Q1 2020 Earnings Call
Eight first quarter results conference call.
Time, all participants are any listen only mode. After the speakers presentation. There will be a question and answer session to ask the question. During this session you need to press star one on your telephone.
Please be advised today's conference is being recorded.
If you look for any further assistance please press star zero.
The hand, the conference over to your Speaker today, Ms. Ackerman Senior Vice President Investor Relations for her responsibility and sustainability interest or Vicki. Please go ahead.
Thank you were saying good morning, ladies and gentlemen, and welcome to the A.O. Smith first quarter 2020 results conference call.
Joining me today, our cabin dealer Chairman and Chief Executive Officer, Exacloud were Chief Financial Officer.
Before we begin with Kevin's remarks, I would like to remind you that some other comments that will be made during this conference call including answer your question.
Constitute forward looking statement.
These forward looking statements are subject to risks that could cause actual results to be materially different.
Those risks include among other matters that we described in this morning.
As a courtesy to others in the question too please limit yourself to one question and one follow up perjury.
If you have more than two questions. Please rejoin the queue.
I will now turn the call over to Kevin will begin our prepared remarks on site.
Thank you Pat.
Undoubtedly these are unprecedented times.
Well, its safety and well being of our employees as the highest car.
I'm extremely proud of our entire team supporting our customers with the central water heating and water treatment products took about this virus.
As a result of the coping 19 pandemic and in support of continuing our manufacturing efforts during these times.
We have undertaken numerous meaningful in some cases extraordinary steps and our manufacturing plants to protect our employees.
Steps include plant accommodations and reconfiguration.
To maintain social dismissing mask availability to all employees.
Pete cleaning.
Orienting individuals with positive test potential exposure to the virus or 14 days and restricting access to facilities among others.
Well. These steps result in lower manufacturing efficiencies in some cases, our focus is on safety first.
The majority of our office personnel had been working from home has done a great job.
In my opinion productivity and supported the business.
As offices have reopened in China and will soon in other countries and in the U.S.
We have implemented returned office protocols.
Which include bringing back office staff in waves over a two month period.
Making mass available.
More frequent cleaning up common areas.
Sanitation stations throughout the office areas.
And limiting use of conference rooms for small group, meaning just to maintain social efficiency.
Our long term relationships in many cases decades long and strength there were partners within various channels, including wholesale distributors.
Yeah, Whitetail hardware stores, I mean supply and independent reps are particularly important as we provide the essential water heating and water treatment products are critical to uninterrupted operations of hospitals clinics.
Grocery stores foodservice companies and many more including the household said many are now using to conduct business and education.
Our global supply chain management team correctly monitors and manages the ability to operate effectively and identified bottlenecks.
Today, we have not seen any meaningful disruption in our supply chain.
Engaged an ongoing communication or supply chain partners to identify and mitigate risk, including multi sourcing and managing inventory at higher levels.
Our recent implementation of Sep has provided improved management tools and visibility into our supply chain.
Additionally, we have improved our manufacturing flexibility as result of water heater tanks standardization projects.
Last five years.
Standardization greatly improves our ability to ship manufacturing went from one plant to another should the need arise.
The stability afforded by the replacement component in residential and commercial water heater and boiler demand, which we estimate at 85% of the U.S. unit volume puts us in a position of strength as we navigate through this pandemic.
We estimate replacement demand is 40% to 50% in China.
Well, we are in a position of strength similar to 2008 in 2009 timeframe, we expect to see lower demand for the majority of our products and added proactive in managing costs.
We have increased their cost reduction programs in China, we continue to monitor the north American environment and customer demand to potentially take further actions such as for a little program and other restructuring.
Ian Smith is in a solid financial position with positive cash flow and a strong balance sheet.
I will turn the call over to Chuck who will elaborate our cash and liquidity on slide four.
Thank you Kevin.
Well ill Smith has a strong balance sheet and capital position, we are proactively managing our discretionary spend in cash position to that end, we suspended our share repurchase program at mid March. In addition, while we continue to focus on strategic investments, including new products and product and production efficiency, we have re.
