Thank you for standing by. Welcome to the A. O. Smith Corporation First Quarter 2025 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. [Operator Instructions] As a reminder, today's program is being recorded. And now, I’d like to introduce your host for today’s program Helen Gurholt. Please go ahead.

Thank you, Jonathan. And 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 Kevin Wheeler, Chairman and Chief Executive Officer; Steve Shafer, President and Chief Operating 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.aosmiths.com. I will now turn the call over to Kevin to begin our prepared remarks. Please turn to the next slide.

Thank you, Helen, and good morning. Before I review our first quarter performance, I like to take a moment to highlight our recent announcement that Steve will assume the role of President and Chief Executive Officer effective July 1st. Over the past year, Steve has worked closely with me and our leadership team to deepen his understanding of our business and identify opportunities to enhance performance and drive growth. I have full confidence in his ability to lead A.O. Smith and advance our position as a global water technology leader. As we have throughout this process, we will continue to ensure a smooth CEO transition over the next two months. I will remain actively engaged as Executive Chairman of the Board, continuing to support the company's strategic direction. Now turning to Slide 4 and our financial performance. Our team delivered a solid performance in the first quarter with volumes tracking our expectations. I am pleased with our sequential quarter over quarter improvement. As anticipated, North America segment sales declined by 2% as higher boiler sales were more than offset by lower water heater volumes. As a reminder, we had a very strong first quarter in 2024 for water heating, creating a challenging year-over-year comparison. Rest of world sales were essentially flat compared to last year and China third party sales declined 4% local currency reflecting ongoing economic weakness and soft consumer demand. In the quarter, we repurchased $121 million of our shares front loading a portion of our full year 2025 repurchase outlook of $400 million. Please turn to slide 5. North America water heater sales declined 4% in the first quarter driven by lower volumes. First quarter 2024 shipments benefited from pre buy related volumes ahead of an announced price increase, a favorable commercial gas mix. In contrast, 2025…

Thank you, Kevin. Good morning everyone. We delivered sales of $964 million in the first quarter of 2025, a decrease of 2% year-over-year and earnings were $0.95 per share, a decrease of 5% compared to the prior period. Please turn to Slide 6. First quarter sales in the North America segment were $749 million decreased 2% compared to a tough comp last year. Higher boiler sales were more than offset by lower volumes of water heaters. North America Segment earnings of $185 million decreased 7% compared to last year. Segment margin was 24.7%, a decrease of 120 basis points year-over-year. The lower segment earnings and segment margin were primarily driven by higher boiler sales that were more than offset by lower water heater volumes, lower volume related absorption and continued strategic investments including tankless. Moving to Slide 7, Rest of the World segment sales of $227 million were essentially flat to last year, including sales from the Pureit acquisition of $12 million. China third party sales decreased 4% on a constant currency basis. Lower sales in China were offset by the addition of Pureit. Rest of the World Segment earnings of $20 million increased 15% compared to segment earnings in 2024 as expense management offset lower sales of China. Segment operating margin was 8.7%, an increase of 110 basis points compared to last year driven by strong margin improvement in China. Pureit will be a margin headwind in the near term as we focus on integration. Turning to Slide 8, we generated operating cash flow of $39 million and free cash flow of $17 million during the first three months of 2025, which is lower than the same period in 2024 but is in line with historical first quarter cash flow, which typically is our lowest cash generating quarter. The…

Thank you Chuck, and good morning everyone. First of all I would like to take a brief moment to let you all know how honored I am to be announced as the next CEO of A.O. Smith effective July 1st. It is a real privilege to be able to work with my dedicated and capable colleagues to help lead this iconic company into the future. I would also like to thank Kevin and his leadership and commitment to the company over the last 30 plus years and for the trust and confidence that both you and the board have put in me. As Chuck mentioned, there is still uncertainty around tariffs and while we are largely in country for country, our business is impacted by the changing tariff environment as we have certain components that are globally sourced. We have mobilized cross-functional tariff response teams across our businesses to identify tariff and supply chain related risks and to develop action plans to mitigate those risks. These teams meet regularly to address the evolving tariff impacts on each of our businesses to ensure that we continue meeting the needs of our customers while taking action to mitigate tariff related costs. In North America, in response to tariff cost increases as well as higher steel and other input costs, we have announced price increases of an average range of 6% to 9% on most of our water heater products. We have also announced price increases on our other product categories. Because of the uncertainty of the tariff environment, we have not included in our announced pricing in our top line guidance. In addition to pricing, other mitigating actions include footprint optimization, strategic sourcing and other cost containment measures. Assuming the current tariffs go into effect as announced, we expect to begin seeing…

