Operator: Good day, and thank you for standing by. Welcome to the A. O. Smith Q3 2026 earnings call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question and answer session. To ask a question during the session, you will need to press star one one on your telephone. You will then hear an automated message advising your hand is raised. To withdraw your question, please press star one one again. Please be advised that today's conference is being recorded. I would now like to turn the conference over to your speaker today, Helen Gurholt. Please go ahead.
Helen Gurholt: Good morning, and welcome to the A. O. Smith Q3 Conference Call. I am Helen Gurholt, Vice President, Investor Relations and Financial Planning and Analysis. Joining me today are Steve Shafer, Chief Executive Officer, and Carrie Anderson, Chief Financial Officer. In order to provide improved transparency into the operating results of our business, we provide non-GAAP measures. Free cash flow is defined as cash from operations plus capital expenditures. Organic growth excludes Leonard Valve and foreign currency impact. Adjusted earnings, adjusted earnings per share, total segment earnings, adjusted segment earnings, and adjusted segment margin exclude the impact of restructuring and impairment expenses. EBIT margin excludes the results of the China business. Reconciliations from GAAP measures to non-GAAP measures are provided in the appendix at the end of this presentation and on our website.
Helen Gurholt: On a forward-looking basis, we provide guidance ex China and adjusted earnings per share excluding China, which are non-GAAP measures. We do not provide a reconciliation of these measures to the most directly comparable GAAP measures, net sales and diluted earnings per share, because we cannot predict or estimate certain reconciling items without unreasonable efforts. These items include forecasted China sales and a forecast of China's contribution to earnings per share. These items are uncertain, depend on factors outside of our control, and could have a significant impact on our GAAP results for the guidance period. 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.
Helen Gurholt: 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.aosmith.com. I will now turn the call over to Steve to begin our prepared remarks.
Steve Shafer: Thank you, Helen, and good morning, everyone. I would like to begin by highlighting an important step forward for A. O. Smith. On 27 October, we announced definitive agreements to sell a majority interest in our China business to CPE, a leading alternative asset manager. These agreements complete the strategic assessment we began in July of last year. I want to sincerely thank all of our China team members for their continued dedication and professionalism throughout this process. I am confident that the increased clarity and certainty that this announcement provides will be energizing for both our employees and customers in China. We approached the assessment with one objective: determine the path that would allow our business in China to have the best chance to compete and win in a very competitive and changing market.
Steve Shafer: China has been an important part of our company's history, and our team there has built a strong brand on the back of great innovation and great service. But the market has changed significantly, and we need to continue to make changes to remain competitive. As a result, we concluded the business is best positioned for its next chapter under an experienced local owner prepared to invest in the business, and CPE brings deep knowledge of the Chinese market with the right capabilities to make that happen. The transaction is structured to deliver value today while preserving a potential upside in the future. CPE will acquire 81% of a business valued at approximately $400 million. We will retain a minority stake of 19%, and the A. O. Smith brand will remain in the market under a multi-decade licensing agreement.
Steve Shafer: Including the estimated value of future royalties, we expect total value to exceed $500 million. We intend to prioritize the after-tax proceeds along with roughly $80 million of cash we expect to repatriate from China to share repurchases. We plan to close in the H1 of 2027, subject to regulatory approvals and customary closing conditions. This transaction sharpens our strategic focus and simplifies our portfolio. Later in the call, I will come back to talk about what this means for A. O. Smith going forward. Let me now turn to our Q3 results on slide 5. At the total company level, Q3 sales were $941 million, essentially flat with last year, and earnings per share were $0.93. In North America, we delivered 3% growth despite the continued challenging macro environment.
Steve Shafer: Excluding Leonard Valve, organic sales grew 1%, led by double-digit growth in our boiler business and mid-single-digit growth in our water treatment business. We continue to believe our investment in product innovation, customer service, and channel partnerships position these businesses well in attractive markets. In water heaters, sales decreased 1% in the quarter. We maintained our market share amid continued softness in residential water heater demand, particularly in the wholesale channel. Commercial water heater volumes remained resilient, adding to the stability of our water heater portfolio. In this environment, our leading brands, broad product offering and channel presence, and strong customer relationships continue to differentiate A. O. Smith. Leonard Valve contributed $15 million in sales in the quarter, and we remain excited about how the business will expand our capabilities in commercial water management. At the same time, we continue to face rising input costs.
Steve Shafer: We expect steel and freight, two of our largest cost categories, to each increase by double digits for the full year. Freight costs rose sharply in Q3, with H2 increases expected well above the full-year rate, driven by tighter trucking capacity and record diesel prices. In the quarter, IEEPA tariff refunds helped offset these pressures. However, we expect these elevated costs to continue. To address these pressures, we recently announced an additional price increase of up to 9.5% on most of our water heater products, effective in December. We are also pursuing additional offsets, including future pricing actions in other parts of our business and cost actions such as procurement savings, supply chain productivity, and disciplined SG&A cost management. We expect these actions to help mitigate the impact of higher costs on our margins over time while still supporting our customers in remaining competitive in their markets.
Steve Shafer: I will now turn the call over to Carrie, who will provide more details on our Q3 performance.
