A.O. Smith Corporation

As we announced this morning, we are taking actions to continue improving our profitability and accelerate long-term growth through footprint optimization and brand rationalization. These steps are part of our ongoing water treatment strategy evolution and allow us to further focus on the areas where we expect to be most competitive going forward. We expect to recognize a restructuring charge of approximately $20 million in the second quarter and a projected annual savings of between $6 and $8 million beginning in 2027. These exciting new tools that help us reimagine our operating processes and our continued strategic focus on prioritizing around our strengths are two ways in which we are bringing operational excellence to life at A.O. Smith. I look forward to sharing more details as this focus area for us matures going forward. Moving to slide 11. Our team responded well, faced with pressure in several of our key markets in the first quarter. I am pleased with the market share improvement we saw in residential water heating, the double-digit valve sales growth that Leonard Valve contributed to the quarter, and the strong free cash flow achieved through diligent working capital management. With the strategic actions that we are taking, supported by our consistent operational discipline, I believe AO Smith will continue to strengthen its leadership position and be well equipped to capitalize on future opportunities. With that, we conclude our prepared remarks, and we are now available for your questions.

Thank you. As a reminder, to ask a question, please press star 11 on your telephone and wait for your name to be announced. To withdraw your question, please press star 11 again. We ask that you please limit yourself to one question and one follow-up. If you have additional questions, please re-enter the queue. One moment for our first question. And our first question will come from the line of Susan McCleary with Goldman Sachs. Your line is open. Please go ahead.

Thank you. Good morning, everyone. Thanks for taking the questions. Good morning. My first question is on the channel inventories in residential. You mentioned that you did have some pull forward around the pricing that you announced. Can you talk a bit more about how much you're seeing in there and how you're thinking about the channel going to the second quarter and how we should think of the flow through in the next couple quarters as a result of that?

Yeah, good morning, Susan. This is Chuck. You know, the reference that I made to pull forward in the first quarter was to last year. So we really haven't seen any pull forward in Q1 of 2026. It is kind of thinking about the quarters. So, by the way, the channel inventories we think are kind of in line with what we would expect coming out of the first quarter.

Okay. Okay. So you haven't seen anything from the pricing you announced this year yet?

Yeah, not meaningful. The price increase that we have is effective mid-May, roughly, so it's pretty early days.

Okay. All right. That's helpful. And then, you know, turning to commercial, you mentioned that that regulatory change got pushed out for a year. Can you just give us more color on what drove that and how you're thinking about the demand there now for the balance of this year and then even into next year as the channel positions for that?

Sure, Susan. So, you know, the regulatory DOE commercial rule that was set to take effect in October of this year, that's been being challenged through the court system and it's been held up so far through the court system, but it is pending and waiting to see if the Supreme Court will review it. So we don't know whether the Supreme Court will take on that challenge or not. But what the DOE issued late last week, was because of that uncertainty around what would happen through the legal system and because we're obviously getting closer and closer to the October 6th date, they issued, in essence, a letter that they would not be enforcing the rule until October of 2027. However, that might also change as things play out both in the court system as well as how DOE thinks about the rule going forward. That was new information as of last week. There's still a lot of uncertainty out there, both on the legal front as well as the DOE positioning, but it has us feeling like it was a more prudent thing to do to think that the industry may do less buy ahead because of that announcement.

Thank you, and one moment for our next question. Our next question will come from the line of Matt Somerville with DA Davidson. Your line is open. Please go ahead.

Thanks. A couple questions. On the water treatment side of things, I guess I was under the impression that getting out of the retailer big box channel was the reset sort of recipe for that business. And it sounds like you're initiating yet another reset in water treatment. Remind us how big that business is and just help us understand a little bit more around how we should be thinking about that looking ahead.

Yeah. Well, good morning, Matt. You know, the business, the water treatment business is just over 250 million roughly. I'd say last time we talked about a reset was the exiting of on-the-shelf retail, and I'll call that ingredient one of the reset. This is kind of the next step of focus, and it's really a step into focusing on leveraging our brands, focusing on our A.L. Smith brand more than some of the brands that we acquired, and then rationalizing our manufacturing footprint. You know, think of it in terms of in 2026 we're looking to expand 200 basis points in our margins to move about 15% operating margins in North America water treatment. We would expect in 2027 with this next restructuring in incremental couple hundred basis points. So, you know, think of it as just kind of the next step and moving that profitability up.

