A O Smith (AOS) Q1 2026 Earnings Transcript

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DATE

Thursday, April 30, 2026 at 10 a.m. ET

CALL PARTICIPANTS

• Chief Executive Officer — Stephen M. Shafer
• Chief Financial Officer — Charles T. Lauber
• Vice President, Investor Relations and Financial Planning and Analysis — Helen E. Gurholt

TAKEAWAYS

• Total Company Sales -- $946 million, down 2%, with North America up 1% to $753 million and Rest of World down 11% to $201 million.
• EPS -- $0.85, down 11%, driven by lower volume and $0.03 per share in Leonard Valve acquisition charges.
• North America Water Heater Sales -- Down 2%, attributed to adverse weather-related production and shipping constraints and softer residential industry demand.
• North America Boiler Sales -- Up 2%, as residential boiler volume growth and carryover pricing offset lower commercial volume.
• North America Water Treatment Sales -- Increased 1%, with 10% growth in the priority dealer channel largely offset by specialty plumbing wholesale softness.
• Leonard Valve Contribution -- $16 million in sales during the quarter; Leonard Valve is on track for double-digit growth for the full year.
• Free Cash Flow -- $119 million, a substantial increase, fueled by working capital management and favorable timing of customer payments.
• North America Segment Margin -- 23.3%, down 140 basis points, primarily due to lower residential water heater volumes.
• Rest of World Segment Margin -- 6.2%, down 250 basis points, reflecting weak consumer demand in China and lower volumes, with partial offset from cost management.
• China Sales -- Down 17% in local currency, as expected, with continued low consumer confidence and reduced government stimulus.
• 2026 Adjusted EPS Guidance -- $3.70 to $4.00 per share, excluding a $20 million North America water treatment restructuring and impairment charge in Q2.
• Steel Cost Assumption -- 15% year-over-year increase is built into 2026 outlook.
• Company Cost of Goods Sold -- Forecast to rise approximately 3% in 2026 due to higher freight, material costs, and tariffs.
• Free Cash Flow Guidance -- $525 million to $575 million expected in 2026.
• Share Repurchases -- 700,000 shares repurchased in the quarter for $51 million; $200 million targeted for the year.
• Dividend -- Quarterly dividend approved at $0.36 per share.
• North America Price Increases -- Announced for most water heater and boiler products, ranging from 4% to 7%, to take effect in mid-May with expected realization in Q3.
• North America Boiler Sales Guidance -- 2026 growth expected at 6% to 8% due to backlog and pricing.
• North America Water Treatment Sales Guidance -- Reduced to 5% to 6% growth due to consumer caution and shift to lower-priced products.
• China 2026 Sales Outlook -- Updated to low double-digit percentage decline in local currency; Q2 sales projected down approximately 15% sequentially from Q1.
• India Growth Guidance -- Top-line growth of approximately 10% expected.
• Total Top-Line Growth Guidance -- 2% to 4% anticipated in 2026.
• North America Segment Margin Guidance -- Projected at approximately 24% for 2026.
• Rest of World Segment Margin Guidance -- Expected between 6% and 7% for 2026.
• North America Water Treatment Restructuring -- $20 million charge projected in Q2, with annual savings of $6 million to $8 million beginning in 2027.
• Net Debt Position -- $412 million, with a leverage ratio of 24.7% following borrowing for the Leonard Valve acquisition.
• Effective Tax Rate -- Estimated between 24% and 24.5% for 2026.
• Outstanding Diluted Shares -- Projected at 138 million at the end of 2026.
• Q2 EPS Weighting -- Second quarter EPS is expected to represent approximately 25% of full-year guidance midpoint, reflecting margin pressure from timing of cost and price realization.
• Capital Expenditure Guidance -- 2026 CapEx expected between $70 million and $80 million.
• Interest Expense -- Projected between $30 million and $40 million, reflecting new debt for the Leonard Valve transaction.
• Corporate and Other Expense -- Forecast at $80 million to $85 million, with $6 million of Leonard Valve transaction costs recognized in Q1.