Certainly. [Operator Instructions] Our first question for today comes from the line of Jeff Hammond from Keybanc Capital Markets. Your question please.

Hey, good morning everyone. Kevin, congrats on a great run and Steve for your promotion. Wanted to start here with I guess you're not really changing anything in the assumptions, but I'm just wondering where you think you might see some demand destruction around incremental pricing actions and just the general uncertainty out there and then just on the price increases, would you expect to get margin on that price or just cover the incremental inflation? Thanks.

Hey Jeff, let me start out on the margin question. So our assumption in 2025 is really EPS neutral. We're expecting to have pricing cover costs. We've kind of laid it out that way. If you kind of look at our pricing, we'll have probably a little bit of headwind in Q2 as we start incurring those costs before we have the pricing actions in place. And I'd say a little bit of headwind relative to Q1. We're really pleased with 24.7% North America margins in Q1. With regards to demand destruction, we're really fortunate to have a replacement stable business with recurring revenue on the water heating side between that 80% and 85%, so that certainly does stabilize our business. Our boiler business performed very well in the first quarter at 10% up. As Steve noted, there may be a little bit of pricing pull forward there, but we're watching the commercial markets as we go through the year and have not increased our boiler guidance based on that. From our perspective and it's early, there's certainly early in the year, but we haven't seen any negative activity. Orders and quoting have been pretty stable on the commercial side of the business, but again, it's pretty early in the year.

Okay, great. And then you mentioned that the tariff exposure, 6% to 8% of cost of goods sold. I'm just wondering if you could just unpack that a little bit. How much of that is steel inflation or steel tariffs and then any other kind of bigger buckets as you think about direct or indirect or purchase components?

Yes, we kind of carve out steel separately when we think about tariffs, even though there is steel tariffs. We've had those before. It is in our outlook and we've got back half steel increases in our outlook. The tariffs themselves that I would say are more direct and more near term and announced as of today, in that 6% to 8%, that's an annual number, so we're looking at kind of annual volumes in the 6% to 8%. The largest component of that is bringing in product either through our suppliers or directly, including our tankless from the China market. And we talked a little bit about mitigating that through accelerating our tankless production as we've always planned to move from China to Mexico to mitigate that in the future, but China is our largest piece of that.

Thank you. And our next question comes from the line of Mike Halloran from Baird. Your question please.

Hey just a clarification there, Chuck, I'm sorry. Did that include -- so you're saying the 6% to 8% does not include the steel inflation, and it's simply the tariff piece?

Our outlook includes the steel piece, but that 6% to 8%, very specific tariffs.

Yes. No, no, no. I appreciate that. And morning, everyone, sorry about that and on to everyone on the changes coming up. So could you just talk to how you think about the sequentials as you work through the year? I understand the steel comments into the back half of the year. But from a demand perspective, as you sit here today, is this just kind of relatively normal seasonality as you work through the year or are there any other nuances I should think about?

No. I mean you think about it in terms of what we talked about in January, a 51%, 49% of residential product in the front half, back half. Orders haven't fallen in quite that way. Steve talked about our initiatives to level load the plant. We could have pushed out more shipments if we had wanted to, but we really are working and very focused on managing the orders that have come in and because of that, we would expect the cadence of the year to be much more normalized even though we have some announced pricing out there. So think of it in terms of a fairly normal year as we lay it out and we're working to try to do that so that we're most efficient as possible.

