What Management Said
Read the full Q2 2025 transcript ↗Free cash flow is defined as cash from operations less capital expenditures. Smith has an outstanding foundation for profitable growth as a global water technology leader. First, I would like to go through our second quarter performance, our updated guidance for the year, and the announcement regarding our China visits. Shipments in the first half of 2024 benefited from pre-buy-related volumes ahead of an announced price increase.
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. 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.
We maintained our operating margin year over year despite lower sales due to our 2024 restructuring initiatives and other cost control measures. We are on track to achieve $15 million in annual benefits, which have resulted in sequential margin improvement quarter-over-quarter. 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. 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.
What went well
- Total company sales were $1 billion in Q2 2025 and earnings were $1.07 per share, a 1% increase over the prior year, with management pleased by the EPS growth despite a challenging comparison.
- North America boiler sales increased 6% versus Q2 2024, led by higher volumes of high-efficiency commercial boilers, and the full-year boiler outlook was raised.
- North America segment operating margin expanded 30 basis points year over year to 25.4%, driven by mix benefits from the water treatment priority-channel strategy and growth in high-efficiency water heaters.
- North America water treatment sales increased slightly as double-digit growth in priority channels (e-commerce, dealer, and direct-to-consumer) offset expected retail declines and improved profitability.
- Legacy India business grew 19% in local currency, and the recently acquired Pureit business added $16 million of sales in the quarter within the Rest of World segment.
- China held its operating margin roughly flat year over year despite an 11% local-currency sales decline, aided by 2024 restructuring initiatives on track to deliver $15 million in annual benefits and sequential margin improvement.
- The company repurchased approximately 3.8 million shares for $251 million in the first six months and raised planned full-year buybacks from $306 million in 2024 to approximately $400 million in 2025, while generating $140 million of first-half free cash flow.
What went wrong
- North America water heater sales decreased 2% in the quarter on lower volumes, as the company deliberately smoothed production and aligned order rates rather than fully chasing pre-buy demand ahead of price increases and tariff risk.
- China second-quarter sales fell 11% in local currency amid ongoing economic challenges, low consumer confidence tied to property values, and limited government subsidy availability outside Tier 1 and 2 cities.
- Rest of World segment sales decreased 2% to $240 million and segment operating margin slipped to 10.5% from 10.6%, with the Pureit acquisition expected to be a near-term margin headwind during integration.
- Management expects North America margins to face a back-half headwind from steel costs rising 15%-20% and the full impact of tariffs, which were only minimally felt in the first half.
- The company acknowledged first-half market share pressure in North America water heaters because it managed production levels rather than fully serving the tariff- and price-driven order surge.
Guidance Changes
| Metric | Period | Current guidance |
|---|---|---|
| Full-year EPS | FY2025 | $3.70-$3.90 (midpoint +2% vs 2024 adjusted EPS) |
| Full-year total sales growth | FY2025 | +1% to +3% vs 2024 |
| North America boiler sales growth | FY2025 | +4% to +6% vs 2024 |
| Planned full-year share repurchases | FY2025 | approximately $400 million |
| China sales growth (local currency) | FY2025 | -5% to -8% (unchanged) |
| China operating margin | FY2025 | 8%-10% (Q&A: 8%-9%) |
| North America water treatment sales | FY2025 | approximately -5% (unchanged) |
| North America water treatment operating margin expansion | FY2025 | +250 to +300 bps |
| North America segment margin | FY2025 | 24%-24.5% (unchanged) |
| Rest of World segment margin | FY2025 | 8%-9% (unchanged) |
| Pureit sales contribution | FY2025 | approximately $50 million (no significant bottom-line contribution) |
| Tariff impact on total company COGS (annualized) | FY2025 | approximately +5% |
| Steel cost increase (back half) | 2H2025 | approximately +15% to +20% |
| Capital expenditures | FY2025 | $90 million to $100 million |
| Free cash flow | FY2025 | $500 million to $525 million |
| Interest expense | FY2025 | $15 million to $20 million |
| Corporate and other expenses | FY2025 | approximately $75 million |
| Effective tax rate | FY2025 | 24% to 24.5% |
| Diluted shares outstanding | year-end 2025 | 142 million |
| Residential and commercial industry unit volumes | FY2025 | approximately flat (unchanged) |
Performance Breakdown
| Metric | YoY | Note |
|---|---|---|
| Total company sales | -1% (to $1 billion) | Lower North America water heater volumes and a decline in China, partly offset by boiler and India growth. |
| Earnings per share | +1% (to $1.07) | Margin expansion in North America and cost control offsetting lower sales. |
| North America segment sales | -1% (to $779 million) | Higher boiler sales more than offset by lower water heater volumes against a difficult prior-year comp. |
