A.O. Smith Corporation

Good day and thank you for standing by. Welcome to the second quarter 2026 earnings conference call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there'll be a question and answer session. To ask a question during the session, you'll need to press star 11 on your telephone. You will then hear an automated message advising your hand is raised. To answer your question, please press star 11 again. Please be advised that today's conference is being recorded. I would now like to turn the conference over to your speaker today. Helen Gurholt, please go ahead.

Thank you, Lisa. Good morning, everyone, and welcome to the AO Smith Second Quarter Conference Call. I'm Helen Gurholt, Vice President, Investor Relations and Financial Planning and Analysis. Joining me today are Steve Shafer, Chief Executive Officer, Chuck Lauber, Executive Vice President, and Carrie Anderson, Chief Financial Officer. In order to provide improved transparency into the operating results of our business, we provided non-GAAP measures. Free cash flow is defined as cash from operations plus capital expenditures. North America segment organic growth excludes the impact of Leonard valve. Adjusted earnings, adjusted earnings per share and adjusted segment earnings exclude the impact of restructuring and impairment expenses. Reconciliations from GAAP measures to non-GAAP measures are provided in the appendix at the end of this presentation and on our website. A friendly reminder that some of our comments and answers during this conference call will be forward-looking statements that are subject to risks that could cause actual results to be materially different. Those risks include matters that we described in this morning's press release, among others. Also, as a courtesy to others in the question queue, please limit yourself to one question and one follow-up per turn. If you have multiple questions, please rejoin the queue. We will be using slides as we move through today's call. You can access them on our website at investor.aosmith.com. I will now turn the call over to Steve to begin our prepared remarks.

Thank you, Helen, and good morning, everyone. Before we get into our results, I want to start by recognizing Chuck Lauber and thanking him for as many years of service as our CFO. Chuck has had a long and meaningful career with AO Smith, and his leadership has had a significant impact on our company. On behalf of all of us, Chuck, thank you for your many contributions, and we wish you all the best in retirement. At the same time, I am very pleased to welcome Carrie Anderson to AO Smith as our new Chief Financial Officer. Carrie brings extensive financial leadership experience across multiple industries, including complex global manufacturing organizations. She also brings a collaborative leadership style and a disciplined approach to execution. Carrie has already become a valued partner to the team, and we look forward to her leadership in strengthening our execution rigor and advancing our strategic priorities. This is another planned and orderly leadership transition at AO Smith, and it reflects the strength of our broader leadership team. We have a highly experienced group of leaders with the right balance of fresh perspective and deep industry knowledge to continue executing our strategy and serving our customers well. Now, moving on to our second quarter 2026 financial performance, please turn to slide four. While the quarter reflected very different market conditions across our businesses, I am pleased with how the AO Smith team executed. We continued to gain traction in North America, delivered strong free cash flow performance, and took additional actions to create value for shareholders. At the company level, sales were approximately $1 billion and adjusted earnings per share were $1.03. While our results were impacted by the continued weakness in China, our teams remained focused on operational execution and cost management across the business. One of the highlights of the quarter was the North America sales increase of 5% to $821 million, which includes Leonard Val, our recent acquisition that expands our water management and digital control capabilities. Excluding Leonard Val, organic sales grew 3% supported by strong boiler growth, carryover pricing actions, and continued focus on serving our customers. Another highlight of the quarter was our cash flow performance. Free cash flow increased nearly 70% in the first half of the year, reflecting the strength and resilience of our operating model. Supported by that performance, we increased our 2026 share repurchase target by 50% to $300 million. reinforcing our commitment to disciplined capital deployment and returning cash to shareholders. As expected, China sales decreased 28% in local currency, largely due to broader market conditions. While the China appliance market remains challenging, particularly in the premium segment, we continue to manage the business thoughtfully while completing our strategic assessments. We expect to share our conclusion on that assessment by our next quarterly earnings call and remain focused on identifying the best path forward to support long-term value creation. With that overview, let's take a closer look at the performance of our North America businesses. North America water heater sales increased 2% in the quarter. Residential water heater industry demand remained pressured by softness in new construction as well as existing home sales, which can weigh on replacement demand. While the residential market remains competitive, we continue to make progress in our market share performance. In an environment where demand remains muted, our leading brands, broad channel presence, and strong customer relationships continue to differentiate AO Smith and reinforce our confidence in the long-term fundamentals of the business. Our North America boiler business delivered a strong quarter, with sales increasing 21%, contributing to 12% growth in the first half of the year. Growth was driven by continued momentum in residential boilers and a return to growth in commercial boilers. We remain encouraged by the performance of this business and believe our investments in product innovation, customer service, and channel partnerships continue to position us well in an attractive market with significant long-term opportunities. North America water treatment sales decreased 2% as growth in our priority dealer channel was offset by softer demand in other channels. While consumers remain cautious in portions of the market, we continue to focus on the channels, products, and customer relationships where we see the greatest opportunities for growth. During the quarter, we advance actions to optimize our footprint and streamline our brand portfolio, which we believe position the business to operate more efficiently and accelerate profitable growth over time. We expect annual savings of approximately $6 to $8 million beginning in 2027. Leonard Valve contributed $16 million to sales in the second quarter of 2026, and we continue to target double-digit growth for the full year. I'll now turn the call over to Chuck, who will provide more specifics on our second quarter performance.