Yes, Mike, maybe another -- just a bit of color on that. We've done quite a bit of inventory checks with our channel partners. And right now, we're in pretty good shape. Most channel partners are relatively flat to last year, even slightly down. So it's a little bit different environment than we had last year as we exited Q1 of 2024.

That makes sense. And then a follow-up, just maybe talk about the rebalancing or how much you feel like you need to rebalance some of the sourcing or some of the footprint for these changes? Obviously, the tank lists come in over this way over the course of this year and into next year that was well telegraphed, but maybe any of the other changes as you look at the network and how important that is all else equal competitively or however you want to frame it?

Mike, I'll take it as we -- I mentioned the teams we've got that are working on this in there's shorter-term actions you can take relative to working with your suppliers where they have facilities that you can take advantage of. I mentioned even within our own supply chain network of getting tankless into Mexico faster, so teams are working on those things. There are longer-term items as well, where there might be either a change in supply or requalification requirement. So we're studying those and some of them are harder than others and obviously, some of them will be dependent upon what plays out in the year relative to tariffs. So we have an understanding if things stay the way they are, certain actions we are working on and we would take. If they move, it might change those actions. So it's a pretty fluid state, and that's why we've got kind of these task force set up so that it's not just executing a plan that the world is today, but it's helping us realign our supply chain as new information becomes available.

Thank you. And our next question comes from the line of Saree Boroditsky from Jefferies. Your question, please.

Hi, thanks for taking the questions and congratulations to Kevin, Steve on the new roles. You talked about prebuy impacting the comp for water here last year on kind of a low single-digit price increase. So I was just curious on the pre-ban expectations given expected pricing actions in response to tariffs. I think you mentioned a difference in orders for a factory level, so will you be delivering on lower-priced products into more of the year as a result. Thanks.

Well, we -- so we really have been managing production to not pull in orders in the first quarter. We expect pricing to come into play later in the second quarter, so the order rate from a price pull forward, we would expect to be pretty smooth from first to second quarter, kind of rounding out that 51, 49 perspective on units being shipped.

And I'd just say we work really closely with our customers on this. So One of the ways we handle this is we flow our lead times as we get orders coming in. We work with our customers in terms of an allocation of how to work through those orders so that we can actually provide some clarity around when the price transition occurs, but it's something we work closely with our customers on. And I think we're handling that through this year with the price changes and the uncertainty around tariff costs very effectively, both to serve our customers well but also to run our plants efficiently.

Well, maybe one other comment there. The whole key we're just not pulling in a bunch of overtime in Q1 to pull it into Q1. But we're trying to be a bit more systematic about it and that may -- that's not going to change within the quarter, how we're going to ship. And so we expect to be, as we've said, to be through shipping through the quarter and then start to benefit from the back half of Q1 with pricing. So it's just a little bit of timing, but it's narrow, but it makes a big difference to our factories and it makes a big difference to our customers to make sure that they can order on a regular basis and have the stock in hand when their contractors needed.

I appreciate the additional color, and then I'm sorry if this is just me being confused, but you have announced price actions, but I believe you've not included this guidance. So I guess, would you expect those price increases to not go into effect if tariffs are not implemented in the current form? And then what would sales guidance be assuming the announced price increases do go into effect? Thanks.

Tariffs are so volatile right now and unpredictable that we felt it was prudent to not include a top line assumption of what may or may not be held into going forward cost towards tariffs. So EPS, we're very conscious of the tariffs that are in place today and the mitigating actions that Steve outlined, one of which includes pricing. So we're comfortable with our EPS outlook just where we fall within the 360 to 390 but we haven't decided, we just felt it was prudent and not try to put a top line assumption out there.

Yes. I would tell you that those can go either way. I think when we know where we're at today, we want to make sure you understood that we have taken action and that we're confident in how we're going to maintain EPS in our guidance on sales. But it's just really early because the equation changes sometimes literally every day. So I think when we get a nice better view of this, but I think the takeaway here is we're prepared not only with our pricing, but all the other actions we've taken with regards to cost controls and so forth and and optimizing our manufacturing that we're in good position to navigate through these tariffs regardless of where they end up.