Then as a follow up, if I think I heard you right, you expect your China business to now be down low double digits. How does that sort of sync up to what is actually happening in the market? are you seemingly losing share? I guess, how do you sort of justify the length of this review process with the potential that you're continuing to kind of bleed share in that business because of how long that process has taken to unfold? Thank you.

Yeah, I mean, first off, regarding the market environment and our performance in it, in the first quarter, I think the whole market saw a lot of the challenges and many of the things that we highlighted in our prepared remarks around the stimulus has kind of run its course. Still, there's a low level of consumer confidence. So it was a challenging first quarter, I'd say, across the market, at least in the categories that we participate in. From the third party data we tracked, we didn't lose a lot of share. I think we actually maintained our share in the first quarter, but it was certainly a down market condition. I think it is probably the biggest driver to why the assessment is taking a bit longer than we had hoped. There's still a lot of really positive things coming out of the assessment for us. And just as context, I go back to we've done some third-party assessments on our business in China, and our brand is just very strong. Our pricing power is very strong. That has been sort of validated also with the partners that we're talking to. There's a lot of interest. in the AO Smith business in terms of partnering with us. So it's been a process and an assessment. There's a lot of interest and lots of competition in terms of people who have thoughts and ideas of how they could work with us to strengthen the business going forward. So that's all been very positive, but we are doing it in the backdrop of a very challenging market environment. And anytime you're having those kinds of conversations with partners and we're all being challenged by the current context of the environment. It gets tough and it makes the dialogue take a little bit longer. And I think that's what we're going through right now. But as I mentioned, we've been having these conversations now for quite some time. They're maturing and I'm hoping that in the coming months we'll be able to get clarity on our path forward.

Thank you. And one moment for our next question. Our next question comes from the line of Tomohiko Asano with JP Morgan. Your line is open. Please go ahead.

Hi. Good morning, everyone. Good morning. Thank you. We understand the guidance revision was mainly driven by external factors in China and North America. In this challenging environment, have you observed any changes in your market share across key regions?

Well, as I mentioned, in China, you know, in the last few years, there's been some market share loss, but I'd say as it is right now in Q1, we don't see any meaningful market share loss. We think we're kind of holding our own in a challenging market. Within the U.S., as we mentioned, you know, in the water heater side, we've stabilized our share position in the wholesale side of the channel. That was a big focus for us over the last quarter. And we're happy with the progress we've made there, but there's still more work to be done in terms of share. And then on the retail side, we're very pleased with the share position we have and the strength we have with our partnerships on the retail side. So at this point, nothing meaningful, but it's a big focus for us is to continue to maintain our share position in the markets where we do.

Thank you. And just follow up on the Leonard Valve and how is the integrations of the Leonard progressing and are you on track to our relied expected synergies?

Yes, we're very pleased with our first quarter in with Leonard Valve. We think it's a great fit with our portfolio, serves as the foundation for our water management strategy going forward. Um, more work to be done there more broadly, but in terms of Leonard valve and the integration, um, we think, uh, we're, we're working well, we're on track with, uh, the plan that we have. Most of our opportunity we see is ways to go to market together. And that's been a big focus for us. And so we've been out, uh, talking to customers in the market. It's been very well received. So we're, we're pleased with the progress so far.

Thank you. And one moment for our next question. Our next question will come from the line of David McGregor with Longbow Research. Your line is open. Please go ahead.

Hey, good morning. This is Joe Nolan. I'm for David. Hi, Joe. I just, hey guys. I just wanted to focus on the margin and price cost outlook over the remainder of the year. So just in the second quarter, you'll be feeling the impact of higher steel and freight costs, but it sounds like you're not expecting to get price benefit until 3Q. Could you just walk through your kind of margin cadence over the remaining quarters of the year?

Sure, I'm happy to do that. So, you know, we were happy with our price-cost relationship in Q1. You know, pricing overcame the cost that we incurred plus a little bit of margin. So we're walking into the second quarter in a good position for the costs that were behind us. You know, we are seeing incremental costs in the second quarter. So we're seeing costs raise up on transportation, diesel fuels up. We've seen costs on steel continue up. And we have the announced price increase. So the announced price increase would come into effect in the third quarter. So, you know, we're going to see a little pressure, costs before we see pricing in the second quarter. We'll see a little pressure in the second quarter. That'll be overcome in the third and fourth quarter with the pricing that we expect to have in place. you know, we feel pretty comfortable with where we're positioned right now. But we're watching costs closely, right, because, you know, some of those costs related to oil seem to be pretty persistent.

Got it. That's helpful. And then another one, just a clarification question. On the commercial water heater industry outlook coming down to flat now, is that really just a reflection of the regulatory change, or is there any other moving pieces within that?

