SMITH A O CORP (AOS)

ITEM 2 - MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Overview

Our company is comprised of two reporting segments: North America and Rest of World. Our Rest of World segment is primarily comprised of China, India, and Europe. Both segments manufacture and market comprehensive lines of residential and commercial gas, heat pump and electric water heaters, boilers, tanks, and water treatment products. Both segments primarily manufacture and market in their respective region of the world.

Consistent with our stated strategic priorities, we continue to seek acquisitions that enable growth, expand our core business, and establish adjacencies. In January 2026, we acquired LVC Holdco LLC (Leonard Valve) for $470 million, subject to customary adjustments, and was funded with cash borrowed under a new term loan with a group of eight banks. Leonard Valve is a leading manufacturer of water temperature and flow solutions and we believe it represents a compelling strategic fit and a meaningful advancement into our presence in the water management market. Leonard Valve is projected to contribute approximately $70 million in sales in 2026 in the North America segment. Leonard Valve contributed approximately $16 million and $32 million to sales in the second quarter and first half of 2026, respectively. In the first quarter, we recognized $6 million of acquisition-related transaction expenses.

Consistent with our Operational Excellence strategic priority, the Company announced a restructuring plan in its North America water treatment business designed to increase operational efficiency and accelerate growth through footprint optimization as well as brand rationalization. In the second quarter, the Company recognized a restructuring charge of $22.6 million, the majority of which is due to non-cash impairment expenses. Beginning in 2027, annual savings are projected to be approximately $6 million to $8 million.

In our North America segment, water heater sales grew two percent in the second quarter of 2026. Water heater sales were flat in the first half of 2026 as pricing benefits were offset by lower residential volumes. We project that full year 2026 residential industry unit volumes will decrease low single digits, due to softness in new construction and a slower than expected start to the year. We project that commercial water heater industry volumes will be similar to last year. The Department of Energy recently announced an up-to-one-year enforcement delay of the October 2026 regulatory change related to energy efficiency requirements on commercial gas products. In response to higher steel and other input costs, in April, we announced price increases of four to seven percent on most of our water heater and boiler products that went into effect at the end of the second quarter. Our boiler sales grew 21 percent and 12 percent in the second quarter and first half of 2026, respectively, due to carryover pricing benefits, a strong response to our annual seasonal pre-buy programs and pre-buy ahead of 2026 price increase. We expect our boiler sales to grow between six and eight percent in 2026. We anticipate sales of our North America water treatment products will grow between five and six percent primarily due to the benefits of pricing actions and as we continue to expand our dealer network, partially offset by softness in our consumer channels.

In our Rest of World segment, China third-party sales declined 28 percent in local currency in the second quarter of 2026 due to continued challenging market conditions including the cessation of the government appliance subsidy programs. For the full year 2026, based on our caution around a recovery timeline of our China business, we project our third-party sales in China to decrease low double-digits in local currency sales compared to 2025. In 2025, we initiated an assessment of strategic opportunities for our China business, including strategic partnerships and other alternatives. We believe the China market has substantial long-term prospects and are committed to realizing the potential upside inherent in our China business. The assessment is ongoing.

Combining all of these factors, we expect our 2026 consolidated sales to grow between two and three percent compared to 2025. Our guidance excludes the impacts from potential future acquisitions, any potential outcomes of the assessment of the China business and and the potential impact of recently announced changes in tariff policy.

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Results of Operations

Our sales in the second quarter of 2026 were $1,004.3 million and were slightly lower than the second quarter of 2025 sales of $1,011.3 million. Sales in the first six months of 2026 were $1,949.9 million and lower than sales of $1,975.2 in the first six months of 2025. Compared to the prior year quarter, our net sales decrease was primarily driven by lower sales in China due to continued weak consumer demand partially offset by the sales contribution from the acquisition of Leonard Valve, and the three percent organic growth in our North America business. Our net sales decrease in the first six months of 2026 was primarily driven by lower sales in China partially offset by the sales contribution from the acquisition of Leonard Valve, and the one percent organic growth in our North America business.