Carrie Anderson: Thank you, Steve, and good morning, everyone. Please turn to slide 6. North America segment sales of $762 million increased 3% compared to last year. As shown on the left side of the slide, organic growth contributed $4 million or approximately 1%, and Leonard Valve contributed 2%. Organic growth was driven primarily by a 13% increase in boiler sales and 5% growth in water treatment. These gains were partially offset by a 1% decline in water heater sales as lower residential volumes more than offset the benefit of our pricing actions. Our boiler performance reflected continued share gains in residential boilers, strong demand for our high-efficiency commercial condensing boilers, and the benefit of pricing actions. In water treatment, growth was led by our professional dealer and specialty wholesale channels, where we have added approximately 30 new dealers since the beginning of the year.
Carrie Anderson: As mentioned earlier, Leonard Valve contributed $15 million in the quarter. Performance in our mixing valve and digital valve business was in line with our expectations, partially offset by softness in boiler controls, where delays in energy efficiency upgrade projects in the New York region affected order timing. Q4 is seasonally Leonard Valve's strongest, and we continue to expect that pattern this year. So we anticipate these regional project delays will moderate the seasonal step-up somewhat. This is reflected in our full-year outlook. Moving to the right side of the slide, North America segment earnings were $180 million, flat with the prior year, and segment margins decreased 60 basis points to 23.6%. Lower volumes reduced earnings by $3 million, and Leonard Valve contributed $55 million. Higher than expected input costs driven by the double-digit steel and freight increases Steve mentioned, reduced earnings by $18 million.
Carrie Anderson: IEEPA tariff refunds and other cost savings partially offset this with a total benefit of $16 million. Finally, we made meaningful progress on water treatment footprint and portfolio optimization initiatives. In October, we ceased manufacturing at our Groveport, Ohio facility and transferred production to other sites. As is typical with a transition of this scope, we expect some near-term shipment delays as those lines come up to full output, which I will touch on in our guidance. We continue to expect annual savings of approximately $6 million to $8 million associated with these initiatives, with approximately $1 million to be realized in H2 2026. Moving to slide seven. Rest of World segment sales of $193 million decreased 7% compared to prior year. Lower organic sales reduced revenue by $20 million, partially offset by a $5 million favorable currency impact, primarily related to China.
Carrie Anderson: In local currency, China sales decreased 17%. This reflects continued weak consumer demand as well as some disruptions to the business related to the strategic assessment we recently concluded. Turning to the right side of the slide, Rest of World segment earnings were $11 million and segment margin was 5.4%. Lower volumes in China reduced earnings by $9 million, partially offset by a $5 million benefit from SG&A and other cost actions. Our team in China continues to manage costs carefully, which helped limit the impact of lower volumes on the segment. Turning to cash flow and capital allocation on slide eight. We continue to generate strong cash. Operating cash flow for the first nine months of 2026 was $429 million compared to $434 million in the same period last year. Capital expenditures were $33 million, lower than the $53 million we spent last year.
Carrie Anderson: Our healthy cash flow lets us invest in growth and return cash to shareholders at the same time. On investing for growth, we deployed $470 million in acquisitions this year with the addition of Leonard Valve. It strengthens our water management platform and is already contributing to our North America growth. On returning cash to shareholders, we have returned $410 million year to date through $149 million in dividends, up from $145 million last year. This reflects our long record of consecutive annual dividend increases, including the 6% dividend raise we announced in Q3, as well as $261 million in share repurchases. Recall earlier this year, we raised our full-year repurchase target by 50% to $300 million, which leaves about $39 million planned for Q4. Our debt to capital ratio was 27% at the end of September, up from 9.2% a year ago, mainly because of the Leonard Valve acquisition.
Carrie Anderson: Our balance sheet remains strong with $235 million of cash and net debt of $439 million, and that gives us continued flexibility. Looking ahead, our priorities have not changed. Invest in organic growth, pursue disciplined acquisitions that expand our core and adjacent water platforms, and return cash to shareholders. As announced earlier this week, we intend to prioritize share repurchases as the use of the after-tax proceeds and repatriated cash following the closing of the China transaction. If we move to slide nine, I will provide an update on our full-year guidance. Following the CPE agreement, we expect to classify the China business as held for sale and reported as discontinued operations beginning in Q4 2026, with prior periods recast accordingly.
Carrie Anderson: As a result, we have updated our full-year 2026 guidance to exclude the China business for all of 2026 and to reflect our updated outlook for the remaining businesses. Full-year sales, excluding China, are expected to grow approximately 4% with adjusted EPS between $3.42 and $3.52 per share. Within North America, our top-line outlook includes the following assumptions. Our outlook for the residential water heater industry remains down low single digits, with the commercial water industry flat to 2025. Retail channel momentum has been sustained, while most of the market pressure year to date has been in the wholesale channel. In our boiler business, we are now raising our growth expectations. Full-year boiler sales are now expected to grow 10% to 12%, up from our prior range of 6% to 8%, reflecting strong year-to-date performance, robust quoting activity, and a healthy order pipeline.
Carrie Anderson: For our North America water treatment business, 2026 sales are expected to grow approximately 3% to 4%, compared with our previous outlook of 5% to 6%. This reflects the continued weakness in the consumer channel and the timing of shipments following the transfer of Groveport production. We expect to end the year with an elevated backlog that we expect to convert to sales as output increases into 2027. We also continue to make good progress in our priority dealer channel, including the expansion of dealer networks, and we expect sales in this channel to grow approximately 10% in 2026. For Leonard Valve, we now project sales of approximately $65 million in 2026, compared with our prior expectation of approximately $70 million.