Thank you, Steve, and good morning, everyone. Before I begin, I want to say how grateful I am for the opportunity to have served as CFO of AO Smith. It's been our privilege to work alongside so many talented colleagues and to be a part of a company with such a strong culture, trusted brands, and a long history of creating value. I'm proud of what we have accomplished together and competent in the company's future. It's been a pleasure representing AO Smith in my many interactions with investors and analysts over the years. I also want to welcome and congratulate Carrie and wish her great success in her new role. I look forward to working with her over the next couple of months during the transition. Let's now turn to slide five. North America's segment sales of $821 million increased 5% compared to last year. As shown on the left side of the slide, organic growth of 3% in the quarter contributed $26 million of additional sales, while Leonard Val sales contributed another $16 million. The organic growth was driven primarily by 21% boiler sales growth, as well as carryover pricing benefits in our water heater business. These benefits were partially offset by lower residential water heater volumes as industry demand remained soft. Our boiler performance this quarter was driven by strong commercial demand, including seasonal orders under early buy programs. In addition, the quarter benefited from customer pre-buy activity ahead of announced price increases on both water heater and boiler products, resulting in some demand pull forward into the second quarter. North America adjusted segment earnings were $200 million, modestly above the prior year period. Adjusted segment margin was 24.4%, a decrease of 100 basis points compared to last year. The benefits of organic growth and the contribution from lettered valves were largely offset by higher steel and other input costs. Steel costs rose year over year approximately 20% in Q2, and combined with tariffs and other inflationary costs, largely offset pricing benefits. IEPA refunds had a minimal impact in the quarter. Moving to slide six, rest of the world segment sales of $195 million decreased 19% due to continued weak consumer demand in China driving lower volumes, which was partially offset by favorable foreign currency translation. Rest of the world second quarter segment earnings of $10 million and segment margin of 5.2% decreased significantly compared with the prior year period. The lower segment earnings and margin were primarily due to lower sales volumes in China, which were partially offset by continued cost management. Please turn to slide seven. Cash flow performance remained a significant strength in the first half of this year. We generated free cash flow of $233 million in the first half of 2026, a 67% increase over 2025, primarily driven by working capital management, which more than offset lower earnings. We ended the quarter with $181 million of cash and a net debt position of $456 million. Our leverage ratio was 25.7%, as measured by total debt to total capital, reflecting the financing associated with the Leonard Valve acquisition completed earlier this year. Even after funding the acquisition and returning capital to shareholders, our balance sheet remains strong and provides substantial flexibility to support future growth investments and acquisition opportunities. Let's now turn to slide eight. Our capital allocation framework remains unchanged and continues to balance investment and long-term growth with meaningful returns to shareholders. Our priorities remain clear. Actively manage our portfolio, invest in innovation to drive organic growth, and advance operational excellence to improve productivity. Within portfolio management, we continue to evaluate M&A opportunities that fit our strategic direction and meet our financial criteria. Earlier this month, our board approved our next quarterly dividend of 36 cents per share. In addition, we repurchased approximately 2.6 million shares for a total of $162 million during the first half of the year. Given our cash flow performance and confidence in the business, we increased our 2026 share repurchase target by 50% from $200 million to $300 million. Importantly, this increased repurchase commitment still preserves significant flexibility to invest and grow, and pursue strategic opportunities as they arise. I'll now turn the call over to Carrie to share our 2026 earnings outlook.

