A. O. Smith Corporation (AOS) Earnings Call Transcript & Summary

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. [Operator Instructions] 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 A.O. 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 less 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 1 question and 1 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 his many years of service as our CFO. Chuck has had a long and meaningful career with A.O. 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'm very pleased to welcome Carrie Anderson to A. O. 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 plan and orderly leadership transition at A. O. 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 4. While the quarter reflected very different market conditions across our businesses, I am pleased with how the A. O. Smith team executed. We continue 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 remain 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 Vale, our recent acquisition that expands our water management and digital control capabilities. Excluding Leonard Vale, 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 assessment. 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 A. O. 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 advanced 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 million 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 observe as CFO of A. O. 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 confident in the company's future. It's been a pleasure representing A.O. Smith and my many interactions with investors and analysts over the years. I also want to welcome and congratulate Carrie and wish her great success in our new role. I look forward to working with her over the next couple of months during the transition. Let's now turn to Slide 5. North America 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 Valve 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 remains 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 Leonard Valve 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 6. Rest of the World segment sales was $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 margins were primarily due to lower sales volumes in China, which were partially offset by continued cost management. Please turn to Slide 7. 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 8. Our capital allocation framework remains unchanged and continues to balance investment in 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 $0.36 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 increase in repurchase commitment still preserves significant flexibility to invest in growth 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 A.O. Smith and appreciate a warm welcome from Steve, Chuck, Helen and the broader team. As I've settled into the role over the 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 Valve 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 replace. 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 programs 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. 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 Valve 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 Carrie 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.

[Operator Instructions] The first question of the day will be coming from the line of Bryan Blair of Oppenheimer.

Chuck, thank you very much for all the help over the years, and Carrie, 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 low single digits still entails stabilization going forward. And that certainly counters pretty weak industry data year-to-date and then generally unchanged macro variables. So I guess, simple question, what gives your team confidence in that stabilization over the coming months?

Yes, Bryan, 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, kind of through May are comping against a pretty strong front half of the year. The way we have the year laid out, the last couple of years, has been in the 52%, 53% in the front half. And this year, we have it about 51% in the front half. So we don't have quite as much pull forward in the overall outlook, and we have a little easier comps as we go into the back half of the year.

Okay. Understood. That makes sense. I was hoping you could offer some more data on how your team is thinking about North American margins in Q3 and Q4. We obviously have your full year outlook sweeping back into the second half overall. But just given all the moving parts at hand, price costs certainly amongst those factors, that would be very helpful if you spoke to quarterly expectations.

Yes. 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 of 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, you see a ramp-up in some of our cost 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 America 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 will have the full benefit in Q4. Anything else Chuck to add?

No, I agree.

Next question is coming from the line of Mike Halloran of Baird.

And let me echo Bryan's comments about Chuck, I enjoyed working with you for what was a very long period of time. And Carrie, welcome. I look forward to working with you as well.

Chuck is a little sensitive to when we say a very long period of time.

Look, I'm incrementing myself there, too, unfortunately. So can we talk a little bit about the residential landscape specifically? Obviously, the environment is 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. And any difference or trend line that you're seeing on the wholesale versus retail side of things?

Yes. So maybe first off, regarding wholesale, retail, we can see -- continue to see kind of retail overall in the industry gain a little bit of share. Some of that is because of the dynamics in the industry like 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 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 1 fact 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, it can be a little bit lumpy as there are some channel movements, and there are some actions that are taken either by us or competitors. And so we see that kind of right 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 then, we're happy with the progress we're making there and some of the stabilization that we see in our share performance.

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 last -- next 2 to 4 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 1 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. And 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. It was delayed. It was delayed a couple of months. So we have a little bit of pressure in Q3 that we may not have seen had it been affected immediately that we're going to always keep competitive in the marketplace, and we feel that it should act out, as it has, as history would act out. So we, right now, have it in our outlook.

Next question is coming from the line of Susan Maklari of Goldman Sachs. One moment for the next question. Our next question is coming from the line of Nathan Jones of Stifel.

Carrie, welcome to the team. I guess, first question, Chuck, you just mentioned that the price increases were delayed by a couple of months. Can you talk about the dynamics around that and why they were delayed and confidence in them getting out into the market now than they're supposed to?

Yes. 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 is 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 is 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 occasions? How confident you are on -- I guess, what you've estimated as pull forward into 2Q that plays out in the back half? I guess, the risk around maybe the pull forward being a bit more, the market being a bit weaker than you think and the risk to the second half, just any color on your confidence there?

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 important thing is we work really closely with our customers, as we think about stepping in and stepping through a price change. A couple of years ago, we saw a really big pull forward in 2024 and 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 when 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 to 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. I mean, this price increase of 4% to 7% is probably on the lower end of what we've experienced over the last couple of years from price increase amount. And to Steve's point, we expect and feel like I said, a little bit less of an impact than maybe some of the other previous price increases.

Our next question will be coming from the line of Scott Graham of Seaport Research Partners.

Chuck, congratulations on a great run. Thank you for being so easy to work with, and Carrie, welcome aboard. I have sort of a similar question to Nathan. Is there any way to size the dollars on the prebuy? What was pulled into the second quarter from the third quarter? And then secondarily, could you talk about some of the competitive and maybe more promotional activity you're seeing in the wholesale channel because we kind of know what they are all about and not a reduction in foot traffic in all of this? And within that, maybe discuss you have a new -- another new competitor, and I know it's not a big overlap with you, but the dynamics of what they're doing in that channel.

I'll take the first part on question on the size of the revalue. We generally don't sign 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 in the third quarter into the second quarter. So I think my comments around the shape of the second half was 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 half -- in the second half of the year, tariff dynamics as well as the pricing that we expect to have full traction in the back half of the quarter.

And I would just supplement that with -- if you look at how we're -- 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 2 years, we're closer to 52% to 53% in the front half. So we do expect to have less of an impact than what we've seen in other price increase pull forward.

Your question around kind of wholesale dynamics, we've talked about some of the things that are putting pressure on the wholesale market. There's a couple of players that I think look to serve that market, and 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 yes, 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 circle the replacement market as well as the new construction demand. You've got to be able to support it with obviously high-quality products at scale. You've got to be able to have the relationships and the brands to reach the contractors and that they know you're going to stand behind the products and it's the products that they're comfortable with and used to and you also have to have products that have the technology moving forward. And I think from that standpoint, that's how we serve that market with conviction. And I think it has served us well and especially served as well as new people try to get into that space. It's difficult to do without that full level of conviction in the full business model.

Next question is coming from the line of Tomo Sano of JPMorgan.

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?