Carrie Anderson: The valve portion of the business continues to perform well, reinforcing our confidence in the strategic value of the acquisition and the long-term growth potential of our water management platform. As I mentioned earlier, the updated outlook reflects timing delays on several regional projects within the controls business. We remain encouraged by the underlying opportunities across the Leonard Valve portfolio and are focused on capturing net growth as project activity progresses. Rounding out the revenue guidance is rest of world, excluding China. We expect foreign currency translation to be a meaningful headwind to our rest of world businesses in 2026. Excluding currency impacts, India remains a bright spot. Including Pureit, we expect India sales to grow double digits in local currency in 2026, in line with our expectations, as we continue to expand our brand and channel coverage.
Carrie Anderson: Our local currency India performance is partially offsetting macro challenges in other international businesses. Turning to costs, input cost inflation remains significant and is affecting all of our businesses. The impact is greatest in water heaters, which are steel-intensive, and in both water heaters and boilers, where product size and weight drive higher freight costs. Full-year steel and freight costs are expected to each increase approximately 15% compared to 2025, adding approximately 5% to our full-year North America segment cost of goods sold. We expect to exit 2026 at a meaningfully higher cost run rate. We are responding with pricing. As a reminder, our 4% to 7% price increase on most North America water heater and boiler products took effect at the end of Q2, with fuller realization beginning mid-Q3.
Carrie Anderson: To help offset these escalating costs, we have announced an additional price increase of up to 9.5% on most water heater products, effective in December. Alongside pricing, we continue to work the cost leverage within our control. With inflationary pressures persisting, our teams across the business remain focused on identifying savings opportunities and running our operations efficiently, and we continue to look for ways to offset higher costs where we can. As we head into the final quarter of the year, our priorities are clear: win the heating season and win the holiday season. In boilers, we enter Q4 with strong momentum. In water heaters, we are working closely with our channel partners to be ready as colder weather drives replacement demand and to manage order patterns ahead of our December price increase.
Carrie Anderson: In water treatment, we are increasing output across our facilities to fulfill our backlog and serve customers throughout the holiday season. Across all of our businesses, we remain focused on execution, disciplined pricing, and cost management to finish 2026 strong. With that, I will turn the call back to Steve.
Steve Shafer: Thank you, Carrie. Please turn to slide 10. Earlier, I described the recently announced China transaction itself. Now I would like to show you what A. O. Smith looks like once it is complete. On this slide, we have recast our 2025 results to exclude the China business. The picture is clear. A more focused company with an enhanced growth and margin profile. First, we keep our scale. Excluding China, our 2025 revenue would have been approximately $3.2 billion, and we retain leading position in our core markets.
Steve Shafer: Second, we improve our growth profile. Excluding China, our 2025 revenue would have grown approximately 3% compared to flat on a reported basis. China has weighed on our consolidated growth, and removing it gives us a more focused portfolio anchored in North America, where we have the strongest positions and greatest opportunity for near-term value creation. Third, we have a higher margin business.
Steve Shafer: Excluding China, our 2025 EBIT margin would have been approximately 200 basis points higher, reflecting the structurally higher margins of our core business. Finally, as you can see on the right side of the slide, our geographic mix shifts decisively. North America would represent approximately 94% of revenue, up from 77%. This is a market where we have deep customer relationships, leading brands, and resilient demand driven largely by replacement. Simply put, the company that emerges from this transaction is a focused water platform anchored in North America with a stronger growth and margin profile. So where do we go from here? Slide 11 summarizes how we intend to grow and create value for shareholders. It starts with our portfolio priorities shown on the left. Our foundation is our leadership in North American water heaters and boilers.
Steve Shafer: We hold leading residential and commercial market share earned through decades of innovation and deep customer relationships. With 80% to 85% of sales driven by replacement demand, this core is highly resilient through the cycle. Building on that core, we have three growth platforms. Water treatment is a growing, scalable business supported by long-term health and sustainability trends, with recurring filter revenue that creates attractive operating leverage. Water management is a new growth platform. With Leonard Valve, we are moving deeper into the commercial mechanical room with spec-driven, digital, high-margin solutions that we can scale through both on acquisition and future connectivity. In India, we see compelling long-term market dynamics where our innovation and expanding brand and channel coverage are driving growth. On the right are the three levers we use to turn that portfolio into shareholder value. First, market-led innovation.
Steve Shafer: Differentiated products that help us navigate the changing regulatory environment, strengthen our brand, and win share. Second, operational excellence. Delivering pricing and productivity that protects our margin and funds our growth investment. Third, disciplined capital deployment. Our strong cash flow and balance sheet let us reinvest in the business, pursue targeted acquisitions, and return cash to shareholders, as reflected in our increased share repurchase target this year. In closing, A. O. Smith is entering its next chapter as a simpler, higher-margin company with a resilient core and multiple platforms for growth. I am proud of how our team continues to execute, and I am confident we are well-positioned to deliver long-term value for our shareholders. With that, we conclude our prepared remarks and open the call for questions.
Operator: Thank you. Ladies and gentlemen, if you have a question or a comment at this time, please press star 1 1 on your telephone. If your question has been answered and you wish to remove yourself from the queue, please press star 1 1 again. We will pause for a moment while we compile our Q&A roster. Our first question comes from Mike Halloran with Baird. Your line is open.
Mike Halloran: Hey, good morning, everyone.
Steve Shafer: Hey, Mike.
Carrie Anderson: Good morning.
Steve Shafer: Go Birds.
Mike Halloran: Lot of happy people, including me.
