A.O.Smith Aktie

Good day, and thank you for standing by. Welcome to the A. O. Smith Corporation First Quarter 2026 Earnings Conference Call.

[Operator Instructions]

Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Helen Gurholt. Please go ahead, ma'am.

Good morning, everyone, and welcome to the A. O. Smith First 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; and Chuck Lauber, Chief Financial Officer.

In order to provide input transparency into our operating results for our business, we have provided non-GAAP measures. Free cash flow is defined as cash from operations plus capital expenditures. Adjusted earnings per share excludes 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.aossmith.com. I will now turn the call over to Steve to begin our prepared remarks. Please turn to the next slide.

Thank you, Helen, and good morning, everyone. Before I discuss our first quarter results, I want to sincerely thank all A.O. Smith employees for their exceptional dedication and resilient during the first quarter. In particular, I would like to recognize our North American water heater team for their swift response to weather-related damage at 1 of our facilities as they acted to ensure the safety of their colleagues while at the same time, finding a way to recover from our production loss and continue to serve our customers well. I remain grateful for your dedication and teamwork, which continue to strengthen our company and our culture.

Now moving on to our first quarter 2026 financial performance. Please turn to Slide 4. North America sales increased 1% to $753 million and Rest of World sales decreased 11% to $201 million, resulting in total company first quarter sales of $946 million, a decrease of 2%. Our EPS was $0.85, a decrease of 11% due to lower volumes and transaction-related expenses recognized in the quarter for the Leonard Valve acquisition.

Despite these headwinds, diligent working capital management helped to drive strong free cash flow performance in the quarter. Our China sales decreased 17% in local currency in the first quarter, which was in line with our expectations as well as broader market performance. With the discontinuation of most government stimulus programs and continued low consumer confidence, the water heater and water treatment markets remain challenged, especially the premium portion of the market where we compete. We expect this softness to persist. We also believe that our ongoing strategic assessment has created some uncertainty in the market and has delayed certain investments, putting further pressure on our business.

We continue to make progress with our assessment and are moving with urgency to provide greater clarity on the future of -- the future of our customers and employees with the goal of defining a clear path forward in the coming months. Now I would like to share some additional color on our North America businesses. North America water heater sales decreased 2% year-over-year. Production and shipping constraints caused by adverse weather, most notably at our Ashland City, Tennessee facility, combined with softer-than-anticipated residential industry demand early in the year negatively impacted the quarter.

As we discussed on our January earnings call, the wholesale residential channel continues to face challenges, including a soft market in new construction and continued initiatives by retailers to expand into serving the professional. Despite these pressures, we are encouraged by the stabilization of our market share in the wholesale channel in the first quarter, while recognizing there's still work to be done with more improvement to come. Additionally, we are pleased with our share performance within the retail channel and the strength of our retail partnerships. Our strong market leadership and balanced presence across both channels provide us with clear visibility in the market trends supported by robust data, analytics and deep customer relationships.

I'm encouraged by the positive momentum we have going into the second quarter. Our North America boiler sales grew 2% compared to 2025 as residential boiler volume growth and carryover pricing benefit more than offset lower commercial volumes. North America water treatment sales increased 1% in the first quarter. 10% growth in our priority dealer channel was largely offset by softness in the specialty plumbing wholesale channel. A cautious consumer environment led to flat growth in our more consumer-facing channels with a general trend towards the trade down to lower-priced products. We expanded operating margin by almost 100 basis points despite the slower start to the year as we continue to work on improving the profitability of this platform.

Leonard Valve contributed $16 million to sales in the first quarter of 2026, led by strong performance in the valves business. We exited the quarter with a strong backlog and Leonard remains on track to achieve another year of double-digit growth. I'll now turn the call over to Chuck, who will provide more details on our first quarter performance.

Thank you, Steve, and good morning, everyone. Please turn to Slide 5. First, I'd like to highlight 2 items impacting the quarter. As Steve noted, we had weather-related headwinds in the quarter, including damage to a portion of our roof at our Ashland City manufacturing facility. Because of our team's swift response and our insurance coverage, we project minimal impact to our full year performance. However, we estimate that production and shipping constraints, offset by insurance coverage on direct costs negatively impacted our first quarter by approximately $0.04 per share. In addition, we acquired Leonard Valve on January 6, and as a result, recognized $0.03 of transaction-related expenses in corporate expense for the quarter. North America segment, first quarter sales of $753 million increased 1% against the top comp.

Carryover pricing benefits in Leonard Valve sales contributions were largely offset by lower residential water heater volumes and weather-related production and shipping constraints. North America segment earnings of $175 million and segment margin of 23.3% decreased by $10 million and 140 basis points, respectively, versus the prior year period. The lower segment earnings and segment margins were primarily the result of lower residential water heater volumes and more than offset the earnings contribution from Leonard Valve. Carryover pricing benefits more than offset cost inflation in the quarter.

The first quarter of 2025 benefited from pull forward demand ahead of an announced price increase and a stronger mix towards higher efficiency products.

Moving to Slide 6. Rest of the World segment sales of $201 million decreased 11% year-over-year due to continued weak consumer demand in China, driving lower sales, which was partially offset by favorable foreign currency exchange. Rest of the world first quarter 2026 segment earnings of $12 million and segment margin of 6.2%, decreased by $8 million and 250 basis points, respectively, versus the prior year period. The lower segment earnings and segment margin in 2026 were primarily due to lower sales volumes, which were partially offset by continued cost management in China.

Please turn to Slide 7. We generated strong free cash flow of $119 million in the first 3 months of 2026, a significant increase over 2025, primarily driven by diligent working capital management and the timing of customer payments that more than offset lower earnings. Our cash balance totaled $204 million at the end of March, and our net debt position was $412 million. Our leverage ratio was 24.7%, term loan used to acquire Leonard valve. We continue to have significant available capacity for future acquisitions.

Turning to Slide 8. In addition to returning capital to shareholders, we continue to drive organic growth through the development of innovative product offerings and productivity through operational excellence, 2 of our key strategic priorities. Earlier this month, our Board approved our next quarterly dividend of $0.36 per share. We repurchased approximately 700,000 shares of common stock in the first quarter for a total of $51 million.

We expect to repurchase $200 million of our shares during the full year 2026. Consistent with our focus on portfolio management, we continue to actively assess M&A opportunities that meet our strategic and financial criteria. Please turn to Slide 9 for our 2026 earnings guidance and outlook. Our revised 2026 outlook includes an adjusted EPS range of $3.70 to $4 per share. This excludes a relatively net cash neutral North America water treatment restructuring and impairment charge of approximately $20 million that we expect to recognize in the second quarter. Key assumptions within our outlook include: steel costs have steadily risen throughout the first quarter, leading us to increase our full year 2026 steel cost assumption to be a year-over-year increase of approximately 15% compared to 2025.

In addition, due to recent oil price volatility, our transportation and certain material cost assumptions have also increased since our previous guidance. We now project that freight, non-steel material costs and tariffs will increase our overall total company cost of goods sold by approximately 3% in 2026. Our guidance assumes oil prices and tariff levels will remain at a similar level to where they are today. We continue to monitor the situation. We maintain our estimate that CapEx 2026 will be between $70 million and $80 million.

We continue to expect strong free cash flow of between $525 million and $575 million, interest expense is projected to be between $30 million and $40 million, an increase over previous years due to the $470 million of additional debt incurred to acquire Leonard Valve. Corporate and other expenses are expected to be between $80 million and $85 million and includes $6 million of transaction expenses associated with the Leonard Valve acquisition recognized in the first quarter.

Our effective tax rate is estimated to be between 24% and 24.5%. And we project our outstanding diluted shares will be $138 million at the end of 2026. I'll now turn the call back over to Steve to expand on our key markets and our 2026 top line growth outlook for each business, staying on Slide 9. Steve?

Thank you, Chuck. Within North America, our top line outlook includes the following assumptions. While the residential water heater industry had a slower-than-expected start to the year, we maintain our view that full year 2026 industry shipments will be flat to down as softness in new construction persists and proactive replacement remains steady. Due to a recent statement from the Department of Energy indicating a 1-year enforcement delay of the October 6 commercial regulatory change, we revised our outlook and now expect less prebuy activity in the quarters leading up to the original transition date. We now project that U.S. commercial industry volumes will be similar to last year. In response to rising steel, freight, and other input cost inflation, we have announced price increases for most of our water heater and boiler products in North America, with increases varying by product, but ranging from approximately 4% to 7%.

We have seen some cost increases already leading into the second quarter, particularly within transportation. We expect to begin realizing the benefit of these announced price increases beginning in the third quarter. As always, we are maintaining ongoing communication with our suppliers, customers and stakeholders as we address current market challenges while also implementing diligent cost management strategies. We continue to project our North America boiler sales to grow between 6% to 8% in 2026 due to pricing benefits and a strengthening backlog in commercial and residential borders.

We have reduced our 2026 sales guidance for North America water treatment to growth of 5% to 6%. The decrease in our outlook reflects the impact of cautious consumer behavior in our consumer-facing channels, which is approximately half of our business, where we have experienced soft demand as well as a shift toward lower priced products. We are pleased with the progress of our priority dealer network expansion efforts and expect sales in that channel to achieve double-digit growth in 2026.

Our guidance at Leonard Valve will achieve double-digit growth and contribute approximately $70 million in sales in 2026 is unchanged. Integration efforts are on track, and we are pleased with the reception we are receiving as we explore ways to go to market together.

Moving to our Rest of the World outlook and assumptions. We have updated our full year guidance for China sales, which we now expect to be down low double digits in local currency compared to last year, with sales in Q2 down approximately 15% compared to Q1 as we balance channel inventories to the current environment. This revised guidance reflects our updated view of the China market where we expect persistent headwinds throughout the year due to continued low consumer demand severely limited government stimulus and ongoing competitive pressures.

We continue to advance our China assessment, evaluating strategic alternatives to strengthen our long-term competitive position. The valuation is providing valuable insights into both the advantages and challenges facing our business. Many actions we've identified to improve the performance of our China business are pending the conclusion of our assessment which is impacting our expected recovery time frame. We are looking to provide greater clarity within the next few months. We project our India business, inclusive of Pureit will have top line growth of approximately 10% and is unchanged.

Based on these 2026 assumptions, we expect total top line growth of approximately 2% to 4%. We expect our North America segment margin to be approximately 24% and Rest of World segment margins to be between 6% and 7%.

Please turn to Slide 10. This morning, I'd like to provide additional color on our operational excellence value creation opportunities. Our focus is to provide sustainable margin improvement in mid-cycle markets and protect our profitable growth in times of less market certainty.

Over many years, we have looked to drive continuous improvement throughout our operations with our AOS operating system. Today, we are building on that foundation with new tools and making more strategic moves to help prioritize around our strengths and drive improved profitability. The tool sets we are now bringing to our operations included enhanced ability for process intelligence and AI capabilities to drive better customer experiences at greater levels of productivity. Initial application examples include order management, warranty claims processing and technical service support, where we are identifying opportunities, developing process improvements and using AI agents to drive that improvement.

Still early days, but we are excited by the potential of what we see. The streamlining of our North America water treatment business is an example of focusing on our strengths to drive more profitable growth. 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 million 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 2 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 based 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 A. O. 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.

[Operator Instructions]

And our first question will come from the line of Susan Maklari with Goldman Sachs.

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 of quarters as a result of that?

Susan, this is Chuck. 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?

Yes, 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 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, is the channel positions for that?

Sure, Susan. So 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 with 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 6 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. So 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 feel there was a more prudent thing to do to think that the industry may do less buy ahead because of that announcement.

Our next question will come from the line of Matt Summerville with D.A. Davidson.

A couple of questions. On the water treatment side of things, I guess I was under the impression that getting out of the retail 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.

Yes. 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 1 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.O. Smith brand more than some of the brands that we acquired and then rationalizing our manufacturing footprint. So 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 an incremental couple of hundred basis points. So think of it as just kind of the next step in moving that profitability up.

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 assuming you're 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 lead share in that business because of how long that process is taken to unfold?

Yes. 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 is 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 track, 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 a driver to why the assessment is taking a bit longer than we had hoped. It's -- 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 A.O. Smith business in terms of partnering with us. So it's been a process and an assessment that's had -- 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 the strength in 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 any time 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 length 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.

Our next question comes from the line of Tomohiko Sano with JPMorgan.

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, 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 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 [indiscernible].

And just a follow-up on the Leonard Valve. And how is the integration of the Leonard progressing in? Are you on track to realize the 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. More work to be done there more broadly. But in terms of Leonard Valve and the integration, we think we're working well. We're on track with the plan that we have. Most of our opportunity we see as ways to go to market together. And that's been a big focus for us. And so we've been out talking to customers in the market, and it's been very well received. So we're pleased with the progress so far.

Our next question will come from the line of David MacGregor with Longbow Research.

This is Joe Nolan on for David. I just -- 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. So 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 we were happy with our price cost relationship in Q1. 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. However, we are seeing incremental cost in the second quarter. So we're seeing cost raise up on transportation, diesel fuels out. We've seen cost on steel continue to have, and we have the announced price increase. So the announced price increase would come into effect in the third quarter. So we're going to see a little pressure cost before we see pricing in the second quarter. We'll see a little pressure in the second quarter that will be overcome in the third and fourth quarter with the pricing that we expect to have in place. So we feel pretty comfortable with where we're positioned right now. And -- but we're watching costs closely, right? Because some of those costs related to oil, it seemed 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?

Yes. That's the biggest driver for the change in our outlook.

Our next question comes from the line of Mike Halloran with Baird.

Could 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 in Q2 from the weather? Or how does that [indiscernible] in 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. Yes, there's a couple of moving parts and a couple of moving parts since our last guidance outlook, right? So let me start with China and start with maybe Steve's comments on China in Q2 being down. We believe it will 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 will 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, 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 is 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.

On the -- so I mean, when you kind of look at, Mike, on Q2, 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 challenged 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 half.

And then a question on the pricing side of things. maybe a twofold question here. One, are you expecting any pull forward of demand ahead of the 4% to 7% price increases you're pushing through here? And then secondarily, how do you think the acceptance is going to go in the channel given some of the moving pieces that are happening in the water heater space in general right now?

Yes. I mean 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. So 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.

Our next question will come from the line of Jeff Hammond with KeyBanc Capital Markets.

Maybe just to go at the guide a little bit different. It seems like you're just cutting EPS $0.15, 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 restructuring savings or catch-up from this plant issue that would kind of mitigate the EPS impact?

Yes. 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. So 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 -- with oil up in transportation. But that's probably the biggest driver that's keeping [indiscernible] cost.

I mean the cost control is sort of the near-term lever a little bit longer term, but obviously, the lever we're going to continue to look at pulling operational excellence, and I mentioned a little bit of some of the tools we're putting to work there. And I think the time frame of when that will kind of play out in terms of giving us some productivity space, it's still -- 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, 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 are now similar pricing around steel, fuel inflation. And just any kind of changes you're seeing in that wholesale channel, which has been pretty competitive.