Our gross profit margin in the second quarter of 2026 was 38.6 percent compared to 39.3 percent in the second quarter of 2025. Gross profit margin in the first six months of 2026 was 38.6 compared to 39.1 percent in the first six months of 2025. The decrease in gross profit margin for the second quarter and first six months of 2026 compared to the prior year periods was primarily due to lower sales volumes and higher material cost.

Selling, general, and administrative (SG&A) expenses in the second quarter of 2026 increased $6.4 million compared to the second quarter of 2025. SG&A expenses increased $17.7 million in the first six months of 2026 compared to the prior year period. The increases in SG&A expenses in the second quarter of 2026 compared to the prior year period were primarily due to the Leonard Valve acquisition including higher amortization expenses, and consulting costs. The increases in first six months of 2026 compared to the prior year period were primarily due to higher employee costs, amortization expense and transaction costs related to the acquisition of Leonard Valve and consulting cost.

Restructuring and impairment expense in the three and six months ended June 30, 2026 was $22.6 million, and was associated with a restructuring plan designed to increase operational efficiency and accelerate growth through footprint optimization and brand rationalization. The expense was related to our water treatment business and recorded in the North America segment.

Interest expense in the second quarter of 2026 was $8.1 million compared to $4.6 million in the same period last year. Interest expense in the first six months of 2026 was $15.2 million compared to $7.5 million in the same period last year. The increase in interest expense in the second quarter and first six months of 2026 was primarily due to higher debt levels as a result of the Leonard Valve acquisition.

Other expense (income), net for the second quarter of 2026 was expense of $1.4 million compared to income of $0.4 million for the second quarter of 2025. Other expense (income), net for the first six months of 2026 was expense of $1.4 million, compared to income of $1.6 million for the first six months of 2025. The change in Other expense (income), net in the second quarter of 2026 was primarily due to higher foreign currency translation losses. The change in Other expense (income), net in the first six months of 2026 was primarily due to higher foreign currency translation losses and lower interest income.

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Our effective income tax rate for the three and six months ended June 30, 2026 was 20.9 percent and 22.3 percent, respectively. The effective income tax rate for the three and six months ended June 30, 2025 was 24.5 percent. The change in the effective income tax rate for the three and six months ended June 30, 2026 compared to the effective income tax rate for the three and six months ended June 30, 2025 was primarily due to a discrete tax benefit recognized during the period ended June 30, 2026 related to U.S. cross border tax elections. We estimate that our annual effective income tax rate for the full year of 2026 will be approximately 24.0 percent.

We are providing non-U.S. Generally Accepted Accounting Principles (GAAP) measures (adjusted earnings, adjusted earnings per share (EPS), total segment earnings and adjusted segment earnings) that exclude the impact of restructuring and impairment expenses, as well as organic growth (decline) that excludes the impact of acquisitions and divestitures and foreign exchange from year-over-year comparisons. Reconciliations from GAAP measures to non-GAAP measures are provided in the Non-GAAP Measures section below. We believe that the measures of adjusted earnings, adjusted EPS, total segment earnings, organic growth (decline) and adjusted segment earnings provide useful information to investors about our performance and allow management and our investors to better understand our performance between periods without regard to items that we do not consider to be a component of our core operating performance or recurring in nature.

North America Segment

Sales in our North America segment were $820.5 million in the second quarter of 2026, an increase of $41.5 million from $779.0 million in the second quarter of 2025. Sales in the first six months of 2026 were $1,573.9 million, or $46.2 million higher than sales of $1,527.7 million in the same period last year. Compared to the prior year quarter, our net sales increase was primarily driven by the benefits of 2025 pricing actions, incremental sales of approximately $16 million from the 2026 acquisition of Leonard Valve, and increased boiler volumes partially offset by lower residential water heater volumes. Our net sales increase in the first six months compared to the prior year period was primarily driven by the benefits of 2025 pricing actions, incremental sales of approximately $32 million from the 2026 acquisition of Leonard Valve, and increased boiler volumes largely offset by lower residential water heater volumes.