Steve Shafer: Yeah.
Mike Halloran: Thank you. First question, kind of just a simple one. Can you just calibrate the current guidance to the old guidance? There are some ranges in the outlook, so I just want to make sure I understand what has or has not changed. Obviously, the water treatment side, a touch lower. Boilers, decent amount higher. Any moving pieces that you are seeing more on the residential or commercial water heater side? Then maybe just touch on what has changed on the price cost side, if anything, going into Q4.
Carrie Anderson: Yeah. Maybe I will start with just kind of level setting July guidance to our current guidance. As you know, we took China out of the current guidance, and we are not providing a direct walk from the July guidance because the assumptions for China have materially changed since
Carrie Anderson: even when we had last talked back in July. No doubt, our China results in Q3 were well below our expectations, and I have talked about a bit of the fact that that is continued China softness itself, but also the impact of the strategic assessment process concluding in Q3 also was a part of that. At this point, I think the China outlook for Q4 is highly variable given the recent announcement. We made the decision in concert with the fact that we are going to intend to move that to discontinued operations to remove China from the outlook. So I can appreciate there is no like for like bridge between July and August. But what we have done, Mike, is to update those assumptions for the rest of the business, and I covered those in my prepared remarks.
Carrie Anderson: I would say the guidance ex China is within the ranges that we would have assumed in the July guidance, with some gives and takes, as you talked about, and I will have Steve talk a bit more about the water heater and industry volume. But no doubt the strength of the boiler side of the business, we have raised expectations there, and it has offset some other softness in some of the other parts of the business to net net be within the ranges that we provided you back in July. Steve, do you want to provide some comments on?
Steve Shafer: Yeah. I would say just as relative to the final few months here, we've got a lot of variables that make it maybe more a wider set of outcomes as we finish the year. We've obviously got this announced price increase out there. The industry has made these price announcements. We've got some competitive situations. We've got how our customers are going to pick up on that, which makes the water heater side of the business a bit uncertain relative to the finish. But as Kerry mentioned, the boiler business is coming in really strong. We've got a little bit of softness in some of the other portfolios. So that's kind of where we net out relative to the growth profile. The change on the earnings side is primarily that piece of the China removal.
Carrie Anderson: Yeah.
Mike Halloran: Got it. No, that's super helpful. Then maybe just a little bit more on the price cost comments there, or the pricing in the environment and just still uncertain how that's going to shake out. Maybe just what's embedded in Q4, specifically in terms of what that price cost spread might look like, and how you're accounting for that in the guidance. Then when do you think that a more neutral or a position will be achieved based on all the actions you're taking? Thanks.
Carrie Anderson: Yeah, Mike, we have maintained the North America margin guidance of approximately 24% for the full year. As I reflect on our Q3 performance, our margin performance in North America actually came in slightly higher than what we expected. As I went through the prepared remarks, I called out the benefit of the IEEPA tariff refunds that actually did help offset some higher than expected costs. That was notably on freight. That certainly was higher than what we expected in July, as well as other input costs that are certainly related to some of the things we're seeing on oil prices and, derived oil pricing and other input costs and other steel-related component costs as well.
Carrie Anderson: The good news is that for Q3, between our own cost savings and the help of the IEEPA benefit tariff refunds, we were able to come in slightly stronger on North America margins. But for the full year, we are expecting to basically hold the original 24%, which means that Q4 will come under, have some amount of pressure. It really goes back to the fact that there will be a lag. So these cost increases are coming in. We're taking action with additional price increases, but there will be a lag on when those additional price increases come into effect. But overall, between the third and the fourth quarter, it's allowing us to stay balanced at that approximately 24%.
Operator: Thank you. One moment for our next question. Our next question comes from Bryan Blair with Oppenheimer. Your line is open.
Bryan Blair: Thank you. Morning, everyone.
Carrie Anderson: Morning.
Bryan Blair: To approach price cost from a slightly different angle, if we were to assume that costs levelize at the current run rate, snap the line, as flawed as that assumption would inevitably be, for the sake of this exercise, assume that. What level of incremental price realization would you need to reach price cost parity in early 2027?
Steve Shafer: Well, what I would say is we always are looking to price through inflationary cost pressures that we cannot offset ourselves, right? I think as we do our own calculations, as we kind of enter next year, that is what is behind our announced price changes. As Carrie Anderson mentioned, there is sometimes a time lag in there, but as you think about heading into 2027, our goal is to offset inflationary pressures and some combination of the cost management controls that we put in place, and pass through pricing when necessary.
Carrie Anderson: And as you refer back to Steve's remarks, we did comment that there will be other price increases in other parts of the business. We have done the 9.5% announcement for water heaters to get ahead of that. We will continue to balance that, as Steve said, with our own cost management, creating additional opportunities there with a balanced approach to pricing.
Steve Shafer: And like he said, it is fluid, right? As we think about things like diesel costs and where steel is going to evolve to, it is just one of those things we constantly monitor and we will continue to react accordingly.
Bryan Blair: Understand. Appreciate the color. Boiler sales were obviously a good guy again in the quarter. You have raised your 2026 guidance in turn. Can you parse out how much of the upside has been driven by stronger industry demand versus share capture for your team?
