulled in, maybe gets kicked out a little bit. But overall, we see nothing that would cause a material change, the backlog is the -- market remains very active, the jobs continue to move forward. Again, labor gets in the way a little bit. But overall, we have a lot of comfort in our backlog and primarily that it's mostly commercial condensing products, which are the heart of our business.

And on the pricing side, and on the water treatment side, going forward, in both for the boiler side and water treatment side, kind of expect to see it come in end of third quarter and in the fourth quarter, but water treatment kind of mid-single digits to 10% price increases depending on product category, similar for the boiler products in that 8% to 12% depending upon product category.

And our next question comes from the line of David MacGregor with Longbow Research.

Good morning. I wanted to just explore further around the residential water heater business. And maybe some of the weaknesses you've seen there and I kind of think about that market is maybe at the risk of oversimplifying this a little bit as the consisting of three buckets. You've got the construction, the replacement demand, and then of course, just changes in the channel inventory. It sounds like the channel inventory is fairly transitory. And you expect that, as you pointed out by August, you can see that kind of normalizing. New construction, I guess watch completions. And I'll give us a good sense of water heater consumption there. But let me just speak to replacement demand and what you're seeing there, and maybe not to be overly skeptical here. But to the extent you think you may have lost some share in replacement demand this quarter, what gives you confidence that your share position remains strong? Thank you.

Yes, okay. When we talked about replacement demand, there's two components of it, you have kind of the proactive replacement, and then you have the emergency replacement. The proactive side, which is renovation, probably driven by kind of remote work had been pretty strong, we saw that, it's coming down a little bit, we test that every quarter and have a good read on that. As far as the overall emergency replacement that will always remain resilient. I mean, people just don't go without hot water for any length of time. So yes, the residential visit has those components. Again, I just want to remind people that 50% of our business is that new construction. So even if it drops a little bit, it's pretty nominal for us. And but it's nice upside and as we go forward. But that's how it plays out. And we feel pretty comfortable with our 4% to 6%. And again, as I mentioned the, I think a lot of the channel inventory adjustments would come out in June and July and a little bit of August. From a shared perspective, we have really good data on that. We talked about this last year and into the quarter that we were a little bit behind. We really expected, I expected that it would normalize as production came up and lead times came down. And that's actually playing out really well on the residential side. I will tell you, we're slightly up moving towards our normal historic market shares. And I'll just throw in commercial, we're already back to our normal rates.

Good to hear. Thank you for that. And just as a follow up, I guess everyone's concerned right now about the slowing macro. And so I'm thinking about sort of where the strength lies in your businesses, it seems to be in the boiler businesses, it has always been sort of one of the stronger elements in the model. How cyclical is that business? How should we be thinking about kind of if 2023 is a soft year and we see pervasive weakness across the market? How stable should that business be?

Yes, it's historic, well, we expect it to be pretty stable. I mean, the replacement component of that business is very similar to the water heater side, and that 80% to 85%. So the replacement piece continues to be resilient. Usually the commercial side would typically lag the residential side, you've got projects in progress, and you’ve got quoting that's happening in advance. And so it's a little more stable and longer. And I, the last recession, on the boiler side, which was 2006 - 2007, the boiler business was impacted, but not as much as the rest of the business, particularly because of some of the underlying growth drivers that you have on the replacement, and high efficiency, most of our products just as reminders, high efficient, energy efficient product that pretty resilient in downturns because of the energy efficiency nature that continues to want to drive a replacement.

So just to be clear, when you say it's resilient in terms of the cyclicality, are you talking about units? Are you talking about profitability?

Both, they're very similar.

And our next question comes from the line of Jeff Hammond with KeyBanc.

Hey, good morning. Just wanted to ask a similar question on, I guess Dave did on the water treatment business. It's a newer platform and just trying to it seems to be something maybe a little more discretionary than a water heater replacement. So just how you think that business would perform in a recession scenario?

