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DATE
Tuesday, October 28, 2025 at 10 a.m. ET
CALL PARTICIPANTS
Chairman, President, and Chief Executive Officer — Stephen M. Shafer
Chief Financial Officer — Charles T. Lauber
Vice President, Investor Relations and Treasurer — Helen E. Gurholt
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RISKS
China sales outlook for fiscal 2025 (period ending September 30, 2025) has been lowered to a projected decline of 10% in local currency, with management citing "continued economic challenges" and discontinuation of government subsidy programs as factors explicitly causing persistent volume pressure.
North America residential water heater industry volumes are now expected to be "flat to slightly down" in 2025. This is due to "lower housing completions, particularly in multifamily, as well as concerns around consumer confidence."
Tariff costs are expected to increase further in Q4 2025, with cumulative 2025 tariffs anticipated to raise total company cost of goods sold by approximately 5%, and "putting a little pressure on North American margins in the fourth quarter," according to Lauber.
The full-year sales growth outlook for 2025 has been reduced from 2% to 3% to a range of flat to up 1%, with management attributing this to "the continued economic challenges in China, and the softening wholesale residential water heater market in the US."
TAKEAWAYS
Global Sales -- $943 million in Q3 2025, up 4% year over year.
Earnings Per Share (EPS) -- $0.94, up 15% over 2024.
North America Sales -- $743 million in Q3 2025, up 6%, driven by pricing actions and stronger commercial water heater and boiler volumes.
North America Segment Operating Margin -- 24.2% in Q3 2025, up 110 basis points as pricing and higher volumes offset increased input costs.
Rest of World Segment Sales -- $208 million in Rest of World segment sales for Q3 2025, including $17 million from the Purit acquisition; overall performance was flat, with China down 12% in local currency.
North America Segment Earnings -- $180 million in Q3 2025, up 11% year over year.
Rest of World Segment Earnings -- $15 million in Q3 2025, up year over year, with operating margin at 7.4%, up 90 basis points.
North America Water Heater Sales -- Up 6% in Q3 2025, driven by price increases and higher commercial volumes.
North America Boiler Sales -- Up 10% in Q3 2025, led by high-efficiency products and pricing actions.
North America Water Treatment Sales -- Down 5% in Q3 2025, as declines in the retail channel more than offset 11% growth in priority dealer, e-commerce, and direct-to-consumer channels.
India Legacy Business Sales -- Up 13% in local currency in Q3 2025.
Operating Cash Flow -- Grown 21% to $434 million for the first nine months of 2025, primarily from lower inventory, and partially offset by lower customer deposits in China.
Free Cash Flow -- Up 35% to $381 million for the first nine months of 2025.
Cash Balance and Net Debt -- $173 million in cash, and $13 million in net debt at Q3 2025 quarter-end, with a leverage ratio of 9.2% (total debt to total capital).
Dividend Increase -- Quarterly dividend raised 6% to 36¢ per share; 2025 marks 32 consecutive years of dividend increases.
Share Repurchases -- 5 million shares repurchased in the first nine months of 2025 for $335 million; full-year 2025 plan raised to approximately $400 million in buybacks.
2025 EPS Guidance -- Narrowed and lowered to $3.70 to $3.85 per share for 2025, down from the previous $3.70 to $3.90.
Tariffs and Input Costs -- Tariffs are estimated to raise cost of goods sold by 5% for fiscal 2025; steel costs rising 15% to 20% in 2025 compared to the first half and overall material costs for the year are expected to remain approximately flat versus last year.
Capex Guidance -- 2025 capital expenditures projected at $75 million, slightly lowered as some projects shift into early 2026.
2025 Free Cash Flow Outlook -- Management projects approximately $500 million in free cash flow for 2025.
Commercial Water Heater Industry Outlook -- Internal projection for U.S. commercial water heater industry volumes in 2025 has been raised from flat to up low single digits.
North America Boiler Sales Outlook -- Expected to increase 4% to 6% year over year in 2025 compared to 2024; unchanged from prior guidance.
North America Water Treatment Sales Outlook -- Projected to decline approximately 5% in 2025, as the company "deemphasizes the less profitable retail channel," according to Stephen M. Shafer.
Purit Contribution -- Expected to add approximately $55 million to 2025 sales, with minimal bottom-line impact due to integration phase.
Segment Margin Outlook -- 2025 guidance: North America segment to remain at 24% to 24.5% margin, Rest of World segment about 7.5%.
Long-Term Strategy -- Company maintains "sufficient dry powder for acquisitions that meet our strategic and financial criteria," according to Charles T. Lauber, and continues to focus on core business strengthening and high-growth adjacencies.
