A. O. Smith - Earnings Call - Q2 2025

Executive Summary

• Q2 2025 results: Revenue $1.011B (-1% YoY), net earnings $152.2M (-3% YoY), diluted EPS $1.07 (+1% YoY); North America margin expanded to 25.4% and Rest of World margin improved sequentially to 10.5%.
• Guidance raised: FY25 consolidated sales to +1–3% ($3.85–$3.93B) and EPS to $3.70–$3.90 (midpoint up vs prior); boiler growth guide raised to +4–6%.
• Strategic catalyst: formal assessment of China business (alternatives include strategic partnerships), while maintaining 2025 China sales down 5–8% and operating margin 8–10%.
• Cost/tariffs update: 2H 2025 steel +15–20%; refined tariff impact ~+5% to COGS for the full year, with pricing and sourcing/footprint actions expected to offset.
• Capital return: $251.3M in buybacks in 1H 2025 and a $0.34 quarterly dividend declared July 7; leverage ratio 14.1% at Q2.

What Went Well and What Went Wrong

• What Went Well

  • North America margin expanded 30 bps YoY to 25.4%, aided by mix (water treatment priority channels) and high-efficiency water heaters.
  • Boiler momentum continued: NA boiler sales +6% YoY in Q2; FY guide raised to +4–6% on strong backlog and high-efficiency product traction.
  • Sequential margin improvement in both segments from 2024 restructuring; Rest of World margin reached 10.5% in Q2.
  • CEO on operational discipline: “smoothing production schedules” to avoid inefficient pull-forward cycles; focus areas include operational excellence, innovation, portfolio management.
  • Product innovation pipeline: ADAPT SC tankless with integrated scale prevention, HomeShield whole-house PFAS filter, and Cyclone Flex next-gen commercial heater.

• What Went Wrong

  • China continued to weigh: sales -11% YoY in local currency; Q2 segment sales -2%; stimulus benefits limited beyond tier 1–2 cities and inconsistently applied.
  • Tariff and input cost headwinds: refined estimate of tariffs ~+5% to total company COGS; steel expected +15–20% in 2H, pressuring NA margins sequentially.
  • Water heater volumes in North America lower YoY; management deliberately muted pre-buy to preserve plant efficiency, creating near-term share pressure expected to normalize in 2H.

Transcript

Operator (participant)

Good day, and thank you for standing by. Welcome to the Second Quarter 2025 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question-and-answer session. To ask a question during the session, you will need to press star one one on your telephone. You will then hear an automated message advising that your hand is raised. To withdraw your question, please press star one one again. 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.

Helen Gurholt (VP of Investor Relations and Financial Planning and Analysis)

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.

Steve Shafer (CEO)

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 am 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 year and a half, 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. First, I would like to go through our second quarter performance, our updated guidance for the year, and the announcement regarding our China visits.

Now, turning to slide four 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 pre-buy-related volumes ahead of an announced price increase. This year, we believe the industry once again bought ahead of price increases and tariff risks. 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. 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 five. 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. 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 SC, 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 HomeShield Whole 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 PFAS reduction performance to a new level, it is also easier to install and provides 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 it will help ensure we are best positioned for the 2026 regulatory change in the commercial market and remain the industry's number one specified yet 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.

Chuck Lauber (CFO)

Thank you, Steve.

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 six. 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 for last year. Segment operating margin was 25.4%, an increase of 30 basis points year-over-year, primarily due to mixed benefits from our water treatment priority channel strategy, as well as growth in high-efficiency water heaters. Moving to slide seven. 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, it will be a margin headwind in the near term as we focus on the integration. Please turn to slide eight. We generated operating cash flow of $178 million and free cash flow of $140 million during the first six months of 2025. 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 nine. 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 six 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 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 and $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%-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%-24.5%. 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?

Steve Shafer (CEO)

Thanks, Chuck. Key assumptions in our top-line outlook include the following. We project that 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 announcements and ahead of our May 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%-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%-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 pre-buy 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 as we de-emphasize 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, and 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%-3% compared to last year. We continue to expect our North America segment margin will be between 24% and 24.5%. 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.

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 strong, trusted, and enduring customer relationships. Our core North America water heater and boiler businesses provide a resilient base with stable 80%-85% replacement rates, strong cash generation, and attractive regulation-driven growth tailwinds. 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 would 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.

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 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 great 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 improvements 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, re-energizing innovation, and driving our portfolio forward will be keys to our success. 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 (participant)

Certainly. As a reminder to ask a question, please press star one one on your telephone and wait for your name to be announced. To withdraw your question, please press star one one again. Please limit yourselves to one question and a follow-up. One moment for our first question. Our first question will be coming from Mike Halloran of Baird. Mike, your line is open.