Yes, I guess the first point of some of our water treatment is it's a much affordable much more affordable product. So this is our first time going through some type of cycle here. Certainly, it will be some discretion there with people, but the way we look at it is the penetration, the awareness is going to continue to go up. And there's a consumable part that we had that it's continued to grow. It's about 50% of our business today. So we -- it's not as, maybe not as resilient as water heaters. It's not a must have. But it's got some built-in components that help offset some of the downturns, but just people becoming more aware of having healthy and clean water. So we think it's going to perform fairly well to any type of economic cycle.

Okay, and then seems like the new entrants in the water heater space kind of finally got the plant open. And I'm just wondering if you're seeing them in the marketplace at all. And if you think there's any pricing disruption around that particularly as input costs rollover, thanks.

Yes, I'll quickly touch base on that. Nothing new from our perspective, yes, their plant is open, but their market activity from our perspective, and what we're getting feedback hasn't changed. In fact, if anything, they're moving away from our customers, our retailers and wholesalers and trying to maybe look at more builders and that type of thing. So can’t anticipate what the future is going to be with them? But right now it's kind of the not a big change from what we saw other than they, they're manufacturing a few products in their US plant.

And our next question comes from the line of Scott Graham of Loop Capital Markets.

Hi, good morning. To an earlier question, Kevin, I was very interested in your view on the residential water heater market, kind of going from the 99 level, I think you said to the lower nines. I'm curious if you can add maybe a little more color from your perspective as the market leader. How much of that do you think is destock?

Again, that's going to be very speculative. The reason I feel confident in the water heater market is I'd still go back to and again, I'm not sure when it's going to normalize. But new construction, there's still a deficit out there. And that's going to continue to grow and move forward. So that's what gives me confidence in the market, a stable replacement side of it. And, yes, again, and quite frankly, as things get a little tougher people do more renovation. But I think it's, if you look at our history the growth rate in the residential water heater market, it's been at that couple percent range. And I think as I go forward, I just think it's going to adjust down, we were in a very hyper inflated market have a lot of money out there, and everybody benefited from it. But I think over time, that's going to just normalize to kind of a run rate that we've seen in the past. The great news of it, though, there's more water heaters out there today, and that's going to go out 10-14 years, that's going to play really well for the industry and for our company. So that's kind of the high level, it's really hard to get into much more detail than that, Scott.

It's fine. And that was helpful. Thanks. So in China, can you give us the sales split for the quarter in, I know you combine both water heaters and treatment, upper middle price point versus premium?

Sure. I mean, premium I'll just, premium side of the market is so about, the low end is about 40% premium on the electric water heater side, the high end is nearing 50% premium on the water and the gas and the gas tankless and then water treatments kind of in between. So not a great deal of change of little uptick on the electric side, we introduced a couple new products, a good dual tank, slimline product on the electric that we're hoping to get some traction on, which bumped that up a bit.

Okay, so you are seeing that number continued to incrementally progress.

Well, quarter-over-quarter for electric it was up and we think it's -- it is due to some new products. Hard to say there a lot of movement. But when we track the upper part of the market and what the industry is telling us from a third party, still positive movement, so still an uptick from the last quarter. Not a large uptick but only positive.

Yes, Scott, I echo that, we talked about it, it is about a couple of years now. And so a lot of our premium products have feature of benefits that still consumers in China are willing to pay for. So we're very pleased with our new products. And we're really pleased to see the upper end continue to move in that kind of northeast direction.

Got it, thank you. And just a follow up then on the share repurchases. I know you're kind of still locked in at that $400 million. I'm just sort of wondering what the market weaker resi conditions, obviously sliding yet you're still having some fairly stable sales based on the replacement nature of them, including in China, good cash flow. What's holding you back from going higher on the share repurchases this year?

Yes, I mean, we did have enough $400 million I think last year were 380-ish or something like that and change. So we're still a little bit of an uptick to historically. I think as we go into this cycle, and we'll have to see how it plays out. But there could be some real opportunities on the M&A side, we want to make sure we're in a position to be able to capitalize on those opportunities. So that's one way to get it. The other is see we're projecting to be at that $400 million now, we don't have intentions to increase it on this call. But we'll continue to watch it as we have and see what the economy does and what our price does so.