| North America segment earnings | essentially flat (at $198 million) | Margin gains from water treatment mix and high-efficiency water heaters offset lower water heater volume. |
| North America segment operating margin | +30 bps (to 25.4%) | Mix benefits from the water treatment priority-channel strategy and growth in high-efficiency water heaters. |
| North America water heater sales | -2% | Lower volumes as management smoothed production and aligned order rates versus a strong 2024 pre-buy. |
| North America boiler sales | +6% | Higher volumes of high-efficiency commercial boilers. |
| North America water treatment sales | increased slightly | Priority-channel growth (e-commerce, dealer, direct-to-consumer) offset expected retail declines. |
| Rest of World segment sales | -2% (to $240 million) | China decline, partly offset by India growth and $16 million from the Pureit acquisition. |
| China third-party sales | -11% (constant currency) | Ongoing economic challenges and limited government subsidy availability outside Tier 1 and 2 cities. |
| Legacy India sales | +19% (local currency) | Continued growth in the India business. |
| Rest of World segment earnings | essentially flat (at $25 million) | Continued expense management offset lower China sales. |
| Rest of World segment operating margin | -10 bps (10.5% vs 10.6%) | Lower China sales, partly mitigated by expense management. |
| Free cash flow (first six months) | higher (to $140 million) | Lower cash outlays for working capital needs, partly offset by lower current-year earnings. |
Earnings Call Themes & Trends
| Topic | Previous mention | Current period | Trend |
|---|---|---|---|
| China business strategic assessment | 2024 restructuring and cost optimization to reposition the business | Initiating a process to evaluate a broad range of options including strategic partnerships and other alternatives, while still viewing China as a high-potential market; no decision made yet | — |
| New CEO priorities | Prior leadership focus | Steve Shafer as new CEO emphasizing operational excellence (expanding the AOS operating system and lean across end-to-end processes), re-energizing innovation, and active portfolio management | — |
| Portfolio management and M&A | Selective, disciplined approach | M&A and strategic partnerships positioned as a critical lever with ample dry powder; interested in building new growth platforms, not ruling out transformational deals, with a few targets potentially actionable in the coming year | — |
| Innovation pipeline | Long history of Cyclone and product leadership | New launches (ADAPT SC tankless, HomeShield Whole House Water Filter, upcoming Cyclone Flex), new product development center in Lebanon, Tennessee, and new CTO Dr. Ming Cheng hired to advance innovation capability | — |
| Production smoothing vs. pre-buy | Served surge demand in 2024 ahead of price increases, creating plant inefficiency | Proactively working with customers to smooth production schedules, accepting some first-half market share pressure to gain operational efficiency and expecting share recovery in the back half | — |
| Tariffs and steel cost management | Tariff impact minimal in the first half | Full tariff and 15%-20% steel cost impact expected in the back half, offset by May price increases and mitigation via footprint optimization, strategic sourcing, and cost controls | — |
Q&A Summary
Why initiate a China strategic assessment now, and how far along is the process?
Management remains excited about China's long-term potential and has been taking restructuring actions; it now wants to broaden the range of options explored to be fully informed about the best path forward. It is very early with no decision made.
Why are Rest of World margins implied down in the back half when they are normally up, and how does North America price/cost play out?
China faces continued headwinds and subsidy inconsistencies, so the fourth quarter is less bullish than usual, though the $15 million restructuring savings hold and China margin should be about 8%-9% for the year. In North America, back-half steel costs rise 15%-20% and full tariff impact hits, but May pricing offsets the costs, yielding a modest back-half North America margin headwind after very strong first-half margins.
What did you see in resi and commercial water heater shipments in June/July and on market share?
Share performance should improve in the back half due to first-half order smoothing; the company's pricing pull-forward benefit was muted. June and July order rates were typical and as expected following the early-May price increase pull-forward.
What was the impact of price in the quarter and how much of the increase was realized in 2Q?
Water heater pricing implemented in May contributed very little in Q2 due to backlog and lead times; there was some pricing benefit across businesses, and tariffs were roughly offset by price for the quarter.
Where did North America water heater volumes come in versus last year and how much of a Q3 pre-buy headwind is expected?
Industry volumes through May were roughly flat on residential and up about a point on commercial, tracking similar to last year; A. O. Smith ran below that due to smoothing. Exact pull-forward is hard to quantify, but the company benefited in the first half and expects its cadence to fall between a normal 51/49 split and the industry's projected 53/47 first-half/back-half split.
Why is China underperforming industry peers -- is it regional concentration or peer pricing?