Thank you. And our next question comes from the line of Bryan Blair from Oppenheimer. Your question, please.

Thanks, good morning everyone. Echo the sentiment, Kevin and Steve, congrats to you both. I wanted to just make sure that I'm understanding the 6% to 8% of COGS potential tariff exposure. That does include the full run rate impact of tankers imports from China, correct? And an extension of that, what would be pro forma figure being assuming the full transition to Juarez production?

Yes. I mean there's a lot of moving parts to our pro forma number, particularly with us accelerating manufacturing from China to Mexico meaning there'll be some trailing tariffs and components because we're probably going to have some components go in to Mexico and prior, we would have been probably focused more on moving those to local sourcing. So it's going to take a little bit of working through to kind of come up with that number, and we're certainly looking to mitigate it. The 6% to 8% includes tankless. It includes tankless at a volume of 2024. I think I talked about it on the last call. We have a meaningful amount of tankless inventory in place. So that may not be quite that number in 2025. But from a full year perspective, tankless is the largest component, single component within the China import costs.

Understood. Appreciate that detail. And then high level, just with regards to competitive positioning and strategy, I guess, setting aside near-term price cost for the moment. Maybe offer some color on how your team is thinking about the risk versus opportunities presented by all of the uncertainties around tariff trade policy, etcetera?

Well, I'd say any time there's uncertainty it's an opportunity to find a way to respond faster, faster than your competitors navigate it more successfully than others in the marketplace. And I think I feel confident in our team's ability, the way we've rallied behind this, the way we've understood the dynamics. We've got our supply chain data pulled together. We've got experts within our organization that I think understand the dynamics well. I think we are very plugged in, in terms of understanding some of the policy decisions that are out there today as well and I think from my standpoint, I'm confident that we can respond better than most because of the capabilities we've put in place.

Yes. I think we just put it -- one of the things we're in country for country, and that's on a global basis. So being able to navigate this with our local teams, I think it's just an opportunity where maybe other companies don't have that luxury. But again, not being this low-cost producer and moving things around, being in country for country with local management. I think it's going to make -- could make a difference for us as this thing plays out.

Thank you. Our next question comes from the line of Scott Graham from Seaport Research Partners. Your question, please.

Thank you and good morning. Kevin, it's been a true pleasure working with you, spent some great time together, and thank you for that. And Steve and I wish you all the luck in the world and look forward to working with you. My questions are really around the residential water heater shipments assumption and then China. The residential macros to date have really not been overly optimistic, overly positive particularly when you consider inflation impacting some of them. I was just wondering what is your assumption for proactive this year within the industry on a year-over-year basis you assuming proactive is flat, maybe even down?

It's been interesting, Scott. The -- we track this. So I think we've talked about it many times for over a decade and we just got to recent data last night, quite frankly, to be honest with you. And right now, the proactive and mercury placement is still tracking at that level that we came out of COVID, as we talked about, maybe this is just an embedded change in the industry. So as we see it right now, we see proactive in the replacement, which is going to be 88%, 85% of our business to be rather stable and resilient.

Okay, thank you for that. And then when you look at China, I know, obviously, with the stimulus over there targeting helping consumers, do you need a broader improvement in housing there to kind of get that business going? What are the things that you're looking for, for that business to start to improve again?

I would characterize it's kind of more -- we're looking for consumer confidence to build in China. And I think with consumer confidence and some of that is connected to the housing market, right, because there's a lot of wealth tied up for the Chinese middle class in their real estate, but with that consumer confidence, you get both the benefit of how folks will invest in their real estate and/or invest in upgrade of their homes, and with the upgrade of homes, you see the premiumization of appliances and kitchen updates that we can take advantage of, so I would characterize it more as consumer confidence than the housing market. The housing market in China, it's got a ways to go, I think, to really recover, but it's that close connection to consumer confidence that we're watching.

Thank you. And our next question comes from the line of Andrew Kaplowitz from Citi. Your question, please.