Yeah, that's the biggest driver for the change in our outlook.

Thank you. And one moment as we move on to our next question. Our next question comes from the line of Mike Halloran with Baird. Your line is open. Please go ahead.

Hey, good morning, everyone.

Hey, Mike.

Do you help put all this in context on how you expect the earnings to cadence through the year here? Obviously, the $0.03 from Leonard goes away, but maybe the price-cost dynamics in 2Q, as you just referenced, are a little less favorable, more favorable in the back half of the year. The timing around some of these other... Headwinds, demand dynamics, do you get a catch-up from GQ from the weather? How does that cadence through the year? So I guess could you just put it together and put the cadencing in line with maybe how it looks normally versus this year and any other nuances we should think about?

Sure, happy to. Yeah, there's a couple moving parts and a couple moving parts since our last guidance outlook, right? You know, let me start with China and start with maybe Steve's comments on China in Q2 being down. We believe it'll be down roughly 15% from Q1. And think of that in terms of decremental margins, 35 to 40%. So we expect a difficult quarter in China. We expect that we'll come out of that quarter with a little bit better balancing of the inventories in the channel. The inventories in the channel are relatively the same as last year. It just, we'd like to be a little bit leaner in this environment. In North America, you're right, we have costs kind of ahead of us in the second quarter before we see pricing in the third quarter. So that's a bit of a headwind to the margin in the second quarter. We also, on the DOE, you know, so if you look at what we're thinking about for the regulatory change for the Department of Energy policy statement, Previously, we would have expected a meaningful amount of pull forward in Q2 and Q3. We just softened that a bit. We may have some, but we would not expect to have the same amount in Q2 and Q3 as what we had before. So that kind of level sets to a flat commercial volume year over year, and that cadence would be pretty similar to other years. So, I mean, when you kind of look at Mike on Q2, you know, overall Q2 EPS is expected to be roughly 25% of our full year guidance midpoint. That's with a little bit of help in Q2, I would say, from some pricing pull forward. So, we do expect a solid performance in North America in the second quarter based on a little bit of pull forward. Our overall industry, we have pretty weak on the first quarter, but coming back decently in the second quarter with that price pull forward. The back half of the year, a little stronger on, I'll call it the boiler part of the business. Third quarter is always stronger. And we have China. If you think about China as normal cadence, the fourth quarter is typically the strongest. So China had a fairly muted first quarter. We're happy with the performance in China at 7%. operating margins in Q1. But Q2 and Q3 we expect to be a little bit of a challenge and then bounce back a bit in Q4 like normal seasonality happens in China. So overall, a little stronger Q2 on the top line, some headwinds on cost, some real headwinds in China, and a little bit more normalization in the back end.

Thanks for that. And then a question on the pricing side of things. Maybe a two-fold question here. One, are you expecting any pull forward of demand ahead of the 47% price increases you're pushing through here? And then secondarily, how do you think the acceptance is going to go on the channel, given some of the moving pieces that are happening in the water heater space in general right now?

We'll see regarding kind of pull ahead, Mike. I think there's always a little bit of that, but we work closely with our customers. And as we've talked about in the past, we navigate through those transitions. We always look to serve our customers well as we go through the price changes and also look to make sure we're being smart around operationally how we serve those transitions. We'll see, but we'll stay close to our customers as we step through that in the second quarter. In terms of going forward, we'll see how the market plays out. I think ultimately at the end of the day, we remain committed to keep our customers competitive, and we'll continue to do that, but also we know we're in an environment of a lot of uncertainty and a lot of cost pressures.

Thank you, and one moment for our next question. Our next question will come from the line of Jeff Hammond with KeyBank Capital Markets. Your line is open. Please go ahead.

Hey, good morning. Good morning. Hey, Jeff. Maybe just to go at the guy a little bit different. It seems like you're just cutting EPS 15 cents, but a lot of the macro assumptions are kind of moving the wrong way. Can you just talk about offsets to that? I mean, I know you're now expecting some price, but any other offsets around EPS? restructuring savings or catch up from this plant issue that would kind of mitigate the EPS impact?