Mike Halloran (Senior Research Analyst)

Hi. Morning, everyone.

Steve Shafer (CEO)

Morning, Mike.

Chuck Lauber (CFO)

Morning, Mike.

Mike Halloran (Senior Research Analyst)

Hey.

Can we just start with the why now on the China side? What was it? Obviously, Steve, you taking over the reins 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 context? And maybe alternatives is the wrong word, but just trying to figure out what the next steps for that region are.

Steve Shafer (CEO)

Yeah. I think, Mike, we remain excited about the future potential of the market there. 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. I think 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.

Mike Halloran (Senior Research Analyst)

Second, can you help me with margins as we get to the back half of the year? Kind of a two-fold question. One, implied margins for Rest of World down back of the half of the year. Normally, they seem to be up back of the half of the year. Maybe just talk through the moving pieces there. Then secondarily, just discussion on price costs in North America and how you see that playing out for the rest of the year.

Chuck Lauber (CFO)

Yeah, 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%-8% down. As we look at the back half of the year, we expect there'll 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. We're not quite as bullish on the fourth quarter as we typically are from a seasonal cadence. We are very pleased with the restructuring results. We expect China will be in that 8%-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 two halves of the year. As we walk into the back half of the year, we'll see steel costs going up 15%-20%. We'll experience the full impact of tariffs. Tariffs will be about 5% for the full year. Tariffs were somewhat minimal in the second quarter as we worked with kind of our key suppliers and good partners on that side. 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.

When you take those two cost drivers together and then pricing that we've implemented effective May 4th, but generally will impact us in a positive way in the back half, we're able to offset those costs. 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 margins. We'll see a little headwind on that North America 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. 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. 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. If you take a look at all those, Mike, a long answer to what we're looking at for margins in North America and price cost relationship in the back half.

Operator (participant)

Our next question will be coming from Saree Boroditsky of Jefferies. Your line is open.

Saree Boroditsky (SVP of Multi-Industrials)

Hi. Thanks for the question. 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 were running ahead of what maybe you saw due to market share. Any other color on the impact of the market share that you experienced in the first half and how that plays out as we go to the second half of the year as well? Thank you.

Chuck Lauber (CFO)

I'll just follow up, Saree, on that. Kind of piggybacking off what I just mentioned on kind of the cadence for the year. 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. 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.

Saree Boroditsky (SVP of Multi-Industrials)

Appreciate the color. 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?

Chuck Lauber (CFO)

Yeah. I'll just talk about water heating because water heating price increased with our backlog, and then you have kind of the lead times, and it was implemented in May. There is 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. 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.

Operator (participant)

Our next question will be coming from Damian Karas of UBS. Your line is open, Damian.

Damian Karas (Executive Director)

Hey. Good morning, everyone.

Chuck Lauber (CFO)

Hey, Damien.

Steve Shafer (CEO)

Morning, Damien.

Damian Karas (Executive Director)

Hey, 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 pre-buy headwind are you expecting now in the third quarter as a result of a little bit of the pre-buy?

Steve Shafer (CEO)

I mean, the industry volumes through May were relatively flat on the residential side. Commercial is up maybe a point. It is tracking very similar to last year. We are not tracking quite to that level because of our smooth production and management of orders through customers. 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 is hard to tell kind of how it fell into the front half of the year versus what we will experience in the back. 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 is a bit hard to tell exactly how much that is. I will frame it typically, like I said before, the industry is 51%/49%. The industry this year we project will be 53%/47%, and we are going to be somewhere in between kind of that 53%/47% and the 51%/49%.

Damian Karas (Executive Director)

Okay. That's helpful. I wanted to ask you about the China water heater business. Appreciate that you are taking a look at options on what to do with that business going forward. 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 and the exchange program?

Steve Shafer (CEO)

Yeah. So I mean, obviously, we have many decades of really strong performance in China. We're viewed as a market leader, great brand. We're known for our innovation in China. 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 support it with the service that people come to expect from A. O. Smith in China. I think that's still healthy in a very challenging market. 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, market dynamics are more challenging. Consumer confidence remains very low in China, and that is also highly connected to retail or, sorry, property values in China. We're all working through that together.

The other thing that's changed is local competitors have gotten much better. The gap in performance, the gap in innovation isn't what it used to be. That's making it a more mature and challenging marketplace. I think that 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 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. On the ground, we're pivoting on those things. We're responding to 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.

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.

Operator (participant)

Our next question will be coming from Susan Maklari of Goldman Sachs. Your line is open.