Prioritized and reduced our capital spending plans for 2020 by approximately 20%.
Through April we have completed 200 million of dividends out of China, and we have repatriated 125 million to the U.S. as of April Thirtyth 2020, we had approximately 850 million in liquidity consisting of cash cash equivalents marketable security.
Okay and.
And borrowing capacity on our credit facility, which remains in place throughout 2020 in 2021 expiring in December 2021.
We continue to focus on Rightsizing, the cost structure of our China business.
We have achieved the 20% head count reduction compared with December 2018, and we will continue to assess the need for additional workforce reduction.
We are targeting 1000 net store closures this year in China, along with further cuts in advertising and other costs.
Total savings are expected totaled 55 million an increase of 10 million from our estimate in January of which 30 million was achieved in 2019.
Our debt maturity schedule is shown on slide five.
The next major maturity date is at the end of next year in December 2021, when our revolving credit facility expires.
We are compliance with our covenants in our credit facility, our leverage ratio was 17.5% gross debt to total capital at the end of March was significantly below the 60% maximum dictated by our credit and various long term facility.
Oh, we begin comments about the first quarter on slide six.
First quarter 2020 sales of 637 million declined 15% compared with the first quarter 2019.
The decline in sales was largely due to a 56% decline in China local currency sales driven by the coated 19 pandemic.
As a result of lower sales in China first quarter 2020, net earnings of 52 million and earnings per share of 32 cents declined significantly compared with the same period in 2019.
Please turn to slide seven.
So that our North America segment of 533 million increased 2% compared with the first quarter 2019.
Incremental sales of 16 million from the water right acquisition purchased in April 2019, organic growth of 17% in North America water treatment products and higher water heater volumes drove sales higher.
These factors were partially offset by water heater sales mix composed of more electric models, which have a lower selling prices and lower contractual formula pricing associated with a portion of water heaters sales based on lower steel costs.
Rest of the World segment sales of 110 million declined 53% same quarter in 2019.
China sales declined 56% in local currency related to weak consumer demand driven by the pandemic.
China Channel inventories declined slightly from the Lovettsville levels at the end of 2019 and remained in the normal range of two to three months.
On slide eight North America segment earnings of 127 million weren't 10% higher than segment earnings in the same quarter in 2019.
The improvement in earnings were driven by lower steel cost incremental profit from water right and improvement in the profitability of the organic water treatment sales, which were partially offset next Q2 electric water heaters and lower contractual pricing.
As a result first quarter 2020 segment margin of 23.9% improved from 22.2% achieved in the same period last year.
Rest of the world loss of 42 million decline significantly compared with 2019 first quarter segment earnings of 12 million.
The unfavorable impact of profits from lower China sales and a higher mix of mid priced products, which have lower margins more than offset the benefit to profits from lower SGN that stuff.
As a result of these factors the segment margin was negative with compared with 5.3% in the same quarter in 2019.
Our corporate expenses of 15 million and interest expense of 2 million were essentially flat.
As last year.
Our effective tax rate of 23.6% than the first quarter 2020 was higher than the 20% tax rate in the first quarter of 2019, primarily due to geographical differences the pretax income.
Please turn to slide nine.
Cash provided by operations, a 54 million during the first quarter of 2020 was higher than $22 million in the same period of 2019 as a result of lower investment in working capital, including time of certain volume incentive payments, which was partially offset by lower earnings compared with that.
Year ago period.
Our liquidity and balance sheet remains strong we had cash balances totaling 552 million and our net cash position was 209 million at the end of March.
During the first quarter 2020, we repurchased approximately 1.4 million shares of common stock for a total of 57 million I.
Ill now turn the call over to Kevin who will begin on slide 10.
Thank you Chuck during April we saw differing levels of impact on the pandemic across our major product lines and geographies.
In North America, our average daily orders for residential water heaters declined low single digits compared with the first quarter pace.