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RISKS

• China sales declined 17% in local currency and are projected down low double digits for the year, as management stated, "we expect persistent headwinds throughout the year due to continued low consumer demand, severely limited government stimulus, and ongoing competitive pressures."
• Steel, freight, and certain material costs are expected to increase total company cost of goods sold by approximately 3% in 2026, with management highlighting, "Costs are volatile right now with oil and transportation. That is the biggest driver we are keeping an eye on."
• Rest of World segment margin fell 250 basis points alongside an $8 million earnings decrease, primarily due to volume-driven pressure in China.
• North America water treatment growth guidance reduced to 5%-6% "reflects the impact of cautious consumer behavior in our consumer-facing channels."

SUMMARY

Management provided revised 2026 adjusted EPS guidance of $3.70 to $4.00 per share, reflecting continued cost inflation, volume pressures, and transaction-related charges. Newly announced North America price increases—ranging from 4% to 7%—will take effect in mid-May with benefit realization expected in the second half. China remains a significant drag, with Q2 sales forecast down around 15% from Q1 and a continued adverse outlook for the remainder of 2026. The company projects free cash flow of $525 million to $575 million, supported by ongoing working capital initiatives, disciplined capital deployment, and a $20 million restructuring of the North America water treatment business targeting annual savings from 2027 onward.

• Management directly stated, "channel inventories we think are kind of in line with what we would expect coming out of the first quarter," indicating no meaningful acceleration in Q1 pull-forward effects from announced pricing.
• Boiler segment growth is projected to be largely price-driven, with "carryover pricing from last year" noted as a major contributor, alongside a strengthening order book.
• The integration of Leonard Valve is progressing as planned, and the acquisition continues to support the company's shift into the water management platform.
• A one-year Department of Energy enforcement delay for commercial water heater regulations led management to reduce pre-buy assumptions, flattening the commercial volume outlook and prompting some delays in associated capacity investments.
• Restructuring actions in the North America water treatment business involve "footprint optimization and brand rationalization" and are expected to result in significant operating margin improvement by 2027.

INDUSTRY GLOSSARY

• Pull-forward: Customer purchasing acceleration ahead of announced price increases or regulatory changes, resulting in higher volume in earlier periods at the expense of future quarters.
• Decremental margin: The percentage loss in profitability for each lost unit of sales, often referenced when describing fixed cost absorption in a volume-declining environment.
• Carryover pricing: The continuing earnings effect in the current period from price increases implemented in the prior year, boosting revenue growth even if no new increases are enacted in the period.

Full Conference Call Transcript

Helen E. Gurholt: Good morning, everyone, and welcome to the A. O. Smith Corporation First Quarter Conference Call. I am Helen E. Gurholt, Vice President, Investor Relations and Financial Planning and Analysis. Joining me today are Stephen M. Shafer, Chief Executive Officer, and Charles T. Lauber, Chief Financial Officer. In order to provide improved transparency into our operating results, we have provided non-GAAP measures. Free cash flow is defined as cash from operations plus capital expenditures. Adjusted earnings per share excludes the impact of restructuring and impairment expenses. Reconciliations from GAAP measures to non-GAAP measures are provided in the appendix at the end of this presentation and on our website.

A friendly reminder that some of our comments and answers during this conference call will be forward-looking statements that are subject to risks that could cause actual results to be materially different. Those risks include matters that we described in this morning’s press release, among others. Also, as a courtesy to others in the question queue, please limit yourself to 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.aielsmith.com. I will now turn the call over to Stephen M. Shafer to begin our prepared remarks. Please turn to the next slide.

Stephen M. Shafer: Thank you, Helen, and good morning, everyone. Before I discuss our first quarter results, I want to sincerely thank all A. O. Smith Corporation employees for their exceptional dedication and resilience during the first quarter. In particular, I would like to recognize our North American water heater team for their swift response to weather-related damage at one of our facilities, as they acted to ensure the safety of their colleagues while at the same time finding a way to recover from our production loss and continue to serve our customers well. I remain grateful for your dedication and teamwork, which continue to strengthen our company and our culture. Now moving on to our first quarter 2026 financial performance.