Yes, Chuck, I guess on that, I guess my whole thinking, of course, is that it's not just about the cash flow, but it's also about the balance sheet. You guys have been running in that cash position for like a decade. And just seems like you have a lot of dry powder there and can still increase the share repurchasing. Is that -- are you looking at a couple of large sized acquisitions? Is that kind of part of the equation?

Yes, I'll jump in here is that's almost a possibility. And so the way we looked at as we go into the year, and things have changed as this year started kind of evolved to where we're at today. The $400 million is pretty much a locked in number for us. Each year, we evaluate where we like to go. So we'll take another look as Chuck said in 2023 but we do think there's some opportunity as we get into the back half of this year with a number of our M&A targets and things are changing and we want to be prepared and have the balance sheet to take action if those opportunities come our way.

[Operator Instructions] Our next question comes from the line of Damian Karas with UBS.

Hi, good morning, everyone. Thanks for all the detailed color around the market outlook. I have a follow up question on margin, I was wondering if you could maybe just help us think about the bridge when you factor in some of the volume deleveraging for the lower steel and input costs. Is there a good way to think about the detrimental margin versus the price cost benefit? And I guess just any perspective, you might be able to provide on additional margin, you could capture later this year, and next year, if sort of steel costs basically hold stable from here.

Yes, this is Chuck. I won't go beyond this year. But when you think about kind of the detrimental margins, and we're really just talking about residential water heater detrimental margin, and then what Kevin mentioned, the light commercial, so you probably think of that in the 35%, detrimental margin range. Steel cost, we've kind of got those visibility, and we have visibility into those costs through the third quarter for sure. And we're starting to see visibility into second. So we feel pretty good about that. So that's probably the next largest driver. And then the stabilization of order rates, as we expect we had a little bit of a disruption in the end of June, and in July here on residential order rates, we would expect plants to perform a little bit better during the back half of the year, and the commercial mix is also favorable. So we expect some help on commercial mix. And if you kind of think about the cadence for the back half of the year we're going to, our guidance is 22.5 to 23, right. And we're kind of tracking below that right now. So we do expect a decent uptick in Q3. And then incrementally Q4 as some of those price increases, I mentioned that water treatment and lock-in and boilers come in. And as we see probably our most favorable steel, for sure, in the fourth quarter. So that's how we kind of think about that margin expansion.

Okay, that's helpful. I want to ask you about your heat pump product. We're seeing heat pumps gain traction in the broader HVAC market kind of on the air side, that's really picking up. I was wondering if you could maybe talk a little bit about what you're seeing, I guess in theory, the economics have probably gotten a little bit worse just because of the steel inflation if you compare that product to the tankless but maybe any ideas, maybe any thoughts on just how that is progressing? And do you think that the market is -- that product could take off on its own? Or are you going to ultimately need some government stimulus?

Well, let me separate that to a residential heat pump versus a commercial heat pump, because I think they're both different markets. The residential heat pump is still an upsell product, it's one of the best value propositions we have in our company. But it's a 3x or 4x regular electric water heater, and there's some installation challenges. There are quite a bit of subsidies out there, whether it be up to state city, which is helping, and that's going to continue to grow. I mean, there's no doubt that it'll grow. It'll grow at a moderate pace, I believe, unless it's regulated in, but it's going to continue to grow. And it's going to be a long-term product for our company in our industry. But it's still a relatively small part of our overall volume. Commercial heat pump is even there's a lot of activity out there. But that's trailing the residential side, just because it does have some size to the installation. And it requires a tank. There's a number of things that have to go along with it, and it's better for new construction than it is for retrofit. But we see that growing we see activity in it. We obviously have products that we participate in, but I think both of those categories are going to grow at a percentage rate pretty high but as an overall volume still going to be more of an upsell product unless there's some regulatory changes that come.

I'm showing no further questions. And I would like to hand the conference back over to Helen Gurholt for any further remarks.

Thank you for joining us today. Let me conclude by reminding you that our Global A. O. Smith team delivered strong sales and earnings in the second quarter despite many challenges. 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 four conferences in the third quarter. Northcoast on August 8, Jeffries on August 9. Stifel on September 7, and Davidson on September 22.

This concludes today's conference call. Thank you for participating. You may now disconnect everyone have a great day.