China Strategic Assessment -- Third-party market review confirms strong brand, necessity of smart-home and AI-linked products, and identifies business model improvement opportunities; no outcome yet determined.
SUMMARY
A. O. Smith (AOS 2.54%) reported EPS of $0.94, up 15% over 2024, and free cash flow up 35% in the first nine months of 2025 while narrowing its full-year EPS guidance range and reducing the full-year sales outlook due to persistent macroeconomic challenges in China and a weakening U.S. residential water heater market.
Lauber stated, "Our full-year outlook at 5% [tariff cost impact] has not changed," but timing effects could create up to 20 basis points of incremental margin pressure in North America during Q4 2025.
Shafer said, "we are lowering our 2025 China sales outlook to a decline of approximately 10% in local currency," reflecting the recent removal of national subsidies and heightened competition.
Sales in the legacy India business were up 13% in local currency, which also indicated priority channel gains in North America water treatment.
Strategic focus areas include active portfolio assessment in China, ongoing acquisition readiness, and margin enhancement through operational discipline, and high-efficiency product innovation.
Shafer commented, "Channel inventories are pretty much where they should be right now."
INDUSTRY GLOSSARY
Purit: Recently acquired water treatment business, included in "Rest of World" segment results, and subject to ongoing integration efforts.
Proactive Replacement: The industry practice of homeowners replacing water heaters before failure based on survey metrics referenced in commentary.
Full Conference Call Transcript
Stephen M. Shafer: Thank you, Helen. Good morning, everyone. I would like to start by briefly thanking the many dedicated A. O. Smith employees and broader set of partners and customers in our ecosystem for another quarter of helping to make clean, hot, and safe water available to millions of people. We appreciate all you do to make that happen. Please turn to Slide four, and I will now review our financial performance. In the quarter, our global A. O. Smith team delivered third quarter sales of $943 million, a year-over-year increase of 4%, and EPS of 94¢, a 15% increase over 2024.
North America sales grew 6%, primarily as a result of our pricing actions and strong commercial water heater and boiler volumes. We achieved North America segment margin expansion of 110 basis points and Rest of World segment margin expansion of 90 basis points. Continued economic challenges and more limited availability of government stimulus programs led to a 12% decrease in local currency sales in China.
Helen E. Gurholt: Purit contributed
Stephen M. Shafer: $17 million of sales in the quarter, and our legacy India business continued its strong double-digit growth trajectory by delivering 13% growth in local currency. North America water heater sales increased 6% in the third quarter, driven by pricing actions taken in response to the higher tariff and other input costs, as well as higher commercial water heater volumes. Our market-leading high-efficiency condensing gas and heat pump products continue to have a compelling payback story in commercial applications. Our residential water heater volumes were also strong, and we believe that Q3 industry volumes declined year over year.
As we expected, we believe we outperformed the residential and commercial markets in part due to our production efficiency initiative that limited the pre-buy impact on our sales in the first half of the year. Our North America boiler sales increased by 10% compared to 2024, led by the benefits of pricing actions and higher volumes of our high-efficiency boilers. North America water treatment sales decreased 5% in the third quarter as continued growth in our priority channels was more than offset by an expected decrease from the retail channel. Our priority dealer e-commerce and direct-to-consumer channels grew 11% in the quarter.
In China, third quarter sales decreased 12% in local currency as the ongoing economic challenges and reduced availability of government subsidy programs, along with an increasingly competitive environment, led to lower volumes. Despite these challenges and the resulting volume pressure, we achieved 90 basis points of margin expansion compared to last year through the restructuring initiatives we undertook in 2024 and other cost-saving measures. Please turn to Slide five. I would now like to take a moment and talk about our commitment to sustainability. For us, sustainability is not just a goal, but a core part of who we are and what we do every day.
We are committed to not only developing and bringing to market innovative, high-efficiency products, but we are also dedicated to sustainability in our facilities and manufacturing processes. Later this week, we will publish our sustainability progress report, which will include our sustainability scorecard and an update on our water conservation, greenhouse gas emissions, and waste reduction goals. What the report will show is that we are meeting or exceeding the goals that we set out for ourselves. The outcome of these efforts is providing both sustainability and bottom-line results.
Example initiatives we have undertaken to support these goals include the test water recirculation system, which recycles water used during our product testing processes, and our glass enamel reuse process, which captures waste glass enamel for reuse in our tank manufacturing process. These are examples of how we seamlessly integrate sustainability into two of our prior years: operational excellence and innovation. We remain dedicated to finding better ways of doing things, including how to improve our business while protecting our planet.