Thank you, Chuck, and good morning, everyone. I'm excited to join AO Smith and appreciate the warm welcome from Steve, Chuck, Helen, and the broader team. As I've settled into the role over these past several weeks, I've been impressed by the strength of the business, the quality of the team, and the discipline around capital allocation and financial management. I look forward to helping build on that foundation as we execute our strategic priorities and create long-term value for our shareholders. And I'm very grateful for Chuck's partnership during this transition and wish him all the best in retirement. With that, let's turn to our 2026 outlook summarized on slide 9. As we enter the second half of the year and have greater visibility into our end markets and our expected full-year performance, Based on our first half results and current outlook, we have narrowed our guidance range. Importantly, our overall view of the business has not materially changed since April. Our outlook for China, North America commercial water heaters, boilers, water treatment, India, and Leonard Bell remain largely unchanged from the assumptions we provided last quarter. The primary change in our outlook relates to the North America residential water heater market, where industry demand has remained softer than we anticipated earlier in the year, reflecting continued weakness in both new construction activity and existing home sales. As a result, we now expect full year sales growth of approximately 2% to 3% and adjusted EPS of $3.70 to $3.85 per share, compared with our prior outlook of 2% to 4% sales growth and adjusted EPS of $3.70 to $4 per share. The upper end of our prior guidance assumes that residential water heater industry demand during the second half of the year would be similar to the first half. Based on what we have seen through June and into July, we now believe results are more likely to skew towards the lower end of that prior range. Within U.S. residential water heaters, We are narrowing our industry outlook to down low single digits for the year compared to our prior expectation of flat to down low single digits. While emergency replacement demand remains stable, we continue to closely monitor proactive replacement activity, which accounts for approximately 30% of total replacement demand and is more sensitive to consumer spending behavior. End market conditions tied to new housing activity have remained soft, primarily impacting the wholesale channel. Looking at our other major market assumptions, we continue to expect U.S. commercial water heater industry volumes to be approximately flat with last year. We are maintaining our North America boiler sales growth of 6% to 8%, North America water treatment sales growth of 5% to 6%, and approximately $70 million of sales from Leonard Valve. We also continue to expect our China sales to decline at a low double-digit rate in local currency. As we think about the phasing of the balance of the year, Q2 earnings benefited from early buy programs in our boiler business as well as customer pre-buy activity ahead of our announced water heater and boiler price increases, which accelerated a portion of expected Q3 demand into the second quarter. In addition, Q2 benefited from a slightly lower effective tax rate than we expect for the full year. And while our full year outlook still assumes steel costs will be approximately 15% higher than 2025 levels, we expect steel inflation in the second half to be somewhat higher than the first half. Non-steel material inflation and tariffs are expected to remain a headwind as we move through the remainder of the year. Tariff policy remains dynamic, and while we continue to evaluate the recently announced changes, we currently expect the new tariffs to have a modestly higher cost impact than the tariffs they replaced. While we continue to expect the overall impact to be manageable, the timing of these cost pressures, combined with the customer pre-buy activity and seasonal boiler early buy program, is expected to create a less favorable earnings profile in the third quarter. Together with continued weakness in China, these factors are expected to result in Q3 EPS that is lower than both Q2 and Q4. The midpoint of our range assumes Q3 segment margins in both North America and rest of world are generally consistent with the margins reported in Q1. I'll now turn the call back over to Steve for closing remarks.

Thanks, Carrie. Moving to slide 10. I'd like to close with the key messages from the quarter. First, we delivered solid second quarter results with sales exceeding $1 billion, 3% North America organic growth, and adjusted earnings per share of $1.03. These results reflect the strength of our North America businesses, disciplined execution across the organization, and the contribution from Leonard Bell as we begin to build out our water management platform. Second, our boiler business continued to perform exceptionally well. Boiler sales increased 21% in the quarter, driving year-to-date growth of 12%. We continue to benefit from strong commercial demand and remain confident in our outlook of 6% to 8% boiler growth for the full year. Third, While residential water heater industry demand remains softer than we anticipated, we are confident in the long-term strength of our North America water heater business. The replacement market continues to represent approximately 80% to 85% of industry demand. Our market position remains strong, and we've continued to make progress stabilizing market share in a highly competitive environment. Fourth, our strategic assessment of the China business is nearing completion. While market conditions remain challenging, we are focused on determining the best path forward to support the long-term success of the business and create value for shareholders. Finally, our business has continued to generate strong cash flow, which provides flexibility to invest in our businesses while returning capital to shareholders. This confidence is reflected in the 50% increase in our 2026 share repurchase target to $300 million. As Kerry discussed earlier, we have updated our full-year outlook to reflect continued softness in North America residential water heater industry demand. Importantly, our outlook for our other major businesses and markets remains largely consistent with the assumptions we provided earlier this year. Overall, we remain confident in our strategy, our market positions, the resilience of our replacement-driven businesses, and our ability to create long-term value for shareholders. With that, we conclude our prepared remarks and open the call for your questions.

Thank you. As a reminder, if you would like to ask a question, please press star one on your telephone. You hear the automated message advising your hand is raised. If you would like to remove yourself from the queue, press star one again. We ask that you wait for your name and company to be announced before proceeding with your questions. One moment while we compile the Q&A roster. The first question of the day will be coming from the line of Brian Blair of Oppenheimer. Please go ahead.

Thank you. Morning, everyone.

Morning.

Chuck, thank you very much for all the help over the years. And Kerry, I look forward to working with you.

Thank you. Likewise. Glad to be here.