Please turn to Slide 4. North America sales increased 1% to $753 million and Rest of World sales decreased 11% to $201 million, resulting in total company first quarter sales of $946 million, a decrease of 2%. Our EPS was $0.85, a decrease of 11% due to lower volume and transaction-related expenses recognized in the quarter for the Leonard Valve acquisition. Despite these headwinds, diligent working capital management helped to drive strong free cash flow performance in the quarter. Our China sales decreased 17% in local currency in the first quarter, which was in line with our expectations as well as broader market performance.

With the discontinuation of most government stimulus programs and continued low consumer confidence, the water heater and water treatment markets remain challenged, especially the premium portion of the market where we compete. We expect this softness to persist. We also believe that our ongoing strategic assessment has created some uncertainty in the market and has delayed certain investments, putting further pressure on our business. We continue to make progress with our assessment and are moving with urgency to provide greater clarity for our customers and employees, with the goal of defining a clear path forward in the coming months. Now I would like to share some additional color on our North America business.

North America water heater sales decreased 2% year over year. Production and shipping constraints caused by adverse weather, most notably at our Ashland City, Tennessee facility, combined with softer-than-anticipated residential industry demand early in the year, negatively impacted the quarter. As we discussed on our January earnings call, the wholesale residential channel continues to face challenges, including a soft market in new construction and continued initiatives by retailers to expand into serving the professional. Despite these pressures, we are encouraged by the stabilization of our market share in the wholesale channel in the first quarter, while recognizing there is still work to be done with more improvement to come.

Additionally, we are pleased with our share performance within the retail channel and the strength of our retail partnerships. Our strong market leadership and balanced presence across both channels provide us with clear visibility into market trends, supported by robust data, analytics, and deep customer relationships. I am encouraged by the positive momentum we have going into the second quarter. North America boiler sales grew 2% compared to 2025, as residential boiler volume growth and carryover pricing benefit more than offset lower commercial volume. North America water treatment sales increased 1% in the first quarter. Ten percent growth in our priority dealer channel was largely offset by softness in the specialty plumbing wholesale channel.

A cautious consumer environment led to flat growth in our more consumer-facing channels, with a general trend towards a trade down to lower-priced products. We expanded operating margin by almost 100 basis points; despite the slower start to the year, we continue to work on improving the profitability of this platform. Leonard Valve contributed $16 million to sales in 2026, led by strong performance. We exited the quarter with a strong backlog, and Leonard remains on track to achieve another year of double-digit growth. I will now turn the call over to Charles T. Lauber, who will provide more details on our first quarter performance. Thank you, and good morning, everyone.

Charles T. Lauber: Please turn to Slide 5. First, I would like to highlight two items impacting the quarter. As Stephen noted, we had weather-related headwinds in the quarter, including damage to a portion of our roof at our Ashland City manufacturing facility. Because of our team’s swift response and our insurance coverage, we project minimal impact to our full-year performance. However, we estimate that production and shipping constraints, offset by insurance coverage on direct costs, negatively impacted our first quarter by approximately $0.04 per share. In addition, we acquired Leonard Valve on January 6 and, as a result, recognized $0.03 of transaction-related expenses in corporate expense for the quarter.

North America segment first quarter sales of $753 million increased 1% against a tough comp, as carryover pricing benefits and Leonard Valve sales contributions were largely offset by lower residential water heater volumes and weather-related production and shipping constraints. North America segment earnings of $175 million and segment margin of 23.3% decreased by $10 million and 140 basis points, respectively, versus the prior-year period. Lower segment earnings and segment margin were primarily the result of lower residential water heater volumes and more than offset the earnings contribution from Leonard Valve. Carryover pricing benefits more than offset cost inflation in the quarter. 2025 benefited from pull-forward demand ahead of an announced price increase and a stronger mix towards higher-efficiency products.