Carrie Anderson: Yeah, we are definitely very, very pleased with that boiler performance. Being able to deliver 10% to 12% is pretty impressive. I would say there are three main things that are really driving that fiscal 2026 growth. The first one is a really strong portfolio that really builds around high efficiency. So it is allowing us to have a leading lineup that is well-placed for continued demand for higher efficiency solutions. Also, we are seeing some of that growth coming through pricing benefits. We have taken pricing actions in the year where needed to offset cost pressures as well. The third one is those share gains in the residential boiler market, driven in part by some competitors that have exited the market, and we will begin lapping those gains in late Q4 of 2026.
Carrie Anderson: Some of these tailwinds, as you can appreciate, won't repeat at that same level, so we wouldn't expect 10% to 12% growth to be an ongoing rate. Over time, we would expect boiler growth to really settle into a 4% to 6% range compared to a market expectation of low single-digit growth for the overall market, which means that we should be able to drive unit growth that's a little bit above the market growth, and then we'll have normalized pricing benefits to basically get into what we would say a normalized growth rate of 4% to 6%. We remain confident that the strength of our portfolio in the boiler area, our quality, and our service capabilities are going to let us keep outperforming the market.
Operator: Thank you. One moment for our next question. Our next question comes from Matt Somerville with D.A. Davidson. Your line is open.
Matt Summerville: Excuse me. A couple questions. Can you remind us what your tariff refunds were in Q2 and Q3, and what, if anything, you expect in Q4? Can you also maybe talk a little bit about actionability as you see it in your M&A pipeline now that China's kind of getting put in the rearview mirror? Then I have a follow-up.
Carrie Anderson: Great. I would say in the Q2 it was a couple million dollars, so not material impact to our Q2 results. In Q3, we've called out that they were about $10 million. I would say going forward for Q4, we're not expecting anything material there in Q4. I think all of the benefits came in in Q3, and I think the timing of that actually worked out well because we did see some higher than expected input costs coming into the quarter that really allowed us to manage the margin in North America quite well and come in a little bit better than what we expected.
Steve Shafer: I will maybe step in on the M&A pipeline. I think we have a strong pipeline in the areas that I talk to often, which is in our core business, our core North America business, in our growth platforms, namely water treatment here in North America, and now we are building out the water management platform. So those are the areas where we focus our platform, or sorry, our pipeline. I would say we continue to cultivate it. We invest time and energy in terms of developing that pipeline. We also remain very disciplined about how we approach it. So it is a priority for our growth strategy, is to build out those platforms and at the same time, protect our core franchise, which generates a lot of cash.
Steve Shafer: I feel good that it is an active pipeline, and we are going to continue to work on it and develop it and obviously still, at the same time, remain disciplined in our approach.
Matt Summerville: Thank you. Then maybe could you comment on what you are seeing, the sort of the updated view on the discretionary side of the resi replacement market? Just more broadly, kind of macro thinking, do you have an early view on what the market might hold for residential volumes in 2027? Thank you.
Steve Shafer: Yeah. It is not a seismic shift that we see. I think we watch that trend very carefully. I think one of the things that in the repair and replace that we know is, well, then we talk a lot about new home construction, but also when homes aren't being transacted and changing in ownership hands, because it is those inspections that often identify the need to, or the interest in refreshing a water heater, for example. That in a lull as well. So that replacement market is seeing a little bit of pressure, but the dynamics are still there. Some of it generational, right? So younger generations tend to replace more proactively than the boomer generation does. So we see that as relatively stable, but a little bit soft just given the environment that we are navigating through.
Carrie Anderson: It is still, Helen, over 30%.
Steve Shafer: Yeah.
Carrie Anderson: The proactive is still at over 30%.
Steve Shafer: Yeah.
Carrie Anderson: As Steve mentioned, we are not seeing any real moves in that number.
Steve Shafer: Yeah. It is one of those things we think about over longer terms too, right? In terms of just how we
Carrie Anderson: Yeah
Steve Shafer: collect our data. We are preparing as we go into next year. We have talked about some of the things of how we see ourselves exiting 2026 that we are preparing for a continued kind of muted environment on those fronts, and we will be ready if that changes. But also our resilient business model that navigates through the cycle is something that we also invest in and make sure we are ready for.
Operator: Thank you. One moment for our next question. Our next question comes from Susan Maklari with Goldman Sachs. Your line is open.
Susan Maklari: Thank you. Good morning, everyone.
Carrie Anderson: Good morning.
Steve Shafer: Morning.
Susan Maklari: Good morning. My first question is on your comments on exiting this year with a more elevated backlog in some of the product categories. Can you just talk more specifically about your expectations there, and how we should think about your ability to work that through as we move into 2027?
Carrie Anderson: Yeah, that was specifically to water treatment, and it relates to the fact that we did cease manufacturing at our Groveport facility and transferred that production to two other facilities, and it's really just associated with the ramp-up of production at those current facilities taking on the additional work. So that's the backlog. So I think the good news is that we would expect to continue to ramp up and be able to work through that backlog as we move into 2027. And again, we expect water treatment to continue to be an area of growth for us with some of the priority work that we're doing in both our consumer channels as well as the dealer side of our pro channel, including wholesale as well. So, I think that bodes well for us to continue to focus on that in 2027.
Susan Maklari: Okay. All right. That's helpful. Then, you mentioned that you've added 30 new dealers so far this year. Can you talk about the kind of dealers that you are adding to the portfolio, what the value proposition is, are you taking share from others, and how we should think about further expansion of the network?