I guess to start, You did revise the U.S. Resi water heater industry volume outlook, although down below single digits still entails stabilization going forward. And that certainly counters pretty weak industry data year to date and generally unchanged macro variables. So I guess simple question, what gives your team confidence in that stabilization over the coming months?

Yeah, Brian, when we kind of look at the way the industry rolls out, just recall that in 24 and in 25, we really had also price increases in the first half of the year, pulling volume into the first half. So some of the comps that we're seeing, industry data, you know, kind of through May, are comping against a pretty strong front half of the year. The way we have the year laid out, you know, the last couple years, it's been in the 52 to 53 Thank you for joining us.

You're fully year outlook, so we can back into the second half overall. But just given all of the moving parts at hand, price costs, certainly amongst those factors, it'd be very helpful if you spoke to quarterly expectations.

Yeah, I'll take that call. And Chuck, if there's something I missed, feel free to chime in here. I would say generally in the second quarter, our price-cost relationship was slightly positive. And overall, We're taking pricing actions in our water heating at 4% to 7%. They're expected to begin to be realized midway through the third quarter. So we expect to see more of a contribution on that price as we move into the second half. But at the same time, we're also, if you go back to my prepared remarks, do see a ramp up in some of our costs that is expected to increase, particularly steel in the back half of the year. and so overall I would say in the back half of the year we're going to be more neutral, more neutral in that price-cost relationship. Specifically for the third quarter, I mentioned that the North American margins will be similar to Q1 and that's more reflective of the fact that as you think about the demand that we saw move into the second quarter compared to the third quarter, that's going to have a bit of some volume pressure there. and the fact that we're going to have some of that price kind of build over the quarter as those new effective price increases come into effect. So we won't have a full quarter impact of those new price increases in Q3 and we'll have the full benefit in Q4. Anything else, Dr. Dan? No.

Agreed.

Thank you. One moment for the next question. Next question is coming from the line of Mike. Halloran of Beard, please go ahead.

Thank you. And let me echo Brian's comments. Best of luck, Chuck. I enjoyed working with you for what was a very long period of time. And Kerry, welcome. I look forward to working with you as well.

Thank you, Mike. Mike, Chuck's a little sensitive to when we say very long period of time.

Hey, look, I'm recriminating myself there too, you know, so don't walk away as unfortunately. So can we talk a little bit about the residential landscape specifically? Obviously, the environment's weaker. I understand the back half guide, but maybe just talk a little bit about the market share comments and how you feel like you're stabilizing things on that side in any difference or trend line that you're seeing on the wholesale versus retail side of things.

Yeah, so maybe first off, regarding wholesale retail, we can continue to see kind of retail overall in the industry gain a little bit of share some of that is because the dynamics in the industry like new construction impact wholesale a little bit more than retail but also some of the big box retailer players are really getting organized around how to go after in particular kind of the small pros and so there's that dynamic that's playing out we've been playing out I'd say for for years and maybe accelerated a bit in the last few quarters as there's been a lot more pressure, I think, on the wholesale side of the business. So that's one factor that's out there. I've talked about in the past kind of market share specifically on the wholesale side. We're very pleased with sort of how we perform in retail with our retail partners. But on the wholesale side, you know, It can be a little bit lumpy as there is some channel movement and there's some actions that get taken either by us or competitors. And so we see that kind of ride up and down a little bit. But what we look to really do is make sure that we have a stable share performance. And with the end of last year, we kind of had a concerted effort to go back and win back a little bit of share that we felt like maybe we had lost in that wholesale channel. We have great relationships across the wholesale channel we obviously know the players in that space very well and we had some targeted actions to win back a little bit of share and we're happy with the progress we're making there and some of the stabilization that we see in our share performance.

Thanks for that and then second question just pricing maybe just talk a little bit about price acceptance in the North America channels both on the boiler and then the commercial and residential water heater side how that's being shuffled through and then I know you answered a little bit for Brian, but as you look at the next two to four quarters here, how does that price-cost relationship start tracking, and when do you feel like you're going to be in a really good spot on a net basis?

Maybe I'll start with that one, and then Chuck can pick up the first part of the question. But I would say it's too early to talk about future price increases at this point. The material cost environment, inclusive of tariffs, remains quite dynamic, and As a result, we're watching and managing this quite closely with our teams. Our goal is to always maintain a balance in that price-cost relationship as we also want to work to make sure that our customers are kept competitive here. So at this point, I would say we're always going to continue to monitor to try to maintain that relationship.

As far as acceptance of the price, I mean, it's pretty early days of the price increase, right? We expect that we're going to start seeing the positive impact of pricing, call it midway through the third quarter, and that's both on water heaters and boilers. You know, it was delayed. It was delayed a couple months. So, you know, we have a little bit of pressure in Q3 that we may not have seen had it been effective immediately that, you know, we're going to always keep competitive in the marketplace, and we feel that it should act out as it has and as history would act out. So we right now have it in our outlook.