Yes. I mean we won't comment on competitor pricing. But we kind of look backwards on our historical performance and how successful we've been to offset costs. So we feel good about our positioning and point the history on that, our ability to be able to cover cost over time. It remains a competitive environment. We would expect our -- 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.

Our next question will come from the line of Nathan Jones with Stifel.

This is Adam Farley on for Nathan. 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 into next year.

Well, we were prepared for the transition from a capacity standpoint and 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 that most -- 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, was there any incremental change to the gross tariff impact is the recent changes to some of the rules? And then what does maybe contemplate any guide on tariffs?

Yes. I mean 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. 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.

Our next question comes from the line of Andrew Kaplowitz with Citi.

This is Natalia on behalf of Andy Kaplowitz. 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 is 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 was 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 is -- we see from the order book is catching up, but price is still a big component of that growth guidance.

Got it. 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 for adjacency areas?

Yes. 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 7, 8 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.

And I'm showing no further questions, and I would like to hand the conference back over to Helen Gurholt 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 4 conferences this quarter: Oppenheimer on May 5, KeyBanc on May 27, Stifel on June 2 and Wells Fargo on June 9. 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.

Hello, and thank you for standing by. Welcome to A.O. Smith Corporation Fourth Quarter 2025 Earnings Conference Call. [Operator Instructions] I would now like to hand the call over to Helen Gurholt, you may begin.

Good morning, everyone, and welcome to the A.O. Smith Full Year and Fourth 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; and Chuck Lauber, 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. 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 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.aomith.com.

I will now turn the call over to Steve to begin our prepared remarks. Please turn to the next slide.

Thank you, Helen, and good morning, everyone. I want to take a moment to sincerely thank all of our employees for their outstanding dedication and hard work in 2025, allowing us to navigate a dynamic environment and deliver record EPS. Their commitment to serving our customers, adapting to new challenges and consistently delivering high-quality solutions is instrumental in our success. Each and every member of the A. O. Smith team plays a vital role in building trust with our customers and upholding the values that define A.O. Smith. I am truly grateful for your ongoing passion and collaboration that has me excited for our potential together in 2026 and beyond. Now moving on to our 2025 financial performance. Please turn to Slide 4. Our 2025 sales increased slightly as pricing benefits and higher commercial water heater and boiler volumes were offset by lower China sales. Our EPS increased 6% to a record $3.85 driven by profitability improvements in both segments.

North America segment margin improved 20 basis points over 2024 adjusted segment margin, led by profitability improvements in our water treatment business as well as mix benefits from higher commercial sales. In our Rest of World segment, benefits from our 2024 restructuring actions and other cost control measures in China resulted in margin expansion of 40 basis points, even with lower China sales. We returned $597 million of capital to shareholders with our dividends and share repurchases. In the fourth quarter, we announced the acquisition of Leonard Valve, which we completed earlier this month. This acquisition expands our water management market reach, digital capabilities and integrated product portfolio. I welcome the Leonard Valve team to the A. O. Smith family.

Now turning to our North America segment performance. North America water heater sales increased 1% in 2025 as cost and tariff-related pricing benefits and higher commercial volumes offset lower wholesale residential volumes. We project that full year 2025 residential industry unit volumes were roughly flat to 2024, and the commercial water heater industry volumes increased approximately 5%. We are pleased with our performance in the commercial market and retail residential channel. However, we faced some challenges in the wholesale residential channel in the fourth quarter. This part of this market is experiencing pressure from a new construction slowdown and continued initiatives by retailers to expand into serving the professional, which is leading to increased competitive intensity. The benefit for us as an industry leader is that we have a strong presence in both the retail and wholesale channels, and we have a good line of sight into how the market moves, backed by data, analytics and extensive customer relationships. We are actively working with select customers to address the specific geographies and product offerings that are under the most pressure to deliver better outcomes in the wholesale market in 2026.

Our North America boiler sales grew 8% compared to 2024 due to higher commercial and residential boiler volumes as well as pricing benefits. We are pleased with our 2025 boiler performance and the continued strong demand for our market-leading high-efficiency products. North America water treatment sales decreased 2% in 2025 as our strategic shift away from the on-the-shelf retail channel offset growth in our more profitable priority channels. Sales in our priority dealer, direct-to-consumer and e-commerce channels grew 10% in 2025. We also expanded operating margin by 400 basis points to almost 13% last year, which we expect to improve by an additional 200 basis points in 2026.

In China, full year third-party sales decreased 12% in local currency as a result of continued economic weakness and soft consumer demand, particularly in the second half of the year as government subsidy programs were discontinued. The restructuring actions we took in late 2024 and expense management drove profitability improvement of 130 basis points despite lower sales as the team executed well in a challenging environment. I'll now turn the call over to Chuck, who will provide more details on our full year and fourth quarter performance.

Thank you, Steve, and good morning, everyone. We delivered sales of $3.8 billion in 2025, a slight increase over last year. 2025 earnings were $3.85 per share compared with adjusted earnings of $3.73 per share in 2024. Turning to Slide 5, full year sales in the North America segment of $3 billion increased slightly compared to 2024. Pricing actions and the higher boiler and commercial water heater volumes were offset by lower volumes of residential wholesale water heaters. North America segment earnings of $728 million increased 2% compared with 2024 adjusted segment earnings. Segment margin was 24.4%, an increase of 20 basis points year-over-year. The higher segment earnings and segment margins were primarily driven by improved profitability of our water treatment business and higher commercial volumes.

Moving to Slide 6. Rest of the World segment sales of $880 million decreased 4% year-over-year primarily driven by lower sales in China that were partially offset by a 13% sales growth in our legacy India business and Pure sales of $54 million. Rest of the World segment earnings of $76 million were flat to 2024 adjusted segment earnings as the impact from lower sales in China was offset by the benefits from our 2024 restructuring actions and other cost saving measures. Segment operating margin was 8.7% and an increase of 40 basis points over 2024 adjusted segment margin.

Please turn to Slide 7. Turning to fourth quarter performance. We delivered sales of $913 million in the fourth quarter of 2025, flat to the same period in 2024. Earnings in the fourth quarter were $0.90 per share, a 6% increase over adjusted earnings of $0.85 per share in the fourth quarter of 2024.

Please turn to Slide 8. In Fourth quarter sales in the North America segment increased 3% to $714 million compared to the same period in 2024, primarily as a result of pricing benefits. North America segment earnings of $165 million increased 7% compared to 2024. Segment margin of 23.1% increased 70 basis points compared to last year's adjusted segment margin. The higher 2025 segment earnings and segment margin were primarily due to pricing benefits and actions taken to improve water treatment profitability, which were partially offset by higher input costs.

Moving to Slide 9. Fourth quarter Rest of the World segment sales of $206 million decreased 13% year-over-year, primarily driven by lower sales in China. Organic India sales grew 18% in local currency in 2025, and Pureit contributed $8 million to sales in the quarter. Rest of the World segment earnings and segment margin of $16 million and 7.8% and respectively, in 2025 compared to adjusted segment earnings and adjusted segment margin of $19 million and 8.1% in 2024. The lower segment earnings and segment margins compared to the prior period were primarily due to lower sales in China, partially offset by the benefits of our 2024 restructuring actions and other cost saving measures.

Please turn to Slide 10. We generated strong free cash flow of $546 million during 2025, a 15% increase over 2024, primarily driven by lower year-over-year capital investments as well as higher earnings and the benefit of a onetime tax adjustment. 2025 free cash flow conversion was 100%. Our cash balance totaled $193 million at the end of December, and our net cash position was $38 million. Our leverage ratio was 7.7% as measured by total debt to total capital. While our 2026 leverage will increase due to the cash we borrowed under a new credit agreement used to acquire Leonard Valve, we continue to have significant available capacity for future acquisitions.

Let's turn to Slide 11. In addition to returning capital to shareholders, we continue to drive organic growth through the development of innovative product offerings and continuous improvement in productivity, 2 of our key strategic priorities. Consistent with our portfolio management priority, we continue to actively assess opportunities that meet our strategic and financial criteria. Earlier this month, our Board approved our next quarterly dividend of $0.36 per share. We have increased our dividend for over 30 consecutive years. We repurchased approximately 5.9 million shares of common stock in 2025 for a total of $401 million. We continue our strong track record of delivering returns to shareholders. Over the last 2 years, we have returned almost $1.1 billion to shareholders through dividends and share repurchases.

Please turn to Slide 12 and our 2026 earnings guidance and outlook. Our 2026 outlook includes an expected EPS range of $3.85 and to $4.15 per share. The midpoint of our EPS range represents 4% growth over our 2025 EPS. Our outlook is based on a number of key assumptions, including within material costs, our guidance assumes that steel prices in the full year 2026 will increase approximately 10% compared to 2025. Other material and freight costs including the carryover impact of tariffs will also be a headwind in 2026. Our guidance assumes no change to the current tariff levels that are in effect today, but we continue to monitor the situation closely. We will continue to invest in our gas tankless offering. As a market leader, we believe that it's important for us to offer best-in-class product in this category. We project our year-over-year impact to our North America margins would be minimal as we continue to build a foundation in this category and gain scale over time. We estimate that 2026 CapEx will be between $70 million and $80 million. We project to generate a strong free cash flow of between $525 million and $575 million. Interest expense is projected to be between $30 million and $40 million, an increase over previous years due to the $470 million of additional debt incurred to acquire Leonard Valve.

Corporate and other expenses are expected to be approximately $80 million to $85 million and include advisory fees associated with the Leonard Valve acquisition. Our effective tax rate is estimated to be between 24% to 24.5%. Our Board has approved million additional shares of stock were repurchased and we expect to repurchase approximately $200 million of our stock in 2026. We project our outstanding diluted shares will be $138 million at the end of 2026. I'll now turn the call back over to Steve who will provide more color on our key markets and top line growth outlook for 2026 as well as the portfolio update staying all on Slide 12. Steve?

Thank you, Chuck. Our top line outlook includes the following assumptions. While we believe that U.S. new home construction remains in a deficit, we project that the softness in new construction will persist into 2026. We assume that proactive replacement remains steady and will be similar to 2025. Based on those factors, we project that 2026 U.S. residential industry unit volumes will be flat to down compared to 2025. Our current projection assumes U.S. commercial water heater industry volumes will increase mid-single digits in 2026 due to a buy ahead of lower efficiency non-condensing commercial gas products that are scheduled to be eliminated as part of the October 2026 commercial regulatory change. We assume that 2026 commercial electric industry volumes will be flat to 2025. In addition, our outlook includes carryover from our May 2025 price increases in North America. We project our North America boiler sales will grow between 6% to 8% in 2026 due to the carryover of pricing benefits and from the continuation of the transition of energy-efficient boilers particularly as commercial buildings look to improve their overall carbon footprint.

We expect North America water treatment sales will grow between 10% and 12% and due to tariff-related pricing benefits as we continue to grow faster than the market through the expansion of our dealer network. And turning to our outlook for China, we foresee continued headwinds in our markets due to continued low consumer confidence, a discontinued government subsidy program and ongoing competitive intensity. Because of these factors, we project that our 2026 China sales will decrease mid-single digits compared to last year. We expect the first half of 2026 to be particularly difficult as consumer demand remains subdued, and we will face comps from 2025 during which stimulus programs were in place. We anticipate a return to growth in the second half of the year.

We continue to manage our discretionary costs prudently in this environment. These decisive actions are designed to protect our profitability and strategically position the business to be competitive during an eventual recovery once market dynamics begin to improve. Our outlook excludes any potential outcomes of the ongoing China assessment. We project our India business, inclusive of Pureit, will have top line growth of approximately 10% as we continue to leverage brand synergies and introduce innovative new products to grow faster than the market. Based on these 2026 assumptions, we expect top line growth of approximately 2% to 5%. We expect our North America segment margin to be between 24% and 24.5% and and Rest of World segment margins to be between 8% and 9%.

Please turn to Slide 13. The 2025 was an exciting year of transition for A. O. Smith with several leadership changes, including myself. As I began my tenure as CEO last year, we announced 3 key strategic value creation levers that will guide A. O. Smith's path forward, portfolio management, innovation and operational excellence. These levers are fundamental to strengthening our industry leadership position, supporting our customers through a dynamic market environment and delivering long-term profitable growth. We will be providing periodic updates on each of these areas going forward. Today, we'll discuss portfolio management. Over the past year, we have been actively working to transform our portfolio to be better positioned for long-term profitable growth. We have been focused on looking at strategic options in our China assessment to better position our business there to be more competitive going forward and take advantage of the eventual market recovery. The assessment is ongoing, and I'm pleased with the quality of discussions we are having with a number of potential partners.

We are also continuing to evaluate opportunities to strengthen our core North American water heater and boiler business. Example of actions we have taken include our recent investments in gas tankless, heat pump and commercial condensing gas product development and manufacturing capacity. We continue to evaluate broader options for strengthening our leadership position in this space. We have also announced over the past year a number of actions to help scale and improve the profitability of our North American water treatment business. We have been learning much about the space through the acquisition of high-quality businesses we have used as the foundation of this platform. and have taken actions to prioritize the channels and further integrate the business to create more synergy and scale. These actions have allowed us to improve the profitability of this business by 400 basis points last year. and we believe additional opportunities are still in front of us to both continue expanding margins and returning the business to higher growth.

Finally, we have done work to evaluate expanding into the broader market of water management. This includes the broader ecosystem of moving, controlling and mixing water across the residential and commercial markets. These products, systems and solutions often interact with our water technology products that serve as our core business today. Leonard Valve and its portfolio of mixing valves and control units represents our first action expanding into this attractive market opportunity.

Please turn to Slide 14 as I share more details about our strategic rationale for this acquisition. Leonard Valve is well aligned with our strategic and financial criteria and is an excellent complement to our core water heater and boiler business. It enters us into the attractive water management market with a well-established premium Leonard and heat timer brands. Leonard's connected products, which represents approximately 30% of their sales and growing expand our digital platform and provide us capabilities to leverage going forward. By broadening and integrating our product offering, we will be able to create new and innovative solutions for our commercial and institutional customers. Along with entire growth profile, the business also has predictable demand with approximately 80% of the volume associated with repair and replacement. Leonard is also a strong cultural fit as a value-based company with deep market experience, a strong brand and reputation across the industry and many long-tenured and dedicated employees that have a passion for serving their customers and the market well. Simply put, they do business a lot like how A.O. Smith does misses, and I'm looking forward to what we can do together. We expect Leonard Valve to contribute approximately $70 million in sales in 2026.

In summary, we are further strengthening our portfolio to deliver greater value to our customers and other stakeholders. We also remain focused on leveraging operational excellence and innovation in addition to portfolio management to drive long-term sustainable growth for A. O. Smith. As we have discussed, while we had challenges to navigate in 2025, we also had meaningful achievements. Highlights include the demonstrated strength and resiliency of our commercial water heater and boiler business. Our leadership in these markets is well recognized and valued by our customers. The significant profit improvement driven by our prioritized approach in North American water treatment. We are now better positioned for long-term growth and profitability. The disciplined cost management actions in China as we look to reposition that business for a more competitive future. The continued double-digit growth of our India business, now complemented by the addition of Pureit to drive continued growth at an even greater scale.