Charles T. Lauber: I'll now turn the call over to Chuck, who will provide more details on our third quarter performance. Thank you, Steve, and good morning, everyone. Please turn to Slide six. Third quarter sales in the North America segment of $743 million increased 6% compared to the same period last year, primarily due to the benefits of pricing actions as well as higher commercial water heater and boiler volumes. North America segment earnings were $180 million in the quarter, an 11% increase over 2024. Segment operating margin was 24.2%, an increase of 110 basis points year over year, primarily due to pricing actions and higher volumes more than offsetting higher material and other input costs.
Moving to Slide seven, Rest of the World segment sales of $208 million decreased slightly compared to last year and included $17 million of sales from the Purit acquisition. Sales in our legacy India business grew 13% in local currency. China third-party sales decreased 12% on a constant currency basis. Rest of the World segment earnings of $15 million increased year over year as continued expense management and the benefits of restructuring actions more than offset lower volumes in China. Segment operating margin was 7.4%, an increase of 90 basis points compared to the prior period. Purit will continue to be a headwind in the near term as we focus on integration, which is progressing well.
Please turn to Slide eight. Operating cash flow grew 21% to $434 million, and free cash flow grew 35% to $381 million during the first nine months of 2025 compared to the same period last year, primarily due to lower inventory balances that were partially offset by other working capital outlays, including lower customer deposits in China. Our cash balance totaled $173 million at the end of September, and our net debt position was $13 million. Our leverage ratio was 9.2% as measured by total debt to total capital. Let's now turn to Slide nine. Earlier this month, our board approved a 6% increase in our quarterly dividend to 36¢ per share, making 2025 the thirty-second consecutive year that A.
O. Smith has raised its dividend. We repurchased approximately 5 million shares of common stock in the first nine months of 2025 for a total of $335 million. This is an increase compared to the same period last year as we raised our planned full-year repurchase intentions from $306 million in 2024 to approximately $400 million of shares for 2025. Consistent with our key priorities, we are actively assessing strategic opportunities and have sufficient dry powder for acquisitions that meet our strategic and financial criteria. Our M&A priority continues to be deals that strengthen our core business or help us build new growth platforms. Please turn to Slide 10.
In our 2025 earnings guidance and outlook, we are narrowing the range and lowering the top end of our 2025 EPS outlook from a range of $3.70 to $3.90 per share to a range of $3.70 to $3.85 per share. We have included the following assumptions in our outlook. We began to see the impact from tariffs in the third quarter and expect that our tariff costs will continue to increase into the fourth quarter as additional impacts make their way through our supply chain.
Though the tariff plans remain uncertain, we maintain our estimates that annualized tariffs will increase total company cost of goods sold by approximately 5%, which includes tariff rates currently in place as well as the mitigation efforts we have implemented. As a reminder, our mitigation strategies include footprint optimization, strategic sourcing, and other cost controls and pricing actions as necessary. Apart from tariffs, we expect overall material costs for the year to remain approximately flat versus last year, with steel costs rising 15 to 20% in 2025 compared to the first half. We estimate that 2025 CapEx will be approximately $75 million. We expect to generate free cash flow of approximately $500 million.
Interest expense is projected to be approximately $15 million. Corporate and other expenses are expected to be approximately $75 million. Our effective tax rate is estimated to be approximately 24%, and we project our outstanding diluted shares will be 142 million at the end of 2025. I will now turn the call back over to Steve, who will provide more color around our key markets, top-line growth outlook, and segment expectations for 2025, remaining on Slide 10. Steve?
Stephen M. Shafer: Thanks, Chuck. Key assumptions in our top-line outlook include the projection that 2025 US residential industry volumes will be flat to slightly down compared to last year, a slight decrease from our previous guidance due to residential new construction expectations that have come down since last quarter. Lower housing completions, particularly in multifamily, as well as concerns around consumer confidence have led to this revised outlook. The wholesale channel impact is expected to be greater due to its heavier exposure to new construction.
That said, we are encouraged by the resilient demand we are seeing in the commercial water heater market segment, and as a result, we are increasing our projection for commercial water heater industry volumes from flat to last year to up low single digits. We are pleased with our strong performance relative to the market in the third quarter and the share momentum we have going into the fourth quarter, supported by our winning products in this segment. Economic challenges persist in China. While government stimulus programs helped to stabilize parts of the market in 2025, we believe the stimulus programs pulled forward a significant amount of demand.