Thank you. One moment for the next question. The next question is coming from the line of Susan McClary of Goldman Sachs. Please go ahead.

Your line is open, Susan. Please go ahead. One moment for the next question.

Our next question is coming from the line of Nathan Jones. Please go ahead. Oh, Steve.

Good morning, everyone. I'll congratulate Chuck again. And, Terry, welcome to the team. I guess first question, Chuck, you just mentioned that the price increases were delayed by a couple months. Can you talk about the dynamics around that and why they were delayed and confidence in them getting out into the market now when they're supposed to?

Yeah, I mean, it was roughly a month that it was pushed back and it really was because we wanted to remain competitive with some of the other market participants that came out with pricing, but everybody's in the market with pricing. we expect it to go forward as planned.

Okay, I guess the second question is you guys have had a fair amount of experience over the last several years with large price increases to cover inflation, so has the industry and a lot of experience with the demand pull forward dynamics that come along with that. Can you talk about how that's played out this time versus in previous And I would say it's a little bit of science and a little bit of art relative to how you manage that and the

The important thing is we work really closely with our customers as we think about stepping in and stepping through a price change. A couple years ago, we saw a really big pull forward in 2024. In 2025, we look to manage that and balance that a little bit with our customers to help on the production efficiencies. Every time we go through this, we try to find the right balance of serving What our customers need responding to the marketplace, but also then optimizing for what makes sense in terms of our own production efficiencies. And so we continue to work with our customers. And I'd say it's not a formula every year is exactly the same. There's always different dynamics to navigate through and different priorities from our customers that we work through with them. But I'd say This year, I think we continue to work closely, make sure we serve the demand, serve our customers well, but also work with our customers when it made sense in terms of getting the efficiencies on that back end. So I think it's a little bit more of a muted pull forward this year just by some of the nature of the dynamics that were out there.

And just as a reference point, you mentioned prior price increases. This price increase of 4 to 7? It's probably on the lower end of what we've experienced over the last couple of years for price increase amounts. And to Steve's point, we expect and feel like it's had a little bit less of an impact than maybe some of the other previous price increases.

Thank you. Our next question will be coming from the line of Scott Graham of Seaport Research Partners. Please go ahead.

Hey, good morning, Chuck. Congratulations on a great run. And thank you for being so easy to work with. And Carrie, welcome aboard. I have a sort of a similar question to Nathan. Is there any way to size the dollars on the pre-buy, you know, what was pulled in to the second quarter from the third quarter? And then secondarily, could you talk about some of the competitive and, you know, Thanks. Yeah.

I'll take the first part on the question on the sizing of pre-value. We generally don't size that, but I think within my prepared remarks, we did want to make sure that we gave you a little bit more commentary around the phasing of the year, because there was some pull-forward demand from the third quarter into the second quarter. So I think my comments around the shape of the second half, with specifically those comments on the third quarter, can help you kind of think through that. in terms of thinking through the dynamics in the third quarter, inclusive of some higher steel costs that we expect in the second half of the year, tariff dynamics as well as the pricing that we expect to have full attraction in the back half of the quarter.

And I would just supplement that with, if you look at how we have the industry laid out for the year, this year we're saying 51% in the first half, 49% in the back half, prior two years were closer to 52 to 53 percent in the front half so we do expect to have less of an impact than what we've seen in other price increase pull forwards.

I think on your question around kind of wholesale dynamics and we've talked about some of the things that are putting pressure on the wholesale market there's a couple players that I think look to serve that market and you know it's a competitive environment and even more so when you don't have kind of meaningful growth that helps all the players sort of kind of move forward so yeah it's a competitive space I do think though I go back to as it relates to new entrants and people trying to get into that space it's difficult to do because you really have to have full conviction I think to serve the wholesale market well you need to have the full breadth of the product portfolio be able to serve both the replacement Thank you for joining us. and I think it has served us well and it has especially served us well as new people try to get into that space. It's difficult to do without that full level of conviction and the full business model.

Thanks.

Thank you. One moment for the next question. Next question is coming from the line of Tomo Sano of JP Morgan. Please go ahead.

Hi, this is Brendan on for Tomo. So if I could just start on your product portfolio, as we think about the ongoing evolution of your product portfolio, which product categories or technologies are your top priorities for incremental R&D investment? And then specifically, what kind of milestones should we watch for progress there?