And finally, the continued focus on making the necessary investments to ensure our bright future despite the challenging and uncertain market conditions. I am confident that the strategic actions we are taking today along with our continued disciplined operational approach will enable A. O. Smith to build on our leadership position become more agile and be better prepared to seize future opportunities. With that, we conclude our prepared remarks, and we are now available for your questions.

[Operator Instructions] Our first question comes from the line of Saree Boroditsky with Jefferies.

This is James on for Saree. I wanted to ask on the residential guidance here. Your outlook is calling for a flattish to down kind of industry volume here for 2026. And I think then this marks kind of third year. So flattish to decline in volumes which we haven't really seen for a while. So can you kind of provide me details on what is making this downturn or weaker is kind of more persistent? And can you provide more details on what you're kind of seeing in the market generally?

Yes. Thanks for the question. So just overall, as we look into 2026, there was really 3 components as we think about it, right? We have the emergency replacement, which is very resilient very reliable, very predictable, and we expect that to continue. We have proactive replacement, which we've talked about being fairly high the last 5 or 6 years. We feel like that's pretty resilient at this point. It's -- it's been out there for 5 years at above 30% of total replacement. And so we're expecting that to continue. Where we're seeing some headwind is kind of the new home completions, multifamily and single family. We see pressure on that as we go into next year. So yes, we've had a couple of years of flat volumes coming off some better growth years earlier that were a little lumpy due to COVID, but the pressure we're seeing next year is really in the new home construction, which we feel like without some stimulus with a lower interest rate or perhaps some velocity on new home sales is going to be a bit of pressure on our top line residential volumes.

Great. And I guess I wanted to ask a question on China. I think your guidance kind of implies like double-digit decline in first half and then return to growth here. What specific like indicators are kind of giving you confidence that it can kind of -- what is the return to growth in the second half?

Yes, some of it is we've got to work through a period where there was a lot of government subsidies that were driving some demand generation. So that's the challenge we're going to face in the first half of this year is we're now comping against that. The return to growth will be partly driven by as we move past that phase and we get back to the remodel wins and the refurbishments that still need to happen in China. And part of it is some of our own actions internally to get behind and focus and drive growth in certain areas.

Our next question comes from the line of Mike Halloran with Baird.

So can we first start on just the comments Steve you made about increased competitive intensity in the wholesale channel. Maybe just a little bit more context of 2 things, I suppose. One, what does it mean in terms of the price, share, et cetera, in that channel? And then secondarily, when you net the 2 together, with the strength you have on the retail side. How is that balancing out all else equal to give both the narrow view and the wholesale, but then draw it back to the -- how that's impacting the cumulative market.

Sure. I'll start by [indiscernible] I mentioned, we have meaningful share in both the retail and wholesale side. So from that standpoint, we participate when there's some movement between the 2. I'd say specific update on wholesale Mike, I mean, the dynamic of low new home construction, which we just talked about and the fact that retail has made some inroads in terms of share gains overall in the industry is just putting pressure on that part of the channel. And any time you've got kind of pressure that way, where there's limited growth or even there's some declines, it just makes it a more competitive environment. And -- from what we see right now, it's not really driven by a lot of kind of new entrants into the space. It is primarily the kind of the leaders that serve the wholesale channel today. And -- it's not new that there's dynamics playing out across the channel in terms of different partners and how that works. I would say a bit accelerated a bit in the last 6 months in particular just because of the pressure that's been in that market.

And I think as we look at it, and this is again another area where because we are such a large player in the space. We know all the industry participants. We know all the different distribution partners. We know where those pressures are the greatest, and that's really our focus going forward. So we obviously were happy with the gains we've made on the retail side and with our partners over there. We think we can do better on the wholesale side to serve that market, and that's where our focus is going to be here right now.

And then maybe just some help with the cadencing through 2026 cumulatively. You have a lot of moving pieces front half to back half. So any thoughts on how the earnings and revenue should cadence relative to normal seasonality? Any 1H, 2H dynamics that are worth mentioning? Any help would be appreciated.

Yes. So yes, as you look at 2026, Mike, it's going to look a little different than '24 and '25. Both those years, '24 and '25, on the residential side, in particular, on commercial water heating, we had price increases that pulled volume forward in the front half of the year. So '24 and '25 cadence on the residential within side was 53% in the front half, 47% in the back half. We look at 2026 and expect a much more normalized year maybe closer to 50-50 or 51-49. So there will be tough comps in the first half of the year, both compared to '25 and '24 on the water heating side. As you also step into next year, our 2026 input costs, we're looking at those very closely. Steel should be up -- is expected to be up about 10%. And as you know, we have pretty good visibility into that in our forward view of what our pricing is. We'll have carryover tariffs into the first half of the year and other costs are also causing a bit of headwind.

And then thinking about China, and we've talked a lot in the past about the cadence in China, as Steve said, a bit around -- we'll see pressure in the first half of the year because the subsidy program was in place. In 2025 this year beginning -- actually beginning midyear last year, it was discontinued, and that's why we saw weakness in the back half of this year. We expect that to continue into next year until there's some traction. We think there was some pull ahead into the marketplace and expect some of that traction to come back perhaps in the second quarter or midyear. As you know, the first quarter is always a challenge in China because of the Chinese festival New Year. We expect that to be a little bit more accentuated this year because of discontinued to the subsidy program. And then return to, I would say, in the back half of the year for China, kind of the normal a little bit better in the third quarter and your outlook expects it to be improved in the fourth quarter like it historically has been with some of the holiday shopping.

Our next question comes from the line of Jeff Hammond with KeyBanc Capital Markets.

This is Mitch [indiscernible] on for Jeff. First, I was just wondering if you could give a bit more color on Leonard Valve, the go-to-market strategy, what end markets they play in? And maybe how much growth the $70 million in sales you're expecting this year, like what growth rate that reflects.

Yes. In terms of markets, they're very strong in kind of the commercial markets, which was appealing to us. they serve in some ways, like with their -- the heat timer controls business, it's very much a spec-in driven business, very similar to like our lock-in-wire business. In fact, we show up on a lot of the same spec sheets together. So there's a similar go-to-market model that way. And there's just overlap in a lot of the channels, both in the representatives to take our products to market and in distribution as well. So it's close to our categories in that way. And then on the actual way the product is used, it interacts in an ecosystem similar to our product. So it's down in the mechanicals, where our products are often found, and I think that similar trades and contractors operate with the product. So from that standpoint, it's a very close adjacency in terms of product expansion. And I think it's what got us excited strategically that there's both ways we can work together and serve the market better and how we go to market, but also ways in which we can innovate and find ways that our products get interface and create better solutions for our customers.

As far as growth rate, the business has been growing double digits. So in that 10% range, it's kind of baked into how we think about the growth rate, largely driven by the digital portion of the market that they serve.

Great. That's helpful. And I know there's a lot of moving pieces around price cost, just with tariffs and lapping price increases and whatnot. But can you maybe just give some thoughts about how you expect price cost to trend through the year?

Yes. I mean, Steve had comments around the competitive nature of what's happening in the marketplace today. We certainly -- we also commented that we have carryover pricing that we expect to carryover in the next year. And historically, and I'll say we do a really good job of protecting our price cost relationship. So we do expect that to continue over time. Also historically, we generally see some fade we'll be watching that closely. I'll just kind of say that we're very committed to making sure in the competitive environment that we keep our customers competitive, and we'll be focused on that.

Our next question comes from the line of Bryan Blair with Oppenheimer.

It would be great to -- I guess following up on Leonard Valve, great to hear a bit more about the build-out and prospects of your water management platform. I guess, how we think about TAM expansion given the new products and applications that are involved there or potential there? And in what way is LVC foundational to the buildout? And again, given the right opportunities, how aggressive would your team like to be on incremental M&A?

We're excited about the way we're defining kind of the water management market. As I mentioned, it's kind of thinking about how does water move, mix, get controlled through the ecosystem of residential and commercial, we play an important part in that today with the categories of our water heaters and boilers. And I think there's a lot of other products that help make that happen. And so we're still early in our journey of kind of shaping up where the right places are for us to participate. So your question around TAM, I think what we're excited about, that it does open us up to bigger market opportunities. We've got what we think is an exciting and healthy pipeline of where we could go to do that. Obviously, when it comes to acquisition, there's a lot of things that have to come together to make that work, but we think our reputation in the industry helps us because we're a good spot for good high-quality companies to kind of come together around in how we serve the market. And I think there will be a near-term opportunities as we think about how we go together into the marketplace, provide these products that are well established categories today.

And then longer term, I think it creates more growth for us because it allows us new ways to create value for our customers. Today, we do that in a meaningful way by driving more efficiency and performance in the water heater and boiler products that we serve the market. But if you think about how commercial customers use our products and are thinking about things like energy efficiency more broadly, having a way to serve the market with an ecosystem, I think is a way to create more value.

Okay. That makes a lot of sense. And you noted the strategic assessment of China is ongoing. So there isn't a definitive update, but you did mention a number of potential partners just curious if you could offer any other color on direction or whether options or considerations have narrowed and whether there's any connection to any of the incremental turnaround actions that are underway there.

Yes. I'd say we're moving with urgency because we know when we talk about an assessment of the business, right, we're still running the business, and we have employees and customers that we want to provide some confidence and certainty too. But I would say, while we do that with urgency, we're also being thoughtful to do it in the right way. And our goal, again, is to make sure that we set the business up to be as competitive as possible going forward. I can't get into the specifics of the folks that we're necessarily working with. But we are learning, I think a lot about other options out there on what we can pursue. I think as I mentioned, the quality of the conversations have been terrific. Our local team in China has been very active and involved in that to make sure we're thinking about things the right way. And we'll continue to move that forward, and we'll continue to update you guys as we learn more. But at this point, we don't have anything in terms of how we've narrowed the scope in terms of what potential options and outcomes could come from it. But I'm pretty happy that we're -- the process itself has been very helpful for us.

Our next question comes from the line of David McGregor with Longbow Research.

I guess I want to start by talking about -- I wanted to begin by asking about the water treatment business. You called out the 400 basis points of margin improvement in 2025, which is quite an accomplishment. And maybe you could maybe talk a little further about just sort of the composition of that improvement. And I guess, as well, just where now in terms of where those margins go? And at one point, I think the goal had been to grow those margins at about 100 basis points a year through a variety of different initiatives. And how are you thinking now about kind of multiyear annual profitability growth in that business?

Yes. We like the space. And for A.O. Smith, we entered in it years ago because we understood the megatrends, and we felt like there was a lot we could bring into the space in terms of how we run our businesses. To kind of build the platform, we made a number of acquisitions. And I think what we've done recently is we've now taken kind of a state of what have we learned through the businesses that we bought and through running the businesses, and that helped define for us a little bit of our journey in our path going forward. And as we've been talking about for the last year or so, part of it was prioritizing which part of the market we wanted to really focus on and invest in. And that's been obviously a little bit of a growth drag for the business as we've decided to deprioritize some things. The end of 2024, we took some restructuring charges to help reorient that business. And now I think -- what we're excited about is that we know the spaces in the market where we really want to focus and play, and that's helping us drive a more profitable part of the business, also the growth in the spaces where we want to play, we're very pleased with.

And then also along with that, it's the natural path of just sort of learning how to kind of integrate the businesses, take advantage of levers you can pull to create value by doing that. And that, I think, is a journey we're still on. And -- going forward, I think -- like I said, I think we're focused on where we want to play. We think we can continue to really add value into the water treatment market. We're excited about where this business can go. We're still very excited about the market opportunity overall. And we think we can continue, as I've mentioned in my prepared comments, to drive meaningful growth with this business as well as continue to expand margins as we scale and as we continue to pull levers on integrating the business.

Can you offer any sort of thought on where those margins might be today versus sort of the North American segment averages? And then I have a follow-up.

Yes. I mean so the margins today at 400 expansion of basis points kind of takes you into the ZIP code of about 13% operating margins. And you know our North America margins at 24.4% this year. So expanding it to another 200 basis points because it's a 15% margins. And we like the fact that we're kind of back to that mid-teens digits and looking for opportunities for M&A to match with the business to continue to grow the business and maybe have opportunities to enhance that margin profile through an M&A transaction.

Great. Congratulations on that progress. As a follow-up, I guess, I just wanted to stay close to the water treatment business and just ask for any thoughts you've got and what you're seeing in the way of consumer demand patterns and how that may be evolving and how that's influencing your guide on '26 -- for water treatment.

Yes. I think overall, that business is closely connected to the consumer. So there's I'd say some caution that we see from consumers. In some segments of the market, we considered a discretionary spend item. So we're -- from that standpoint, I think there's maybe cautiousness as we enter 2026. But overall, we still see it as growth because we see the category is still growing. We still see penetration opportunities, and we still see our opportunity to build out our own dealer network and grow even beyond the market.

Our next question comes from the line of Scott Graham with Seaport Research Partners.

I wanted to maybe get a little bit more color from you guys on maybe beyond what you provided with the initial question on this competition in distribution wholesale. And what I'm wondering is, are you kind of saying that like residential water heaters in that channel are now kind of more jump ball? Or is it that maybe some of the higher-end stuff because of the PROs that is what is maybe under a little bit of pressure. Is it -- so in other words, if wholesale is half of residential approximately, is that entire half an area of concern now? Or is it less?

No, I don't think the characterization of a jump ball is what's happening. I would characterize it more of a lot of the industry dynamics that have always been out there, right? And you have channel partners that are dedicated to certain brands, and we partner very closely with them to help reach and serve the contractors and trade groups well and then there's others that carry multiple brands and there's some share shift that happens through those dynamics. I would say that those are the dynamics they've always been in that part of the market. There's still the dynamics playing out today. What we find is oftentimes, when there are movements around share there's typically reactions to those movements and those take time to play out. And I think where we are right now in the wholesale market, like I said, it gets a little bit more intense when the market itself is not growing because the new construction builds aren't there, that the wholesale channel primarily is the mechanism that serves that part of the market. There's a little bit of pressure, as we mentioned, coming from the retail players who are really looking to make inroads with the professionals. So that intensity up a little bit, but the dynamics itself are not new.

And I'd say they're ones that we typically know how to navigate. And we do it working closely with our customers. And like I said, there are actions and movements that happen there's typically reactions. And over time, those things work their way out, and that's our focus of what we're going to navigate here when we talk about the start of 2026.

Okay. I want to maybe just ask a follow-up question on capital. And with the Leonard Valve acquisitions, it's clearly more of a pivot to Stephen, what you said about water management. And so what I'm wondering here is that with this pivot, and I know you found Leonard Valve, and that's wonderful. But for many years, the focus was on water treatment pretty much as a silo. And I'm just wondering how the pipeline is in water management with Leonard now done? Is that something that you have to build? Or have you been building a pipeline there?

