A. O. Smith Corporation (AOS) Q3 2026 Earnings Call Transcript

Operator: Day and thank you for standing by. Welcome to the A. O. Smith Third Quarter 2026 Earnings Call. At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. To withdraw your question, please press 1, 1 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 E. Gurholt. Please go ahead.

Helen E. Gurholt: Good morning, and welcome to the A. O. Smith Third Quarter Conference Call. I am Helen E. Gurholt, Vice President, Investor Relations and Financial Planning and Analysis. Joining me today are Stephen Shafer, chief executive officer and Carrie L. 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 less capital expenditures. Organic growth excludes Leonard Valve and foreign currency impacts. 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 excluding China 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. On a forward looking basis, we provide guidance for net sales excluding 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. 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 1 question and 1 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.

Stephen Shafer: Thank you, Helen, and good morning, everyone. I would like to begin by highlighting an important step forward for A. O. Smith. On October 27, announced a definitive agreement 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 this announcement provides will be energizing for both our employees and customers in China. We approached the assessment with 1 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. 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 $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. 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 first half of 2027 subject to regulatory approvals and customary closing conditions. This transaction sharpens our strategic focus 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 third quarter 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. 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 investments in product innovation customer service, and channel partnerships position these businesses well for growth 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 $50 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. We expect steel and freight 2 of our largest cost categories, to each increase by double digits for the full year. Freight costs rose sharply in Q3. With second half 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 and 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 and remaining competitive in their market. I will now turn the call over to Carrie, who will provide more details on our third quarter performance.

Carrie L. 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. 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 action. 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. As mentioned earlier, Leonard Valve contributed $15 million in the quarter. Performance in our mixing 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. The fourth quarter 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 of $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 $155 million. Higher than expected input cost driven by the double-digit steel and freight increases Steve mentioned, reduced earnings by $18 million. 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 in 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 the second half of 2026. Moving to Slide 7. 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. In local currency, China sales decreased 17% This reflects continued weak consumer demand as well as some disruption 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 8. We continue to generate strong cash flow. Operating cash flow for the first 9 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. 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 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. 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 9, 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 the fourth quarter of 2026. With prior periods recast accordingly. As a result, we have updated our full year 2026 guidance to exclude the China business for all of 2026. And reflect our updated outlook for the remaining businesses. Our 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 heater 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. 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 network and we expect sales in this channel to grow by approximately 10% in 2026. For Leonard Valve, we now project sales of approximately $55 million in 2026 compared with our prior expectation of approximately $70 million 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 and Valve portfolio and are focused on capturing that growth as project activity progresses. And 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. 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 cost. 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. And 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 the second quarter with fuller realization beginning mid third quarter. To help offset these escalated 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. When the heating season and win the holiday season. In boilers, we entered 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. And 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. And with that, I will turn the call back to Steve.

Stephen 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 AO 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 retained leading positions in our core markets. 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. Excluding China, our 2025 EBIT margin would have been approximately 200 basis points higher. Reflecting the structurally higher margins of our core business. And 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. We hold leading residential and commercial market share earned through decades of innovation and deep customer relationships. And with 80% to 85% of sales driven by replacement demand, this core is highly resilient through the cycle. Building on that core, we have 3 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 bolt-on acquisitions and future connectivity. And 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 3 levers we use to turn that portfolio into shareholder value. First, market led innovation. 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 margins and funds our growth investments. And 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, AO 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 we will open the call for questions.

Operator: Thank you. Press 11 on your telephone. If your question has been answered, you wish to move yourself from the Our first question comes from Mike Halloran with Baird. Your line is open.

Mike Halloran: Hey. Good morning, everyone.

Stephen Shafer: Hey, Mike.

Carrie L. Anderson: Good morning.

Stephen Shafer: Go Brewers.

Carrie L. Anderson: Good morning.

Stephen Shafer: Lot of happy people, including me. Thank you.

Mike Halloran: So first question, kind of a just a simple 1. Can you just calibrate the current guidance to the old guidance? You know, there is some ranges in the outlook, so I just wanna make sure I what has or has not changed. Obviously, feel like the treatment side a touch lower,, boilers, decent amount higher. Any moving pieces that you are seeing on the more on the residential or commercial water heater side, and then maybe just touch on what is changed on the price cost side, if anything, going into the fourth quarter?