Good morning everyone. Kevin, Steve, congratulations. Chuck, I'm just trying to understand the EPS cadence a little bit more for the year in tariff versus pricing. If we think that the 6% to 8% of annualized cost of tariffs is going to be the headwind. Do you see full impact in Q2 without much help from pricing yet, so we need to forecast that in Q2? And then do you end up covering more than the tariffs in the second half of the year under the transition cost from tankless later in the year? Like how does that cadence work?

Yes. let me start with, we're very pleased with North America margins in Q1 at 24.7%. Cost containment measures and some of the other actions to level load the plan have been very helpful to that margin. A reminder, our full year guidance is 24% to 24.5%. So Q1 was a little bit better than the full year guidance. We haven't changed our full year guidance. From an EPS standpoint, we -- from a margin profile standpoint, but from a North America margins, we would expect to be slightly down in Q2 because we are starting to see costs on tariffs. We're working to mitigate those costs, as Steve mentioned, working with our suppliers through the quarter, and we'll see pricing come in, in June. So there'll be a little bit of a headwind, and we haven't changed our full year guidance, 24% to 24.5%. So a lot to play out yet in the rest of the year. Q2 probably see a little bit of North America margin headwind but for the full year, we're comfortable that EPS is kind of on track.

Very helpful. And then maybe just a follow-up on China for Kevin or Steve, your sales start out only down 4%, which I think was slightly better than Q4. Did Stimulus help at all? Can you give us more color on sort of what you see there, and I know you continue to think about China as strategically important, but has it become at all more difficult to do business in China recently given what's going on.

Yes. Just regarding the start to the year, I think we're starting out kind of as we had expected to start the year and we're cautious. I think we're cautious about how the euro play out, the economic conditions in China, so we're watching it closely. But as we've said, we still think that the market recovery will take some time there and so I think that's reflected in our guidance of how we proceed forward. And our focus really is making sure that we can maintain our competitiveness in China, maintain our premium brand position in China. And that's what the team has been focused on while at the same time, rightsizing the organization, I think, to the new market reality. So I think we're off to a good start there, but we're very cautious as it relates to how the year will play out. Regarding whether we're seeing a major shift in dynamic, I'd say, the trends are very consistent to what we've seen over the last few years. It's a challenging macro environment as we talked about, consumer confidence is not where it needs to be to sort of drive growth. The trade-in program is stabilizing, but not really driving growth for us in the marketplace. And so right now, we're looking to compete in, and obviously, we have local competitors there that means we've got to be really on our game. So I think those conditions haven't changed. We haven't really seen a big shift relative to consumer sentiment around our products. We're in China for China, and we're well respected, and we have a great brand there and I think we still see that as the way in which we're competing and seeing in the marketplace.

Thank you. And our next question comes from the line of David MacGregor from Longbow Research. Your question, please.

Hi, good morning everyone and congratulations to Kevin, Stephen. I guess I want to start off by just asking you about capacity available to you in the United States and specifically maybe how much excess capacity do you have in your Tennessee and Kentucky component plants and your ability to repatriate manufacturing to the U.S. And I guess as part of that, how does an increase in the tariffs affect your thinking around vertical integration? And I have a follow-up after that, thanks.

Well, maybe I'll touch on that. In the water heater side, we're very vertically integrated already. And so again, we're in country for country. So repatriating, I don't think that's an issue because we don't have many products that come in from outside of the United States, so that's played out well for us, and it continues to play out well for us. And so I just don't see that being a major challenge for us. From a capacity standpoint, we do have this capacity. We structure our plants appropriately, like we've been talking about and making sure that we have the right run rate so we can optimize our efficiency. And we have the ability -- we have three large residential plants. We have the ability to shift things around and move them more optimal for our customers as well as for A.O. Smith from a margin standpoint. So no big plans to repeat it because we don't do that. And I think our teams are working well together with Steve and the operating groups to make sure we're positioning ourselves well to kind of navigate the situation, but that that's where we're at. And again, it's playing out well, our strategy for in country for country is playing out pretty well on a global basis, considering the uncertainty and volatility in the market today.