I think it's a pipeline that's been pretty visible for us for a while. I mean I think when you're in kind of the plumbing space, you know who the players are. Like I said, there's a lot of overlap on how you go to market. There's a lot of overlap in terms of how you serve contractors. So it's not a starting from scratch kind of pipeline. I think that's been visible to us. I think the focus and attention we're putting on it is now kind of dialed up because there's a lot of different options of ways we could go. As you mentioned, we've been very focused on building out the water treatment platform. And this is a pivot that's not us walking away from water treatment. In fact, we think that's a very attractive growth platform that we're going to continue to invest in. But we do feel like there's more opportunity for us as a company. And we love our core water heater and boiler business today. It generates great cash flow. It's very resilient.

We're a market leader in that space. And we want to think about how do we leverage that to actually find more growth opportunities that we participate. That's what we're trying to do with our water management effort. I think we know who the players are out there. But as I mentioned, with any acquisition strategy, there's a lot dependent upon what's available and when. And I think we can be competitive there. We're also going to remain disciplined in our approach on how we go after it.

Our next question comes from the line of Tomohiko Sano with JPMorgan.

This is Ethan on for Tomo. I wanted to ask for a little bit more color on India. It seems like the guys have delivered strong growth with the Pure integration adding incremental revenue. Can you share a little bit on the road map for scaling India over the next 3 to 5 years? And maybe any details on potentially further M&A within that area?

I think right now, our primary focus is on how do we take advantage of the Pureit addition to our portfolio. India is a market that we've invested there significantly to get the business up and running and Obviously, the pure was an additional investment to that business. We've got a local team there that really understands the local market -- and we think we've got a lot of opportunities now kind of organically, if you will, with the combination of Pureit and A.O. Smith business. It's a market that requires a lot of high pace innovation, bringing new products out to market. That's a big driver of how we've been able to grow double digits for many years in a row. And that's we're now going to do at a bigger scale, as you mentioned. So that's our primary focus. Ultimately, over time, does it mean more acquisitions or not, I think that still has to play out, but our focus right now is primarily running the business we've got.

And looking more on the margin side for international, with India continue to scale up, can we kind of forecast out strength within operational improvements similar to this year out into maybe 2027 or looking more on a longer-term scale with China potentially improving in the second half of this year?

Yes, this is Chuck. I would say a little bit more longer term still. I mean we're still investing in growth in India. We love the fact we're growing double digits together with Pureit bringing those business together, India is still in the growth profile. China, I think it's a little early to call out much margin improvement. We're very pleased with how China performed this year in the fourth quarter, particularly the restructuring actions that we took in 2024 are paying off and the team managing through a tough top line did a very good job of managing the margin. So margin improvement in both businesses, I think, will take a little bit of time, and we'll have to see how that plays out. particularly the economy in China and as we grow scale and India investment growth.

Our next question comes from the line of Nathan Jones with Stifel.

One follow-up on steel prices. You guys said you're expecting steel prices to be up 10%. Can you just clarify what that means? Is that like average 2026 over average 2025? Or are you expecting steel prices to increase from where they are now? And then does that imply that you need to get more price in order to cover some of these inflationary pressures, along with some of the other things that you mentioned there are still inflationary pressures.

Yes. Steel pricing has gone up, right? So we've seen kind of a gradual increase in the index, which does drive what we pay on a 90- to 120-day lag. That 10% up is the year-over-year average I would say if you kind of box it in, it's 10%, 2026 over 2025 as well as 10% up quarter-over-quarter 2025. So we'll see steel, we project still to still rise a bit as we go through the back half of the year, but on average, up 10% year-over-year. As far as price cost relationship, we do have carryover tariffs. We've got other costs that are going up. I'll just kind of point to kind of our historical ability to be able to, over time, kind of maintain and protect our price cost relationship and our margin profile.

Okay. I guess. And then my follow-up question. The slide on Leonard Valve as 2022 to 2025 revenue CAGR of double digits, I think you said it was about 10%. There was a lot of inflation, and I assume that there's a lot of metals in a lot of their products as well. And a fair amount of that kind of growth was probably driven by price as well. Could you maybe just comment on what you think the long-term growth of that business is kind of the volume that they can generate rather than what I just assume is some price-driven growth that you've seen there over the last few years.

Actually, the biggest source and Chuck mentioned of the growth in Leonard Valve has been the digital transition of mixing valves. So it's a technology upgrade that's happening that's adding a lot of value in the marketplace. And so more so than just a pure kind of pass-through of cost pricing. That's been the big driver of the growth over the last few years. And it was 1 of the real appealing characteristics for us to both get more involved on that digital upgrade, but also bring that kind of capability of thinking into the broader ecosystem of solutions that we can serve our customers. So -- from that standpoint, we think it's a growth that has still more momentum to it.

And just to frame about 30% of their volume or the revenue is digital and connected products. it's a base that we look to grow over time.

Our next question comes from the line of Andrew Kaplowitz with Citi.

Good morning. Steve, I know that the strategic review is ongoing in China, as you said, but restructuring does seem to be helping stabilize the margin of the business. So if, for instance, the market doesn't come back as you expect in the second half, do you have more restructuring that you can do? How do you think about the ability to sort of maintain margin if the market is still difficult.

Yes. I mean, look, over long periods of time, right, the answer in China is not continuing to restructure and cut cost and not be able to grow the business. So we're doing what we think is necessary to protect the business today and and we're making, I think, smart decisions around where we do cut. There's a lot still to play out in terms of how the market will kind of respond, especially as we start to lap these subsidies. So we're watching that carefully. Obviously, the strategic assessment we're doing might change kind of how we approach our business in China. That's the high-quality discussions that we're having with partners whether there's more structuring in the future, I think we'll evaluate that as we go. I think ultimately, though, our goal is we need to find a way for the business to be even more competitive than it has been going forward. And eventually, the market will recover. But when that is, I think it's still obviously a big uncertainty. But we'll do what we need to do to make sure we can maintain the competitiveness of the business there financially. But ultimately, we need to find a strategic path forward that allows the business to grow again.

That's helpful. And then your boiler businesses continue to be pretty solid, and I think you have a good forecast for '26. So maybe just a little more color on the health of that market? I know your high-efficiency boat boilers are doing well, but is that mostly what this is? Or is it the market strength overall?

It's a good market, but I would say our lock-in bar brand, and it is the, I think, premier brand in that marketplace. We have great technology, as we've talked about, on the high efficiency and it's a great product. So it's a little bit of both. It's been a strong market, but also I think we're performing well and even taking share in that market with the strength of our product portfolio.

Ladies and gentlemen, I am showing no further questions in the queue. I would now like to turn the call back over to Helen for closing remarks.

Thank you, everyone, for joining us today. Let me conclude by reminding you that despite many challenges, A.O. Smith achieved record EPS of $3.85 in 2025. We look forward to updating you on our progress in the quarters to come. In addition, please mark your calendars to join our presentation at 3 conferences this quarter. Citi on February 19. We North Coast on March 12 and JPMorgan on March 17. Thank you, and enjoy the rest of your day.

Ladies and gentlemen, that concludes today's conference call. Thank you for your participation. You may now disconnect.

Good day, and thank you for standing by. Welcome to the A.O. Smith Third Quarter 2025 Earnings Call. [Operator Instructions] Please be advised that today's conference is being recorded. [Operator Instructions]

I would now like to hand the conference over to your speaker today, Helen Gurholt.

Good morning, and welcome to the A.O. Smith Third Quarter Conference Call. I'm Helen Gurholt, Vice President, Investor Relations and Financial Planning and Analysis. Today, I'm joined by Steve Shafer, Chief Executive Officer; and Chuck Lauber, Chief Financial Officer.

Within today's presentation, we have provided non-GAAP measures. Free cash flow is defined as cash from operations less capital expenditures. 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 use -- we will be using slides as we move through today's call. You can access them on our website at investor.aosmith.com.

I'll now turn the call over to Steve to begin our prepared remarks.

Thank you, Helen, and good morning, everyone. I would like to start by briefly thanking the many dedicated A.O. Smith employees and broader set of partners and customers in our ecosystem for another quarter of helping to make clean, hot and safe water available to millions of people. We appreciate all you do to make that happen.

Please turn to Slide 4, and I will now review our financial performance in the quarter. Our global A.O. Smith team delivered third quarter sales of $943 million, a year-over-year increase of 4%, and EPS of $0.94, a 15% increase over 2024. North America sales grew 6%, primarily as a result of our pricing actions and strong commercial water heater and boiler volumes. We achieved North America segment margin expansion of 110 basis points and Rest of World segment margin expansion of 90 basis points.

Continued economic challenges and more limited availability of government stimulus programs led to a 12% decrease in local currency sales in China. Pureit contributed $17 million of sales in the quarter, and our legacy India business continued its strong double-digit growth trajectory by delivering 13% growth in local currencies.

North America water heater sales increased 6% in the third quarter, driven by pricing actions taken in response to higher tariffs and other input costs as well as higher commercial water heater volumes. Our market-leading high-efficiency condensing gas and heat pump products continue to have a compelling payback story in commercial applications.

Our residential water heater volumes were also positive, so we believe that Q3 industry volumes declined year-over-year. As we expected, we believe our -- we believe we outperformed the residential and commercial markets in the quarter, in part due to our production efficiency initiative that limited the prebuy impact on our sales in the first half of the year.

Our North America boiler sales increased by 10% compared to the third quarter of 2024, led by the benefits of pricing actions and higher volumes of our high-efficiency boilers. North America water treatment sales decreased 5% in the third quarter, as continued growth in our priority channels was more than offset by an expected decrease from the retail channel. Our priority dealer, e-commerce and direct-to-consumer channels grew 11% in the quarter.

In China, third quarter sales decreased 12% in local currency, as the ongoing economic challenges and reduced availability of government subsidy programs along with an increasingly competitive environment led to lower volumes. Despite these challenges and the resulting volume pressure, we achieved 90 basis points of margin expansion compared to last year through the restructuring initiatives we undertook in 2024 and other cost-saving measures.

Please turn to Slide 5. I would now like to take a moment and talk about our commitment to sustainability. For us, sustainability is not just a goal, but a core part of who we are and what we do every day. We are committed to not only developing and bringing to market innovative, high-efficiency products, but we are also dedicated to sustainability in our facilities and manufacturing processes.

Later this week, we will publish our sustainability progress report, which will include our sustainability scorecard and an update on our water conservation, greenhouse gas emissions and waste reduction goals. What the report will show is that we are meeting or exceeding the goals that we set out for ourselves.

The outcome of these efforts are providing both sustainability and bottom line results. Example initiatives we have undertaken to support these goals include the test water recirculation system, which recycles water used during our product testing processes and our glass enamel reuse process, which captures waste glass enamel for reuse in our tank manufacturing process.

These are examples of how we are seamlessly -- how we seamlessly integrate sustainability into 2 of our priority areas, operational excellence and innovation. We remain dedicated to finding better ways of doing things, including how to improve our business while protecting our planet.

I'll now turn the call over to Chuck, who will provide more details on our third quarter performance.

Thank you, Steve, and good morning, everyone. Please turn to Slide 6. Third quarter sales in the North America segment of $743 million increased 6% compared to the same period last year, primarily due to benefits of pricing actions as well as higher commercial water heater and boiler volumes. North America segment earnings were $180 million, an 11% increase over the third quarter of 2024. Segment operating margin was 24.2%, an increase of 110 basis points year-over-year, primarily due to pricing actions and higher volumes, more than offsetting higher material and other input costs.

Moving to Slide 7. Rest of the World segment sales of $208 million decreased slightly compared to last year and included $17 million of sales from the Pureit acquisition. Sales in our legacy India business grew 13% in local currency. China third-party sales decreased 12% on a constant currency basis. Rest of the World segment earnings of $15 million increased year-over-year as continued expense management and the benefits of restructuring actions more than offset lower volumes in China. Segment operating margin was 7.4%, an increase of 90 basis points compared to the prior period. Pureit will continue to be a headwind in the near term as we focus on integration, which is progressing well.

Please turn to Slide 8. Operating cash flow grew 21% to $434 million, and free cash flow grew 35% to $381 million during the first 9 months of 2025 compared to the same period last year, primarily due to lower inventory balances that were partially offset by other working capital outlays, including lower customer deposits in China. Our cash balance totaled $173 million at the end of September, and our net debt position was $13 million. Our leverage ratio was 9.2% as measured by total debt to total capital.

Let's now turn to Slide 9. Earlier this month, our Board approved a 6% increase in our quarterly dividend to $0.36 per share, making 2025 the 32nd consecutive year that A.O. Smith has raised its dividend. We repurchased approximately 5 million shares of common stock in the first 9 months of 2025 for a total of $335 million. This is an increase compared to the same period last year, as we raised our planned full-year repurchase intentions from $306 million in 2024 to approximately $400 million of shares for 2025.

Consistent with our key priorities, we are actively assessing strategic opportunities and have sufficient dry powder for acquisitions that meet our strategic and financial criteria. Our M&A priority continues to be deals that strengthen our core business or help us build new growth platforms.

Please turn to Slide 10 and our 2025 earnings guidance and outlook. We are narrowing the range and lowering the top end of our 2025 EPS outlook from a range of $3.70 to $3.90 per share to a range of $3.70 to $3.85 per share. We have included the following assumptions in our outlook. We began to see the impact from tariffs in the third quarter and expect that our tariff costs will continue to increase into the fourth quarter as additional impacts make their way through our supply chain. Though the tariff landscape remains uncertain, we maintain our estimate that annualized tariffs will increase total company cost of goods sold by approximately 5%, which includes tariff rates currently in place as well as the mitigation efforts we have implemented.

As a reminder, our mitigation strategies include footprint optimization, strategic sourcing and other cost controls and pricing actions as necessary. Apart from tariffs, we expect overall material costs for the year to remain approximately flat versus last year, with steel costs rising 15% to 20% in the second half of 2025 compared to the first half. We estimate that 2025 CapEx will be approximately $75 million. We expect to generate free cash flow of approximately $500 million.

Interest expense is projected to be approximately $15 million. Corporate and other expenses are expected to be approximately $75 million. Our effective tax rate is estimated to be approximately 24%. And we project our outstanding diluted shares will be 142 million at the end of 2025.

I will now turn the call back over to Steve, who will provide more color around our key markets, top line growth outlook and segment expectations for 2025, remaining on Slide 10. Steve?

Thanks, Chuck. Key assumptions in our top line outlook include the following. We project that 2025 U.S. residential industry unit volumes will be flat to slightly down compared to last year, a slight decrease from our previous guidance due to residential new construction expectations that have come down since last quarter. Lower housing completions, particularly in multifamily as well as concern around consumer confidence, have led to this revised outlook. The wholesale channel impact is expected to be greater due to its heavier exposure to new construction.