Commercial average order rates in April were down 30% to 35%.
It's difficult to interpret order rates in April as customers are likely adjusting inventory levels as a manager inventory investment dollars.
And China dependent make had a significant impact on our volume in the first quarter.
50% of our sales volume occurred before the Chinese new year shutdown on January 24.
With manufacturing government offices restaurants in schools now largely reopened and the majority of installers able to access apartments in China.
We have seen sequential improvement in sell out in orders in April compared with February and March.
Consumers remain cautious and it's too early to determine when consumers will return to normal levels in retail environments.
A portion of the improvement could be pent up demand.
In North America demand for residential boilers has remained soft following a warm winter.
And we have delayed or early buy incentive program in this environment.
Our commercial condensing boiler backlog has doubled from levels at this time last year, but some orders have extended delivery dates.
Construction sites close in some states timing of delivery is difficult to project.
Okay.
Safety and security of drinking water.
Hi priority for consumers during this time.
The North American water treatment end market strength, we saw in the first quarter continued in our direct to consumer product portfolio.
Which skews to lower price easier to install products.
In April we experienced some challenges in parts of the country with installed in home products.
In India, a water treatment products are considered essential, but our manufacturing plant as close as worker transportation is difficult in this environment.
We believe the current environment, just not a while for the forecast or performance with reasonable precision.
As a result, we continue to suspend our 2024 year guidance.
As the depth of the disruption and pace of recovery in our end markets become clear.
We look to return to our practice of providing a current year outlook.
Please turn to slide 11.
In Mexico similar to other companies, we temporarily suspended operations as governmental agencies continue to sort through the industrys designated is essential.
In a while to continue to operate as well as the conditions and safety measures under which businesses deem essential are allowed to operate.
We temporary shifted manufacturing from Mexico to the us to minimize disruption of our customers.
Each day, we move closer to an understanding of when we will resume production and believe that we will be in a week or two and.
And at a reduced Manny and capacity.
These lower rates, coupled with the us output are expected to support demand for customers over the coming months.
Our global supply chain team has been proactive from early in the first quarter and continues to monitor and manage availability of component.
Again today, we have experienced minimal disruptions in our global supply chain.
Our largest suppliers in Mexico, which are in different states that are were as plant are now reopened but at a reduced capacity.
Well the disruption has been minimal.
Our experienced reduced safety stock levels on certain items and our supply team is an ongoing communication with our suppliers to mitigate operational risk and manage inventory levels.
We believe replacement demand for water heaters, and boilers and view us as approximately 85%.
In 2006 through 2009.
Which captures.
The great recession peak to trough industry shipments of residential water heater volumes declined 18%.
The decline was primarily driven by a $1.5 billion decline in new homes constructed.
During that period, we were able to flex our operations to maintain margins.
At 1.3 million new homes in 2019, we do not anticipate the new home construction impact will be as great as the great recession.
The replacement base of our core us products.
Stabilizing buffer to the economic downturn expected in the remaining three quarters of 2020.
Please turn to slide 12.
After being closed for several weeks in February and compliance with local orders are three plants in China are open and operating.
Foot traffic in our retail network in China remains low and we are building to order at lower than normal operating capacities.
Our suppliers are open we're now and we're not experiencing disruptions.
Customers continue to preferred products with fewer features continuing the trend we saw last year as you would expect in this environment.
Our mid priced products are positioned for this trend.
Despite reduced head count.
Retail footprint and advertising costs.
We continue to invest in R&D in the region.
Product development continues with a focus on taking cost out of our most popular new products to improve contribution margins.
Product development has been one of the pillars to our success in China, and we're committed to our investment in engineering resources in China in around the world.
Please turn to slide 13.
After a hard closure of the economy in the first quarter, China is slowly returning to business.
Well, we have seen April orders and incrementally improve from February March it's too early to predict if the recent improvement is is the result of pent up demand or by consumers slowly returning to the market.