Okay, good thanks for that. I guess secondly, just given all the changes that are taking place at the administration level in this country, I wanted to ask you about the 2026 change in regulatory requirements around the elimination of low-efficiency commercial gas product. Are you seeing anything at the federal level that would suggest that this might be delayed or would be reduced in scope. I think at one point, you thought the changes would impact about 55% of units sold.

Yes, I would tell you, I'm just going to take -- there's two major rule-makings out there. One is on the commercial rulemaking, which is October 26, and that's reason from not commission to the condensing product in the commercial segment. And then, of course, there's what we refer to as NACF [ph] 4, which is a little bit further around that's going to be in 2029. What I'll start with is both of these have gone through Congress, and they are law, okay? So it's going to be difficult to change any of those standards that we have there. So what we're doing is we're simply preparing for that. And the first step is going to be on the commercial side, and that will be mainly in our Mac B commercial facility, which we're taking steps there. There is a lot of chatter out there with regards to this and regulatory, but we're proceeding until we see something really meaningful, we're proceeding as both of these rule makings will go in effect at the appropriate time. And if they don't, we're a pretty nimble company and we can make adjustments. But as of right now, again, their law and we're proceeding as if they're going to go into effect as scheduled.

Thank you. And our next question comes from the line of Damian Karas from UBS. Your question, please.

Hey good morning, everyone. Hopping on the line late here, so apologies for any repetition, warning, warning. Yes, I was just wondering if you could elaborate on the pricing actions for North America water heaters, again, sorry if I missed this, but have you your 6% to 8%. Is this kind of like already executed like a round of increases? Or are there sort of some pending rounds of price changes that are going to take effect? And I'm also just curious, I mean, thinking about the past, right, and the North American industry kind of construct, like price increases have typically been similar happening at the same time, whether it was steel inflation or supply chain bottlenecks. This time is a little bit different just because of the very specific tariff factors and the fact that you have a different footprint from some of your peers. So just curious if like your price actions, if you're seeing anything kind of different in the market out there.

So first off, on the pricing announcements, they have been made and they're out in the marketplace, and we've been communicating with our customers around that. So that is a step we've already taken. You are correct in that this is a little bit of a different dynamic as you think about tariffs versus other inflationary pressures that we've worked through in the past and tariffs sort of have defined dates and supply chains, and we're all impacted a little bit differently across the different companies. But I would say it comes down to -- we have really good relationships with our customers. We work through these things. Right now, obviously, we have to move forward with what we know and the best information we have available to us and I think as that information changes, what might be different is we will continue to work with our customers around the implications that has in terms of our pricing.

Okay. Understood. And I was wondering if you could maybe update us to the status of the Mexico capacity ramp -- and I'm curious if like on the tankless side of tariffs might actually present an opportunity to kind of accelerate your position in North American tankless. My understanding is that a lot of the North American market is still coming from overseas ex Mexico?

We are looking to accelerate our ramp-up in Juarez. We have our premium condensing of that product that is launched there already. We have two more products that we're planning to launch through the course of this year to be ready for next year with the full portfolio and we are looking to accelerate those efforts so that we can get our products producing out of our Juarez, Mexico facility, and part of that acceleration is the economic case presented from the tariffs.

Yes, Damian, it's always been our intent to start production in China and move it to or heads, and this just accelerates the ability for us to start production in whereas versus on the last two products, start-up production in China.

Thank you. And this does conclude the question-and-answer session of today's program. I'd like to hand the program back to Helen Gurholt for any further remarks.

Thank you, everyone, for joining us today. Let me conclude by reminding you that we are pleased with our quarter-over-quarter improvement even in a challenging environment. We look forward to updating you on our progress in quarters to come. In addition, please mark your calendars to join our presentations at four conferences this quarter: Oppenheimer on May 5, North Coast on May 6, Keybanc on May 28 and Stifel on June 3. Thank you, and enjoy the rest of your day.

Thank you, ladies and gentlemen, for your participation in today's conference. This does conclude the program. You may now disconnect. Good day.