A. O. Smith's second-quarter 2026 sales topped $1 billion with adjusted EPS of $1.03, as strength in North America offset continued weakness in China. North America segment sales rose 5% to $821 million (3% organic excluding the newly acquired Leonard Valve, which added $16 million), led by 21% boiler growth and carryover water-heater pricing, though adjusted segment margin fell 100 basis points to 24.4% as roughly 20% higher steel costs, tariffs and other inflation largely offset those gains. Rest-of-World sales dropped 19% as China fell 28% in local currency, cutting segment margin to 5.2%. A standout was cash generation: first-half free cash flow jumped 67% to $233 million on working-capital management, prompting a 50% increase in the 2026 buyback target to $300 million. Management narrowed and lowered full-year guidance to 2%-3% sales growth and $3.70-$3.85 adjusted EPS, citing softer residential water-heater industry demand (now seen down low double digits) tied to weak new construction and existing-home sales, while maintaining boiler (6%-8%), water-treatment (5%-6%) and China (down low double digits) assumptions. A roughly one-month delay in 4%-7% price increases, customer pre-buy and seasonal boiler early-buy pulled demand into Q2, and combined with rising second-half steel, transportation and oil-based input costs, is expected to make Q3 EPS the low point of the year. Strategically, the year-long China assessment is nearing completion with all outcomes still open and a conclusion promised next quarter, water-treatment footprint and brand streamlining should yield $6-$8 million of annual savings from 2027, and the quarter marked a planned CFO transition from retiring Chuck Lauber to Carrie Anderson.
Thank you, Lisa. Good morning, everyone, welcome to the A. O. Smith Q2 conference call. I am Helen Gurholt, Vice President, Investor Relations and Financial Planning and Analysis. Joining me today are Stephen Shafer, Chief Executive Officer, Chuck Lauber, Executive Vice President, Carrie Anderson, Chief Financial Officer. In order to provide improved transparency into the operating results of our business, we provided non-GAAP measures. Free cash flow is defined as cash from operations plus capital expenditures. North America segment organic growth excludes the impact of Leonard Valve. Adjusted earnings, adjusted earnings per share, adjusted segment earnings exclude 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 investors.aosmith.com. I will now turn the call over to Stephen to begin our prepared remarks.
Thank you, Helen, good morning, everyone. Before we get into our results, I want to start by recognizing Chuck Lauber and thanking him for his many years of service as our CFO. Chuck has had a long and meaningful career with A. O. Smith, his leadership has had a significant impact on our company. On behalf of all of us, Chuck, thank you for your many contributions, we wish you all the best in retirement. At the same time, I am very pleased to welcome Carrie Anderson to A. O. Smith as our new Chief Financial Officer. Carrie brings extensive financial leadership experience across multiple industries, including complex global manufacturing organizations. She also brings a collaborative leadership style and a disciplined approach to execution.
Carrie has already become a valued partner to the team, and we look forward to her leadership in strengthening our execution rigor and advancing our strategic priorities. This is another planned and orderly leadership transition at A. O. Smith, and it reflects the strength of our broader leadership team. We have a highly experienced group of leaders with the right balance of fresh perspective and deep industry knowledge to continue executing our strategy and serving our customers well. Now, moving on to our Q2 2026 financial performance, please turn to slide 4. While the quarter reflected very different market conditions across our businesses, I am pleased with how the A. O. Smith team executed. We continued to gain traction in North America, delivered strong free cash flow performance, and took additional actions to create value for shareholders.
At the company level, sales were approximately $1 billion, and adjusted earnings per share were $1.03. While our results were impacted by the continued weakness in China, our teams remain focused on operational execution and cost management across the business. One of the highlights of the quarter was the North America sales increase of 5% to $821 million, which includes Leonard Valve, our recent acquisition that expands our water management and digital control capabilities. Excluding Leonard Valve, organic sales grew 3%, supported by strong boiler growth, carryover pricing actions, and continued focus on serving our customers. Another highlight of the quarter was our cash flow performance. Free cash flow increased nearly 70% in the first half of the year, reflecting the strength and resilience of our operating model.
Supported by that performance, we increased our 2026 share repurchase target by 50% to $300 million, reinforcing our commitment to disciplined capital deployment and returning cash to shareholders. As expected, China sales decreased 28% in local currency, largely due to broader market conditions. While the China appliance market remains challenging, particularly in the premium segment, we continue to manage the business thoughtfully while completing our strategic assessment. We expect to share our conclusion on that assessment by our next quarterly earnings call, and remain focused on identifying the best path forward to support long-term value creation. With that overview, let's take a closer look at the performance of our North America businesses.