In North America, we have previous experience and weathering through difficult economic conditions. Most recently in the 2008 recession.
However, with the massive an abrupt impacted jobs and end markets like restaurants hotels in hospitals is difficult to predict this current state of shelter at home and state by state closures will play out similar to the 2008 recession.
Well, we would expect that our replacement business in both water heating and Bruce will provide a buffer and the same manner as we have seen before the impact to construction and discretionary spend and closure of certain jobsite activity is difficult to predict for the remainder 2020.
In India. It is clear that our targets breakeven at 20, Tony will be pushed out as the country battles coated 19.
Please turn to slide 14.
We believe that particularly in these uncertain times A.O. Smith is a compelling investment for a number of reasons.
We have leading market share and our major product categories.
Estimate replacement demand represents approximately 85% of us water heater and boiler volumes.
We have a strong premium brand in China, a broad product offering and our key product categories broad distribution and a reputation for quality and innovation in that region.
Over time, we're well positioned to maximize favorable demographics, and both China and India to enhance shareholder value.
We have strong cash flow and balance sheet supporting the ability to continue to invest for the long term with investments in automation.
Innovation and new products as well as acquisition.
And return to cash and returning cash to shareholders.
We will continue to proactively manage our business and this uncertain environment.
As we've seen consumer demand trends emerge in China, where we were first impacted by the pandemic and now in North America as the current economy begins to reemerge after the economic shutdown.
We have a strong team, which has navigated successfully through prior downturns I'm confident in our ability to execute to cobot 19.
That concludes our prepared remarks, and we are now available for your questions.
Okay.
As a reminder to ask a question you need to press star one on your telephone to withdraw your question press the pound key please stand by while we can probably Q and a roster.
And your first question line of Jeff Hammond with Keybanc.
Hey, Good morning, guys, Hey, Mark Jeff Good morning.
Good really good color on April and the trends and I just wanted to understand this China sellout.
A little bit better is it fair to say that like the last five weeks sell out has been kind of inline with prior year and and maybe how does that frame.
How you're thinking about twoq for China versus the steep drop you saw one Q.
Yes, Jeff.
Let me just kind of walk forward for January getting Kevin Kevin said it on his remarks that half of our first quarter sales we for the holiday Festival.
So before January 24th we had 50% of or our Q1 sales already in February was by far the weakest.
Sequentially marketable March got a little bit better and we've seen April get a little bit better and that's just our sales. When you look at demand demand will be seen in April and demand is approaching the sell out is approaching what we saw last year. So we're encouraged by it and think some of it could be pent up demand.
But but we're encouraged by the by the the way, it's starting to track to last year.
Okay.
Thanks, Brett.
And on top of that just want to sort of come back to channel inventories. We we start channel inventories decreased slightly in the first quarter. Two so we're we're really building to demand we're pleased with that.
Okay, and then in North America.
Kind of stark difference between the commercial water heater commentary and I think what you're saying about locking bar, but it sounds like you expect lock converted.
To see declines as well can you just maybe differentiate between those two and what you kind of expect.
Well, let me just take the North American water heating side of the market first.
As we talked about our orders were down a little bit on residential in April and the commercial I wouldn't read too much into April right now.
Down 30, 35% is in our mind, probably our distributors kind of rebalancing inventory keep in mind that there are large investment is in our.
Dollar amounts in our commercial products, so there's probably some rebalancing going on there.
As far as lock and bar again, Lockheed bar has had a very nice commercial.
I'll start to the year again some of those jobs are in New York in a few other states that have been suspended but having a strong order book is is really good and we're still seeing quite frankly.
Recent quote activity out there so as we move forward.
Again, I think it's still too early to put a number on on what new construction will look like and when these jobs that have been.
Postpone will be released but overall I like our position as we head into Q2, and then we're going to have to read and react as we see this market open up it's very early right now.
Okay. Thanks, guys I'll get back in Q.
Your next question, Matt Summerville with D.A. Davidson.
To that point.