Susan Maklari (Senior Equity Research Analyst)

Thank you. Good morning, everyone.

Steve Shafer (CEO)

Good morning.

Susan Maklari (Senior Equity Research Analyst)

My first question, good morning. 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 approached that, what was different relative to the past, and how you're thinking about efforts to continue to perhaps maintain that going forward?

Steve Shafer (CEO)

The industry, when they see upcoming changes, and in this particular case, this year, it was a combination of both tariff risks as well as announced price changes, look to buy ahead and get in front of that. We saw that last year with the price changes. We saw that this year again with price changes and tariff announcements. 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, you're investing in your operations to crew up, add shifts, run overtime to meet that demand. Once the inventory is out there in the channel, it takes time to work off and bleed through. Obviously, then the consequence of that on our manufacturing operations is we have plants that become underutilized.

It is a pretty lumpy and inefficient way to run our manufacturing operations. We experienced that last year. This year, we wanted to kind of get ahead of that. We worked really closely with our customers. It is not an exact science. It is a little bit of art and science to work with our customers around making sure they're getting the product they need and expect, but at the same time, doing it in a way that does not drive unnecessary inefficiencies through the entire supply chain. 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.

We think we've got a better way of actually manning our operations, and we work with our customers to make sure that they're still getting the product they need and when they need it, but also that we're able to smooth out how our plants run so that we're not investing in overtime upfront and then underutilization on the back half.

Susan Maklari (Senior Equity Research Analyst)

Okay. That's great color. Maybe as you think about the business, Steve, you come into this new role, can you talk a bit about other areas that may be also non-core or things that you'd like to de-emphasize 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?

Steve Shafer (CEO)

Yeah. 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. 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.

We've got a real focus 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.

Operator (participant)

Thank you. Our next question will be coming from Matt Summerville of D.A. Davidson. Matt, your line is open.

Matt Summerville (Managing Director and Senior Research Analyst)

Thanks. 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? I have a follow-up.

Steve Shafer (CEO)

Yeah. I mean, it's one that's active and moving. I think we have a few spaces we're pretty excited about. 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. We're excited about a few areas. Actionability of those targets can vary. It's never a certain thing. I think we're excited that a few assets that we think could be really good fits may be actionable in the coming year, but we can't commit to anything, and we don't know. As always, we'll be disciplined about how we step into those opportunities.

Matt Summerville (Managing Director and Senior Research Analyst)

Just as a follow-up. Are you willing to consider something more transformational, maybe add another leg to the stool, so to speak? Just a quick one on the boiler business. Guide 4%-6%, I think in Q1 you're up 10, Q2 you're up 6. Help me understand what that's implying about the back half of the year specifically to boilers? Thank you.

Steve Shafer (CEO)

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 risk and challenges that come with something that's bigger and more transformational. 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. Not ruled out, but obviously, those things oftentimes take time to build towards. As it relates to the boiler business, I think we're being cautious about the back half of the year. Certainly, we like the growth performance that we saw the first half of 2025. We've got a good healthy backlog. I think we're entering the second half of the year in a strong position.

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. That's part of that. That's part of the reason for the cautiousness. Also just what happens with projects and how those play out by the time we get to the end of the year.

Operator (participant)

Thank you. Our next question will be coming from Bryan Blair of Oppenheimer. Bryan, your line is open.

Bryan Blair (Managing Director and Senior Analyst)

Thank you. Good morning, everyone.

Steve Shafer (CEO)

Good morning.

Bryan Blair (Managing Director and Senior Analyst)

Quick question on the assessment of A. O. Smith, China. As you're thinking about the varying opportunities at hand or potential opportunities, is this specific to or exclusive to A. O. 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?

Steve Shafer (CEO)

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

Bryan Blair (Managing Director and Senior Analyst)

Okay. Understood. Thank you. Sorry if I missed this detail. With North American water treatment, are you still tracking toward the 250 basis points margin expansion you had outlined before? I guess, more importantly, with mix progressing toward your targeted, more favorable mix, how should we think about incremental margins as you lapse the retail declines and get back to growth?

Chuck Lauber (CFO)

Yeah. We are tracking to our target of 250 to 300 basis points improvement. The business has performed well through the front half of the year. On-the-shelf retail transition, it was a pretty clean transition. 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. We are 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.

Steve Shafer (CEO)

I would add too, just kind of going forward, in addition to some of those go-to-market prioritization decisions we have made, we are also taking actions to take advantage of the integration work of the different acquisitions we have brought together to build that business.

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 have done.

Operator (participant)

Thank you. Our next question will be coming from Jeff Hammond of KeyBanc Capital Markets. Your line is open, Jeff.