Carrie L. Anderson: Yes. So maybe I will start with just kind of level setting July guidance to our current guidance. So as you know, we took China out of the current guidance we are not providing a direct walk from the July guidance because the assumptions for China have materially changed since-- even when we had last talked back in July. And no doubt our China results in Q3 were well below our expectations, and I have talked about a bit of the fact that is continued China softens itself, but also the impact of the strategic assessment process concluding in the third quarter also was a part of that. So at this point, I think the China outlook for Q4 is very. Is highly variable given the recent announcement. So 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 there is. 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 our my prepared remarks. I would say the guidance ex China is within the ranges that we would have assumed in the in the July guidance. With some puts and takes as you as you talked about. And I will have Steve talk a bit more about the water heater industry volume But no doubt the strength of the boiler side of the business, we have raised expectations there. And it is offset some other you know, softness in some of the other parts of the business to net. Still well. You know, be within the ranges that we provided you back in July?

Stephen Shafer: Steve, do you want to provide some comments on Yeah. I would say just as relative to the kind of final few months here, we have got a lot of variables that make it maybe more kind of a wider set of outcomes as we finish the year. We have obviously got this announced price freeze out there. The industry has kind of made these price announcements. We have got some competitive situations. We have got how our customers are gonna kind pick up on that, which makes the water heater side of the business a bit uncertain relative to the finish, but I Carrie mentioned, you know, the boiler business is coming in really strong. We have got a little bit softness in some of the other portfolios. So that is kind of where we kinda net out relative to the growth profile and the change on the earnings side is primarily that piece of the China.

Mike Halloran: Yeah. Got it. No. that is super helpful. And 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 is gonna shake out. Maybe just what is embedded in the fourth quarter specifically in terms of what that price cost spread might look like, and how you are accounting for that in the guidance? And then when do you think that a more neutral position will be achieved based on all the actions you are taking? Thanks.

Carrie L. Anderson: Yeah. Mike, I. We have maintained the North margin guidance of approximately 24% for the full year. And as I reflect on our Q3 performance, our margin performance in North America actually came in slightly higher than what we And 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 and that was notably on freight. That certainly was higher than what we expected in July, as well as well as other input costs that are certainly related to some of the things we are seeing on oil prices and crude-oil-derived pricing and other input costs and other steel related component costs as well. So 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 some amount of pressure. And it really goes back to the fact that there will be a lag. So these cost increases are coming in We are 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 is allowing us to stay balanced at that approximately 24%. Thank you.

Operator: 1 moment for our next question. Our next question comes from Bryan Blair with Oppenheimer. Your line is open.

Bryan Blair: Morning. So approach price cost from a slightly different angle, if we were to assume that cost levelized at the current run rate kind of snap the line-- as flawed as that assumption would, you know, 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?

Stephen Shafer: I mean, it is. What I would say is we always are looking to price through inflationary cost pressures that we cannot offset ourselves. Right? And 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 mentioned, there is sometimes a time lag in there, but as you think about heading into 2027, our goal is to offset inflationary pressures in some combination of the net the cost management controls that we put in place and pass through pricing when necessary.

Carrie L. 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. So we have done the 9.5% announcement for water heaters to get ahead of that. And so we will continue to balance that, as you said, with our own cost management, creating additional opportunities there. With a balanced approach to price. To pricing.

Stephen Shafer: And like I said, it is fluid. Right? So, you know, as we think about things like diesel costs and where steel is gonna evolve to. it is just 1 of those things we constantly monitor and we will continue to react accordingly. Understand.