Yeah, we had a little bit of catch up on the plant issues, not a lot, but that would help us a bit in the second quarter, I think. If you kind of look at the year, really from last guidance, the big change was what we saw in China and then this Department of Energy policy statement. know other opportunities the teams continue to look at cost management like we have in china and continue to do that in north america as we watch kind of the market mature throughout the rest of the year on the cost side we're just going to have to really watch costs i mean costs are pretty volatile right now with the oil up with oil up and transportation um but that's probably the biggest drivers of us keeping an eye on costs yeah i mean the the cost control is the sort of the near-term lever

TAB, A little bit longer term, but obviously the lever we're going to continue to. TAB, Look at polling is is operational excellence and I mentioned a little bit of some of the tools we're putting to work there and I think. TAB, The timeframe of when that will kind of play out in terms of giving us some productivity space it's still. TAB, we're still trying to get our head around and understand, but I think that's another area where we're investing significant time and focus is to figure out how do we. get our operations even more productive with some of those tool sets.

Okay, great. And then just on, you know, I guess competitive dynamics between wholesale, retail, and kind of this price increase. One, have you seen the other players in the water heater space announce similar pricing around, you know, steel, you know, fuel inflation, and just any kind of changes you're seeing, you know, in that wholesale channel, which has been pretty competitive. Thanks.

We won't comment on competitor pricing, but we kind of looked backwards on our historical performance and how successful we've been to offset costs. So we feel good about our positioning and point to history on that, our ability to be able to cover costs over time. It remains a competitive environment. We would expect the whole industry to be experiencing very similar cost inputs. And as Steve said a little earlier, our commitment is to make sure we keep our customers competitive.

Thank you. And one moment for our next question. Our next question will come from the line of Nathan Jones with Stifel. Your line is open. Please go ahead.

Good morning. This is Adam Farley on for Nathan. Hey, good morning. Following up on the commercial water heating regulatory impact, does that change how you guys are planning to ramp capacity for that commercial water heating change? And then maybe more broadly, just update us on capacity plans for this year and next year.

Well, we were prepared for the transition from a capacity standpoint. We made a bit of the investments to get ready for that and I think at this point if the demand is pushed out and customers delay their orders and in fact the regulatory rule goes into effect later, we'll be ready with those investments. Many of them made and some of them were still in front of us and we're delaying until we have the certainty of the need for the demand.

Okay, fair enough. And then maybe on tariffs, you know, was there any incremental change to the gross tariff impact with the recent changes to some of the rules? And then, you know, what is maybe contemplating a guide on tariffs? Thank you.

Yeah, we saw some relief on the IEPA tariffs, and then other tariffs came in. So I mean, overall, kind of the tariff outlook, maybe a little net neutral, maybe a little favorable, but then kind of overshadowed by some of these other costs that we see in front of us related to oil, you know, diesel fuel going up, transportation, we've seen steel be very resilient. So net net, it's just a bit of a headwind on our costs. And that's why we have pricing out there.

Thank you, and one moment for our next question. Our next question comes from the line of Andrew Kaplowitz with Citi. Your line is open. Please go ahead.

Hi, good morning. This is Natalia on behalf of Andy Kaplowitz.

Good morning. Good morning.

First question I'll start with, you have the outlook for boilers despite lowering expectations across most other product categories. Can you maybe just unpack what you're seeing in underlying demand? I know you mentioned earlier on the call you're seeing strength in commercial and residential, but specifically how much of that is volume versus pricing?

Our growth for the year has a big price component into the carryover pricing from last year. I think Q1 was a little bit softer on commercial, which we highlighted. But we see those orders coming up, and this is a typical seasonality, too, for that business. So we still remain confident in that 6% to 8% growth forecast. Commercial is the one that I think we see from the order book is catching up. But price is still a big component of that growth, guys.

That's helpful color. And then my second question, as you think about capital deployment, how are you viewing the current M&A pipeline, particularly in terms of opportunities within your core business or adjacency areas?

Yeah, I mean, there are a few opportunities to strengthen our core as it relates to M&A, but there's also a lot of organic investment we do to make sure we maintain our leadership position there. I think getting scale and profitability in our water treatment platform, that's been a big focus for us on the M&A side over the last seven, eight years. And there's still a few opportunities for us to strengthen that business through M&A. And then a big focus for us is on the water management platform. And Leonard Valve was a business that we closed on in January that we put into that category and we think that's probably the richest area for us from an M&A standpoint is how do we build out and expand in that water management category.

Thank you and I'm showing no further questions and I would like to hand the conference back over to Helen Gerholt for closing remarks.

Thank you for joining us today. We look forward to updating you on our progress in the quarters to come. In addition, please mark your calendars to join us at four conferences this quarter. Oppenheimer on May 5th, KeyBank on May 27th, FIFO on June 2nd, and Wells Fargo on June 9th. Thank you and enjoy the rest of your day.

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