That said, we are encouraged by the resilient demand we are seeing in the commercial water heater market segment. And as a result, we are increasing our projection for commercial water heater industry volumes from flat to last year to up low single digits. We are pleased with our strong performance relative to the market in the third quarter and the share momentum we have going into the fourth quarter, supported by our winning products in this segment.

Economic challenges persist in China. While government stimulus programs helped to stabilize parts of the market in the first half of 2025, we believe the stimulus programs pulled forward a significant amount of demand. During the third quarter, national sub fees were discontinued, resulting in increased promotional activity and discounting from our competitors, much of which we chose not to participate in.

Because we do not expect an improvement in market conditions in the near term, we are lowering our 2025 China sales outlook to a decline of approximately 10% in local currency. We continue to benefit from the restructuring actions taken in 2024, as well as other cost-saving measures, which we project will offset the margin impact of lower volumes for the year.

Our 2025 North America boiler sales projection of an increase of between 4% and 6% compared to 2024 is unchanged. We are very pleased with our growth in the first 9 months of the year, although we believe we may have benefited from a minimal amount of prebuy related to price increases implemented in the second quarter. We continue to monitor our key markets closely. We have not changed our guidance that North America water treatment sales will decline approximately 5% in 2025, as we deemphasize the less profitable retail channel.

We continue to be pleased with the growth we have seen in our priority channels and our onboarding of new dealers during the year. Our plan to drive 250 basis points of operating margin improvement in 2025 for the North America water treatment business is on track.

Finally, we expect the addition of Pureit will add approximately USD 55 million in sales in 2025, slightly higher than our earlier guidance. It will not have a significant bottom line contribution this year, as we work through integration.

Based on the continued economic challenges in China and the softening wholesale residential water heater market in the U.S., we have lowered our full-year sales outlook from 2% to 3% growth to a range of flat to up 1% compared to last year. We continue to expect our North America segment margin will be between 24% to 24.5%, and we expect that Rest of World segment margin will be approximately 8%.

Please turn to Slide 11. Last quarter, I laid out my areas of focus. Earlier this month, the top 140 leaders of A.O. Smith gathered to talk about the future of our company, to align on key priorities and inspire each other through the opportunity to connect and share ideas on how to deliver the next great chapter of the A.O. Smith legacy. I came away from this important time together confident in our path forward and with the commitment from our leadership team to execute. I look forward to sharing more regarding this leadership summit and our focus areas in the quarters to come.

I am also pleased to welcome Chris Howe as our new Chief Digital Information Officer. Chris is the transformational leader that we need to help us invest wisely in new technologies for the future and unlock even more value potential in the technologies we are invested in today. In his previous roles, Chris led transformational effort to leverage enterprise software solutions or most recently worked on the forefront of generative AI solutions. He will be instrumental in ensuring we have the technical capabilities needed to support all our priorities, especially operational excellence and innovation.

As we shared last quarter, and as part of our portfolio management priority, we announced the intention of our formal China strategic assessment. While we remain early in the process, we are making good progress. We commissioned a third-party analysis of the China market, and it confirmed many of our assumptions entering the strategic assessment.

One, our brand remains strong, well-known and respected among Chinese consumers, especially with regard to our innovative products and premium solutions. Two, our strategy to expand into broader categories that can be connected by smart home solutions and our AI Link capability was a necessary path forward. And three, we have a number of go-to-market and business model opportunities to better strengthen the business and capture our fair share of market recovery.

We believe that we have a good understanding of our challenges and are evaluating potential opportunities to ensure the future success of this business, as we drive greater value for shareholders, employees and other stakeholders.

In conclusion, I am pleased with our third quarter execution, particularly in the North American segment. I'm also encouraged by the progress we are making on our strategic priorities, including portfolio work to help strengthen our business going forward.

Regarding execution, we delivered a solid third quarter in North America, led by pricing performance and our strong commercial, high-efficiency portfolio while expanding margins through operational discipline.

Looking forward, we remain confident in our ability to navigate the tariffs and competitive landscape in our core water heater and boiler businesses, where we serve a large replacement-driven market with a broad industry-leading portfolio and go-to-market model.

Regarding our portfolio, we are driving double-digit growth in priority areas, including boilers, select North America water treatment channels and India. At the same time, through our strategic assessment, we are working to understand and address what is required to improve the performance of our China business.

Finally, we continue to generate cash, maintain a strong balance sheet and are ready with dry powder necessary to build out our portfolio in ways that complement our business today.

With that, we conclude our prepared remarks and are now available for your questions.

[Operator Instructions] Our first question comes from Saree Boroditsky with Jefferies.

Maybe just building on some of the China color. You obviously lowered expectations around China sales. Could you just talk about your performance versus the overall market there? And is this just a weaker market? Or is there any competitive dynamics going on?

Yes. It's a little bit of both. So the market continues to have its challenges. And as I mentioned, there's been a little bit of a pull-forward demand driven by the government subsidy program. So we're on the other side of that. And I think within that down market, the competitive intensity continues to increase. So we see a lot of promotional activities trying to step in where government subsidies were playing a role to generate demand previously. And so that's adding to the competitive pressure.

And I think, as we see our path forward, as I mentioned, we've got confirmation that our brand remains very strong there. We have a really strong innovative portfolio to serve our customers, but we need to work through this period of challenging market conditions.

Appreciate that. And then obviously, one of the bright spots this quarter was in the North America commercial water heater sales. I think previously, you attributed some of the strengths to prebuy. So just maybe a little bit more detail on what you're seeing in that market and what's driving the strength there?

Yes. It's been a strong market condition for commercial products, but I'd also say we have a really strong portfolio in that space. And I mentioned on the last earnings call, the launch of our FLEX commercial water heater, and -- so we've got that out in the marketplace that I think is performing very well. So it's a combination of a really strong market backdrop, but also in an area where we've got a really competitive product offering.

And I would add that during the third quarter, we benefited from our production efficiency program to make sure that we were level loading a bit closer to the market. And some of that strength we saw in commercial and residential heater was a part of the output of that benefit in the level loading program.

Our next question comes from Bryan Blair with Oppenheimer.

Just to level set on the China strategic review. We know there isn't a timetable as of now in terms of the ultimate decision, but given the insights from the assessment so far, has the range of potential outcome has been narrowed in any way?

No, Bryan, not yet. I mean, we're still early enough in the process that we're not ruling out any outcomes at this point. So like I said, we've done some really good work just trying to profile and understand the market. We've gotten some third-party assessment to do that. We've started the process of reaching out to other participants, which is why we wanted to announce that we were putting the business under the strategic assessment, but we're not at a point yet where we've kind of narrowed down or have a view of what the outcome of that is yet. It's still too early.

Yes. Understood. Appreciate the color. The priority channel growth in North American water treatment, certainly encouraging in Q3, and that 11% nicely aligns with the 10% to 12% organic growth target you had put out at Investor Day. With mix now reset for the platform, is that kind of organic growth in play going forward?

I mean, that's certainly how we think about the business long term. I would say there's still more work to be done, right? So we've done some reprioritization of the channels and where we think we can be competitive and win. I think there's still more work and investment in that space to build out that platform. But we feel good about the growth potential of that business.

Our next question comes from Jeff Hammond with KeyBanc Capital Markets.

Just on the U.S. resi water heater market, I think you didn't change your industry shipment assumptions, but seem to lean a little more cautious. So I just wanted to understand a little bit better how you see that playing out.

Yes. Our outlook for the industry, we were talking about flat industry on our last call. And now, we're saying flat to slightly down. So we do see a little bit of pressure on the residential side. Most of that is coming through new home construction completions on the residential side that we're seeing some of that weakness. So we've taken it down just a tad.

And are you seeing kind of the market share recapture play out as you thought?

Yes. As we were looking at level loading our production this year, we've seen our performance relative to the market in Q3 come back and gain share back as we expected.

Okay. And then just -- I think you mentioned some additional tariff headwinds, maybe quantify or talk about where you're seeing that? And then just as you look at steel pricing and kind of forward tariffs into '26, how does that kind of inform pricing actions you need to take into '26? We're seeing -- we're hearing from kind of other channels that maybe next year is another above average increase. I just wanted to get your view there.

Yes. This is Chuck. I mean, the mention on tariff pressure was really framing from third quarter to fourth quarter. It's probably maybe 20 basis points on North America margins, where we are seeing a bit heavier tariffs kind of accumulate. Our full year outlook at 5% has not changed. So it's still a little bit of timing, putting a little pressure on the North American margins in the fourth quarter. We'll be back in January. We're giving a little bit of an outlook on cost. The tariff world is a bit volatile. So I think we'll kind of hold off commentary to see where material costs go in that respect.

Our next question comes from Mike Halloran with Baird.

Could you talk a little bit through what you're seeing in the residential side of things in terms of the discretionary spend? I certainly heard the commentary earlier that some of that weakness that -- or incremental weakness you saw in the residential volume side from an outlook perspective is tied to new housing starts being a little bit lower, no surprise. Are you seeing anything different on the discretionary piece?

We really haven't seen that change. We do a survey every quarter, and we look at proactive replacement, as you know. And if we kind of look at that survey, there's quarters where it edges up, edges down. But overall, it's still above that 30%. Proactive replacement remains pretty resilient. Certainly, something we'll watch as we go forward. But -- it's a backward since the last trailing 12 months survey. So we'll have to continue to watch that and make sure we understand if there is a trend developing. But right now, still above 30%.

So -- and then following up on Jeff's other question, I know you're not giving '26 thought process, but if trends were to play out, and we weren't going to get any incremental actions, the pricing that you've taken in your mind is enough to make you price-cost positive or at least be price-cost neutral on the margin line or in terms of EBITDA dollars once kind of all the catch-up happens. Is that a thought process? Or is there still going to be some gaps relative to what you're seeing from an inflation perspective with the actions you've already taken?

Yes. When we do our price increases, and it really was no different other than the amount of the price increase this time with the tariff costs hitting us, we typically look to cover margin plus cost. So just a reminder, the last one was second quarter because it was effective. When we announce those prices, they go out, and certainly, we see pressures over time on the price, and we have a bit of a fade. So I think we'll kind of still reserve kind of the answer to that as we get into the next quarter, but we're comfortable with our price-cost relationship now. But as you'll see, there's some pressure when you look at our guidance and a little bit of pressure on margins in the fourth quarter.

Our next question comes from Susan Maklari with Goldman Sachs.

This is Charles Perron-Piche. First, I'd like to go back on the China market. Understanding the market conditions are tough, but I guess, do you have any thoughts on potential additional restructuring initiatives in the region given the environment and something that would be done ahead of potential strategic announcement?

I think it's one of the things we're going to continue to kind of work through and learn more about as we go through our strategic assessment, and I kind of alluded to the fact that there's opportunities for us as we think about how we go to market, our business model. We're going to continue to evaluate those things. Whether we do those through partnerships or we do them for ourselves, it's something we still have to work through. But our goal is to make sure that the business is set up well for success. And obviously, a little bit of market recovery will help aid that in a bit. But we're going to continue to kind of learn from the changing market environment and make the necessary changes. And whether that comes through things that we'll take on and self-help to do that or whether that's done through partnerships is one of the things we're assessing right now.

Okay. That's helpful color. And then I think in your prepared remarks, you talked about the potential for a strategic acquisition within your or adjacent market. I guess, on this, can you talk about what is the pipeline for these types of opportunities in the current environment, along if the timing of any strategic decision on that is dependent on the potential announcement of the strategic review in China?

No, I think one of the strengths we have, right, is a strong balance sheet and our cash generation capabilities, so we've got an active pipeline. We continue to evaluate that from kind of a strategic lens, financial lens, where we want to go next. And as I mentioned, partly it's how do we strengthen the core of our business, how do we think about building new higher-growth businesses, and we're going to continue through that process. So I don't think it's connected to other decisions we're making across our portfolio at this time, and we're ready to move, I think, when the right opportunities come about.

Our next question comes from David MacGregor with Longbow Research.

I wonder if you could just give us an -- I was wondering if you could just give us an update on gas tankless and the progress to date on relocation of manufacturing and market development and just the impact on third quarter margin contribution and maybe the implied fourth quarter, which you've got in the '25 guide?

Sure. As you know, we've made a big investment to enter with our own products into the gas tankless space. We've been building out the right set of products, the manufacturing capability here in North America. And all of that is progressing well. I think the market itself for tankless is under pressure, heavily connected back to the residential construction market that we talked about. So from that standpoint, it remains kind of a challenging market. But I think we're really excited that I think we've got the right products, we've got the manufacturing capability ready.

As we've talked about in the past, we've made some changes. In the past, we were talking about launching in China, moving to North America. We've made some changes into that strategy, which has made some delays to our current plan in terms of how we're going to go after the market. But I think we're happy with where we're at. We'd like to move faster in the marketplace. And I think as the market picks up and recovers, especially around new construction, and with the product offering we have and the supply chain we have, we'll be ready to compete successfully.

Are you getting good feedback -- sorry, go ahead.

I was just going to answer the question on margin pressure. It's -- we're anniversarying when we first launched the product last year, so the margin pressure is a bit less than the 40 basis points we had historically talked about. For the quarter, it's probably about 20 basis points. It's not overly significant.

And I think you were asking about feedback.

Yes. I was just going to get you to talk a little bit about what you're getting back from the marketplace and people. I know that you were undertaking a phased launch on that product in terms of just incremental models, and is the acceptance level relatively good at this point? Or are people waiting for the full assortment? Just any commentary on that would be helpful.

Yes, folks love the product. And when they get their hands on it, and they get comfortable with it. And as you know, we've been building out our portfolio. So when we have the full portfolio, we'll be even more compelling. There's also elements of how we serve this market, right? A lot of more gas tankless tied to the new construction. So we're working out on the business model as well. But I would say, at the end of the day, the product is a market-leading product, and that's what we look to do when we got kind of our own product offering into this space.

Our next question comes from Nathan Jones with Stifel.

This is Adam Farley on for Nathan. Let me follow up on -- I wanted to follow up on the China commentary. I know fourth quarter is typically seasonally stronger quarter due to the shopping holidays. So what is your expectation for the selling season going into the fourth quarter, balancing that with some of the headwinds you guys are seeing there?

Well, you're exactly right. It's typically the fourth quarter is one of our strongest quarters in China. Our outlook assumes that there is an uptick in volume in the fourth quarter compared to the third quarter. But I will say when you kind of frame our outlook for China overall to be down 10%, you'll note the fourth quarter gets a little more pressure on year-over-year comps compared to the third quarter. So without the -- with the discontinuation of the subsidy program, there's a bit of uncertainty in China on how the fourth quarter may play out. But right now, we have kind of normal cadence, but not at normal volumes. But just kind of relative to the third quarter, we do see a bit of an uptick.

That's helpful. And then maybe shifting to boilers, which was a bright spot in the quarter, I think you mentioned maybe you think there's a little bit of pre-buy there, but I was also wondering if the boiler sales cycle is maybe elongating at all due to general market uncertainty or maybe that's not an issue at all?

