A.O. Smith Corporation 2026 Q3 Earnings Call

Please go ahead. Good morning, and welcome to the A.

O. Smith third quarter 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 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 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. A friendly reminder that some of our comments and answers during this conference call will be forward-looking statements that are subject to risks that could cause actual results to be materially different. Those risks include matters that we described in this morning's press release, among others.

Also, as a courtesy to others in the question queue, please limit yourself to one question and one follow-up per turn. If you have multiple questions, please rejoin the queue. We will be using slides as we move through today's call. You can access them on our website at investor.aosmith.com. I will now turn the call over to Steve to begin our prepared remarks.

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, 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.

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.

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 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 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 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.

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 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&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.

I'll now turn the call over to Carrie, who will provide more details on our third quarter performance.

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.

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 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.

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-$8 million associated with these initiatives, with approximately $1 million to be realized in the second half of 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.