North America water heater sales increased 2% in the quarter. Residential water heater industry demand remained pressured by softness in new construction as well as existing home sales, which can weigh on replacement demand. While the residential market remains competitive, we continue to make progress in our market share performance. In an environment where demand remains muted, our leading brands, broad channel presence, and strong customer relationships continue to differentiate A. O. Smith and reinforce our confidence in the long-term fundamentals of the business.
Our North America boiler business delivered a strong quarter, with sales increasing 21%, contributing to 12% growth in the first half of the year. Growth was driven by continued momentum in residential boilers and a return to growth in commercial boilers. We remain encouraged by the performance of this business and believe our investments in product innovation, customer service, and channel partnerships continue to position us well in an attractive market with significant long-term opportunities. North America water treatment sales decreased 2% as growth in our priority dealer channel was offset by softer demand in other channels.
While consumers remain cautious in portions of the market, we continue to focus on the channels, products, and customer relationships where we see the greatest opportunities for growth. During the quarter, we advanced actions to optimize our footprint and streamline our brand portfolio, which we believe position the business to operate more efficiently and accelerate profitable growth over time. We expect annual savings of approximately $6 million-$8 million beginning in 2027. Leonard Valve contributed $16 million to sales in the Q2 of 2026, and we continue to target double-digit growth for the full year. I'll now turn the call over to Chuck, who will provide more specifics on our Q2 performance.
Thank you, Stephen, and good morning, everyone. Before I begin, I want to say how grateful I am for the opportunity to have served as CFO of A. O. Smith. It's been our privilege to work alongside so many talented colleagues and to be a part of a company with such a strong culture, trusted brands, and a long history of creating value. I'm proud of what we have accomplished together and confident in the company's future. It's been a pleasure representing A. O. Smith in my many interactions with investors and analysts over the years.
I also want to welcome and congratulate Carrie and wish her great success in her new role. I look forward to working with her over the next couple of months during the transition. Let's now turn to slide 5. North America segment sales of $821 million increased 5% compared to last year. As shown on the left side of the slide, organic growth of 3% in the quarter contributed $26 million of additional sales, while Leonard Valve sales contributed another $16 million. The organic growth was driven primarily by 21% boiler sales growth, as well as carryover pricing benefits in our water heater business. These benefits were partially offset by lower residential water heater volumes as industry demand remained soft.
Our boiler performance this quarter was driven by strong commercial demand, including seasonal orders under early buy programs. In addition, the quarter benefited from customer pre-buy activity ahead of announced price increases on both water heater and boiler products, resulting in some demand pull forward into the Q2. North America adjusted segment earnings were $200 million, modestly above the prior year period. Adjusted segment margin was 24.4%, a decrease of 100 basis points compared to last year.
The benefits of organic growth and the contribution from Leonard Valve were largely offset by higher steel and other input costs. Steel costs rose year-over-year approximately 20% in Q2, and combined with tariffs and other inflationary costs, largely offset pricing benefits. IEEPA refunds had a minimal impact in the quarter. Moving to slide six. Rest of the World segment sales of $195 million decreased 19% due to continued weak consumer demand in China driving lower volumes, which was partially offset by favorable foreign currency translation. Rest of the World Q2 segment earnings of $10 million and segment margin of 5.2% decreased significantly compared with the prior year period. The lower segment earnings and margin were primarily due to lower sales volumes in China, which were partially offset by continued cost management. Please turn to slide seven.
Cash flow performance remained a significant strength in the first half of this year. We generated free cash flow of $233 million in the first half of 2026, a 67% increase over 2025, primarily driven by working capital management, which more than offset lower earnings. We ended the quarter with $181 million in cash and a net debt position of $456 million. Our leverage ratio was 25.7%, as measured by total debt to total capital, reflecting the financing associated with the Leonard Valve acquisition completed earlier this year. Even after funding the acquisition and returning capital to shareholders, our balance sheet remains strong and provides substantial flexibility to support future growth investments and acquisition opportunities. Let's now turn to slide eight. Our capital allocation framework remains unchanged and continues to balance investment in long-term growth with meaningful returns to shareholders.
Our priorities remain clear: actively manage our portfolio, invest in innovation to drive organic growth, and advance operational excellence to improve productivity. Within portfolio management, we continue to evaluate M&A opportunities that fit our strategic direction and meet our financial criteria. Earlier this month, our board approved our next quarterly dividend of $0.36 per share. In addition, we repurchased approximately 2.6 million shares for a total of $162 million during the first half of the year. Given our cash flow performance and confidence in the business, we increased our 2026 share repurchase target by 50%, from $200 million to $300 million. Importantly, this increased repurchase commitment still preserves significant flexibility to invest in growth and pursue strategic opportunities as they arise. I'll now turn the call over to Carrie to share our 2026 earnings outlook.