During the third quarter, national subsidies were discontinued, resulting in increased promotional activity and discounting from our competitors, much of which we chose not to participate in. Because we do not expect an improvement in market conditions in the near term, we are lowering our 2025 China sales outlook to a decline of approximately 10% in local currency. We continue to benefit from the restructuring actions taken in 2024 as well as other cost-saving measures, which we project will offset the margin impact of lower volumes for the year. Our 2025 North America boiler sales projection of an increase of between 4 to 6% compared to 2024 is unchanged.
We are very pleased with our growth in the first nine months of the year, although we believe we may have benefited from a minimal amount of pre-buy related to price increases implemented in the second quarter. We continue to monitor our key markets closely. We have not changed our guidance that North America water treatment sales will decline approximately 5% in 2025 as we deemphasize the less profitable retail channel. We continue to be pleased with the growth we have seen in our priority channels and our onboarding of new dealers during the year. Our plan to drive 250 basis points of operating margin improvement in 2025 for the North America water treatment business is on track.
Finally, we expect the addition of Purit will add approximately $55 million in sales in 2025, slightly higher than our earlier guidance. It will not have a significant bottom-line contribution this year as we work through its integration. Based on the continued economic challenges in China and the softening wholesale residential water heater market in the US, we have lowered our full-year sales outlook from 2% to 3% growth to a range of flat to up 1% compared to last year. We continue to expect our North America segment margin will be between 24% to 24.5%, and we expect that Rest of World segment margin will be approximately 7.5%. Please turn to Slide 11.
Last quarter, I laid out my areas of focus. Earlier this month, the top 140 leaders of A. O. Smith gathered to talk about the future of our company, to align on key priorities, and inspire each other through the opportunity to connect and share ideas on how to deliver the next great chapter of the A. O. Smith legacy. I came away from this important time together confident in our path forward and with the commitment from our leadership team to execute. I look forward to sharing more regarding this leadership summit and our focus areas in the quarters to come. I'm also pleased to welcome Chris Howe as our new Chief Digital Information Officer.
Chris is the transformational leader that we need to help us invest wisely in new technologies for the future and unlock even more value potential in the technologies we are invested in today. In his previous roles, Chris led transformational efforts to leverage enterprise software solutions and most recently worked on the forefront of generative AI solutions. He will be instrumental in ensuring we have the technical capabilities needed to support all our priorities, especially operational excellence and innovation. As we shared last quarter, as part of our portfolio management priority, we announced the intention of our formal China strategic assessment. While we remain early in the process, we are making good progress.
We commissioned a third-party analysis of the China market, and it confirmed many of our assumptions entering the strategic assessment. One, our brand remains strong, well-known, and respected among Chinese consumers, especially with regard to our innovative products and premium solutions. Two, our strategy to expand into broader categories that can be connected by smart home solutions and our AI link capability was a necessary path forward. And three, we have a number of go-to-market and business model opportunities to better strengthen the business and capture our fair share of market recovery.
We believe that we have a good understanding of our challenges and are evaluating potential opportunities to ensure the future success of this business as we drive greater value for shareholders, employees, and other stakeholders. In conclusion, I am pleased with our third quarter execution, particularly in the North American segment. I'm also encouraged by the progress we are making on our strategic priorities, including portfolio work to strengthen our business going forward. Regarding execution, we delivered a solid third quarter in North America, led by pricing performance and our strong commercial high-efficiency portfolio, while expanding margins through operational discipline.
Looking forward, we remain confident in our ability to navigate the tariff and competitive landscape in our core water heater and boiler businesses, where we serve a large replacement-driven market with a broad industry-leading portfolio and go-to-market models. Regarding our portfolio, we are driving double-digit growth in priority areas, including boilers, select North America water treatment channels, and India. At the same time, through our strategic assessment, we are working to understand and address what is required to improve the performance of our China business. Finally, we continue to generate cash, maintain a strong balance sheet, and are ready with the dry powder necessary to build out our portfolio in ways that complement our business today.
With that, we conclude our prepared remarks and are now available for your questions. Thank you.
Operator: As a reminder, to ask a question, please press 11 on your telephone and wait for your name to be announced. To withdraw your question, please press 11 again. Please limit yourself to one question and one follow-up. One moment for questions. Our first question comes from Saree Emily Boroditsky with Jefferies. You may proceed.
Saree Emily Boroditsky: Hi. Good morning, and thanks for all the color and the commentaries. Maybe just building on some of the China color, you obviously lowered expectations around China sales. Can you just talk about your performance versus the overall market there? Is this just a weaker market, or is there any competitive dynamics going on?