Moving to Slide 6. Rest of World segment sales of $201 million decreased 11% year over year due to continued weak consumer demand in China driving lower sales, which was partially offset by favorable foreign currency exchange. Rest of World first quarter 2026 segment earnings of $12 million and segment margin of 6.2% decreased by $8 million and 250 basis points, respectively, versus the prior-year period. The lower segment earnings and segment margin in 2026 were primarily due to lower sales volumes, which were partially offset by continued cost management in China. Please turn to Slide 7.

We generated strong free cash flow of $119 million in the first three months of 2026, a significant increase over 2025, primarily driven by diligent working capital management and the timing of customer payments that more than offset lower earnings. Our cash balance totaled $204 million at the end of March, and our net debt position was $412 million. Our leverage ratio was 24.7% as measured by total debt to total capital, higher than 2025 due to the cash we borrowed under a new term loan used to acquire Leonard Valve. We continue to have significant available capacity for future acquisitions. Turning to Slide 8.

In addition to returning capital to shareholders, we continue to drive organic growth through the development of innovative product offerings and productivity through operational excellence—two of our key strategic priorities. Earlier this month, our Board approved our next quarterly dividend of $0.36 per share. We repurchased approximately 700 thousand shares of common stock in the first quarter for a total of $51 million. We expect to repurchase $200 million of our shares during the full year 2026. Consistent with our focus on portfolio management, we continue to actively assess M&A opportunities that meet our strategic and financial criteria. Please turn to Slide 9 for 2026 earnings guidance and outlook.

Our revised 2026 outlook includes an adjusted EPS range of $3.70 to $4.00 per share. This excludes a relatively net cash neutral North America water treatment restructuring and impairment charge of approximately $20 million that we expect to recognize in the second quarter. Key assumptions within our outlook include: steel costs have steadily risen throughout the first quarter, leading us to increase our full-year 2026 steel cost assumption to be a year-over-year increase of approximately 15% compared to 2025. In addition, due to recent oil price volatility, our transportation and certain material cost assumptions have also increased since our previous guidance.

We now project that freight, non-steel material costs, and tariffs will increase our overall total company cost of goods sold by approximately 3% in 2026. Our guidance assumes oil prices and tariff levels will remain at a similar level to where they are today; we continue to monitor the situation. We maintain our estimate that 2026 CapEx will be between $70 million and $80 million. We continue to expect strong free cash flow of between $525 million and $575 million. Interest expense is projected to be between $30 million and $40 million, an increase over previous years due to the $470 million of additional debt incurred to acquire Leonard Valve.

Corporate and other expenses are expected to be between $80 million and $85 million and include $6 million of transaction expenses associated with the Leonard Valve acquisition recognized in the first quarter. Our effective tax rate is estimated to be between 24% and 24.5%. We project our outstanding diluted shares will be 138 million at the end of 2026. I will now turn the call back over to Stephen M. Shafer to expand on our key markets and our 2026 top-line growth outlook for each business. Staying on Slide 9.

Stephen M. Shafer: Thank you, Chuck. Within North America, our top-line outlook includes the following assumptions. While the residential water heater industry had a slower-than-expected start to the year, we maintain our view that full-year 2026 industry shipments will be flat to down as softness in new construction persists and proactive replacement remains steady. Due to a recent statement from the Department of Energy indicating a one-year enforcement delay of the October 6 commercial regulatory change, we revised our outlook and now expect less pre-buy activity in the quarters leading up to the original transition. We now project that U.S. commercial industry volumes will be similar to last year.

In response to rising steel, freight, and other input cost inflation, we have announced price increases for most of our water heater and boiler products in North America, with increases varying by product, ranging from approximately 4% to 7%. We have seen some cost increases already leading into the second quarter, particularly within transportation. We expect to begin realizing the benefit of these announced price increases beginning in the third quarter. As always, we are maintaining ongoing communication with our suppliers, customers, and stakeholders as we address current market challenges while also implementing diligent cost management strategies.