Jeff Hammond (Managing Director and Equity Research Analyst)

Hey, good morning, everyone.

Steve Shafer (CEO)

Good morning, Jeff. Good morning.

Jeff Hammond (Managing Director and Equity Research Analyst)

Hey, just wanted to clarify the market share comment, weaker first half, better second half. Is that just simply that your competitors did not limit pre-buy and maybe they saw more pre-buy, so that levels out? Just more broadly on the competitive landscape, maybe just speak to kind of the new player in the market and the JV partnership. It seems like some distributors are opening up to multiple sourcing for water heaters. Just talk about the competitive landscape more broadly.

Steve Shafer (CEO)

Sure. Maybe on the 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 is really what is 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. That is the drive road. There is a lot to still play out for the second half of the year to validate this, but that is our assumption. What was the second question? Sorry.

Chuck Lauber (CFO)

With respect to the recent JV?

Steve Shafer (CEO)

Oh, yeah. And competitive. Yeah.

I think there is obviously, over the last few years, there has been a number of announcements and new entrants looking to get into the space. Those always get our attention, right? We are the market leader, and we are mindful of when there are new people looking to participate in the North America water heater space. I would say to really be successful in this market, you have to have real conviction. I think that conviction requires you to have the full breadth of portfolio. You have got to have that portfolio available at a moment's notice, especially when you have got 80%-85% that is replacement. People do not really like to take a cold shower twice. You have that portfolio available through the channel partners that can reach the contractors on a moment's notice. That is the types of investments we make.

That is the kind of conviction level we have for this market. I think it is also why it is proven to be pretty challenging relative to new entrants coming into the space. On top of that, it is actually a pretty complicated landscape as you go forward, especially on the regulatory front where there is a lot of uncertainty. You have got to have the right technologies available in the right state at the right time with those changes. That is the advantage we have as the market leader, right? We help lead the industry through those types of changes. I think it is challenging for a new entrant to come in. We do not take it lightly. We take it seriously. We are always thinking about making sure that we continue to serve the market well so that there is not need for alternatives.

I think, as we have said before too, as it relates to channel and share shifts in channel and even how that plays out across the big three, that is something we always have had to deal with. We navigate it through. I think we have always been able to find a way to make that work out well for us, working closely with our channel partners, and we will continue to do that going forward.

Operator (participant)

Our next question will be coming from Scott Graham of Seaport Research Partners. Your line is open, Scott.

Scott Graham (Senior Equity Research Analyst)

Yes. Hey, good morning. 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. Obviously, sales are off-peak. Margin is well off-peak. Is this more of an announcement maybe that it's a look at the business to see which portions of it need to be pared, a major restructuring? 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?

Steve Shafer (CEO)

Yeah. I mean, our announcement today is not an announcement of any decision made on the business. We're still very early, and we're just sort of at this point announcing that we're initiating this assessment. 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? 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 and this great asset that we have in China for success and to be able to compete and win in the future. We think what we're doing is broadening the aperture of that, of what potential options could look like. Any strategic partnerships or anything else we would explore, our primary goal would be, how does it make the business better? How does it make the business have a better chance of success going forward? That's the lens we're going to take to it.

Scott Graham (Senior Equity Research Analyst)

Understood. Thank you for that. My follow-up is around pricing. You went out with an announcement, I believe it was in April, on the price increases that were going to be a big part of your offsetting tariffs. You are saying essentially that there was not really much of a tariff impact in the second quarter. I guess I am wondering. Are you now rolling back pricing in some way? Because effective May 1st, I would have to believe that some people might be looking for some type of rollback given that the tariffs were rolled back.

Chuck Lauber (CFO)

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. In the back half, we'll have the full impact of tariffs. We'll have the full impact of 15%-20% steel costs going up. The announcement was effective in May. As you know, we do not 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. That portion of it really does not roll in until almost as we start into the third quarter.

Scott Graham (Senior Equity Research Analyst)

Understood. Thank you. Nice execution around the operations in 2Q.

Chuck Lauber (CFO)

Thanks, Scott.

Operator (participant)

Our next question will be coming from Nathan Jones of Stifel. Your line is open.

Nathan Jones (Managing Director)

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'd announced pricing to the market that was going to be 6%-9% across the majority of the North American business. 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. 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?

Chuck Lauber (CFO)

Yeah. Thank you for the clarification on that, Nathan. It is 5% across all of the business. Our tariff impact is largely North America business that we have the cost impact. 5% across the business, but it is predominantly focused within North America.

Nathan Jones (Managing Director)

Okay. The COGS number in North America is a bit higher and maybe in that 6-9% range. It is a bit more offsetting.