Well, as we've been talking about, certainly here in North America, in The water heater and the boiler space, we've been making big investments to expand our portfolio in the tankless segment as well as with heat pump technology. We believe those technologies have a relevant position in the future for how the water heating and the boiler space will evolve. So we've been making over many years now investments there to kind of complement the strength of our more traditional tank portfolio. and we're really happy with the progress we've made in terms of the performance, the technical steps forward and how we roll those out into the marketplace and how they've been accepted in the marketplace. So I think those are areas that, you know, I think on the tankless side, we'll see how it has to play out with new construction. On the heat pump side, obviously still very much connected to regulatory and rebate actions, but we do believe that those are technologies relevant for our future. Water treatment is a space where I think there's more innovation happening and lots of awareness happening around water treatment in North America. And then how do you serve that awareness with the right types of technologies in the marketplace? That's an area that we've got an increased focus on innovation as we go forward because we think it's a market space that is ripe for more innovative products. I'd say if you think about outside North America, our markets in China and India, those are real, I'd say, innovation juggernauts. The pace of change and innovation in those markets requires us to move at an incredibly high pace and may evolve and consumer tastes evolve pretty quickly there. So that's a little bit really embedded in our DNA of how we bring new products to those consumers.

Great, thank you. If I can get one more here. You've highlighted deploying AI tools across order management, warranty processing, technical service. Just sort of thinking how you're thinking about the scale and timeline of productivity benefits from those initiatives. Is this primarily a cost story, a customer experience story, both? And how does that kind of fit within the broader margin improvement framework?

Like a lot of companies now where there's AI kind of experiences and experimentation happening all across the company. Some of it is just more in general productivity gains and how all employees everywhere kind of bring it into their lives and bring it into their professional careers. And then there's more targeted AI use cases that we're developing. And you mentioned a few of them. And I think We see the reality is having a meaningful impact on both things like customer experience and our productivity. It takes time a little bit to kind of build up the, first of all, get the data structured and oriented and build up the models to really drive those programs. So we do feel like it's still early to kind of really size that for folks, but we're learning really quickly, right? It's just as you think about how quickly AI is learning and I think our use cases of AI is evolving very quickly. And so it is one of those things that I think we'll all be talking about more and more as we go forward and as we step in through the next few quarters and years about how we are putting to work those types of models. But I do see it playing out very much in serving our customers better and doing it in much more efficient, more productive ways.

Thank you. If you would like to ask a question, please press star 11 on your telephone. One moment for the next question. Next question is coming from the line of Jeff Hammond of KeyBate Capital Markets. Your line is open.

Hey, everyone. This is Mitch Moron for Jeff. Good morning. Good morning. Just on the China decision, sounds like you're getting close and look forward to the update next quarter. But if you look at the spectrum of potential outcomes, Any chance you could give us any color on which direction you're leaning?

Yeah, I mean, all outcomes are still on the table, Mitch. And we've been at this process for almost a year. We've had a lot of great conversations with a lot of different potential parties. We've learned a lot about our business and the potential levers we can pull. And I think we're actually getting pretty good clarity of what we think we need to do to kind of position the business for success going forward. Whether that's done in a structure where somebody else leads those changes and pulls those levers or whether we do it in partnership or whether we do it ourselves, I think all those options at this point are still on the table. And I think that's part of the clarity we'll look to provide by our next earnings call is exactly how we're going to move forward there. And that clarity, I know we owe it to you and our investors, but also our customers and our employees, obviously. As we've gone through this assessment, there's a lot of uncertainty there. And so we recognize the need to kind of move forward and step forward and drive some of the changes that we think are needed for the business. And like I said, how we do that or how somebody else moves forward, that is what we're trying to finalize.

Thank you. Appreciate the color there. And then just to clean up question, I think you mentioned the IEPA refunds were minimal in the quarter. Could you just quantify that, and do you anticipate any more in the second half?

Yeah, I'll take that question. I mean, I think just as a reminder, we are primarily a domestic manufacturer. So a significant portion of our tariff exposure is indirect, but those tariff costs pass through to us via supplier price increases. And as Chuck mentioned, in Q2, we did receive some refunds related to the IEFA tariffs. In the cases where A.O. Smith was the importer of records, however, the amount in this quarter was not material, I would say about a penny, but recognize that the tariff environment remains fairly fluid, including the recently announced Section 301 tariff. So if I step back a bit more broadly, overall tariffs, including tariff refunds, we aren't expecting to have a material impact on earnings or margins for the full year. And we just continue to monitor that evolving environment.

One moment for the next question. Our next question is coming from the line of David McGregor of Longbow Research. Please go ahead.

Hey, good morning. This is Joe Nolan on for David. I just wanted to, good morning. I just wanted to follow up on the tariff comments right there. I think it was mentioned in the prepared remarks that you'd see a slightly higher impact from tariffs. Could you just quantify the impact to the second half from higher tariffs?