Stephen M. Shafer: Yeah. Good morning. It's a little bit of both. So the market continues to have its challenges, and as I mentioned, there's been a little bit of a pull-forward demand driven by the government subsidy program. So we're on the other side of that. And I think within that down market, the competitive intensity continues to increase. So we do a lot of promotional activities trying to step in where government subsidies were playing a role to generate demand previously. And so that's adding to the competitive pressure. And, you know, as we see our path forward, as I mentioned, we've got confirmation that our brand remains very strong there.
We have a really strong innovative portfolio to serve our customers. But we need to work through this period of challenging market conditions.
Saree Emily Boroditsky: Appreciate that. And then, obviously, one of the bright spots this quarter was in the North America commercial water heater sales. You know, I think previously, you attributed some of the strength to pre-buy. So just maybe a little more detail on what you're seeing in that market and what's driving the strength there.
Stephen M. Shafer: Yeah. It's been a strong market condition for commercial products, but I'd also say we have a really strong portfolio in that space. And I mentioned on the last earnings call the launch of our flex commercial water heater, and so we've got that out in the marketplace. That I think is performing very well. So it's a combination of a really strong market backdrop but also in an area where we've got a really competitive product offering. And I would add that, you know, during the third quarter, we benefited from our production efficiency program to make sure that we were level loading a bit closer to the market.
And some of that strength we saw in commercial and residential heaters was a part of the output of that benefit of the level loading.
Operator: Thank you. Our next question comes from Bryan Francis Blair with Oppenheimer. You may proceed.
Bryan Francis Blair: Morning, everyone. Just to level set on the China strategic review. We know there isn't a timetable as of now in terms of the ultimate decision. But given the insights from the assessment so far, has the range of potential outcomes been narrowed in any way?
Stephen M. Shafer: No, Bryan. Not yet. I mean, we're early enough in the process that we're not ruling out any outcomes at this point. So like I said, we've done some really good work just trying to profile and understand the market. We've got some third-party assessments to do that. We've started the process of reaching out to other participants, which is why we wanted to announce that we were putting the business under the strategic assessment. But we're not at a point yet where we have narrowed down or have a view of what the outcome of that is yet. Still too early.
Bryan Francis Blair: Yes. Understood. Appreciate the color. The priority channel growth in North American water treatment is certainly encouraging in Q3, and that 11% nicely aligns with the 10 to 12% organic growth target you'd put out at Investor Day. With MiX now reset for the platform, is that kind of organic growth in play going forward?
Stephen M. Shafer: I mean, that's certainly how we think about the business long term. I would say there's still more work to be done. Right? So we've done some reprioritization of the channels and where we think we can be competitive and win. I think there's still more work and investment in that space to build out that platform, but we feel good about the growth potential of that.
Operator: Thank you. Our next question comes from Jeffrey David Hammond with KeyBanc Capital Markets. You may proceed.
Jeffrey David Hammond: Hey. Good morning. Just on the US residential water heater market, I think you didn't change your industry shipment assumptions, but seemed to lean a little more cautious. So I just wanted to understand a little bit better how you see that playing out.
Stephen M. Shafer: Yeah. Our outlook for the industry, you know, we were talking about a flat industry on our last call, and now we're saying flat to slightly down. So we do see a little bit of pressure on the residential side. Most of that is coming through new home construction completions. On the residential side, we're seeing some of that weakness. So we've taken it down just a tad.
Jeffrey David Hammond: And are you seeing the market share recapture play out as you thought?
Stephen M. Shafer: Yes. As we were looking at level loading our production this year, we've seen our performance relative to the market in Q3 come back and gain share back as we expected.
Jeffrey David Hammond: Okay. And then just I think you mentioned some additional tariff headwinds. Maybe quantify or talk about where you're seeing that. And then just as you look at steel pricing and forward tariffs into '26, how does that inform pricing actions you need to take in '26? We're hearing from other channels that maybe next year is another above-average increase and just wanted to get your view there.
Charles T. Lauber: Yeah. This is Chuck. The mention on tariff pressure was really framing from third quarter to fourth quarter. Probably maybe 20 basis points on North America margins where we're seeing a bit heavier tariffs accumulate. Our full-year outlook at 5% has not changed. So it's a little bit of timing, putting a little pressure on the North American margins in the fourth quarter. We'll be back in January giving a little bit of an outlook on cost. The trade-off world is a bit volatile. So I think we'll hold off commentary to see where material costs go in that respect.
Operator: Thank you. Our next question comes from Michael Patrick Halloran with Baird. You may proceed.
Michael Patrick Halloran: Good morning, Mike. Could you talk a little bit through what you're seeing in the residential side of things in terms of the discretionary spend? I certainly heard the commentary earlier that some of that incremental weakness you saw in the residential volumes side from an outlook perspective is tied to new housing starts being a little bit lower. No surprise. Are you seeing anything different on the discretionary piece?