Would it be possible covenant of just talk about what you believe sell through looks like in April in the commercial business versus sell him of where you indicated and then as my follow up can you talk about how the new entrant into the residential water heater market later this year may impact.
Or not market stability I'd love to get your take on that thank you.
I would tell you when you start talking about North American and sell in and so we don't really have great data there. So.
It would be more speculative on my part as we go forward I still believe the 85% replacement markets going to hold up and continue but the new construction is just.
Just too early for us to put it on kind of a number on that.
No and again as I mentioned, a lot of the jobs being suspended and quite a bit of activity up in the northeast and so forth.
So.
Not trying to Dodge. The question is just we really don't have that kind of bisbee visibility to give you a or for me to give you a a reasonable answer right now.
And as it comes down to a competitor entering the market at the end of this year again as we've looked at it A.O. Smith has has dealt with competitors for a long period of time as we've mentioned on prior calls we have very strong relationships with our distributors and mentioned in his remarks. They go back decades.
To be a full time player in this market you have they have to have a complete product line of residential commercial and on top of that have excellent service levels. So we're going to focus on ourself as we go forward and continue to do and provide value to our distributors as we've had over the last decades.
Thank you.
Your next question a line of Scott Graham with Rosenblatt Securities.
Hi.
Good morning.
Jeff Pat.
Hey, I was just hoping.
On slide for the 55 million in China.
Is the math there as simple as assuming a 25 million drops into operating income. This year. It is it is Scott we were talking about.
15 million the January call and we've increased that by 10.
Yes, Thank you and then.
You have to look at each business individually in.
We are certainly within North America, but.
Is there.
Particularly with concerns out there about the speed of.
With the release of the of the backlogs that are out there on commercial off for that to kind of start up against fully.
I think that there is some concerns out there and I guess my question is it.
Does that preclude you.
Like you does your backlog and you are quite preclude you from.
Maybe taking some structural costs out there and and maybe more broadly in North America.
What are the trigger points that you're maybe looking at to get more aggressive on the cost side in North America again more broadly.
Well, let me just take the.
Hi, leveling of Chuck fill in some of the.
Some of the blanks here, but if you look at it.
Demand, we have been able in and we've demonstrated it.
Through 2008, and the recession to be able to flex our plants appropriately and so that's a skill set that came out of the great recession that we continue to use today. So from that will be simply demand demand driven and we will adjust appropriately whether it's in our water heater facility or in a boiler.
Facility.
And as far as.
Costs right now.
The quarter came in I think pretty reasonable for us will continue to watch demand.
The things we've already taken we have our head count on hold traveling entertainment's down, but we haven't taken any major structural changes or decided to take any structural changes yet we'll continue to look at it we're prepared if necessary.
To execute but we're just not net position and we'll continue to monitor demand in our customers as we head into Q2, yes, I mean, the trigger point for us is really watching that demand.
Back to your backlog question I mean, we're pleased to have the backlog we wish it was a little more predictable and when we were going to ship it but that doesn't really preclude us from taking some of the actions that Kevin mentioned on.
Taking similar cost out as we watch the backlog.
Your next question line of David Macgregor with Longbow Research.
Yes, good morning, everyone.
Question on Chuck.
I hope you're well.
You too yes. Thank you just a question on China that I guess, we've been talking now for few quarters about evolving mid price point product that youve introduced into the.
He's market I guess I wanted to tightness in a little bit was what you're doing on SGN a because.
Clearly, you're you're making progress in terms of addressing yes, gionee issue, but to the extent that you're relying more and more on mid price 0.1 would presume that that some more competitive segment of the market as a consequence would require more in the way of AD support market support and.
Just wondering if if the migration into.
Greater mass and the in the in the mid price point constrained you in terms of which are able to do and flexing is today.
Yes.
The products that we're introducing in that kind of upper mid point price point is really helping us.
Bid on the online.
So as you might expect in Q1, we saw our online business doing a bit better than we've done we've seen in the path.