Yeah, we didn't quantify that. I think, again, when you think about the Section 301 tariffs replacing the Section 122 tariffs, as you think about how that was described, it would be a slightly higher headwind there. But I think our intent is to try to continue to manage those costs, like we're managing all of our different material cost inflation headwinds in the back half of the year. So at this point, we didn't quantify that other than to say we're working through those changes and obviously believe that there will be a modest cost increase. But at this point, our plan is to continue to mitigate and manage as best we can.

And I would say we're getting pretty good at navigating tariff uncertainty reactions, understand our supply base. So there's a lot of levers we can pull to navigate through that. And I'd also say anything you can count on going forward on tariffs, I think it's just going to be a continued evolving landscape. So I think all companies sort of have to get really good at just responding to those changes, and I think we're getting better at that.

Got it. That's helpful. And then I just wanted to circle back on pricing. I was just wondering, in a softer demand environment, are you seeing higher price elasticity on the recent price increases relative to increases over recent years?

I would say no. In a software environment, consumers are not really focused on the end price when they put in a water heater. So from a price elasticity, we're not seeing the consumer push back. When you do have a situation, though, when you have volumes down, and Steve mentioned earlier some of the challenges in the wholesale channel, the wholesale channel, as a reminder, is a large part of where housing gets pulled through is the housing side. and certainly it's a competitive environment, but we wouldn't say price elasticity plays out directly.

Thank you. One moment for the next question. Next question is coming from the line of Ryan Connors of North Coast Research. Please go ahead.

Good morning. Thanks and congrats, Chuck, and welcome, Carrie. Thank you. You've covered a lot of ground here. I appreciate you fitting me in, but talk about dating ourselves. I've been around the story long enough to remember that next week is the 10-year anniversary of closing on Aquasana, which was really the platform creation of the water treatment business in North America. Obviously, I don't think it's quite reached the critical scale we would have thought at this point. I guess as you go through the restructuring process, Can you just update us on your strategic thinking there? I mean, are we at a point where that's going to start moving the needle in the next few years? Or at some point, do you have to make a strategic decision that it's just not reaching that scale and what's holding it back from doing that? Just curious if you could step back from the tactical restructuring talk and just address that business from a strategic context relative to where expectations would have been that it was today.

I'd say when we decided 10 years ago to step into the water treatment space, a lot of work was done to understand the landscape, understand the megatrends, try to understand where the world was going around, interest and understanding of water cleanliness, how regulatory frameworks were going to impact that. So we viewed it as an attractive space and we knew we needed to get you know inorganically into it so that we could get a collection of people and businesses that really understood the space well and as you mentioned Aquasana was kind of the initial entry into this and we bought a number of businesses since then really high quality assets that have served that water treatment space well for a number of years and I think as we've gone through that journey and as we've put These businesses together, we ourselves have learned a lot about the market space and learned about kind of what the different elements of the market, the different channels, the different products. And I think what you see now is putting that learning to work. So what did we learn along the way? And then what does it mean for us in terms of how AO Smith can participate and create value going forward? And sure, we have every aspiration to make the business More scaled, more profitable, and a bigger contributor to our portfolio. And that's some of the actions we're taking now are related to trying to position the business to do that going forward. Obviously, as you sort of refine and you focus and you prioritize, it can take a step back in terms of just sort of the growth profile as you do that. And we've got to focus on really fine tuning where we want to compete and win. that will help us, I think, drive more profitable growth going forward. And we've been taking some of those actions. And I think we still see it as a really attractive space. And I think now we see it as a really attractive space with, I think, even greater clarity having been a participant in it for the last decade about where it is we can go and where we think our business model can create value.

Got it. That's a very helpful update. I appreciate that. And then secondly, you talked a lot about the shifts in the wholesale channel. The one thing in particular we hear a lot about is some of your channel partners talk about this dual trade evolution where HVAC and plumbing being melded into one. Can you talk about how that impacts A.O. Smith? Is that an opportunity? Is that a risk? And how you view that and whether that's part of the shift that you talk about in wholesale?

When I talk about shifting wholesale, it's a little bit more, I'd say, kind of near-term dynamics related to kind of housing starts and how they're serving the pros and how the retail side of the channel is serving the pros. So that's a little bit more of kind of what we're seeing right here and now. I think that the topic you're talking about is, you know, how are the trades coming together with the HVAC world? What does that mean for the wholesalers who serve those spaces? What does that mean for the OEM manufacturers? I think that's a longer-term trend, and I'd say it's one we follow closely, and we have a lot of conversations across our industry and the HVAC industry about those changes and what does it mean. Right now, at the end of the day, you have plumbers and you have HVAC technicians. They're very different people. There's different skill sets. The replacement cycles are different. That converging isn't necessarily driving big impact for how people want to interact with their water heater OEMs. Now, over time, I think it does create opportunities. It's one thing we need to watch carefully is does consumers and does do trades folks shift the way they think and operate. But it's one of those ones that because we're an industry leader and we're a thought leader across the industry, we're very much actively involved in understanding how those dynamics are changing. But we view it as a bit of a longer term.