No. I mean, we do believe that there was some pre-buy, so there is certain boilers that, I'll call it, inventoriable size. They're small enough that you'd be willing to invest and put them in inventory. We've seen a couple of strong quarters in boilers. Typically, our strongest quarter is the third quarter. So we do think we'll see a little bit of a headwind as we go into the fourth quarter for some of the unwind of the, call it, inventoriable boilers that will come out in the fourth quarter. But overall, the market quoting remains pretty steady, pretty consistent, particularly on the large CREST units. So we're not seeing any major change or elongation in, what I would say, quoting to the order cycle.

Our next question comes from Andrew Kaplowitz with Citi.

Steve, obviously, you've had good operating experience in your past positions. Maybe just stepping back as you've looked at AOS, and given how many of your markets are relatively sluggish, how have you sized the potential opportunity for cost out overall at AOS and/or the potential to accelerate new product-related growth as you begin to transition into '26?

Yes. Andy, so as I've mentioned, 2 of our priority areas are A.O. -- the operational excellence and how do we get more out of the A.O. Smith operating system and innovation. And I think that gets after both components of your question. I think -- we don't have a good sizing yet of what the value is at stake on that, but what I'll tell you is I'm encouraged by the fact that we can bring even more kind of discipline into our operating rhythm at A. O. Smith.

I think we have great manufacturing capability, and we run a lot of our business with great people with a lot of experience. And I think bringing some discipline, and I mentioned Chris Howe joining us as our CDIO, I think discipline and leveraging some of the technology investments we've made is going to be a meaningful opportunity for us. And we haven't kind of framed that in numbers yet. We're sort of building the foundation that we can build on. And I think that's something we'll continue to talk to you all about going forward.

And then, on the innovation front, we also have a new CTO, and one of the things we're really focused on is how do we kind of increase the pace and success of our commercialization capabilities and -- across our businesses. And so that's another area of focus. And again, we're kind of putting the foundation in place. But we've got a great history at this company of breakthrough innovation, creating categories. And so tapping into that culture of innovation is something that's another big priority for us.

That's helpful. And maybe just a little more color on inventories across your resi channels, anything you're seeing there? Obviously, resi HVAC is having much more difficult time than resi water heaters, given their own inventory problems over there. It doesn't seem to be the case with you guys here, but what's the risk given weaker consumer confidence that we could see some destocking?

Right now, I would say we think that inventories in the channel on both residential and commercial side is at pretty normal levels, pretty much target levels. As there's hesitancy, maybe on new home construction, may see some of the distributors looking to be very prudent on how they manage inventories in the back half of the year. But we feel like channel inventories are pretty much where they should be right now.

Our next question comes from Tomohiko Sano with JPMorgan.

My first question is on CapEx. Could you talk about the CapEx guidance compared to 3 months ago, including what kind of items like did you revise for the full year, please?

Yes. We lowered our CapEx outlook just a little bit. We pushed out some of the investments that we had planned for the fourth quarter of this year into early next year. Some of those, not all of those were related to just watching the DOE commercial regulatory initiatives out there, and we're just being prudent on making those investments until we have a more surety around that.

And my follow-up is capital allocation. So you have been aggressive with buybacks and dividend increases, how do you prioritize capital allocations going forward, especially if the macro headwinds persist, please?

I mean, certainly, the dividend is very important to us. We've raised it for 32 years. We look at that from a yield perspective, and we feel pretty comfortable with where we are at on that. Buybacks, we're framing really to not grow cash, which we're buying back a prudent amount, we believe to not grow cash and still reserve firepower for acquisitions. So as Steve mentioned, we have adequate firepower. We're looking for adding those acquisitions, and we're in a good position to do that.

And I'd say in terms of market conditions and how they change, we still recognize we need to deploy capital to our core business, and we have a very resilient core business from that standpoint. So making sure that we maintain a very strong core business that's cash flow generating is in that dynamic as well. And at the same time, we're looking to how do we provide more adjacencies that get us into kind of higher growth businesses.

[Operator Instructions] Our next question comes from Scott Graham with Seaport Research Partners.

I'm sorry for jumping on late, balancing several conference calls. So I missed your prepared remarks. Was sort of the lean into the -- I should say, the reduction to the lower end of the guide range for the year, was that on China exclusively because it looks like the North American items are fairly flat versus last quarter? Was that China? Or was it something else?

Yes. Scott, there were 2 things we pointed out. There was obviously the softness, and we did revise down our China outlook for the year to down 10%. So that was a big part of it. The other thing we've highlighted is weakness on the residential side of the North America business, and we just see that a little bit softer now, where previously, we talked about it as a flat market. We now see it as flat to slightly down. So those 2 components are what have us being a little bit more cautious.

Okay. And I'm sorry for having to ask that. It was something you already said. Does that presuppose that, or maybe contemplate that, the October industry shipments were better than September because September really dropped off there? Can you kind of talk about what you're seeing in the industry in October?

Well, the industry shipments, August really was down quite a bit on the residential side. We think September will be -- not similarly down, but was also weak. And as we think about kind of our orders, and maybe that's where we can comment in October because we haven't seen any industry data yet for October. But in October, as we look at our orders, we haven't seen resiliency, particularly on the wholesale side, which is generally more influenced by new home construction. So it's been a bit weak overall. So those all kind of -- all those factors come into play, Scott, when we're thinking about a flat industry last quarter, now flat to slightly down. We just see a little bit of pressure, particularly on the new home construction.

And we've talked about our approach to trying to level load our production a bit more for the efficiency benefits of that, working closely with our customers to do that. So we saw Q3 where the industry was down a bit, but we also gained share as was our intention as we walked through the quarter because of the way we level-loaded our production.

Thank you. I would now like to turn the call back over to Helen Gurholt for any closing remarks.

Thank you for joining us today. Let me conclude by reminding you that we are pleased with our growth in the quarter. 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 3 conferences this quarter: Baird on November 11; UBS on December 3; and Goldman on December 4.

Thank you, and enjoy the rest of your day.

This concludes the conference. Thank you for your participation. You may now disconnect.

Good day, and thank you for standing by. Welcome to the Second Quarter 2025 Earnings Conference Call. [Operator Instructions] Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Helen Gurholt. Please begin.

Good morning, and welcome to the A. O. Smith Second Quarter Conference Call. I'm Helen Gurholt, Vice President, Investor Relations and Financial Planning and Analysis. Today, I'm joined by Steve Shafer, Chief Executive Officer; and Chuck Lauber, Chief Financial Officer.

Within today's presentation, we have provided non-GAAP measures. Free cash flow is defined as cash from operations less capital expenditures. 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. We believe A.O. Smith has an outstanding foundation for profitable growth as a global water technology leader. I am both honored and excited to build on this foundation as the company's new CEO, and I'm confident in our company's future. This future will be powered by the many dedicated and capable A. O. Smith colleagues I have started to get to know over the past 1.5 years, and I look forward to the journey we have in front of us together. Later in our prepared remarks, I will share some of my early thoughts on priorities going forward that I believe will be most impactful in delivering that bright future for us.

But first, I would like to go through our second quarter performance, our updated guidance for the year and the announcement regarding our China business. Now turning to Slide 4 and our financial performance in the quarter. North America water heater sales decreased 2% in the second quarter, driven by lower volumes. Shipments in the first half of 2024 benefited from prebuy-related volumes ahead of an announced price increase. This year, we believe the industry once again bought ahead of price increases and tariff risk. We decided to take a more proactive approach by working closely with our customers to better align order rates to our strategy of smoothing production schedules in order to achieve greater operational efficiency. Like the overall industry, we still benefited in the quarter from a demand pull forward. However, our 2025 pull-forward impact was less pronounced compared to the demand pull forward we experienced in 2024, and we expect to gain operational efficiencies through the year because of these actions.

Our North America boiler sales increased by 6% compared to the second quarter of 2024, led by higher volumes of our high-efficiency commercial boilers. North America water treatment sales increased slightly in the second quarter as growth in our priority channels, e-commerce, dealer and direct-to-consumer continued to offset expected retail declines. In addition to the growth in these priority channels, we are pleased with the improved profitability it provided, which helped contribute to North America segment operating margin expansion in the quarter. In China, second quarter sales decreased 11% in local currency as the ongoing economic challenges and limited availability of government subsidy programs outside of Tier 1 and 2 cities resulted in lower volumes. We maintained our operating margin year-over-year despite lower sales due to our 2024 restructuring initiatives and other cost control measures.

In addition to announcing our Q2 performance in China, we are also announcing today that we are initiating a process to further assess our China business in an effort to ensure that it is best positioned to compete and succeed in the future. We intend to evaluate a broad range of options in addition to further business improvements, including strategic partnerships and other alternatives. As we announced in Q4 of last year, given the market conditions, we have been working to optimize the operating structure in China and reduce costs to better position the business for the future. These initiatives are already delivering positive results. We are on track to achieve $15 million in annual benefits, which have resulted in sequential margin improvement quarter-over-quarter. Despite the current macroeconomic challenges, we believe the China market has substantial long-term potential.

Our China business also has many competitive strengths, including a premium brand position, differentiated innovation capabilities, a well-established distribution network and a talented local team. We are committed to realizing the full potential inherent in our China business for our company and our shareholders, while benefiting our employees, valuable partners and customers. We believe that the assessment announced today will allow us to properly understand the potential options available to realize the full potential of the business. As the review progresses, we will continue to deliver best-in-class products and service just as we always have.

Please turn to Slide 5. I would now like to take a moment to discuss innovation at A. O. Smith. As a water technology leader, we continue to invest in and launch new to the world differentiated products. And I would like to highlight a few of those offerings today. We recently introduced the second product in our AdAPT gas tankless line, the Adapt which is our standard condensing product featuring industry-first integrated scale prevention technology. This product is positioned in the high-volume segment of the tankless market and is the latest proof point in our commitment to become the North American leader in tankless technology.

We have also just launched our Home Shield Full House water filter, which is certified to reduce PFAS to less than 4 parts per trillion for 500,000 gallons of water. In addition to taking whole house PPaaS reduction performance to a new level, it is also easier to install and provide both economic and ecological benefits for the homeowner. Next month, we will introduce the cyclone Flex, the next generation of our industry-leading commercial water heater that is smarter, more efficient and more flexible than ever. Staying the industry leader means never standing still, and this product is a continuation of our long history of cyclone enhancements and will help ensure we are best positioned for the 2026 regulatory change in the commercial market and remain the industry's #1 specified commercial gas water heater.

These are just a few examples of the exciting pipeline of new products we are bringing to market that has us confident in our future. I'll now turn the call over to Chuck, who will provide more details on our second quarter performance.

Thank you, Steve, and good morning, everyone. We delivered sales of $1 billion in the second quarter of 2025, a decrease of 1% year-over-year. Earnings were $1.07 per share a 1% increase compared to the prior period.

Please turn to Slide 6. I Second quarter sales in the North America segment of $779 million decreased 1% compared to a difficult year-over-year comp. Higher boiler sales were more than offset by lower volumes of water heaters. North America segment earnings of $198 million were essentially flat to last year. Segment operating margin was 25.4%, an increase of 30 basis points year-over-year primarily due to mix benefits from our water treatment priority channel strategy as well as growth in high-efficiency water heaters.

Moving to Slide 7. Rest of the World segment sales of $240 million decreased 2% compared to last year. and included $16 million of sales from the Pureit acquisition. Sales in our legacy India business grew 19% in local currency. China third-party sales decreased 11% on a constant currency basis. Rest of the World segment earnings of $25 million were essentially flat year-over-year as continued expense management offset lower sales in China. Segment operating margin was 10.5% compared to 10.6% in the prior period. The Pureit acquisition is progressing well. However, we'll be a margin headwind in the near term as we focus on the integration.

Please turn to Slide 8. We generated operating cash flow of $178 million and free cash flow of $140 million during the first 6 months of 2025 and higher than the same period last year, primarily due to lower cash outlays for 2025 working capital needs that were partially offset by lower current year earnings. Our cash balance totaled $178 million at the end of June, and our net debt position was $126 million. Our leverage ratio was 14.1% as measured by total debt to total capital.

Let's now turn to Slide 9. Earlier this month, our Board approved our next quarterly dividend of $0.34 per share. We repurchased approximately 3.8 million shares of common stock in the first 6 months of 2025 for a total of $251 million an increase over the same period last year as we increased our planned full year repurchase intentions from $306 million in 2024 and to approximately $400 million of shares for 2025. We also opportunistically bought shares during the first half of the year. We are actively assessing strategic opportunities and have sufficient dry powder for suitable acquisitions. Our priority is on deals that strengthen our core business or help us build new growth platforms.

Please turn to Slide 10. In our 2025 earnings guidance and outlook. We are raising the midpoint of our 2025 EPS outlook from a range of between $3.60 and $3.90 per share to a narrowed range of between $3.70 to $3.90 per share. The midpoint of our revised EPS range is an increase of 2% compared to our 2024 adjusted EPS. We have included the following key assumptions in our outlook. Our guidance assumes an approximate 15% to 20% increase in the cost of steel in the back half of the year as well as the full impact of currently announced tariffs, which minimally impacted the first half of the year. Other input costs outside of steel and tariffs are slightly higher than 2024 and ratable for the year. The tariff landscape remains uncertain. We have refined our estimate of the annualized tariff impact on total company cost of goods sold to be an increase of approximately 5%, which is inclusive of currently announced tariff rates as well as the mitigation efforts we have implemented.

Our mitigation strategies include footprint optimization, strategic sourcing and other cost controls. We estimate that 2025 CapEx will be between $90 million and $100 million as we continue to invest in engineering capabilities and prepare for the upcoming regulatory changes. We expect to generate free cash flow of between $500 million and $525 million. Interest expense is projected to be between $15 million and $20 million. Corporate and other expenses are expected to be approximately $75 million. Our effective tax rate is estimated to be between 24% to 24.5%, and we project our outstanding diluted shares will be $142 million at the end of 2025.

I'll now turn the call back over to Steve, who will provide more color around our key markets, top line growth outlook and segment expectations for 2025 remaining on Slide 10. Steve?

Thanks, Chuck. Key assumptions in our top line outlook include the following: we project the 2025 residential and commercial industry unit volumes will be approximately flat to last year, which is unchanged. As we expected, we believe there will be some pressure on our market share in the first half of the year, as we managed our production levels despite the strong order rates we saw in response to tariff announcement and ahead of our main price increases. We anticipate a market share recovery in the second half of the year as we work through our backlog and our customers return to more normalized order patterns.

In China, we believe the economy remains challenged, and we continue to project that our sales in China will decrease 5% to 8% in local currency. While the stimulus programs benefited sales in Tier 1 and 2 cities, where we saw relatively flat sales compared to last year, stimulus programs were inconsistently applied in other regions, particularly in smaller cities. Additionally, many regions have not yet resumed subsidies in the second half of the year. Our forecast assumes that the currency translation impact will be minimal in 2025. We continue to expect to realize annual savings of approximately $15 million from our 2024 restructuring actions. And as a result, China operating margin is projected to be in the 8% to 10% range for 2025, even with lower volumes.