Chuck Lauber (CFO)

That's correct.

Nathan Jones (Managing Director)

I guess the other question I wanted to ask is around the operational excellence. Kind of priority, Steve, that you set. Maybe just any comments around that. It sounded a little bit to me like lean outside the four 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.

Steve Shafer (CEO)

Yeah. I would not characterize it as lean outside the four walls as much as referencing as lean in our end-to-end processes. I think where the AOS operating system today has done a really nice job of focusing on the plant floor with model lines and engaging our workforce around continuous improvement, and we have yielded some good results from that. Expanding it to really think about end-to-end processes. Obviously, many of our processes run through our plants, which is why I would not characterize it as outside the manufacturing walls. Leveraging our ERP system to get more discipline around our processes. As we do that, realizing more efficiencies.

Nathan Jones (Managing Director)

Thanks for taking my questions.

Steve Shafer (CEO)

Yep.

Operator (participant)

Thank you. Our next question will be coming from David McGregor of Longbow Research. Your line is open, David.

Joe Nolan (Associate Analyst)

Hey, good morning. This is Joe Nolan on for David. You mentioned steel costs up 15%-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?

Chuck Lauber (CFO)

Yeah. 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 cost not associated with the tariff impact.

Joe Nolan (Associate Analyst)

Got it. Okay. 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?

Steve Shafer (CEO)

Yeah. I think we're making really good progress on that business. I think the focus on our priority channels has brought focus to the places where we think we have the best chance to compete and win. The integration work we're doing in our acquisitions to help the businesses get healthier and stronger, and it's a growth platform for us. 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. 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.

Chuck Lauber (CFO)

Your comments around kind of the weakness in the retail channel, it's really a proactive strategy that we took to de-emphasize on-the-shelf retail.

It's intentional that we've moved that channel, and it's helped our margin profile as we step into the year.

Operator (participant)

Our next question will be coming from Sam Snyder of Northcoast Research. Your line is open, Sam.

Sam Snyder (Research Analyst)

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

Steve Shafer (CEO)

Yeah. I mean, we've obviously been working closely with our China team around how to improve the competitiveness and the success of our China business. I think what changes, we want to just think about a full range of options of what's the best way to do that, right? 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. As I mentioned, it's a market we think there's got a lot of potential in. What we want to do is say, what's the best way to do that? We think it could involve working with strategic partners and thinking about options beyond just some of the things we've been doing to this date. We're starting this process, right?

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.

Sam Snyder (Research Analyst)

Okay. Thanks. And then just real quick, if I get it in on innovation, 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.

Steve Shafer (CEO)

Yeah. 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. For me, it's fundamental to a really successful industrial business. I got to see that up close at 3M. It's one of the more successful innovation industrial companies out there. I think it's an important part of our future. Also, what's really nice is it's been a huge part of our past, right? We have innovated and really totally changed markets as we stepped into them over our 150-year history. I think it's a big part of our 150-year future. It includes innovation processes that allow you to launch products successfully and efficiently and on time, meeting customer needs. It's a culture.

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. It's really understanding and defining the technologies that are going to be relevant for the future and making sure you invest in those technologies. Those are the types of things that we're focusing on. As I mentioned, our new CTO, I think, is going to be a great boost to helping us get to the next level.

Operator (participant)

One moment for our last question, which will be coming from Andrew Kaplowitz of Citigroup. Your line is open, Andrew.

Andrew Kaplowitz (Managing Director)

Good morning, everyone. Thanks for sitting me in.

Steve Shafer (CEO)

Good morning.

Andrew Kaplowitz (Managing Director)

Steve, I know you said you'll consider all alternatives when you're using your balance sheet moving forward, but A. O. Smith has been sitting with what I think some would call an under-levered 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?

Steve Shafer (CEO)

Yeah. I mean, I think it's important for our future. We're going to look to continue to find attractive growth platforms for us. 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. We're going to do that. 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. Look, I think we're in a great position because we do have a strong balance sheet.

I think we do have some core capabilities that I think we can stretch into new areas that will be able to create a lot of value. It's going to be a big focus for us.

Andrew Kaplowitz (Managing Director)

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

Steve Shafer (CEO)

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

Chuck Lauber (CFO)

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

Operator (participant)

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

Helen Gurholt (VP of Investor Relations and Financial Planning and Analysis)

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 three conferences in the quarter. Seaport on August 18th, Jefferies on September 3rd, and D.A. Davidson on September 18th. Thank you and have a great day.

Operator (participant)

This is today's conference call. Thank you for participating. You may now disconnect.