Stephen M. Shafer: We really haven't seen that change. You know, we do a survey every quarter and we look at proactive replacement, as you know. And if we look at that survey, there are quarters where it edges up, edges down. But overall, it's still above that 30%. Proactive replacement remains pretty resilient. Certainly something we'll watch as we go forward, but it's a backward-looking survey. So we'll have to continue to watch that and make sure we understand if there's a trend developing. But right now, still about 30%.
Michael Patrick Halloran: So and then following up on Jeff's other question, I know you're not giving '26 thought process, but if trends were to play out and we weren't going to get any incremental actions, the pricing that you've taken in your mind is enough to make you price cost positive or at least be price cost neutral on the margin line or in terms of EBITDA dollars once all the catch-up happens. Is that the thought process? Or is there still going to be some gap relative to what you're seeing from an inflation perspective with the actions you've already taken?
Charles T. Lauber: Yeah. When we do our price increases, and it really was no different other than the amount of the price increase this time with the tariff cost hitting us, we typically look to cover margin plus cost. So just a reminder, the last one was second quarter. It was effective. When we announced those prices, they go out and certainly we see pressures over time on the price and we have a bit of a fade. So I think we'll still reserve the answer to that as we get into the next quarter, but we're comfortable with our price cost relationship now.
But as you'll see, there's some pressure when you look at our guidance, a bit of pressure on margins in the fourth quarter.
Operator: Thank you. Our next question comes from Susan Marie Maklari with Goldman Sachs. You may proceed.
Susan Marie Maklari: Hi. Good morning, everyone. This is Charles Perron in for Susan. Thanks for taking my question. First, I'd like to go back on the China market, understanding the market conditions are tough. But I guess, do you have any thoughts on potential additional restructuring initiatives in the region given the environment and something that would be done at potential strategic announcement?
Stephen M. Shafer: I think it's one of the things we're going to continue to work through and learn more about as we go through our strategic assessment. I kind of alluded to the fact that there are opportunities for us as we think about how we go to market, our business model. We're going to continue to evaluate those things. Whether we do those through partnerships or we do them for ourselves, it's something we still have to work through. But our goal is to make sure that the business is set up well for success. And obviously, a little bit of market recovery will help aid that a bit.
But we're going to continue to learn from the changing market environment and make the necessary changes, whether that comes through things that we will take on and self-help to do that or whether that is done through partnerships. One of the things we're assessing right now.
Charles Perron: Okay. That's helpful color. And then I think in your prepared remarks, you talked about the potential for strategic acquisition within your adjacent market. Can you talk about what is the pipeline for these types of opportunities in the current environment? How long is the timing of any strategic decision on that dependent on the potential announcement of the strategic review on China?
Stephen M. Shafer: No. I think one of the strengths we have is a strong balance sheet and our cash generation capabilities. So we've got an active pipeline. We continue to evaluate that from a strategic lens, financial lens, where we want to go next, and as I mentioned, partly, it's how do we strengthen the core of our business, how do we think about building new higher growth businesses. And we're going to continue through that process. I don't think it's connected to other decisions we're making across our portfolio at this time, and we're ready to move when the right opportunities come about.
Operator: Thank you. Our next question comes from David MacGregor with Longbow Research. You may proceed.
David MacGregor: Yes. Good morning, everyone. I was wondering if you could just give us an update on gas tankless and the progress to date on relocation manufacturing and market development and just the impact on third quarter margin contribution and maybe the implied fourth quarter? What you've got in the '25 guide?
Stephen M. Shafer: Sure. As you know, we've made a big investment to enter with our own products into the gas tankless space. We've been building out the right set of products and the manufacturing capability here in North America, and all of that is progressing well. I think the market itself for tankless is under pressure, heavily connected back to the residential construction market that we talked about. So from that standpoint, it remains kind of a challenging market. But I think we're really excited that we've got the right product, we've got the manufacturing capability ready. As we've talked about in the past, we've made some changes. In the past, we were talking about launching in China, moving to North America.
We've made some changes to that strategy, which has made some delays to the current plan in terms of how we're going to go after the market. But I think we're happy with where we're at. We'd like to move faster in the marketplace. And I think as the market picks up and recovers, especially around new construction and with the product offering we have and the supply chain we have, we'll be ready to succeed.
David MacGregor: Are you getting good feedback?
Charles T. Lauber: Oh, sorry. Sure. Go ahead.
David MacGregor: I was just going to ask about margin pressure. It's, you know, we're anniversarying when we first launched the product last year. So the margin pressure is a bit less than the 40 basis points we had historically talked about. For the quarter, it's probably about 20 basis points. It's not overly significant.