Steve Shafer: Yeah. Where we're engaging is kind of independent dealers who are looking for a reliable and trusted kind of OEM manufacturer for water treatment. To be a part of our brand. I think what they find out is that we've got a great product and an innovative lineup, a brand that we stand behind and provide the technical service. Those are hallmarks of A. O. Smith. We also really are investing in supporting these independent dealers. How do they actually go out and drive demand generation, find new business, be able to provide the technical support out in the field? That's part of the value proposition. It's a space, it's highly fragmented today in terms of the people who are in this space. It's very regional.
Steve Shafer: Again, those are some dynamics we know well from maybe the plumbing side of the business, and our ability to bring a compelling product offering, but then wrap it up into how we actually support small business owners and help them drive their business forward is part of how we go and sign those guys up.
Operator: Thank you. One moment for our next question. Our next question comes from Nathan Jones with Stifel. Your line is open.
Nathan Jones: Good morning, everyone.
Steve Shafer: Good morning, Nathan.
Carrie Anderson: Good morning.
Nathan Jones: Just a quick question on the bridge for operating earnings on North America. There is other cost savings in there, that is $6 million, that goes along with the IEEPA refunds. Is that something those structural savings that continue going forward or something that was more one time in nature in the quarter?
Carrie Anderson: Yeah, go ahead.
Steve Shafer: I was going to say, it is a continued evolution of our A. O. Smith operating system that I have talked about, and that is our model for how we go after and eliminate waste and deploy lean across the company. Our goal is to make that repeatable, right? In a repeatable process. I would say, as we have made some changes, we have brought in some new leaders to the company over the last few years. I think those new leaders are bringing in even fresh ideas on how we can even expand that further. We are thinking about how do we take our AOS operating system and make it broader and make it even more impactful.
Steve Shafer: Our goal is certainly make it sustainable and get the flywheel spinning, and you are seeing some of that in some of the results that we talk about, but I think there is more to come.
Nathan Jones: Okay. That sounds like something that is more structural. I guess my other question is around potential inventory levels in the channel at the end of the year. Typically, when you have price increases, you see demand pull forward. You had a price increase at the end of June, which maybe pulled demand forward into Q2. Now you have got another price increase in December, so maybe there would be some demand pulled forward into the Q4, but maybe it was already pulled forward earlier in the year to get through some of the other price increases. There is a lot of stuff going on there related to where inventories might end the year.
Nathan Jones: Just your thoughts on whether or not it is going to be in a balanced position, whether there will be a need to run out some of that inventory in the Q1 of 2027, or just how you are thinking about that.
Steve Shafer: Yeah. You characterized with more color my previous comment about there is a lot of uncertainty for the final 2 months, right? We have got a previous price increase that is now in the marketplace. Now we have introduced a new one. We have got a holiday period. How our customers respond. We are going to work closely with them, as we always do, to navigate through to the end of the year. So there is some variability there, but I will say, we will be ready, and we will serve our customers well, and we will work closely with them to figure out how to navigate and provide them the product that they need.
Steve Shafer: Not every year is the same, right? This is a unique situation in terms of both the timing of the price change, the impact of what is happening, calendarization. There are other things at play here in terms of what our competitors are doing.
Steve Shafer: We will follow it closely, but we will be ready to serve our customers well.
Carrie Anderson: Yeah, our lead times, our order lead times remain pretty stable, so we can respond if there are any changes there.
Steve Shafer: Yeah.
Operator: Thank you. One moment for our next question. Our next question comes from Jeff Hammond with KeyBanc Capital Markets. Your line is open.
Jeff Hammond: Hey, good morning.
Steve Shafer: Morning.
Carrie Anderson: Good morning.
Jeff Hammond: Just on the China deal. One, what are the cash proceeds? I know you talked about the $80 million you can repatriate, and then just speak to how the royalties work, and if there is any predetermination around eventually exiting the 19%, or if that is just at some point in time in the future.
Carrie Anderson: Well, maybe I will start there. I would say right now we are estimating that the after-tax proceeds plus the repatriated cash would give us about $350 million to prioritize towards returning cash to shareholders. That is really what we want to prioritize when we get it closed. So we will finalize the details at that point. But my current estimate is that approximately $350 million would be the number. I would say that, as we think about the minority or the royalty rate, I would say we are not disclosing the specifics on the royalty rate, but we believe it is consistent with arm's length rates for brand licenses of that type. The transaction in our earnings announcement and in the announcement that we put out a couple of days ago on the China transaction, we did estimate the value of that royalty at about $100 million.
Carrie Anderson: So essentially $400 million for the transaction value and the royalty present value of about $100 million. So a totality of $500 million. So I will ask Steve to comment on the minority.
Steve Shafer: Yeah. I think, first of all, I will go back and reiterate, we see the 19% retained ownership stake as a way to help participate in future upside of the business, along with the brand’s licensing. Part of the rationale for selecting CPE is they are a very capable company. They have got a very capable set of leaders that they are going to help bring into the business, and we believe in the plan that they have to grow the business. They are also great, passionate stewards of the brand and A. O. Smith.
Steve Shafer: So we feel optimistic about where the future of the business could go under their leadership and that there will be value that we will participate in along with that. We are going to stay connected with them because the brand is a big part of the value that they are buying into, and the A. O.
Steve Shafer: Smith brand means obviously a lot to us. I think the monetization of that in the future, we will see. We are optimistic of where it could go and believe that the China market will have a recovery period in front of it. Obviously, CPE, as a kind of financial asset manager, will look at some point for their own exit, and we will work closely with them on what that will look like.