North America segm

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ITEM 7 – MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

OVERVIEW

Our company is comprised of two reporting segments: North America and Rest of World. Our Rest of World segment is primarily comprised of China, India, and Europe. Both segments manufacture and market comprehensive lines of residential and commercial gas, heat pump and electric water heaters, boilers, tanks, and water treatment products. Both segments primarily manufacture and market in their respective region of the world.

Consistent with our stated strategic priorities, we continue to seek acquisitions that enable growth, expand our core business, and establish adjacencies. In November 2025, we announced that we signed a definitive agreement to acquire LVC Holdco LLC (Leonard Valve) for $470 million, subject to customary adjustments, and was funded with cash borrowed under a new term loan with a group of eight banks. The transaction was completed in January 2026. Leonard Valve is a leading manufacturer of water temperature and flow solutions and we believe it represents a compelling strategic fit and a meaningful advancement into our presence in the water management market. Leonard Valve is projected to contribute approximately $70 million in sales in 2026 in the North America segment. On November 1, 2024, we acquired Pureit from Unilever for approximately $125 million, subject to customary adjustments. Pureit, a leading water purification business in South Asia, offers a broad range of residential water purification solutions. Pureit contributed $54 million to sales in 2025 in the Rest of World segment. The acquisition fits squarely in our core capabilities and doubled our market penetration in the South Asia region.

We continue to look for opportunities to add to our existing product portfolio in high growth regions demonstrated by our previous introductions of kitchen products and connected product technologies in China. We also recently introduced our internally designed and manufactured gas tankless water heaters in North America. In addition, we are expanding our commercial water heater capacity in North America in preparation for the new efficiency rule for commercial water heaters that the Department of Energy (DOE) has adopted that will take effect in October 2026.

In our North America segment, water heater sales increased one percent in 2025 compared to 2024 as pricing benefits and higher commercial volumes were partially offset by lower wholesale residential volumes. We estimate that 2025 residential industry unit volumes were approximately flat compared to the prior year and we project 2026 industry residential unit volumes will be flat to down, driven by softness in new construction. We anticipate that commercial water heater industry volumes will increase mid-single digits in 2026 after growing approximately five percent in 2025. We believe that the 2026 growth will come from the buy ahead of products that will be eliminated as a part of the DOE regulatory change for commercial water heaters that will take effect in October 2026. In response to higher steel and other input costs, including tariffs, we announced price increases on most of our water heater and boiler products in the first half of 2025. In addition to pricing, we continue to mitigate the impact of tariffs through footprint optimization, strategic sourcing actions and other cost containment initiatives. Our boiler sales grew eight percent in 2025 primarily due to higher volumes and pricing benefits. We expect our boiler sales to grow between six and eight percent in 2026 due to carryover pricing benefits and continued demand for our commercial high efficiency condensing gas boilers. We anticipate sales of our North America water treatment products will grow between 10 and 12 percent primarily due to tariff-related pricing benefits and as we continue to expand our dealer network.

In our Rest of World segment, China third-party sales declined 12 percent in local currency in 2025 due to continued weak consumer demand and the cessation of the government appliance subsidy programs in the second half of the year. For the full year 2026, we project our third-party sales in China to decrease mid-single digits in local currency compared to 2025 due to continued softness in consumer demand. In the third quarter of 2025, we initiated an assessment of strategic opportunities for our China business, including strategic partnerships and other alternatives. We believe the China market has substantial long-term prospects and are committed to realizing the potential upside inherent in our China business. The assessment is ongoing.

Combining all of these factors, we expect our 2026 consolidated sales to grow between two and five percent compared to 2025. Our guidance excludes the impacts from potential future acquisitions, any potential outcomes of the assessment of the China business and changes to tariffs.

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RESULTS OF OPERATIONS

In this section, we discuss the results of our operations for 2025 compared with 2024. We discuss our cash flows and current financial condition under “Liquidity and Capital Resources.” For a discussion related to 2024 compared with 2023, please refer to Item 7 of Part II, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K for the Year Ended December 31, 2024, which was filed with the United States Securities and Exchange Commission (SEC) on February 11, 2025, and is available on the SEC's website at www.sec.gov.