Bryan Blair: 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 L. Anderson: Yeah. I mean, we are definitely very, very pleased with that weather performance. It. You know, being able to deliver 10% to 12% is pretty impressive. I would say there are 3 main things that are really driving that fiscal 2026 growth. The first 1 is a really strong portfolio that is really built 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 1 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 fourth quarter of 2026. And because some of these You know, some of these tailwinds, as you can appreciate, will not repeat at the same level. And so we would not expect 10% to 12% growth to be an ongoing rate. Over time, we would expect further growth to really settle in to a 4% to 6% range compared with our market expectation of low single digit growth for the overall market. Which means that should be able to drive unit growth that is a little bit above the market growth and then we will have normalized pricing benefits to basically get into what we would say a normalized growth rate of 4% to 6%. So we remain confident that the strength of our portfolio in the boiler area our quality and our service capabilities are gonna let us keep outperforming the market. Thank you.

Operator: 1 moment for our next question. Our next question comes from Matt Summerville with D. A. David. Your line is open.

Matt Summerville: Excuse me. A couple of questions. Can you remind us what your tariff refunds were in Q2 and Q3 And what, if anything, you expect in Q4? And then you know, can you also maybe talk a little bit about, you know, actionability as you see it in your M&A pipeline now that China is kind of getting put in the rearview mirror? Then I have a follow-up.

Carrie L. Anderson: Great. I would say in the second quarter, was a couple of million dollars, so not material impact to our second quarter results. In Q3, we have called out that they were about $10 million And then I would say going forward for Q4, we are not expecting anything material there in Q4. I think all of the benefit came 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.

Stephen Shafer: I will maybe step in on the M&A pipeline. I think we have got we have got a strong pipeline. You know, it is in the areas that I talk to often, which is, you know, in our core business, right, our core North America business. In our growth platforms, namely water treatment here in North America and now we are building out of the water management platform. So those are the areas where we focus our platform. I would or sorry, our pipeline. You know, 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. And so I feel good that it is an active pipeline, and we are gonna continue to work on it and develop it and still, at the same time, remain disciplined in our approach.

Matt Summerville: Thank you. And 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 and just more broadly kind of macro thinking do you have a view on. An early view on what the market might hold for residential volumes in 2027? Thank you.

Stephen Shafer: Yeah. I mean, it is not a seismic shift that we see. I think we watch that trend very carefully. I think 1 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 are not being transacted and changing in ownership hands because if those inspections that often identify the need to or the interest in refreshing a water heater, for example, That slows 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 we are navigating through.

Helen E. Gurholt: And it is still Helen: Over 30%. The-- yeah. The proactive, it is still at over 30 percent. So it is as Steve mentioned, we are not seeing any real moves in that number.

Stephen Shafer: Yeah. And it is some of the things we think about over the longer term too, right, in terms of just how we how we collect our data. You know? And 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 you know, we are preparing for a continued kind of muted environment. On those fronts. And we will be ready if that changes, but, also, our, you know, our resilient business model that navigates through the cycle is something that we also invest in and make sure we are ready for. Thank you.

Operator: 1 moment for our next question. Our next question comes from Susan McClary with Goldman Sachs. Your line is open.

Susan Maklari: Thank you. Good morning, everyone.

Carrie L. Anderson: Good morning.

Stephen Shafer: Good morning.

Susan Maklari: 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? How we should think about your ability to work that through as we move into 2027?

Carrie L. Anderson: Yeah. That was specifically the water treatment. And it relates to the fact that we did cease manufacturing. At our Groveport facility and transferred that production to 2 other facilities, and it is really just associated with the ramp up of production at those at those at those current facilities taking on the additional work. that is 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 are 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. Alright. that is helpful. And then, you mentioned that you have 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?

Stephen Shafer: Yeah. Where we are engaging is kind of independent dealers who are looking for a reliable and trusted kind of OEM manufacturer for water treatment. And to be a part of our brand and think what they find out is that we. We have got a great product and innovative lineup a brand that we stand behind and provide the technical service that those are sort of hallmarks of A. O. Smith. We also really are investing in supporting for these independent dealers, you know, how do they actually go out and drive demand generation find new business, be able to provide the technical support out in the field. And so that is part of the value proposition. You know, it is a space. it is it is highly fragmented today in terms of the people who are in this space. it is very regional. 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 as part of how we go and sign those guys up. Thank you.

Operator: 1 moment for our next question. Our next question comes from Nathan Jones with Stifel. Your line is open.