We continue to project our North America boiler sales to grow between 6% to 8% in 2026 due to pricing benefits and a strengthening backlog in commercial and residential boilers. We have reduced our 2026 sales guidance for North America water treatment to growth of 5% to 6%. The decrease in our outlook reflects the impact of cautious consumer behavior in our consumer-facing channels, which is approximately half of our business, where we have experienced soft demand as well as a shift toward lower-priced products. We are pleased with the progress of our priority dealer network expansion efforts and expect sales in that channel to achieve double-digit growth in 2026.

Our guidance that Leonard Valve will achieve double-digit growth and contribute approximately $70 million in sales in 2026 is unchanged. Integration efforts are on track, and we are pleased with the reception we are receiving as we explore ways to go to market together. Moving to our Rest of World outlook and assumptions, we have updated our full-year guidance for China sales, which we now expect to be down low double digits in local currency compared to last year, with sales in Q2 down approximately 15% compared to Q1, as we balance channel inventories for the current environment.

This revised guidance reflects our updated view of the China market, where we expect persistent headwinds throughout the year due to continued low consumer demand, severely limited government stimulus, and ongoing competitive pressures. We continue to advance our China assessment, evaluating strategic alternatives to strengthen our long-term competitive position. The evaluation is providing valuable insights into both the advantages and challenges facing our business. Many actions we have identified to improve the performance of our China business are pending the conclusion of our assessment, which is impacting our expected recovery timeframe. We are looking to provide greater clarity within the next few months.

We project our India business, inclusive of Spirit, will have top-line growth of approximately 10%, and this is unchanged. Based on these 2026 assumptions, we expect total top-line growth of approximately 2% to 4%. We expect our North America segment margin to be approximately 24%, and Rest of World segment margin to be between 6% and 7%. Please turn to Slide 10. This morning, I would like to provide additional color on our operational excellence value creation opportunities. Our focus is to provide sustainable margin improvement in mid-cycle markets and protect our profitable growth in times of less market certainty. Over many years, we have looked to drive continuous improvement throughout our operations with our AOS operating system.

Today, we are building on that foundation with new tools and making more strategic moves to help prioritize around our strengths and drive improved profitability. The tool sets we are now bringing to operations include enhanced stability for process intelligence and AI capabilities to drive better customer experiences at greater levels of productivity. Initial application examples include order management, warranty claims processing, and technical service support, where we are identifying opportunities, developing process improvement, and using AI agents to drive that improvement. Still early days, but we are excited by the potential of what we see. The streamlining of our North America water treatment business is an example of focusing on our strengths to drive more profitable growth.

As we announced this morning, we are taking actions to continue improving our profitability and accelerate long-term growth through footprint optimization and brand rationalization. These steps are part of our ongoing water treatment strategy evolution and allow us to further focus on the areas where we expect to be most competitive going forward. We expect to recognize a restructuring charge of approximately $20 million in the second quarter and a projected annual savings of between $6 million and $8 million beginning in 2027. These exciting new tools that help us reimagine our operating processes and our continued strategic focus on prioritizing around our strengths are two ways in which we are bringing operational excellence to life at A. O.

Smith Corporation. I look forward to sharing more details as this focus area for us matures going forward. Moving to Slide 11. Our team responded well when faced with pressure in several of our key markets in the first quarter. I am pleased with the market share improvement we saw in residential water heating, the double-digit valve sales growth that Leonard Valve contributed to the quarter, and the strong free cash flow achieved through diligent working capital management. With the strategic actions that we are taking, supported by our consistent operational discipline, I believe A. O. Smith Corporation will continue to strengthen its leadership position and be well equipped to capitalize on future opportunities.

With that, we conclude our prepared remarks. We will now open the call for questions.

Operator: Thank you. We ask that you please limit yourself to one question and one follow-up. One moment for our first question. Our first question will come from the line of Susan Marie Maklari with Goldman Sachs. Your line is open. Please go ahead.