Our sales in 2025 were $3,830.2 million, an increase of $12.1 million compared to 2024 sales of $3,818.1 million. Our net sales increase was mainly due to implementing price increases to address rising input costs, including tariffs, as well as higher sales volumes of commercial water heaters and boilers. Additionally, the acquisition of Pureit in late 2024 contributed incremental sales of $54 million in 2025. These positive factors outweighed the impact of decreased volumes in China, lower residential water heater sales in North America, and an unfavorable currency translation of approximately $7 million due to the depreciation of foreign currencies compared to the U.S. dollar.

Our 2025 gross profit margin of 38.8 percent increased compared to 38.1 percent in 2024. The higher gross profit margin in 2025 compared to 2024 was primarily driven by the benefits of pricing actions implemented early in 2025 to address increased input costs in North America and higher mix of commercial water heaters and boilers.

Selling, general, and administrative (SG&A) expenses were $759.4 million in 2025, or $20.1 million higher than in 2024. The increase in SG&A expenses in 2025 compared to the prior year was primarily due to higher employee costs, partially offset by benefits of our 2024 China restructuring actions.

We recognized $17.6 million of restructuring and impairment expenses during the year ended December 31, 2024. Of these expenses, $6.3 million was related to our water treatment business in the North America segment and was a result of a profitability improvement strategy that prioritizes improving our cost structure and emphasizes more profitable channels. In the Rest of World segment, restructuring included severance costs in China of $11.3 million and was related to the right sizing of that business for current market conditions. Restructuring and impairment expenses in 2023 were $18.8 million, of which $15.7 million was recorded in the Rest of World segment and $3.1 million was recorded in Corporate Expense and related primarily to the sale of our business in Turkey.

Interest expense was $13.5 million in 2025, compared to $6.7 million in 2024. The increase in interest expense in 2025 compared to the prior year was primarily due to higher average debt levels throughout 2025.

Other income - net for 2025 was income of $0.6 million, compared to income of $8.5 million in 2024. The decrease in other income - net was driven by lower foreign currency translation losses compared to the prior year and lower interest income from lower average cash balances.

Our effective income tax rate in 2025 and 2024 was 23.6 percent and 23.9 percent, respectively. The change in the effective income tax rate in 2025 compared to the prior year was primarily due to reductions in US cross-border tax. We estimate that our annual effective income tax rate for the full year of 2026 will be approximately 24 to 24.5 percent.

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We are providing non-U.S. Generally Accepted Accounting Principles (GAAP) measures (adjusted earnings, adjusted earnings per share (EPS), total segment earnings, and adjusted segment earnings) that exclude the impact of restructuring and impairment expenses. Reconciliations from GAAP measures to non-GAAP measures are provided in the Non-GAAP Measures section below. We believe that the measures of adjusted earnings, adjusted EPS, total segment earnings, adjusted segment earnings, and free cash flow provide useful information to investors about our performance and allow management and our investors to better understand our performance between periods without regard to items that we do not consider to be a component of our core operating performance or recurring in nature.

North America Segment

Sales in our North America segment were $2,984.2 million in 2025, or $34.1 million higher than sales of $2,950.1 million in 2024. Our net sales increase in 2025 was driven by pricing actions and higher commercial water heater and boiler volumes, which were partially offset by lower residential water heater volumes and unfavorable currency translation of approximately $6 million.

North America segment earnings were $727.9 million in 2025, or $20.4 million higher than segment earnings of $707.5 million in 2024. Segment margins were 24.4 percent and 24.0 percent in 2025 and 2024, respectively. Higher segment earnings and segment margin in 2025 compared to 2024 were primarily driven by pricing benefits, higher boiler and commercial water heater volumes that more than offset lower residential water heater volumes and higher input costs, including tariffs. Segment earnings and margin in 2024 included restructuring and impairment expenses of $6.3 million related to our water treatment business and a result of a profitability improvement strategy that prioritizes improving our cost structure and emphasizes our more profitable channels.

Adjusted segment earnings and adjusted segment margin in 2024 were $713.8 million and 24.2 percent, respectively, which excludes $6.3 million of pre-tax restructuring and impairment expenses. We estimate our 2026 North America segment margin will be approximately 24.0 to 24.5 percent.

Rest of World Segment

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