Nathan Jones: Good morning, everyone.

Stephen Shafer: Good morning, Nathan.

Carrie L. Anderson: Hi, Nathan.

Nathan Jones: Just a quick question on the bridge for operating earnings on North America. there is an other cost savings in there that is $6 million that goes along with the IEEPA tariff refunds. Is that something. Those structural savings that continue going forward or something that was more onetime in nature in the quarter?

Carrie L. Anderson: Yeah. Go ahead. Go ahead.

Stephen Shafer: I was just saying it is a continued evolution of-- we-- Our AOS 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. And so our goal is to make that repeatable, right, in a repeatable process. And I would say as we have made some changes, we 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. And so we are thinking about how do we take our AOS operating system and make it broader and make it even more impactful. So our goal is certainly make it sustainable and get the flywheel spinning, and you are seeing some of that some of the results that we talked about, but I think there is there is more to come.

Nathan Jones: Okay. So 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, you have price increases, you see demand pull forward. Had a price increase at the end of June, which, you know, maybe pulled demand forward into 2Q. Now you have got another price increase in December. So maybe there would be some price some demand pulled forward into the fourth quarter, but maybe it was already pulled forward earlier in the year to get through of the other price increases. So there is a lot of stuff going on there with. Related to where inventories might end the year. So just your thoughts on whether or not it is gonna be in kind of a balanced position, whether there will be a need to run out some of that inventory in the first quarter of 27 or just how you are thinking about that?

Stephen Shafer: You characterized with more color my previous comment about there is lot of uncertainty for the final 2 months, right? And you know, you. We have got a previous price increase that is now of in the marketplace. Now we have introduced a new 1. We have got a holiday period. How our customers sort of respond We are gonna work closely with them as we always do to kinda navigate through to the end of the year. So there is some variability there, but I will say we will we will be ready, and we will serve our customers well, and we will work closely with them to figure out how to how to navigate and provide them the product they need. So you know, it is it is not every year is the same. Right? And this is a unique situation in terms of both the timing of the price change, the impact of kind of what is happening in calendarization. there is other you know, things at play here in terms of what our competitors are doing. So we will follow it closely, but we will be ready to serve our customers.

Carrie L. Anderson: Yeah. Our lead times. Our order lead times remain pretty stable, and so we can respond if there is any changes there. Yep.

Nathan Jones: Thank you.

Operator: 1 moment for our next question. Our next question comes from Jeffrey Hammond with KeyBanc Capital Markets. Your line is open.

Jeff Hammond: Morning.

Carrie L. Anderson: Good morning.

Jeff Hammond: Just on the China deal. 1, what are the cash proceeds? I know you talked about the $80 million you can repatriate. And then just speak to how the royalty works and if there is any predetermination, you know, around eventually exiting the 19% or if that is just, you know, at some point in time in the future?

Carrie L. Anderson: Yeah. 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 as that is really what we wanna 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 And I would say that you know, 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. And so the transaction is in our earnings announcement and in the announcement that we put out a couple days ago on the China transaction, we did estimate the value of that royalty at about $100 million. So, essentially, $400 million for the transaction value. And the royalty present value about $100 million. So totality of $500 million.

Stephen Shafer: So I will ask Steve to comment on the minority. Yeah. I mean, 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 licensing and you know, we. Part of the rationale for selecting CPEs is they are very capable company. They have got a very capable set of leaders that they are gonna help bring into the business, and we believe in the plan that they have to grow the business. They are also great, you know, passionate stewards of the brand in A. O. Smith. So we feel optimistic about where the future of the business could go under their leadership. And 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 they also brand means obviously a lot to us. And I think the monetization of that in the future you know, we will see. We think we are we are optimistic of where it could go, and you know, believe that the China market will have a recovery period in front of it. And obviously, CPE, is a kind of financial asset manager, we will we will look at some point their own exit. We will work closely with them on what that will look like.