Susan Marie Maklari: Thank you. Good morning, everyone. Thanks for taking the questions. My first question is on the channel inventories in residential. You mentioned that you did have some pull forward around the pricing that you announced. Can you talk a bit more about how much you are seeing in there and how you are thinking about the channel going into the second quarter? And how we should think of the flow-through in the next couple of quarters as a result of that?

Charles T. Lauber: Good morning, Susan. The reference that I made to pull forward in the first quarter was to last year, so we really have not seen any pull forward in 2026. By the way, the channel inventories we think are kind of in line with what we would expect coming out of the first quarter.

Susan Marie Maklari: Okay. So you have not seen anything from the pricing you announced this year yet?

Charles T. Lauber: Not meaningful. The price increase that we have is effective mid-May, roughly, so it is pretty early days.

Susan Marie Maklari: Okay. That is helpful. And then, turning to commercial, you mentioned that the regulatory change got pushed out for a year. Can you give us more color on what drove that and how you are thinking about the demand there now for the balance of this year and then even into next year as the channel positions for that?

Charles T. Lauber: Sure, Susan. The DOE commercial rule that was set to take effect in October has been challenged through the court system, and it has been held up so far, but it is pending and waiting to see if the Supreme Court will review it. We do not know whether the Supreme Court will take on that challenge or not. What the DOE issued late last week, because of that uncertainty and because we are getting closer to the October 6 date, was, in essence, a letter stating they would not be enforcing the rule until October 2027.

However, that might also change as things play out both in the court system as well as how DOE thinks about the rule going forward. There is still a lot of uncertainty out there, but it has us feeling like it was more prudent to think that the industry may do less buy-ahead because of that announcement.

Operator: Thank you. One moment for our next question. Our next question will come from the line of Matt J. Summerville with D.A. Davidson. Your line is open. Please go ahead.

Matt J. Summerville: Thanks. A couple of questions. On the water treatment side of things, I was under the impression that getting out of the retailer big-box channel was the reset for that business, and it sounds like you are initiating yet another reset in water treatment. Remind us how big that business is and help us understand a little bit more around how we should be thinking about that looking ahead. Then, as a follow-up, you expect your China business to now be down low double digits. How does that sync up to what is actually happening in the market? Are you losing share?

How do you justify the length of this review process with the potential that you are continuing to bleed share in that business because of how long the process has taken to unfold?

Stephen M. Shafer: Good morning, Matt. The water treatment business is just over $250 million, roughly. Last time we talked about a reset, it was the exiting of on-the-shelf retail, and that was one ingredient of the reset. This is the next step of focus. It is really about leveraging our brands—focusing on our A. O. Smith Corporation brand more than some of the brands that we acquired—and rationalizing our manufacturing footprint. Think of it this way: in 2026, we are looking to expand margins by about 200 basis points to move to about 15% operating margins in North America water treatment. In 2027, with this next restructuring, we would expect an incremental couple hundred basis points.

It is the next step in moving that profitability up. Regarding the China market environment and our performance, the whole market saw challenges in the first quarter, many of which we highlighted—stimulus has run its course and consumer confidence remains low—so it was a challenging quarter in the categories we participate in. From the third-party data we track, we did not lose meaningful share; we actually maintained our share in the first quarter, but it was certainly a down market condition. That environment is probably the biggest driver to why the assessment is taking a bit longer than we had hoped. There are still a lot of positive things coming out of the assessment for us.

Third-party assessments validate that our brand and pricing power are very strong, and there is a lot of interest from potential partners. The dialogue is maturing, and I am hoping that in the coming months we will be able to provide clarity on our path forward, but it is occurring against a challenging market backdrop.

Operator: Thank you. One moment for our next question. Our next question comes from the line of Tomohiko Sano with JPMorgan. Your line is open. Please go ahead.

Tomohiko Sano: Hi. Good morning, everyone. We understand the guidance revision was mainly driven by external factors in China and North America. In this challenging environment, have you observed any changes in your market share across key regions? And as a follow-up, on Leonard Valve, how is the integration progressing, and are you on track to realize the expected synergies?