Jeff Hammond: Okay, great. Then just on the price increases, it seems like this second price increase mid-year was maybe more difficult than in the past. I do not know if that is competitive dynamics with wholesale retail timing or just consumer fatigue, but I am just trying to get a sense of how confident you are that you can kind of push this 9.5% price. Then Steve, I did not know if I caught this. Have you seen your competitors do a similar price increase, or you said you have not seen it yet? Thanks.
Steve Shafer: We have seen announcements from competitors in the marketplace for similar price changes and similar timing. So that is out there in the industry right now. I think we are all dealing with very similar realities. We all are making products primarily made of steel and that are big and bulky and have to be shipped, and those are rates that I think are pressuring the entire industry. As you mentioned, past dynamics around retail wholesale, those are equalizing because of the changes happening in the marketplace. Past dynamics in the past that made it murky were IEEPA refunds, right? We are kind of through that, too. So we are pretty confident that I think this is a price change that is going to be required for the industry to remain profitable.
Operator: Thank you. One moment for our next question. Our next question comes from Brendan Shea with J.P. Morgan. Your line is open.
[Analyst] (JPMorgan): Hi. Good morning. This is Tomo from J.P. Morgan. Thanks for taking my question.
Steve Shafer: Great.
[Analyst] (JPMorgan): So if we step it back and once China is largely out of the portfolio, how should we think about the through-cycle growth profile of the new A. O. Smith? What would it need to go right for the company to sustainably grow above its historical rates, please?
Steve Shafer: Well, I will walk through our portfolios and where they stand. Our core North American water heater and boiler business, and you have seen the growth profile of our boiler business. That is a terrific franchise. Our Lochinvar business is a great business, and with the product offering and the value proposition and the technical support we supply the marketplace, we expect that that will continue to be a growth business and be very competitive and take share in the marketplace. I think on the commercial water heater side, it is also a great franchise business and we are the market share leader there and we have a great offering, and again, supported by our go-to-market model and our technical capabilities. I think on the residential side, we are going to continue to navigate through the cycle on that.
Steve Shafer: Ultimately, a recovery in some of the macro factors will help improve the growth profile there. Also, regulatory changes. We had a regulatory change on the commercial side this year that did not go through. We still believe longer term regulation is going to drive greater efficiency and greater technology upgrades. That is an opportunity to grow the business as well as we tend to lead through those technical changes. Those are some areas in our core that I would highlight as future growth opportunities for us. Then really a lot of growth for us we see coming through the additional growth platforms. In water treatment, which we have been on a journey with, but I think we have got a great strategy for how we are focusing that business and in the right areas where we have the right to compete and win.
Steve Shafer: With our Leonard Valve acquisition this year, we have stepped into building out a platform around water management. As I said, there is more work to be done on both of those platforms, including on the M&A front. I think that is going to position us into some higher growth markets and then also allow us to think about how innovation and connectivity can bring that together longer term.
[Analyst] (JPMorgan): Great. Thank you, Steve. I will leave it there.
Operator: One moment for our next question. Our next question comes from Scott Graham with Seaport Research Partners. Your line is open.
Scott Graham: Hey, good morning. Thanks for taking the question.
Steve Shafer: Good morning.
Scott Graham: So back on this price increase for water heaters. Apart from changes in efficiency standards, I do not remember a price increase this large. I am wondering, since you are telling us, I am sure you have talked to customers. I am wondering what that feedback has been, and is there a risk here that the couple of new entrants use this as an opportunity to gain more ground in the territory?
Steve Shafer: Well, I would say the industry has had a track record of meaningful price changes, and often the driver for it has been steel. Because one of the things for tank-type water heaters in particular, steel is a major component. That is the case for everybody and even new entrants who want to get into that space. From that standpoint, I think the industry does have history around when there is meaningful movement in steel. The industry understands that there is a price pass-through because it is a very steel-based product. From that standpoint, I think there is spirit there. Look, we always take new entrants seriously and we watch folks who look to get into the space. I think as I have said in the past, it is not just about reaching a price point, it is the holistic business model.
Steve Shafer: You need to have a comprehensive portfolio with the right channel partners that can have inventory available when a customer needs it, and support that with all of the technical service and the reliability and the brand trust that we provide. It is a comprehensive business model, one that we invest heavily in, and I think it is that business model that makes it difficult for somebody to play in a small scale way.
Scott Graham: Yeah, fair. Thank you. Just to follow up on capital allocation. You indicated in your agreement to divest the China announcement that you would be looking seemingly heavily towards share repurchases. I guess with that agreement signed, visibility on what the proceeds will be and you are having a small level of net leverage. Is there a reason why we cannot start that acceleration in share repurchases now?
Carrie Anderson: Yeah, I would say certainly part of the transaction unlocks cash. The transaction needs to close to be able to get a portion of that. We also want to make sure we have a general idea of all of the after-tax, the tax consequences of the deal, as well as any of the customary closing costs and all those things to get a better estimate. We did increase our buyback earlier this year from $200 million to $300 million. We are on track with that. So we will finish out the Q4 with additional share buybacks to close out the $300 million program. Then, as part of our 2027 planning, we will then figure in, again, approximately $350 million is what we are expecting. So I think it will figure prominently in how we think about our 2027 plan at this point.
Operator: Thank you. One moment for our next question. Our next question comes from Andy Kaplowitz with Citigroup. Your line is open.
Andy Kaplowitz: Good morning, everyone.
Steve Shafer: Morning.
Carrie Anderson: Morning.