Jeff Hammond: Okay. Great. And then just on the price increases, it seems like the second price increase kinda midyear was maybe more difficult than in the past. And I do not know if that is competitive dynamics with wholesale retail timing or, you know, just consumer fatigue, but I am just trying to get a sense of you know, how confident you are that you can kinda push this 9.5% price? And then Steve, I did not know if I caught this. Have you heard. Have you seen your competitors do a similar price increase, or you said you have not seen it yet? Thanks.

Stephen Shafer: We. We have seen announcements from competitors in the marketplace for similar price changes and similar timing. So that out there in the in the industry right now I think we are all dealing with very similar realities. Know, 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, I mean, those are equalizing because of the changes happening in the marketplace. Past dynamics in the past that made it murky where IECA refunds. Right? We are caught through that too. So we are pretty confident that, I think, this is a price change that is gonna be required for the industry to remain profitable. Thank you.

Operator: 1 moment for our next question. Next question comes from Brendan Shea with JPMorgan. Your line is open.

Brendan Shea: Hi, good morning. This is Tomohiko Sano from JPMorgan. Thanks for taking my question. 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 for A.O. Smith? But what would it need to go right for the company to sustainably grow about its historical rate, please?

Stephen Shafer: Well, I will I will I will I will walk through kind of our portfolios and where they stand. You know, our core our core North American water heater and boiler business. So we. 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. We the marketplace. We expect that will continue to be you know, kind of 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 very. A great franchise and we are the market share leader there. We have a great offering and, again, supported by our go to market model and our technical capabilities. I think on the residential side, you know, we. We are gonna continue to navigate through the cycle on that. Ultimately, you know, a recovery in some of the macro factors will help improve the growth profile there. Also, regulatory changes. You know, 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 is going to drive greater efficiency and greater technology upgrade. And so that is a. that is an opportunity to kinda grow the business as well as we tend to lead through those technical changes. And so those are some areas in our core that I would highlight as future growth opportunities for us. And then really a lot of growth for us we see coming through the additional growth platforms. And 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. And then with our Lennar valve acquisition this year, we have stepped into building out a platform around water management. And like I said, there is there is more work to be done on both of those platforms. Including on the M&A front. And I think that is going to position us into some higher growth markets and then also allow us think about how innovation and connectivity can bring that together longer term. Analyst (Brendan Shea): Great. Thank you, Steve.

Brendan Shea: I will leave it there.

Operator: 1 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. So back on this price increase for water heaters,, apart from changes and efficiency standards, I do not remember a price increase this large. So 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 kind of gain more ground in the territory?

Stephen Shafer: Well, I would say the industry has had a track record of meaningful price changes, and often the driver it has been steel. Right? Because 1 of the things for tank type water heaters in particular, steel is a major component. And that is the case for everybody. And even new entrants who wanna get into that space. So from that standpoint, I think the industry does have history around when there is meaningful movements in steel, The industry understands that there is a price pass through because it is a very steel based product. So from that standpoint, I think there is it is good there. And, look, we always take new entrants seriously, and we watch folks who look to get into the space. And I think as I have said in the past, it is not just about reaching a price point. The holistic business model. If you need to have a comprehensive portfolio of 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. So it is a comprehensive business model, 1 that we invest heavily in. And I think it also makes. it is that business model that makes it difficult for somebody to play in a small scale way. that is fair.

Scott Graham: Thank you. Just a follow-up on capital allocation. So 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 like, small level of, you know, net leverage. Is there a reason why we cannot start that acceleration in share repurchases now?

Carrie L. Anderson: Yeah. I would I would say, certainly, part of the transaction unlocks. Cash. So we want to. The transaction needs to close to be able to get a portion of that We also wanna 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 to 300 million and we are on track with that. So we will finish out the fourth quarter with additional share buybacks to close out the $300 million program. And then as part of our 2027 planning, we will then figure in, again, approximately 350 million is what we are expecting. Expecting. So I think it will it will figure prominently in how we think about our 2027 plan at this point. Thank you.

Operator: 1 moment for our next question. Our next question comes from Andy Kaplowitz with Citigroup. Your line is open.

Andrew Kaplowitz: Hey, good morning, everyone.

Carrie L. Anderson: Good morning.

Stephen Shafer: Good morning.