Stephen M. Shafer: Good morning. In China, in the last few years there has been some market share loss, but in Q1 we do not see any meaningful market share loss; we think we are holding our own in a challenging market. Within the U.S., on the water heater side, we have stabilized our share position in the wholesale channel, which was a big focus over the last quarter. There is still more work to be done. On the retail side, we are very pleased with our share position and the strength of our partnerships. Regarding Leonard Valve, we are very pleased with the first quarter.

It is a great fit with our portfolio and serves as the foundation for our water management strategy going forward. Integration is on track with the plan. Most of our opportunity is in ways to go to market together. We have been out talking to customers, and it has been very well received.

Operator: Thank you. One moment for our next question. Our next question will come from the line of Joseph Nolan with Longbow Research. Your line is open. Please go ahead.

Joseph Nolan: Good morning. I wanted to focus on the margin and price/cost outlook over the remainder of the year. In the second quarter, you will be feeling the impact of higher steel and freight costs, but it sounds like you are not expecting to get price benefit until Q3. Can you walk through margin cadence over the remaining quarters of the year? And as a clarification, on the commercial water heater industry outlook coming down to flat now, is that really just a reflection of the regulatory change, or are there other moving pieces?

Charles T. Lauber: Sure. We were happy with our price/cost relationship in Q1; pricing overcame the costs we incurred plus a little bit of margin, so we are walking into the second quarter in a good position for the costs behind us. However, we are seeing incremental costs in the second quarter—transportation is up, diesel fuel is up, and steel costs continue to rise. We have an announced price increase that takes effect in the third quarter. So we will see a little pressure in Q2 before pricing benefits begin, and that should be overcome in Q3 and Q4 with the pricing we expect to have in place.

We feel comfortable with our positioning but are watching costs closely, especially those related to oil and transportation. On commercial water heaters, the biggest driver of the outlook change to flat is the DOE regulatory timing and the related reduction in anticipated pre-buy.

Operator: Thank you. One moment as we move on to our next question. Our next question comes from the line of Mike Halloran with Baird. Your line is open. Please go ahead.

Mike Halloran: Good morning, everyone. Can you help put this in context on how you expect earnings to cadence through the year? The $0.03 from Leonard goes away, price/cost dynamics in Q2 are a little less favorable with more favorable in the back half, and timing around headwinds and demand dynamics—do you get a catch-up in Q2 from the weather? How does that key into the year? And on pricing, are you expecting any pull-forward of demand ahead of the 4%–7% price increases, and how do you think channel acceptance will go given the moving pieces in the water heater space?

Charles T. Lauber: There are a couple of moving parts since our last outlook. Starting with China, Q2 is expected to be down roughly 15% from Q1, with decremental margins of 35% to 40%, so we expect a difficult quarter there. We expect to come out of Q2 with better balance of channel inventories; they are relatively the same as last year, but we would like to be leaner in this environment. In North America, costs are ahead of us in Q2 before we see pricing in Q3, which is a headwind to margin in Q2.

On DOE, previously we would have expected a meaningful amount of pull-forward in Q2 and Q3; we have softened that, so commercial volume cadence is now expected to be pretty similar to other years with flat volume year over year. Overall, Q2 EPS is expected to be roughly 25% of our full-year guidance midpoint. That includes a little help in Q2 from some pricing pull-forward. We expect a solid performance in North America in Q2 based on a little pull-forward. The back half should be a little stronger on boilers—Q3 is always stronger—and China typically has its strongest quarter in Q4 after a muted Q1.

So, stronger Q2 on the top line, some headwinds on cost, real headwinds in China, and more normalization in the back half.

Stephen M. Shafer: On pull-forward ahead of the 4%–7% price increases, there is usually a little of that, and we work closely with our customers to navigate these transitions, serving them well while being smart operationally. Ultimately, we remain committed to keeping our customers competitive, even as we manage through cost pressures and market uncertainty.

