A. O. Smith's first quarter of 2026 saw total sales decline 2% to $946 million and adjusted EPS fall 11% to $0.85, pressured by weather-related production constraints at its Ashland City water heater facility (about $0.04 per share), Leonard Valve transaction expenses (about $0.03), and weak China demand. North America sales edged up 1% to $753 million as carryover pricing and the newly acquired Leonard Valve ($16 million) offset lower residential water heater volumes, while Rest of World sales dropped 11% to $201 million on a 17% local-currency decline in China. Bright spots included strong free cash flow of $119 million, stabilizing wholesale water heater share, a nearly 100 bps water treatment margin expansion, and a $51 million buyback with a maintained $0.36 dividend. Management cut its full-year adjusted EPS outlook to $3.70-$4.00 (excluding a ~$20 million Q2 water treatment restructuring), citing weaker China (now down low double digits) and a DOE one-year enforcement delay that flattens the U.S. commercial water heater outlook, while raising steel cost assumptions to ~15% and total added freight/material/tariff COGS to ~3%. To offset inflation, the company announced 4%-7% price increases with benefit expected from Q3. Strategically, the focus is on concluding the China assessment within a few months, advancing the North America water treatment reset (brand rationalization and footprint optimization), building the Leonard Valve-anchored water management M&A platform, and deploying AI-driven operational excellence tools.
Good morning, everyone, 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 Steve Shafer, Chief Executive Officer, and Chuck Lauber, Chief Financial Officer. In order to provide improved transparency into our operating results of our business, 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. As a courtesy to others in the question queue, please limit yourself to one question and one follow-up per turn. If you have multiple questions, please rejoin the queue. We will be using slides as we move through today's call. You can access them on our website at investor.aosmith.com. I will now turn the call over to Steve to begin our prepared remarks. Please turn to the next slide.
Thank you, Helen. Good morning, everyone. Before I discuss our first quarter results, I want to sincerely thank all A. O. Smith 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. Moving on to our first quarter of 2026 financial performance, please turn to slide four.
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 volumes 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 on the future of our customers and employees with the goal of defining a clear path forward in the coming months. I would like to share some additional color on our North America businesses. 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 improvements 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'm encouraged by the positive momentum we have going into the second quarter.
Our North America boiler sales grew 2% compared to 2025 as residential boiler volume growth and carryover pricing benefits more than offset lower commercial volumes. North America water treatment sales increased 1% in the first quarter. 10% 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 as we continue to work on improving the profitability of this platform. Leonard Valve contributed $16 million to sales in the first quarter of 2026, led by strong performance in the valve business.
We exited the quarter with a strong backlog, and Leonard remains on track to achieve another year of double-digit growth. I'll now turn the call over to Chuck, who will provide more details on our first quarter performance.
Thank you, Steve, and good morning, everyone. Please turn to slide five. First, I'd like to highlight two items impacting the quarter. As Steve 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 6th, 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 the top comp.
Carryover pricing benefits in 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. The 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. The first quarter of 2025 benefited from pull-forward demand ahead of an announced price increase and a stronger mix towards higher efficiency products. Moving to slide six.
Rest of the 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 the 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 seven.
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 term loan used to acquire Leonard Valve. We continue to have significant available capacity for future acquisitions. Turning to slide eight. 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 700,000 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 nine for our 2026 earnings guidance and outlook. Our revised 2026 outlook includes an adjusted EPS range of $3.70-$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 CapEx 2026 will be between $70 million-$80 million.
We continue to expect strong free cash flow of between $525 million-$575 million. Interest expense is projected to be between $30 million-$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-$85 million and includes $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%-24.5%, and we project our outstanding diluted shares will be 138 million at the end of 2026. I'll now turn the call back over to Steve to expand on our key markets and our 2026 top-line growth outlook for each business, staying on slide nine. Steve?
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 6th commercial regulatory change, we revised our outlook and now expect less pre-buy activity in the quarters leading up to the original transition date. 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, but ranging from approximately 4%-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%-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%-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 to 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 valuation is providing valuable insight into both the advantages and challenges facing our business. Many actions we've 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 Pureit, will have top-line growth of approximately 10% and is unchanged. Based on these 2026 assumptions, we expect total top-line growth of approximately 2%-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'd 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 our operations include an enhanced ability 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 improvements, 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. I look forward to sharing more details as this focus area for us matures going forward. Moving to slide 11. Our team responded well, 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 will continue to strengthen its leadership position and be well-equipped to capitalize on future opportunities. With that, we conclude our prepared remarks, and we are now available for your questions.