We remain cautious about the near-term market outlook, including the impact from the appliance discount trade-in program. However, we are pleased with how our China team continues to manage the challenging environment. We have raised our 2025 North America boiler sales projection from an increase of between 3% and 5% to an increase of between 4% and 6% compared to 2024. We are very pleased with our growth in the first half of the year. However, we believe we may have benefited from a minimal amount of prebuy related to price increases implemented in the second quarter. We continue to monitor the commercial markets closely.

We have not changed our guidance that North America water treatment sales will decline approximately 5% in 2025 and as we deemphasize the less profitable retail channel. We are pleased with the momentum we are seeing in our priority channels where we are seeing double-digit growth. We continue to project an operating margin expansion of approximately 250 basis points in 2025 for the North America water treatment business. Lastly, we continue to expect the addition of Pureit will add approximately $50 million in sales in 2025 and will not have a significant bottom line contribution this year as we work through integration. Based on our confidence in our ability to manage tariffs and other cost pressures, our expected improved relative market share performance in the back half of the year. our strong boiler sales in the first half of 2025, we have raised our full year sales outlook from flat to 2% to an increase of 1% to 3% compared to last year. We continue to expect our North America segment margin will be between 24% and 24.5%, and Rest of World segment margin will be between 8% and 9%.

Please turn to Slide 11. As I reflect on my last 16 months, there were several things that led me to join the company in March 2024. And I found that those first impressions have proven to be accurate. First, the company's dedication to its foundational values and doing business the right way, the Smith way, strongly resonates with me. Second, the genuine commitment of the entire global team to a strong culture of collaboration and innovation. Third, the quality of our businesses where we are a leader in the markets that we serve with a strong, trusted and enduring customer relationships. Our core North America water heater and boiler businesses provide a resilient base with stable 80% to 85% replacement rates, strong cash generation and attractive regulation-driven growth tailwind. And fourth, an amazing set of strategic opportunities that we can lean into to build our bright future.

As I now step into the CEO role, I'd like to highlight a few areas that my leadership team and I are focused on that I believe will play an important role in creating value at A. O. Smith as we go forward. First, operational excellence, we will remain focused on accelerating productivity and the elimination of waste through the expansion of our AOS operating system. While A. O. Smith already has a great foundational culture of continuous improvement on the plant floor, I believe we can benefit from a renewed focus on the application of lean principles not only to our manufacturing processes, but to other processes as well. I have personal experience both in deploying and running a number of operating systems in my career. And I believe the opportunity to expand our thinking of end-to-end processes and waste elimination can even further improve the operational and working capital efficiencies of our company.

An example of our focus on this operational discipline is our initiative this year to work with our customers to smooth our production schedules in our plants, which we discussed earlier. I also see technology playing a big role in helping us achieve new levels of productivity going forward. Both leveraging those technology investments we have already made more effectively and investing in new technologies to help us advance the way we work. We are also going to build upon our great legacy of innovation at A. O. Smith. Our pipeline of innovative products is strong, and we have made a number of major investments to prepare for the future both in terms of regulatory and technology shifts. Included in this investment is the recent commissioning of our brand-new product development center in Lebanon, Tennessee.

Earlier, I shared some of the exciting new products we are introducing this year as examples of our powerful innovation capability. There is still much more we can do and I look forward to the opportunity to advance A.O. Smith's innovation capability to the next level. I am pleased to announce that Dr. Ming Cheng joined the company earlier this month as our next Chief Technology Officer. I worked with him for over 10 years at 3M and developed great respect for his leadership, business sense, technical expertise and great curiosity, all important attributes for an innovation leader. I'm confident that Ming will help us achieve this next level of innovation capability.

The third focus area I would like to mention is portfolio management. making sure that A. O. Smith is positioned well with a portfolio of businesses and products for future success. The assessment of the China business as well as the restructuring actions we took in China and North America water treatment last year, are consistent with my commitment to continually evaluate our portfolio and take the actions necessary to position them well for profitable growth. M&A and strategic partnerships to build out our business platforms will likely be a critical lever to enable this portfolio of work. And we have ample dry powder and management focus to help deploy it for the right targets. I look forward to sharing more information about these priorities as we lean into them and drive them forward to create value for A.O. Smith.

Moving to Slide 12. In conclusion, as we continue to navigate the tariff landscape and pursue our long-term strategic investments, I am pleased with our team's second quarter performance. We executed well both responding to a number of uncertain factors in North America with agility and discipline and resetting the business in China to address the ongoing challenging market environment. These actions have allowed us to continue to make sequential margin improvement in both the North America and Rest of World segments. We continue to see strong growth momentum in areas where we are expecting growth performance, including the North America boiler and India businesses as well as the prioritized channels in the North America water treatment business. In both our margin improvement and growth efforts, I would like to thank all my A.O. Smith colleagues for your dedication and delivery.

We also believe the strategic actions we are taking are positioning us well for the future. Leveraging the AOS operating system, reenergizing innovation and driving our portfolio forward will be key to our success. And I am pleased to see our leadership team rallying around these priorities. Our strong market leadership, recurring revenue from our core water heater and boiler businesses and our solid balance sheet enable us to invest strategically and maximize shareholder return even in the face of uncertainty. We are confident in our future and our proven ability to achieve profitable growth. With that, we conclude our prepared remarks, and we are now available for your questions.

[Operator Instructions] Our first question will be coming from Mike Halloran of Baird.

Can we just start with the why now on the China side. What was it? Obviously, Steve, you're taking over the range is maybe part of the catalyst. But why is this the right opportunity to start thinking about alternatives for China? How far are you in the process and just kind of any incremental comp in the incremental context? And maybe alternatives is the wrong word, but just trying to figure out what the next steps for that region are?

Yes. I think, Mike, we remain excited about the future potential of the market there. And as you know, we've been working through some changes within the business, taking some restructuring actions, making sure that we're positioning the business to compete and perform as the market goes through this challenging environment. I think we're just at the point where we want to just broaden the horizon of options to explore. Our focus is completely and remains on how do we make this business most successful going forward. And so I think it was it came time where we wanted to open the aperture, look at other options and make sure that we're fully informed about what's the right path forward for the business.

So second, can you help with margins as we get to the back half of the year and kind of a twofold question. One, implied margins for rest of world down back at the half of the year. Normally, they seem to be up back in the half of the year? Maybe just talk through the moving pieces there? And then secondarily, just a discussion on price costs in North America and how you see that playing out for the rest of the year?

Yes, Mike. Rest of the world, I'll take that. So we talked a bit about our China volumes this quarter being down 11% in local currency and full year being 5% to 8% down. So as we look at the back half of the year, we expect will be some continued headwinds in China and our cost reduction actions are working well. We do expect to realize that full annual savings of $15 million. However, the pressures we feel that we'll see with some inconsistencies within the application of the government subsidy program. We expect to continue a bit through the back half of the year. So we're not quite as bullish on the fourth quarter as we typically are from a seasonal cadence. But we are very pleased with the restructuring results. We expect China will be in that 8% to 9% operating margin for the year.

On the North America side and price cost, I mean, I think the way we think about that is really 2 halves of the year. As we walk into the back half of the year, we'll see steel costs going up 15% to 20%, we'll experience the full impact of tariffs. Tariffs will be about 5% for the full year. So tariffs were somewhat minimal in the second quarter as we work with kind of our key suppliers and good partners on that side. So we have direct impact and then you have indirect through suppliers and some of those were coming in a little bit slower than what we expected, but we expect the full impact in the back half of the year. So when you take those 2 cost drivers together and then pricing that we've implemented effective May 4, but generally, we'll impact us in a positive way in the back half. We're able to offset those costs.

But the net, if you look at our full year guidance, pretty strong front half North America margins, very, very pleased with where we were at in North America margin, but we'll see a little headwind on that North American margin in the back half because of those extra costs coming in. We also will see volume shift a bit in the back half of the year. So Typically, the water heater cadence, as you know, is about 51% in the front half and 49% in the back half on the residential side. We see the industry this year playing out very similar to last year. Last year, the cadence for the industry was about 53% front half and 47% back half. And what we would expect for our performance this year would be somewhere in between kind of a normal year and somewhere in between the price pull forward because we did benefit from pricing pull forward in the front half of the year.

So if you take a look at all of those, Mike, a long answer to what we're looking at for margins in North America and price cost relationship in the back half.

And our next question will be coming from Saree Boroditsky of Jefferies.

Could you just talk through what you saw in resi and commercial water heater shipments in June and into July? Obviously, it seems like industry shipments running ahead of what maybe you saw due to market share. So any other color on the impact of the market share that you experienced in the first half and how that plays out as you go to the second half of the year as well.

I'll just follow up, Saree on that. Kind of piggybacking off what I just mentioned kind of the cadence for the year. So we would expect that our share performance would be a bit better in the back half of the year due to the smoothing and the working with our customers, we did on order management in the front half of the year. Certainly, we benefit a bit on the price increase pull forward in the first half of the year. But we believe ours is a bit muted. So as we go into the back half of the year, as Steve mentioned, we would expect to pick up a bit of share in the back half of the year. Order rates, as you would expect in June and July are very typical and kind of right where we expect them to be after a price increase pull forward like we experienced early May.

Appreciate the color. And then I know you don't usually say much on pricing, but just the impact of price in the quarter and how much of the price increase did you realize in 2Q versus the remainder of the year?

Yes. I'll just talk about water heating because water heating price increase with our backlog and then you have kind of the lead times and it was implemented in May a bit of pricing but very little that came into the second quarter. We had pricing in all of our businesses. So there was some pricing benefit. But price cost relationship for the quarter. From a tariff perspective, I'll just kind of stay with the tariff perspective, we roughly offset the increased cost in tariffs for the quarter.

And our next question will be coming from Damian Karas of UBS.

I wanted to ask you about the North America water heater business and the volumes you saw in the second quarter. Could you give us a sense relative to last year where the volumes came in that you shipped? And how much of a prebuy headwind are you expecting now in the third quarter as a result of a little bit of the pre-buy?

I mean the industry volumes through May were relatively flat on the residential side. Commercial is up maybe 1 point. So it's tracking very similar to last year. We're not tracking quite to that level because of our smooth production and management of orders through customers. So we would expect to pick up a bit in the back half of the year relative to kind of the industry performance. Pull forward percentage, it's hard to tell kind of how it fell into the front half of the year versus what we'll experience in the back. But we do know we do know we had a benefit in the first half and in the second quarter for pull forward. Like I mentioned, orders are still a bit muted.

So it's a bit hard to tell exactly how much that is. I'll frame it typically, like I said before, the industry is 51-49. The industry this year, we project will be 53 47, and we're going to be somewhere in between kind of that 53, 49 in the 51, 40 -- sorry, 53, 47 and the 51-49.

Okay. That's helpful. And then I wanted to ask you about the China water heater business. I appreciate that you are taking a look at options on what to do with that business going forward? But just looking at, I think, where some of the industry peers have been seeing their domestic shipments. It feels like you've been underperforming and maybe experiencing greater headwinds than the broader industry. Could you just help us to understand a little bit why that might be? Does it come down to your regional concentration maybe being more in the Tier 1 or Tier 2? Are you still seeing peers maybe price more aggressively, anything that could just help us understand why you're maybe trailing a little bit in that market in the exchange program.

Yes. So I mean, obviously, we have many decades of really strong performance in China. We're viewed as a market leader, great brand or known for our innovation in China. And I would say all of that is still the case on the ground. We're an aspirational premium product, and that's backed up by our ability to continue to put great products in the marketplace, drive innovation and and support it with the service that people come to expect from A.O. Smith in China. And I think that's still healthy in a very challenging market, and we see that through in the premium positions where we continue to be able to hold our own and maintain share. Obviously, what's changed recently that market dynamics are more challenging. Consumer confidence is -- remains very low in China, and that is also highly connected to retail -- or sorry, property values in China. And so we're all working through that together. The other thing that's changed is local competitors have gotten much better. So the gap in performance, the gap in innovation isn't what it used to be. So that's making it a more mature and challenging marketplace.

And I think that's starting to play out in parts of share, either down market. There's also shifts happening in terms of how people buy in the channels where we have a very strong distribution network, more of that's moving to online. That also serves as a headwind, especially as we try to get our more premium innovative message out there. So on the ground, we're pivoting on those things. We're responding them. We're getting more active in digital. We're getting more active as the market also gets into more connected and intelligent devices, and we've made investments to be able to ride that wave as well. So we're going through a transition and some of those transitions relative to competition, some of those transitions relative to go-to-market models are things we have to work through, and that's a lot of the work we've been doing that's been a challenge for the business the last few years, but one that we're continuing to navigate through.

And our next question will be coming from Susan Maklari of Goldman Sachs.

My first question is on the efforts that you mentioned to help better manage the pull forward of volumes in the first half. Can you just give a bit more detail on how you approach that? What was different relative to the past and how you're thinking about efforts to continue to perhaps maintain that going forward?

So the industry, when they see upcoming changes, and in this particular case this year, it was a combination of both tariff risk as well as announced price changes, look to buy ahead and get in front of that. And we saw that last year with the price changes. We saw that this year again with price changes and tariff announcements. And the impact that has on our operations is when you get a lot of orders that come in and you look to serve all those orders right away as you're investing in your operations to crew up , add shifts, run overtime to meet that demand.

And then once the inventory is out there in the channel, it takes time to work off through. And obviously, then the consequence of that on our manufacturing operations is we have plants that become underutilized. So it's a pretty lumpy and inefficient way to run our manufacturing operations. We experienced that last year. And this year, we wanted to kind of get ahead of that. We work really closely with our customers. It's not an exact science. It's a little bit of art site to work with our customers around making sure they're getting the product they need and expect, but at the same time, doing it a way that doesn't drive unnecessary inefficiencies through the entire supply chain.

And so -- as we work with our customers through that, yes, we do still have some pull ahead that we've expected that we've seen in Q2. But also, we think we've got a better way of actually manning our operations, and we work with our customers to make sure that their they're still getting the product they need and when they need it, but also that the way we're able to smooth out how our plants run so that we're not investing in over time upfront and then underutilization on the back half.

Okay. That's great color. And then as you think about the business, Stephen, you come into this new role, can you talk a bit about other areas that maybe also noncore or things that you'd like to deemphasize? And any areas or adjacencies that you're interested in building into and your thoughts on perhaps M&A or organic initiatives in those areas.

Yes. A high priority for me, as I mentioned, is portfolio management. I think that's always continuing to review the portfolio we have today and making sure we're the right owner, the best owner for the business. And we'll continue to always evaluate that and keep that top of mind just as we always have. I think it's also very important as we think about our capital deployment priorities. We're going to continue to invest in our core businesses to make sure we maintain leadership positions, which we generally have today, but also to actually build out new business platforms. I think that's important for us to get into growthier spaces. I think M&A is a core component for how we're going to do that. And we've got a real focused effort on thinking about where we go, having our strategies right on that, having conviction about where we go next and then executing and following through the pipeline.