Thank you. One moment for the next question. Our next question is coming from the line of Susan McClary of Goldman Sachs. Please go ahead.

Thank you. Good morning, everyone. I'm sorry I missed you earlier. Thanks for taking the question.

Good morning.

I want to start on the boiler outlook, which seems to imply that you expect a meaningful step down in the second half despite the pricing that you're getting there. I realize that there was some pull forward in that, but could you talk about the broader outlook there and your performance relative to that?

Yeah, I mean, we're really pleased with our boiler performance in the first half of the year. If you recall, the first quarter was a little weaker on the commercial side, but we've built momentum and overall year-to-date being up 12% is a pretty healthy position. We haven't changed our outlook. You know, we haven't changed our outlook for the full year, 6% to 8%. We are watching. If you recall, a couple of years ago, there was more channel inventory built up on a price increase than perhaps what we've seen before. and at our prepared remarks, you know, we do have pre-buy programs that occur in the second quarter and somewhat fall into the third quarter, but largely in the second quarter. And so there will be some softness in the third quarter as a result of some of those pre-buy and price increase pull-forwards that happen in Q2. So, you know, overall though, commercial order and quoting remains healthy and we're very pleased with how we're performing in the market on the residential side of the boiler business.

Okay. That's helpful. And then you also mentioned that you're seeing inflation in areas outside of steel. Can you talk about that headwind, quantify it for us a bit, what's driving that, and your ability to offset that pressure?

Yeah, I mean, when you look at our cost, right, so steel is the largest, and we really see Q4 steel taking a meaningful increase in our cost base. But the other factors that are out there are kind of whale related, I would call them. So if you think about transportation, we've seen a meaningful amount of increase in our transportation costs due to diesel surcharges and just demand in transportation being a little more costly than what it has been in the past. And then also oil-based products. We have quite a bit of foam that we put in our product and other plastics that are under pressure for some of the oil-based pricing or costs that we see hitting us, particularly driving up costs in the back half of the year. Second part of the question was... Ability to offset. Offset, and I think Carrie covered that pretty well. I mean, we have pricing in the marketplace in Q3. But we'll see some pressures on margins as we go through the back half of the year because the costs, particularly in the fourth quarter, are wrapping up pretty quick.

Yeah, but overall, I think my comments were to one of the questions was the price-cost relationship fairly neutral in the second half. So we'll continue to find ways to mitigate that. But I think there is some nuance in the phasing to pick up in my prepared remarks that should help you kind of shape that back half of the year.

Thank you. One moment for the next question. Our next question is coming from the line of Amit Matraha of UBS. Please go ahead.

Amit Matraha Hey, good morning. This is Pratap Pond for Amit Matraha. Amit Matraha Morning. Amit Matraha Hey, so my first question is, like, looking at the North America I think you mentioned third quarter margin is similar to the first quarter and it seems second half could be similar to the first half as well. But when we take a look at the last three years, margins have been down in the second half compared to the first half. So can you walk us through some key drivers present this and what makes it different from prior years?

Yeah, it's a little different. And each of the last few years have been somewhat unique. So we've had somewhat of a volatile environment as far as pricing and timing of pricing. So some of the reasons last year, our volume was a little bit more under pressure. I mentioned earlier about at least the residential water heater industry being 51% in the front half, 49% in the back half. Prior years were a little bit more skewed towards the front half because of pricing. So that helps a bit, even that out. So I think volume is a big part of that.

Great. That's very helpful. Thank you. And just a follow-up on the commercial water heater market, that is like output is still flattish for the year. But can you give details on how it has been trending in the first half? And are there in markets doing better or worse? and additionally, what would need to improve for growth to re-accelerate in this business other than the regulatory changes which got pushed forward?

The end markets on the commercial water heating side remain stable. We talked about it a bit on our last call, the 2026 commercial DOE efficiency change. We adjusted in our first quarter our outlook on commercial because that was pushed out a year or the enforcement of that regulation was pushed out to 2027. So, you know, we probably saw a little bit more strength on commercial in the early part of the year before that announcement came out. And then since then, you know, a little softness on commercial as there's probably some pre-buy. But I think as we exit the second quarter, we're probably in a pretty neutral position for that change.

Thank you.

Thank you. And that concludes today's Q&A session. I would like to turn the call back over to Helen for closing remarks. Please go ahead.

Thank you, everyone, 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 our presentations at two conferences this quarter, CPORT on August 18th and DA Davidson on September 24th. Thank you and enjoy the rest of your day.

This does conclude today's program. Thank you so much for joining you may now disconnect.