A. O. Smith retains a premium brand and holds share in premium segments, but the market is more challenging: weak consumer confidence tied to property values, local competitors closing the innovation gap, and a channel shift to online. The company is pivoting toward digital and connected/intelligent devices to navigate the transition.
How did you better manage the pull-forward of volumes in the first half and can it continue?
The industry buys ahead of tariff and price changes, forcing overtime then plant underutilization. This year the company worked closely with customers to smooth schedules -- part art and science -- so customers still get needed product while plants run more efficiently; some expected pull-ahead still occurred in Q2.
Are there other non-core areas to de-emphasize and what adjacencies interest you for M&A or organic growth?
Portfolio management is a high priority: continually assessing whether A. O. Smith is the best owner of each business, investing in core leadership positions, and building out new growth platforms with M&A as a core component.
How would you assess the actionability and quality of the M&A pipeline?
The pipeline is active with a few exciting spaces; actionability varies and nothing is certain, but a few assets that could be good fits may be actionable in the coming year, approached with discipline.
Would you consider a more transformational deal, and what does the 4%-6% boiler guide imply for the back half?
Transformational M&A is not ruled out, but the focus is building new platforms that fit the company well, which takes time. On boilers, the company is being cautious in the back half despite strong first-half growth and a healthy backlog, given uncertain pull-ahead and commercial project timing.
Is the China assessment specific to China or could the India business be included?
The announcement is specific to China and options for the China business only.
Is North America water treatment still tracking to ~250 bps margin expansion and how should incremental margins look as retail declines lap?
The business is tracking to a 250-300 bps improvement target with a clean on-the-shelf retail transition; margin gains should carry through the rest of the year, with additional growth and margin levers from integrating acquisitions.
On market share, did competitors simply not limit pre-buy, and what about the new entrant/JV and multi-sourcing in the competitive landscape?
The industry took a more aggressive posture on fulfilling orders than A. O. Smith, driving the first-half share dip and expected back-half recovery. New entrants get attention, but success requires full portfolio breadth, availability for the 80%-85% replacement market, and navigating regulatory complexity -- advantages the market leader holds.
Why now on China -- is this really a major restructuring rather than a divestiture, which would seem imprudent at trough?
No decision has been made; the company is only initiating an assessment to understand the full set of options, including strategic partnerships, and is not committing to a divestiture. The goal is to position the China asset to compete and win.
Given tariffs were rolled back and little Q2 tariff impact, are you rolling back the May pricing?
No. The limited Q2 tariff impact was due to timing; the back half will see full tariff and 15%-20% steel cost impact, and pricing benefits only roll in from the third quarter after working through backlog and lead times.
You announced 6%-9% pricing but cited 5% COGS tariff impact -- is there margin upside, and is the 5% across all COGS?
The 5% tariff impact is across all of the business but predominantly North America; the North America COGS tariff impact is higher, so pricing is a bit more offsetting there.
On operational excellence, is this lean outside the four walls?
It is better described as lean across end-to-end processes, not outside manufacturing; the AOS operating system has driven plant-floor gains and can be expanded, leveraging the ERP system for more process discipline and efficiency.
How are other input costs outside steel moving into the second half?
Other input costs excluding steel and tariffs are up slightly year over year but ratable, and are not expected to move up meaningfully in the back half.
What is the outlook for the water treatment business in the second half given still-weak retail?
Good progress via focus on priority channels and integration of acquisitions; the retail weakness is an intentional, proactive strategy to de-emphasize on-the-shelf retail, which has helped the margin profile, and the business is now positioned to return to growth.
What has changed with China versus a quarter ago and what could a partnership look like?
It reflects an evolution in thinking toward a full range of options for setting up the China business for success, potentially including strategic partners, beyond the actions taken to date; the process is just starting.
What is your view of innovation across the US and Rest of World?
Innovation is core to organic growth and outsized profitability for an industrial company -- delivering differentiated products, strong launch processes, a culture of experimentation and curiosity, and investment in future-relevant technologies; the new CTO is expected to help reach the next level.
With an under-levered balance sheet, could the company get more aggressive on capital allocation?
It is a high focus going forward; the company will protect and drive its cash-generating core while transforming the portfolio over time, with balance-sheet deployment determined by strategy and the actionability of M&A targets.
Is the raised boiler guidance just high-efficiency traction, and how healthy are commercial customers?
The business, especially Lochinvar, performs well meeting demand for high-efficiency products; the 4%-6% guide protects against pre-buy given prior channel inventory unwinds, but performance in the market is strong.
More on Smith A O Corp
Reported 2025-07-24 · figures from the Smith A O Corp Q2 2025 earnings call.
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