And our next question will be coming from Matt Summerville of D.A. Davidson.

Two questions. First, on the more recent point you made about building new business platforms. Can you provide a deeper assessment or maybe initial assessment on the actionability and quality of A.O. Smith's current M&A pipeline? And then I have a follow-up.

Yes. I mean it's 1 that's active and moving. And I think we have a few spaces we're pretty excited about, and there are spaces where we think we can step in and be good owners of businesses and run them in the A.O. Smith way. So we're excited about a few areas. Actionability of those targets can vary. It's never a certain thing. But I think we've -- we're excited that a few assets that we think could be a really good fit may be actionable in the coming year, but we can't commit to anything, and we don't know. And as always, we'll be disciplined about how we step into those opportunities.

And just as a follow-up, are you willing to consider something more transformational, maybe add another leg to the stool, so to speak? And then just a quick one on the boiler business. guide 4% to 6%. I think in Q1, you were up 10%, Q2, you were up 6%. So help me understand what that's implied about the back half of the year, specifically to boilers.

So on the first question on transformational M&A. I mean I think we wouldn't rule it out. We are trying to build new businesses. Obviously, there's a whole bunch of additional kind of risks and challenges that come with something that's bigger and more transformational. But I think our view of where we want to go next is we want to build out new business platforms and ones that are great fits for our company and what we do well. So not rolled out, but obviously, those things oftentimes take time to build towards. As it relates to the boiler business, I think we're just -- we're being cautious about the back half of the year. Certainly, we like the growth performance that we saw in the first half of 2025. We've got a good healthy backlog. So I think we're entering the second half of the year in a strong position.

And that's why we're really watching the commercial market closely. Difficult to know for sure how much pull ahead we potentially had in the first half as part of that. That's part of the reason for the cautiousness and then also just what happens with projects and how those play out. by the coming to the end of the year.

And our next question will be coming from Bryan Blair of Oppenheimer.

Quick question on the assessment of A.O. Smith China. As you're thinking about the varying opportunities at hand for potential opportunities. Is this specific to or exclusive to Smith China? Or could your faster-growing India business be included as you're looking more so on the side of strategic opportunities, or partnerships, other alternatives?

Yes. The announcement today is specific to China and just looking at options for our China business.

And sorry if I missed this detail. With North American water treatment, are you still tracking towards the 250 basis point margin expansion you had outlined before? And then I guess -- and more importantly, with mix progressing towards your targeted more favorable mix. How should we think about incremental margins as you lap the retail declines and get back to growth?

Yes. We are tracking to our target of 250 to 300 basis points improvement that the business has performed well through the front half of the year. And on the shelf retail transition, it was a pretty clean transition. So we saw a nice increase in the first quarter which carried through to the second quarter just based on the channel strategy to de-emphasize on the shelf retail. So we're comfortable with that 250 to 300 basis points increase and would expect that to pretty much be carrying forward for the rest of the year.

I would add, too, just kind of going forward in addition to some of those go-to-market prioritization decisions we've made, we're also taking actions to take advantage of the integration work of the different acquisitions we've brought together to build that business. And we have opportunities there to also both drive growth and continued margin performance through those levers, which goes above and beyond just the prioritization work we've done.

Our next question will be coming from Jeff Hammond of KeyBanc Capital Markets.

Just wanted to clarify the market share comment, weaker first half, better second half. Is that just simply that your competitors didn't limit prebuy and maybe they saw more prebuy so that levels out? And then just more broadly on competitive landscape. Maybe just speak to kind of the new player in the market, and the JV partnership. And then it seems like some distributors are opening up to multiple sourcing for water heaters. So you just talk about competitive landscape more broadly?

Sure. Just maybe as a first point around how do we think our actions relative to the industry. We do think the industry maybe took a more aggressive posture of fulfilling order demand than what we did. That that's really what's behind our commentary around market share, both first half of the year compared to second half and why we do believe we will have an uptick in market share in the back half as we manage some of those orders back through kind of what will play out in the second half. So that's the driver. There's a lot to still play out for the second half of the year to validate it, but that's our assumption. The second question, sorry.

With respect to the recent JV.

Oh, yes, and competitive. Yes. I think there's obviously -- over the last few years, there's been a number of announcements and new entrants looking to get into the space. And those always get our attention, right? We're the market leader and we're mindful of when there's new people looking to participate in the North America water heater space. But I would say, to really be successful in this market, you have to have real conviction. And I think that conviction requires you to have the full breadth of portfolio. You've got to have that portfolio available at a moment's notice, especially when you got 80%, 85% that's replacement. People don't really like to take a cold shower twice. So you have that portfolio available through the channel partners that can reach the contractors on a moment's notice. And that's the types of investments we make, and that's the kind of conviction level we have for this market.

And I think it's also why it's proven to be pretty challenging relative to new entrants coming into the space. And then on top of that, it's actually a pretty complicated landscape as you go forward, especially on the regulatory front where there's a lot of uncertainty. You got to have the right technologies available in the right states at the right time with those changes. And that's the advantage we have as the market leader, right? We help lead the industry through those types of changes. So I think it's challenging for a new entrant to come in. We don't take it lightly. We take it seriously. We're always thinking about making sure that we continue to serve the market well so that there's no need for alternatives. And I think as we've said before, too, as it relates to channel and share shifts in channel and even how that plays out across the big that's something we always have had to deal with. We navigate it through.

I think we've always been able to find a way to make that work out well for us, working closely with our channel partners, and we'll continue to do that going forward.

And our next question will be coming from Scott Graham of Seaport Research Partners.

I wanted to follow-up on Mike's question of why now. I don't think anyone would debate the strength of your China business. It's been around forever, you're a market leader, the whole thing. But obviously, sales are off-peak margin is well off peak. So is this more of an announcement maybe that it's and look at the business to see which portions of it need to be paired a major restructuring? Because it just seems like a divestment today would not be prudent. Could you talk to what some of the maybe more looked upon favorably assessments within the options that you're talking about here? Could it just be a major restructuring of the business?

Yes. I mean our announcement today is not announcement of any decision made business. We're still very early, and we're just sort of at this point announcing that we're initiating this assessment. And actions we could take within the business, those are ones we consider and think about and evaluate ongoing, and we'll continue to do that for sure. I think the why now is, I think we want to explore what our full set of alternatives are, right? And we're not sitting here today committing to a divestiture of the business. What we're talking about is we would like to understand and be well informed around what the full potential options are for the business going forward to make sure we actually do what we can to position the business in this great asset that we have in China for success and to be able to compete and win in the future.

And we think what we're doing is broadening the aperture of that, of what potential options could look like. And any strategic partnerships or anything else we would explore, our primary goal would be how to make the business better. how does it make the business have a better chance of success going forward, and that's the ones we're going to take to it.

Understood. I just -- my follow-up is around pricing. So you went out with an announcement, I believe it was in April on the price increases that were going to be part -- a big part of your offsetting tariffs and you're saying essentially that there wasn't really much of a tariff impact in the second quarter. So I guess I'm wondering, are you now rolling back pricing in some way because effective May 1, I'd have to believe that some people might be looking for some type of rollback given that the tariffs were rolled back.

No, we're not, Scott. What we're trying to indicate is for the second quarter, it was not a meaningful impact because of some of the timing of when the tariffs came in. We did see some offsetting in pricing. But in the back half, we will have the full impact of tariffs. We'll have the full impact of 15% to 20% steel costs going up. So we're -- the announcement was effective in May. And as you know, we don't really realize the benefits of any pricing until you work through the backlog and lead times, which takes us to the very end of June. So that portion of it really doesn't roll in until almost as we start into the third quarter.

Understood. And nice execution around the operations in 2Q.

And our next question will be coming from Nathan Jones of Stifel.

Good morning, everyone. I guess I'll follow up on that last question around tariffs and pricing. I think you guys said on the last call, you announced pricing to the market that was going to be 6% to 9% across the majority of the North American business. And I think you talked about 5% impact to COGS on this call. maybe that was across COGS for the whole business and not COGS just in North America, but it would seem that maybe there's some margin upside there from price versus what you're seeing from tariffs or maybe that 5% is spread across all of COGS rather than just North America? Any comments you can make there?

Yes. Thank you for the clarification on that, Nathan. It is 5% across all of the business and our tariff impact is largely North America business that we have the cost impact. So 5% across the business, but it's predominantly focused within North America.

Okay. So the COGS number in North America is a bit higher and maybe in that 6% to 9% range. So it's a bit more offsetting.

That's correct.

I guess the other question I wanted to ask is around the operational excellence kind of priority stave that you set. Maybe just any comments around that. It sounded a little bit to me like lean outside the 4 walls is somewhere that you see an opportunity -- just maybe any color around that and any specific places that you see opportunities to improve the operational performance of the business.

Yes. I wouldn't characterize it as lean outside the 4 walls as much as referencing lean in our end-to-end processes. And I think where the AOS operating system today is done a really nice job of focusing on the plant floor with model lines and engaging our workforce around continuous improvement, and we did some good results from that. Expanding it to really think about end-to-end process. And obviously, many of our processes run through our plans, which is why I wouldn't characterize it as outside the manufacturing walls. But leveraging our ERP system to get more discipline around our processes and as we do that, realizing more efficiencies.

And our next question will be coming from David McGregor of Longbow Research.

This is Joe Nolan on for David. You mentioned steel costs up 15% to 20%. I was just hoping you could talk about what you're seeing with some of the other input costs and how those are moving directionally into the second half of the year.

Yes. Year-over-year, other input costs outside of steel and tariffs, of course, they're up slightly year-over-year, but pretty ratable for the year. We don't necessarily see those moving up in a great deal in the back half. Again, that's not cost not associated with the tariff impact.

Got it. Okay. And then the water treatment business had a good quarter overall. It sounds like retail business might still be a little weak there. Can you just talk a bit more about your outlook into the second half for that business?

Yes. I think we're making really good progress on that business. I think the focus on our priority channels has brought focus to places where we think we have the best chance to compete win, the integration work we're doing with in our acquisitions to help the businesses get healthier and stronger. And it's a growth platform for us. And we had a bit of a reset to go through kind of last year and into this year relative to positioning the business to be more competitive. And I think where we are now is we like the positioning of where we're at and now it's time to get back to growth.

In your comments around kind of the weakness in the retail channel, it's really a proactive strategy that we took to deemphasize on the shelf retail. So it's intentional that we've moved that channel, and it's helped our margin profile as we step into the year.

And our next question will be coming from Sam Snyder of Northcoast Research, lines.

I have a couple of questions. Thanks for getting in at the end of the call. But I wanted to know what has changed from a quarter ago with the China business? I know -- I mean maybe I'll ask it a different way, but what's on the table now that wasn't on the table before in terms of strategic actions. Maybe help us imagine what -- not a sale outright, but something else, like a partnership like what could that look like? And I have a follow-up on innovation maybe more long term, if we can get to it.

Yes. I mean we've obviously been working on closely with our China team around how to improve the competitiveness and the success of our China business. I think what changed is we want to just think about a full range of options of what's the best way to do that, right? And I think it's an evolution of our thinking as we think about how do we set up our China business. We've got a great asset with many competitive strengths. And as I mentioned, it's a market we think there's got a lot of potential in and so what we want to do is say, what's the best way to do that. And we think it could involve working with strategic partners and thinking about options beyond just some of the things we've been doing to the state. And we want -- we were starting this process, right? So what we want to do is we want to be fully informed and ultimately, at the end of the day, make sure that we set this business up for the best path forward to be most successful.

Okay. And then just real quick if I get it in on innovation. Like what do you see -- when you think about innovation, whether it's U.S. market or rest of world, maybe illustrate some of the things you're talking about.

Yes. I mean I'm a big believer that innovation for industrial companies is core to how you drive organic growth and how you maintain outsized profitability, you have to be able to bring things to the world. that are differentiated and that solve real problems. So for me, it's fundamental to a really successful industrial business. I got to see that up and close at 3M. It's 1 of the more successful innovation industrial companies out there. And I think it's an important part of our future. And also, what's really nice is it's been a huge part of our past, right? We have innovated and really to totally changed markets as we stepped into them over our 150-year history. And I think it's a big part of our 150-year future. And it includes innovation processes that allow you to launch products successfully and efficiently and on time, meeting customer needs.

It's a culture and making sure that we continue to embrace and energize a culture of innovation, which includes being able to experiment, be curious, take risks as you step into doing new things to the world. And it's really understanding and defining the technologies that are going to be relevant to the future and making sure you invest in those technologies. So those are the types of things that we're focusing on. And as I mentioned, our new CTO, I think, is going to be a great boost to helping us get to the next level.

And one moment for our last question, which will be coming from Andrew Kaplowitz of Citigroup.

Good morning, everyone. Thanks for fitting me in Steve, I know you said you'll consider all alternatives when you're using your balance sheet moving forward. But ALS has been sitting with what, I think, some would call an underlevered balance sheet for some time. As you assess just overall capital allocation. Do you think the company could get a bit more aggressive in general using its balance sheet? Or how do you think about that?

Yes. I mean I think it's important for our future, and we're going to look to continue to find attractive growth platforms for us. So it's a high focus for us. I think we obviously need to protect and run and drive performance in our core businesses because that's what helps fund cash and maintain a strong balance sheet. So we're going to do that. But I do think it's going to be a big focus for me. going forward is figuring out how do we transform our portfolio over time. How we put that balance sheet to work will obviously be determined by some of the strategies we pursue and then some of the actionability of some of the M&A targets that will be out there. But look, I think we're in a great position because we do have a strong balance sheet. And I think we do have some core capabilities that I think we can stretch into new areas that we'll be able to create a lot of value. And so it's going to be a big focus for us.

Helpful. And then you obviously raised your boiler forecast. I know you answered a previous question that you want to be conservative in the second half. But is your improved guidance just continued traction on your high-efficiency boilers? Or is there any change in the market? How would you rate the health of your commercial customers right now?

I think the business performs well. I think -- like I said, we have great interactions with our customers who are still looking for high-efficiency products. So that's where our business and our lock in bar business in particular, really plays well and is meeting the market needs. So we see the business performing well in the marketplace as well as what it's delivering in terms of growth financially for the company.

Yes, this is Chuck. We are -- when you look at our guide 4% to 6%, and Steve said it earlier, kind of protecting ourselves on the prebuy because we did experience some inventory in the channel and boilers a couple of years ago, which unwound a bit. And we would expect there's a little bit of pull forward, but we're very, very pleased with kind of how we're performing in the market.

And I'm showing no further questions. I would now like to turn the conference back to Helen Gurholt for closing remarks.

Thank you for joining us today. Let me conclude by reminding you that we are pleased with our EPS growth in the quarter. 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 3 conferences in the quarter. Seaport on August 18, Jefferies on September 3 and D.A. Davidson September 18. Thank you, and have a great day.

And this concludes today's conference call. Thank you for participating. You may now disconnect.