David MacGregor: Okay. I think you're asking about show feedback?
Stephen M. Shafer: Yeah. I was just going to get you to talk a little bit about what you're getting back from the marketplace. And there are people I know that you were undertaking a phased launch on that product in terms of just incremental models. And is the acceptance level relatively good at this point, or are people waiting for the full assortment? Just any commentary, that would be helpful.
Stephen M. Shafer: Yeah. Folks love the product. And when they get their hands on it and they get comfortable with it, and as you know, we've been building out our portfolio. So when we have the full portfolio, we'll be even more compelling. And there's also elements of how we serve this market. Right? A lot of more gas tankless tied to the new construction. So we're working out on the business model as well. But I would say at the end of the day, the product is a market-leading product, and that's what we look to do when we got our own product offering into this space.
Operator: Thank you. Our next question comes from Nathan Hardie Jones with Stifel. You may proceed.
Nathan Hardie Jones: Good morning. This is Adam Farley on for Nathan. Morning, Adam. Wanted to follow-up on the China commentary. I know the fourth quarter is typically a seasonally stronger quarter due to the shopping holidays. So what is your expectation for the selling season going into the fourth quarter, balancing that with some of the headwinds you guys are seeing there?
Stephen M. Shafer: Well, you're exactly right. Typically, the fourth quarter is one of our strongest quarters in China. Our outlook assumes that there is an uptick in volume in the fourth quarter compared to the third quarter. But I will say when you frame our outlook for China overall to be down 10%, you'll note the fourth quarter gets a little more pressure on year-over-year comps compared to the third quarter. So without the discontinuation of the subsidy program, there's a bit of uncertainty in China on how the fourth quarter may play out. But right now, we have kind of normal cadence, but not at normal volumes.
It's just kind of relative to the third quarter we do see a bit of an uptick.
Adam Farley: That's helpful. And then maybe shifting to boilers, which was a bright spot in the quarter. I think you mentioned maybe you think there's a little bit of pre-buy there. But I was also wondering if the boiler sales cycle is maybe elongating at all due to general market uncertainty or maybe that's not an issue at all?
Stephen M. Shafer: No. I mean, we do believe that there was some pre-buy. So there are certain boilers that I'll call it inventoriable size. You know, they're small enough that you'd be willing to invest and put them in inventory. You know, we've seen a couple of strong quarters in boilers. Typically, our strongest quarter is the third quarter. So, you know, we do think we'll see a little bit of headwind as we go into the fourth quarter for some of the unwind of the, call it, inventoriable boilers that will come out in the fourth quarter. But overall, the market quoting remains pretty steady. Pretty consistent. Particularly on the large Crest units.
So we're not seeing any major change or elongation in what I would say quoting to the order cycle.
Operator: Thank you. Our next question comes from Andrew Alec Kaplowitz with Citi. You may proceed.
Andrew Alec Kaplowitz: Good morning, everyone.
Stephen M. Shafer: Good morning.
Andrew Alec Kaplowitz: Steve, obviously, you've had good operating experience in your past positions. Maybe just stepping back as you've looked at A. O. Smith and given how many of your markets are relatively sluggish, how have you sized the potential opportunity to cost that overall at A. O. Smith and or, you know, the potential to accelerate new product-related growth as you begin to transition into '26?
Stephen M. Shafer: Yeah. And as I've mentioned, two of our priority areas are operational excellence and how do we get more out of the A. O. Smith operating system and innovation. And I think that gets after both components of your question. I think, you know, we don't have a good sizing yet of what the value is at stake on that. But what I'll tell you is that I'm encouraged by the fact that we can bring even more discipline into our operating rhythm at A. O. Smith. I think we have great manufacturing capability, and we run a lot of our business with great people with a lot of experience.
And I think bringing some discipline, and I mentioned Chris Howe joining us as our CDIO, I think discipline and leveraging some of the technology investments we've made is going to be a meaningful opportunity for us. And we haven't framed that in numbers yet. We're sort of building the foundation that we can build on, and I think that's something we will continue to talk to you all about going forward. And then on the innovation front, you know, we also have a new CTO, and one of the things we're really focused on is how do we increase the pace and success of our commercialization capabilities across our business. So that's another area of focus.
And we're kind of putting the foundation in place, but, you know, we've got a great history at this company of breakthrough innovation, creating categories, and so tapping into that culture of innovation is something that's another big priority for us.
