A. O. Smith Corporation (AOS) Earnings

Management highlights

### Leadership Transition - Long-time CFO Chuck Lauber is retiring, and the company recognizes his many years of meaningful contributions and impactful leadership. The transition is planned and orderly, reflecting the strength of AO Smith's broader leadership team. - Carrie Anderson joins as the new CFO, bringing extensive financial leadership experience across complex global manufacturing, a collaborative leadership style, and disciplined execution approach. She has already become a valued member of the leadership team. ### Business Execution and Core Performance - Total company Q2 sales were approximately $1 billion, with adjusted earnings per share of $1.03. North America organic sales grew 3% year-over-year, with overall strong operational execution across the business. - The North America boiler business delivered exceptional performance, with 21% Q2 sales growth and 12% year-to-date growth, driven by momentum in residential boilers and returning growth in commercial boilers. Investments in product innovation, customer service, and channel partnerships position the business well for long-term growth. - North America residential water heater industry demand remains pressured by soft new construction and existing home sales, which also impacts replacement demand, but AO Smith has made progress stabilizing market share in a competitive environment, supported by strong leading brands, broad channel reach, and solid customer relationships. - North America water treatment sales saw a 2% decline, as growth in the priority dealer channel was offset by softer demand in other channels. The company has taken steps to optimize its operational footprint and streamline its brand portfolio to improve efficiency and drive profitable long-term growth, expecting $6 to $8 million in annual savings starting in 2027. - China sales decreased 28% in local currency year-over-year, impacted by broader weak market conditions, especially in the premium appliance segment. AO Smith is completing a strategic assessment of the China business, and will share conclusions by the next quarterly earnings call. - Acquired Leonard Valve contributed $16 million in Q2 sales, and the company remains on track to hit its full-year sales target for the business, which expands AO Smith's water management and digital control capabilities. ### Cash Flow and Capital Allocation - Free cash flow increased 67% year-over-year to $233 million in the first half of 2026, driven by strong working capital management. This strong cash performance reflects the resilience of AO Smith's operating model. - The company ended Q2 with a strong balance sheet: $181 million in cash, net debt of $456 million, and a leverage ratio of 25.7%, providing substantial flexibility for future growth investments and acquisitions. - Capital allocation priorities remain unchanged: active portfolio management, investment in innovation to drive organic growth, and advancing operational excellence to improve productivity. The board approved a quarterly dividend of 36 cents per share. - Given the strong first half cash performance, the company increased its 2026 share repurchase target by 50% from $200 million to $300 million, reflecting its commitment to returning capital to shareholders while retaining flexibility for strategic opportunities.

Guidance

- The company narrowed its full year 2026 guidance range, with no material change to its overall view of the business or to outlooks for most segments (North America commercial water heaters, boilers, water treatment, India, and Leonard Valve) relative to prior quarter estimates. The primary change reflects continued softer-than-expected demand in the North America residential water heater market. - Full year 2026 sales growth guidance is narrowed to 2% to 3%, down from the prior range of 2% to 4%. Adjusted EPS guidance is narrowed to $3.70 to $3.85, down from the prior range of $3.70 to $4.00. - The North America residential water heater industry volume outlook is narrowed to a low single-digit decline for the full year, from the prior expectation of flat to down low single digits. Emergency replacement demand remains stable, while proactive replacement (30% of total replacement demand) remains sensitive to consumer spending. - The company maintained guidance for: 6% to 8% full year North America boiler sales growth, 5% to 6% full year North America water treatment sales growth, approximately $70 million in full year sales from Leonard Valve, and a low double-digit decline in full year China sales in local currency. - Q2 2026 earnings benefited from customer pre-buy activity ahead of announced water heater and boiler price increases, which pulled a portion of expected Q3 demand into Q2. Q2 also benefited from a lower effective tax rate than expected for the full year. As a result, Q3 adjusted EPS is expected to be lower than both Q2 and Q4 2026, with Q3 segment margins for both North America and Rest of World expected to be consistent with Q1 2026 levels. - Full year 2026 steel costs are still expected to be approximately 15% higher than 2025 levels, with higher steel inflation expected in the second half than in the first half. Non-steel material inflation and new tariffs will remain a headwind through the second half of the year.