Operator: Thank you. One moment for our next question. Our next question will come from the line of Jeff Hammond with KeyBanc Capital Markets. Your line is open. Please go ahead.

Jeff Hammond: Hey, good morning. It seems like you are just cutting EPS $0.15, but a lot of the macro assumptions are moving the wrong way. Can you talk about offsets to that—price, restructuring savings, or catch-up from the plant issue—that would mitigate the EPS impact? And on dynamics between wholesale, retail, and this price increase: have you seen other players announce similar pricing around steel and fuel inflation, and any changes you are seeing in the wholesale channel?

Charles T. Lauber: We had a little bit of catch-up on the plant issues—not a lot—but that will help a bit in the second quarter. From our last guidance, the big changes were China and the DOE policy statement. Teams continue to look at cost management in China and North America as we watch the market play out. Costs are volatile right now with oil and transportation. That is the biggest driver we are keeping an eye on.

Stephen M. Shafer: We will not comment on competitor pricing, but historically we have been successful offsetting costs over time, and we feel good about our positioning. It remains a competitive environment, and we would expect the industry to experience similar cost inputs. Our commitment is to make sure we keep our customers competitive.

Operator: Thank you. One moment for our next question. Our next question will come from the line of Adam Farley with Stifel, on behalf of Nathan Jones. Your line is open. Please go ahead.

Adam Farley: Good morning. Following up on the commercial water heating regulatory impact, does that change how you are planning to ramp capacity for that commercial change? And more broadly, can you update us on capacity plans for this year and into next year? Also, on tariffs, was there any incremental change to the gross tariff impact with recent rule changes, and what is contemplated in the guide?

Stephen M. Shafer: We were prepared for the transition from a capacity standpoint and made investments to get ready. If demand is pushed out and customers delay orders, and if the regulatory rule goes into effect later, we will be ready with those investments. Many have been made, and some that were still in front of us we are delaying until we have certainty of the demand need. On tariffs, we saw some relief in certain areas and increases in others. Overall, the tariff outlook is maybe net neutral to slightly favorable, but that is overshadowed by other costs related to oil, diesel fuel, transportation, and resilient steel prices.

Net-net, it is a bit of a cost headwind, which is why we have pricing out there.

Operator: Thank you. One moment for our next question. Our next question comes from the line of Andrew Alec Kaplowitz with Citi. Your line is open. Please go ahead.

Analyst: Hi. Good morning. This is Natalia on behalf of Andy Kaplowitz. First, you held the outlook for boilers despite lowering expectations across most other product categories. Can you unpack what you are seeing in underlying demand—how much is volume versus pricing? And second, as you think about capital deployment, how are you viewing the current M&A pipeline, particularly in terms of opportunities within your core business versus adjacency areas?

Charles T. Lauber: Our boiler growth for the year has a big price component, including carryover pricing from last year. Q1 was a little softer on commercial, which we highlighted, but we see orders coming up, and that business has typical seasonality. We remain confident in the 6% to 8% growth forecast. Commercial is catching up based on the order book, and price remains a big component of the growth.

Stephen M. Shafer: There are opportunities to strengthen our core via M&A, alongside significant organic investment to maintain our leadership. Getting scale and profitability in our water treatment platform has been a big focus for us over the last seven to eight years, and there are still a few opportunities to strengthen that business through M&A. A big focus for us is on the water management platform. Leonard Valve, which we closed in January, is in that category, and we think it is probably the richest area for us from an M&A standpoint as we build out and expand in water management.

Operator: Thank you. I am showing no further questions. I would like to hand the conference back over to Helen E. Gurholt for closing remarks.

Helen E. Gurholt: Thank you for joining us today. We look forward to updating you on our progress in quarters to come. Please mark your calendars to join us at four conferences this quarter: Oppenheimer on May 5, KeyBanc on May 27, Stifel on June 2, and Wells Fargo on June 9. Thank you, and enjoy the rest of your day.

Operator: This concludes today’s conference call. Thank you for participating, and you may now disconnect. Everyone have a great day.