Andrew Kaplowitz: Give us a little bit more color on what is going on at Leonard Valve. I think you mentioned you are seeing, you know, some project delays. Maybe just a little bit more detail into those delays and, you know, how the business should fare as we go into 20 seventh?

Stephen Shafer: Yeah. There. there is 2 primary components of the Leonard Valve portfolio. there is 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 readily go to market as heat timer as its brand. And you know, when we bought the business, we really like both sides of that business. You know, the mixing valve is a key component. it is stepping into water management. And the boiler control side too is part of that, but also has a great connectivity to our franchise around the Lochinvar boiler systems. So we like both of 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 we. As expected and is providing good growth for our business going forward. And 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 AO Smith lineup. On the timer side, the boiler timer piece, you know, that can be tied to, like, other parts of our business are at times. Certain regulatory changes and policy decisions. Made, right, about upgrading for higher efficiency. So the heat timer business is tied to increasing building efficiencies And right now, in parts of the country where they have high penetration, there is been some changes in policy decisions has put projects on delay. that is 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. Ultimately, at the end of the day, building owners are still gonna look to improve the efficiency of their buildings, and we are part of that solution. And longer term, we just think having a timer business is a great synergy with how we go to market with our boiler franchise and then more broadly how water management is gonna play within our portfolio. Got it.

Andrew Kaplowitz: And maybe to that point, like, obviously, we understand the focus on repurchases with the divestiture cash. But as you probably know, there is been a fair amount of derating on water assets out there. So do you see more M&A as you go into 2027,, whether it is adding into water management or some other adjacency, you know, should we expect a little bit more activity out of you guys at that point?

Carrie L. Anderson: Maybe I will I will start there, and I will I will ask Steve to comment specifically on M and A. But 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. So it does not mean choosing between share repurchases or growth investments. So 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.

Stephen Shafer: So I will just kind of pick up on that theme. Yeah. I would just say as it relates to how we wanna deploy capital across our allocation priorities, and it is specifically as we think about how we wanna build out the portfolio on the platforms that I talked about. You know, from my standpoint, it starts with having a clear strategy. Of where you wanna go, clear understanding for how you are gonna create value, by going there, and then you have to have conviction around following through and doing. And I think what we have is a clear strategy, understanding how we are gonna create value and conviction of what we wanna do. That alone does not get you to then putting capital to work. Right? So the world of m and a, in particular, timing, you know, timing has to line up. Sometimes you gotta be patient. Right? As I mentioned, we are we are gonna be a discipline acquirer. And. But I like our strategy. I think we have clear understanding of where we wanna go. Think we have got 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 got the right asset that we can find a way to close it and then build out our portfolio. But you know, it is it is difficult to control the timing, and we are playing this for the long game. And we are gonna take the time that is needed to do it.

Andrew Kaplowitz: Thank you.

Operator: 1 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 1, is the 80 million in cash being repatriated, is that the entirety of the cash balance in China?

Carrie L. Anderson: Or is there anything else? After that? Yeah. I would say that there is certainly cash that is needed to run the business. So this transaction obviously facilitates to bring back some of that excess cash back as a result of the transaction. But there is still cash there as we are need to operate the business still.

Ryan Connors: Right. But nothing material in terms of further repatriation. Correct.

Stephen Shafer: And then as the business kinda moves through and continues to return to a growth path, the royalty stream that will come from that you know, potential for payments and other things down the road.

Carrie L. Anderson: Correct.

Ryan Connors: Got it. Okay. And then the second 1 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 L. Anderson: No. Again, I would I would just say that our intent is prioritize my estimate of around $350 million to share repurchases after closing. So that money will come back and be free and clear for repurchases immediately upon closing.

Stephen Shafer: Does not that close? Yeah. Correct.

Ryan Connors: Okay. Great. Thank you.

Stephen Shafer: Thank you.

Operator: I am not showing any further questions at this time. I would like to turn the call back to Helen for any further remarks.

Helen E. 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 2 conferences this quarter. Baird on November 10 and Goldman on December 2. Thank you, and enjoy the rest of your day.

Operator: Ladies and gentlemen, that does conclude today's presentation. You may now disconnect, and have a wonderful day.