Segment performance

1. North America Segment: Total Q2 2026 sales were $821 million, an increase of 5% year-over-year, contributing 82.1% of total company revenue. Organic sales grew 3% year-over-year, adding $26 million in incremental sales, while acquired Leonard Valve contributed $16 million in Q2 sales. Sub-segment performance: water heater sales increased 2%, boiler sales increased 21%, water treatment sales decreased 2%. Adjusted segment earnings were $200 million, slightly above the prior year, with an adjusted segment margin of 24.4% (down 100 basis points year-over-year). 2. Rest of World Segment: Total Q2 2026 sales were $195 million, a decrease of 19% year-over-year, contributing 17.9% of total company revenue. The decline was driven primarily by weak consumer demand in China, partially offset by favorable foreign currency translation. Segment earnings were $10 million, with a segment margin of 5.2%, both down significantly year-over-year due to lower sales volumes in China, partially offset by ongoing cost management efforts.

Risks & headwinds

- Continued weak macroeconomic and market conditions in China, particularly in the premium appliance segment, have resulted in steep sales declines and compressed margins, creating uncertainty around the future of the business in the region, while the company finalizes its strategic assessment. - Persistent softness in North American new construction activity and existing home sales has pressured residential water heater demand, dragging down overall sales growth relative to prior expectations. - Inflationary cost pressures, including 15% expected full year 2026 higher steel costs (with accelerating inflation in the second half), higher transportation costs (from diesel surcharges), rising prices for oil-based inputs (foam, plastics), and a modestly higher cost impact from newly implemented tariffs compared to the previous tariff regime, all create margin pressure in the second half of 2026. - Recent shifts in the wholesale channel, including growing retail share of the residential water heater market and increased competitive pressure, create channel-related uncertainty, though AO Smith has made progress stabilizing its market share in the wholesale segment. - Forward-looking statements about future performance, strategic outcomes, and cost impacts are subject to unforeseen changes in market conditions, consumer behavior, and regulatory policy that could lead to actual results differing materially from expectations.

Analyst Q&A

• Q: Given the downward revision to the U.S. residential water heater volume outlook that still calls for stabilization, what gives AO Smith confidence in this trajectory? What is your outlook for the quarterly price-cost relationship?

  A: Industry comps year-to-date are against a strong first half in 2025, when pricing increases pulled demand forward, so the soft year-to-date data is partially a comparison effect. New 4% to 7% pricing increases will go into effect mid-way through Q3, so the full benefit will not hit until Q4. Cost pressure is expected to ramp up in the back half, particularly for steel, so the overall price-cost relationship is expected to be neutral for the second half, after being slightly positive in Q2. Q3 North American margins will be similar to Q1 levels due to the pulled-forward demand and the phase-in of new pricing.

• Q: How is AO Smith progressing on stabilizing residential water heater market share, especially across wholesale vs retail channels? What is the outlook for price acceptance, and when will the price-cost relationship turn positive?

  A: Retail has been gradually gaining industry share, accelerated by softness in new construction that disproportionately impacts wholesale, and big box retailers are increasingly targeting small professional installers. AO Smith has performed well in retail, and after targeted actions to win back share in the wholesale channel, the company is seeing solid progress stabilizing its wholesale market share. Price increases for both water heaters and boilers are just going into effect, so it is too early to judge long-term acceptance, but management expects the rollout to proceed as it has historically. Management will continue monitoring the dynamic cost environment to maintain balanced price-cost relations, and does not plan to announce future increases at this time.

• Q: What are AO Smith's top R&D priorities for product and technology innovation, and what is the expected timeline and benefit from AI investments?

  A: Top R&D priorities are expanding tankless water heater and heat pump boiler portfolios in North America, which are expected to be key growth areas for the future as the market evolves, and increasing innovation in water treatment products to capitalize on growing consumer awareness. Outside North America, rapid product innovation is a core priority to match the fast pace of changing consumer preferences in China and India. AI is being deployed both for general employee productivity and targeted use cases like order management, warranty processing, and technical service, delivering benefits for both customer experience and operational efficiency. It is still early to size the total benefits, as work continues on data structuring and model building, but the company expects AI will become an increasingly meaningful driver of efficiency over time.

• Q: What is the update on the strategic assessment of the China business, and what outcomes are being considered?

  A: The assessment has been ongoing for nearly a year, and management has gained clear clarity on what changes are needed to position the business for long-term success. All potential outcomes are still on the table: full restructuring under AO Smith's ownership, a partnership with another party, or a full sale to a new owner. Management will share a final decision and full strategic plan at the next quarterly earnings call, to resolve uncertainty for investors, employees, and customers.