Andy Kaplowitz: Give us a little bit more color on what is going on in Leonard Valve. I think you mentioned you are seeing some project delays, maybe just a little bit more detail into those delays and how the business should fare as we go into 2027.
Steve Shafer: Yeah. There are two primary components of the Leonard Valve portfolio. There is the mixing valve and the digital mixing valve side of the business, and then there is the boiler controls side of the business, which primarily goes to market as Heat Timer as its brand. When we bought the business, we really liked both sides of that business. The mixing valve is a key component in stepping into water management. The boiler control side too, is part of that, but also has a great connectivity to our franchise around the Lochinvar boiler system. So, we like both of those parts of the portfolio for very strategic reasons. In terms of the kind of the performance that we talked about today, the mixing valve side of the business continues to perform very well and as expected, and is providing good growth for our business going forward.
Steve Shafer: We also like a lot of the synergies that we have been having in the dialogues with our customers in the marketplace about adding that to the A. O. Smith lineup. On the timer side, the Heat Timer piece, that can be tied to, like other parts of our business are at times, certain regulatory changes and policy decisions made about upgrading for higher efficiency. So the Heat Timer business is tied to increasing building efficiencies.
Steve Shafer: Right now in parts of the country where they have high penetration, there has been some changes in policy decisions which has put projects on delay. That is what we are feeling right now in terms of the near-term financial performance. We do not believe it is structural or a fundamental shift in how that business will perform. We believe that many of those policy decisions just need to work their way through the system.
Steve Shafer: Ultimately, at the end of the day, building owners are still going to look to improve the efficiency of their buildings, and we are part of that solution. Longer term, we just think having the Heat Timer business is a great synergy with how we go to market with our boiler franchise and then more broadly, how water management is going to play within our portfolio.
Andy Kaplowitz: Got it. Maybe to that point, obviously we understand the focus on repurchases with the divestiture cash, but as you probably know, there has been a fair amount of de-rating on water assets out there. Do you see more opportunity as you go into 2027, whether it is adding the water management or some other adjacency? Should we expect a little bit more activity out of you guys at that point?
Carrie Anderson: Well, I will start there and I will ask Steve to comment specifically on M&A. I would say our use of the after-tax China proceeds and the repatriated cash for share repurchases is not going to limit our opportunity to do other capital allocation priorities. It does not mean choosing between share repurchases or growth investments. It is not an or, but I like to think of it as an and. Our balance sheet and our cash flow are strong enough that we can continue to balance capital allocation priorities. I seem to pick up on some of these things.
Steve Shafer: Yeah, I would just say as it relates to how we want to deploy capital across our allocation priorities, and specifically as we think about how we want to build out the portfolio on the platforms that I talked about. From my standpoint, it starts with having a clear strategy of where you want to go, clear understanding for how you are going to create value by going there, and then you have to have conviction around following through and doing it. I think what we have is a clear strategy, understanding how we are going to create value, and conviction of what we want to do. That alone does not get you to then putting capital to work, right? In the world of M&A in particular, timing has to line up. Sometimes you have to be patient, right? As I mentioned, we are going to be a disciplined acquirer.
Steve Shafer: But I like our strategy. I think we have clear understanding of where we want to go. I think we have a robust pipeline, and it is just a question of continuing to work it, staying active, and then making sure we have the conviction when the time is right and we have the right asset that we can find a way to close it and build out our portfolio. But it is difficult to control the time, and we are playing this for the long game, and we are going to take the time that is needed to do it.
Operator: Thank you. One moment for our next question. Our next question comes from Ryan Connors with Northcoast Research. Your line is open.
Ryan Connors: Great. Yeah, thanks for fitting me in. Just a couple of very quick housekeeping points of clarification on the China cash and proceeds. Number one, is the $80 million in cash being repatriated, is that the entirety of the cash balance in China, or is there anything else after that?
Carrie Anderson: Well, I would say that there is certainly cash that is needed to run the business. So this transaction obviously facilitates to bringing back some of that excess cash back as a result of the transaction. But there is still cash there as we need to operate the business still.
Ryan Connors: Right. But nothing material in terms of further.
Carrie Anderson: Correct.
Ryan Connors: repatriation. Okay.
Steve Shafer: As the business moves through and continues to return to a growth path, the royalty stream that will come from that.
Ryan Connors: Sure
Steve Shafer: potential for dividend payments and other things down the road.
Carrie Anderson: Correct.
Ryan Connors: Got it. Okay. The second one was, the $350 million in proceeds, will that be repatriated immediately? I would assume that was the case, but then you did use the term portion when you talked about the repatriation post-closing.
Carrie Anderson: No, again, I would just say that our intent is to prioritize my estimate of around $350 million to share repurchases after closing.
Ryan Connors: So that money will come back immediately and be free and clear for repurchases immediately upon closing.
Steve Shafer: At the net close.
Carrie Anderson: Yes.
Ryan Connors: Correct. Okay, great. Thank you.
Steve Shafer: Thank you.
Operator: I am not showing any further questions at this time. I turn the call back to Helen for any further remarks.
Helen Gurholt: Thank you everyone for joining us today. We look forward to updating you on our progress in the quarters to come. In addition, please mark your calendars to join our presentations at two conferences this quarter, Baird on 10 November and Goldman on 2 December. Thank you, and enjoy the rest of your day.
Operator: Ladies and gentlemen, this concludes today's presentation. You may now disconnect and have a wonderful day.