Andrew Alec Kaplowitz: That's helpful. And maybe just a little more color on inventories across your residential channels. Anything you're seeing there? Obviously, residential HVAC is having a much more difficult time than residential water heaters, you know, given their own inventory problems over there. Doesn't seem to be the case with you guys here, but what's the risk given weaker consumer confidence that we could see some destocking?
Stephen M. Shafer: You know, right now, I would say we think that inventory in the channel on both residential and commercial sides is at pretty normal levels. Pretty much target levels. You know, as there's hesitancy, maybe on new home construction, you may see some of the distributors looking to be very prudent on how they manage inventories in the back half of the year. But we feel like channel inventories are pretty much where they should be right now.
Operator: Thank you. Our next question comes from Tomohiko Sano with JPMorgan. You may proceed.
Tomohiko Sano: Good morning, everyone. Thank you for taking my questions. My first question is on CapEx. Could you talk about the CapEx guidance compared to three months ago, including what kind of items, like, did you revise for the full year, please?
Charles T. Lauber: Yeah. We've lowered our CapEx outlook just a little bit. You know, we've pushed out some of the investments that we had planned for the fourth quarter of this year into early next year. Some of those, not all of those, were related to just watching the DOE commercial regulatory initiatives out there, and we're just being prudent on making those investments until we have more surety around that.
Tomohiko Sano: Thank you. And my follow-up is capital allocations. So you have been aggressive with the buybacks and dividend increases. How do you prioritize capital allocations going forward, especially if the macro headwinds persist, please?
Charles T. Lauber: I mean, certainly, the dividend is very important to us. We've raised it for thirty-two years. We look at that from a yield perspective, and we feel pretty comfortable with where we are at on that. Buybacks, we're framing, you know, really to not grow cash, which, you know, we're buying back a prudent amount, we believe, to not grow cash and still reserve firepower for acquisitions. So as Steve mentioned, we have adequate firepower. We're looking at adding those acquisitions, and we're in a good position to do that. And I'd say, in terms of market conditions and how they change, you know, we still recognize we need to allocate capital to our core business.
And we have a very resilient core business. So making sure that we maintain a very strong core business that's cash flow generating is in that dynamic as well.
Operator: Thank you. And as a reminder, to ask a question, please press 11 on your telephone. Our next question comes from Scott Graham with Seaport Research Partners. You may proceed.
Scott Graham: Yeah. Hi. Good morning. I'm sorry for jumping on late. Not bouncing. Several conference calls. So I missed your prepared remarks. Was, you know, sort of the lean into the, you know, the reduction to the lower end of the guide range for the year. Was that on China exclusively? Because it looks like the North American, you know, items are fairly, you know, fairly flat versus last quarter. Was that China, or was it something else?
Stephen M. Shafer: Yeah. Scott, there were two things we pointed out. There was obviously the softness, and we did revise down our China outlook for the year to down 10%. So that was a big part of it. The other thing we've highlighted is weakness on the residential side of the North America business, and we just see that a little bit softer now. Where previously, we talked about it as a flat market, we now see it as flat to slightly down. So those two components are what have us being a little bit more cautious.
Scott Graham: Okay. So thank you for that. I and I'm sorry for having to ask that. Or something you already said. Does that presuppose that or maybe contemplate that the October industry shipments were better than September because September really dropped off there? Can you kind of talk about what you're seeing in the industry in October?
Stephen M. Shafer: Well, the industry shipments, you know, August really was down quite a bit on the residential side. You know, we think September will be, you know, not similar to down, but was also weak. And as we think about kind of our orders and, you know, maybe that's where we can come in October because we haven't seen any industry data yet for October. But in October, as we look at our orders, we haven't seen resiliency, particularly on the wholesale side, which is generally more influenced by new home construction. So it's been a bit weak overall.
So those all kind of all those factors come into play, Scott, when we're thinking about a flat industry last quarter, now flat to slightly down. We just see a little bit of pressure, particularly on the new home construction. And we've talked about, you know, our approach to trying to level load our production a bit more for the efficiency benefits of that working closely with our customers to do that. So, you know, we saw Q3 where the industry was down a bit, but we also gained share as was our intention as we walked through the quarter because of the way we level loaded our production.
Operator: Thank you. I would now like to turn the call back over to Helen E. Gurholt for any closing remarks.
Helen E. Gurholt: Thank you for joining us today. Let me conclude by reminding you that we are pleased with our growth in the quarter. We look forward to updating you on our progress in the quarters to come. Please mark your calendars to join our presentations at three conferences this quarter: Baird on November 11, UBS on December 3, and Goldman on December 4. Thank you, and enjoy the rest of your day.
Operator: Thank you. This concludes the conference. Thank you for your participation. You may now disconnect.