Thank you, Chuck, and good morning, everyone. I'm excited to join A. O. Smith and appreciate the warm welcome from Stephen, Chuck, Helen, and the broader team. As I've settled into the role over these past several weeks, I've been impressed by the strength of the business, the quality of the team, and the discipline around capital allocation and financial management. I look forward to helping build on that foundation as we execute our strategic priorities and create long-term value for our shareholders. I'm very grateful for Chuck's partnership during this transition and wish him all the best in retirement. With that, let's turn to our 2026 outlook summarized on slide 9.
As we enter the second half of the year and have greater visibility into our end markets and our expected full-year performance, based on our first half results and current outlook, we have narrowed our guidance range. Importantly, our overall view of the business has not materially changed since April. Our outlook for China, North America commercial water heaters, boilers, water treatment, India, and Leonard Valve remain largely unchanged from the assumptions we provided last quarter.
The primary change in our outlook relates to the North America residential water heater market, where industry demand has remained softer than we anticipated earlier in the year, reflecting continued weakness in both new construction activity and existing home sales. As a result, we now expect full-year sales growth of approximately 2%-3% and adjusted EPS of $3.70-$3.85 per share, compared with our prior outlook of 2%-4% sales growth and adjusted EPS of $3.70-$4.00 per share. The upper end of our prior guidance assumes that residential water heater industry demand during the second half of the year would be similar to the first half.
Based on what we have seen through June and into July, we now believe results are more likely to skew towards the lower end of that prior range. Within U.S. residential water heaters, we are narrowing our industry outlook to down low double digits for the year, compared to our prior expectation of flat to down low double digits. While emergency replacement demand remains stable, we continue to closely monitor proactive replacement activity, which accounts for approximately 30% of total replacement demand and is more sensitive to consumer spending behavior. End market conditions tied to new housing activity have remained soft, primarily impacting the wholesale channel. Looking at our other major market assumptions, we continue to expect U.S. commercial water heater industry volumes to be approximately flat with last year.
We are maintaining our North America boiler sales growth of 6%-8%, North America water treatment sales growth of 5%-6%, and approximately $70 million of sales from Leonard Valve. We also continue to expect our China sales to decline at a low double-digit rate in local currency. As we think about the phasing of the balance of the year, Q2 earnings benefited from early buy programs in our boiler business as well as customer pre-buy activity ahead of our announced water heater and boiler price increases, which accelerated a portion of expected Q3 demand into the Q2. Q2 benefited from a slightly lower effective tax rate than we expect for the full year.
While our full-year outlook still assumes steel costs will be approximately 15% higher than 2025 levels, we expect steel inflation in the second half to be somewhat higher than the first half. Non-steel material inflation and tariffs are expected to remain a headwind as we move through the remainder of the year. Tariff policy remains dynamic, and while we continue to evaluate the recently announced changes, we currently expect the new tariffs to have a modestly higher cost impact than the tariffs they replace. While we continue to expect the overall impact to be manageable, the timing of these cost pressures, combined with the customer pre-buy activity and seasonal boiler early buy programs, is expected to create a less favorable earnings profile in the Q3.
Together with continued weakness in China, these factors are expected to result in Q3 EPS that is lower than both Q2 and Q4. The midpoint of our range assumes Q3 segment margins in both North America and rest of world are generally consistent with the margins reported in Q1. I'll now turn the call back over to Stephen for closing remarks.
Thanks, Carrie. Moving to slide 10, I'd like to close with the key messages from the quarter. First, we delivered solid Q2 results, with sales exceeding $1 billion, 3% North America organic growth, and adjusted earnings per share of $1.03. These results reflect the strength of our North America businesses, disciplined execution across the organization, and the contribution from Leonard Valve as we begin to build out our water management platform. Second, our boiler business continued to perform exceptionally well. Boiler sales increased 21% in the quarter, driving year-to-date growth of 12%. We continue to benefit from strong commercial demand and remain confident in our outlook of 6%-8% boiler growth for the full year. Third, while residential water heater industry demand remains softer than we anticipated, we are confident in the long-term strength of our North America water heater business.
The replacement market continues to represent approximately 80%-85% of industry demand. Our market position remains strong, and we've continued to make progress stabilizing market share in a highly competitive environment. Fourth, our strategic assessment of the China business is nearing completion. While market conditions remain challenging, we are focused on determining the best path forward to support the long-term success of the business and create value for shareholders. Finally, our businesses continue to generate strong cash flow, which provides flexibility to invest in our businesses while returning capital to shareholders. This confidence is reflected in the 50% increase in our 2026 share repurchase target to $300 million. As Carrie discussed earlier, we have updated our full-year outlook to reflect continued softness in North America residential water heater industry demand.
Importantly, our outlook for our other major businesses and markets remains largely consistent with the assumptions we provided earlier this year. Overall, we remain confident in our strategy, our market positions, the resilience of our replacement-driven businesses, and our ability to create long-term value for shareholders. With that, we conclude our prepared remarks and open the call for your questions.