Online historically has been 20% of our business last year first quarter. This year, it's approaching 30%.
And the selling models a little bit different.
Non line after you make the sale.
Then we do on the offline footprint. So some of the tie into kind of the mid priced products and some of the actions we're taking.
Is looking at our store footprint. So the thousand stores that we talked about.
That's the area that we're really looking at low efficiency stores trying to take some cost out.
But were but it's really those mid priced products help us help us a bit on online as well as inox offline and we're working on cost reduction products that are projects to continue to reduce the cost on those.
I would just add the cost of sale on lines, a little bit lower than offline and.
A lot of the action were taken with stores, we're going to re purpose.
Some of those investments towards our online activities, but I don't view it as being a.
The incremental add to our marketing efforts I, just I look at it or re purpose you know how we go to market.
Is there any chance we could get some such a proportion from you in terms of what percentage of your business over there as mid price point versus the kind of legacy premium price point.
We don't have that that's split.
Handy right now I would say certainly in this environment.
We've seen a shift to more of the upper mid priced and low low end of the premium price product, but exact numbers. We just don't have frontlist, Okay and my follow up question is really on the water treatment.
Impressive numbers there was this quarter.
This is improved profitability is really just being driven by scaling that business offers or product mix or channel mix issue. You just talked about some of the progress you've made in water treatment.
It's all that.
It's some scale it did some process improvement that we've had strong demand always helps the organic growth of 17% in the business really really improves it and we're very very pleased with the addition of water right because water rate has performed very very well for us and.
And helps that margin as we get more scale.
I guess, just this Kevin environment, whether somebody concerns about how the consumer discretionary spend might respond to the macro.
Are you seeing anything in April that would give you pause.
No I actually in our remarks, you talked about water treatment and we had very strong in our minds very strong Q1 and that really transferred over to April.
You know a clean water is a critical element in the consumers' minds, right now and and having the ability for US yes, one of the things in our water treatment. We have several channels that we marketed and this has proved to be a nice advantage for us being going through E commerce going through a dealer network VI why providing those.
Opportunities through the various consumers.
Played out really well in Q1, and we think will play out as we go forward into Q2.
Your next question line of Robert Mccarthy with Stephens.
Hi, good morning, everyone.
Good morning.
All right. So I guess first on on China.
Could you just talked and amplify some of your existing commentary about the cost actions you took the narrative and the back half of last year and the incremental cost actions, you've taken now and how thats changed or whats accelerated what's the difference and then is there any granularity as to the negative margin you put up this quarter that.
That could give us.
Better sense of the components of the loss because that's a pretty sizable loss, yes. So I'll, let me start with the cost actions and I'll take it back kind of categories. So.
Head count reduction when we were when we were on January's call. We we talked about the fact that we were targeting 20% to happen through the first half of the year, we've achieved that 20% and we're looking at at some further head count if necessary. So we're looking very closely of headcount as well as watching.
The consumer demand.
We really increased our selling and our advertising expense. So where's the increase there is with the thousand stores and we're looking at our footprint. We're kind of we're targeting to take out further selling and online or im sorry offline and offline infrastructure costs.
Okay, and then I guess.
As a follow up on just the cash flow statement.
Just give me a sense of what's really been the change at current asset liabilities.
For three months 2020 versus 2019, just give me some complexity in around the conversion there.
In terms of what's going on in inventories and receivables.
Inventories are up slightly I'd say, the biggest swing and cash flows just some timing of some volume incentive payments that.
Occurred in the first quarter last year that will occur in the second quarter. This year.
Let me go back to China for second because you had mentioned about the the I think you've mentioned is pretty large document.
The volume really matters in China, when you get to that level. So we've been kind of consistently talking about when volume goes down and using a 50% decrement and I think it falls in line pretty close to that.
Q1 was.
Not much time for the China team to react Q1 was very abrupt and a leaving the spring festival holiday for the Chinese new year expecting to be back in a week and not returning for several weeks. So reacting on cost in Q1 was quite difficult, particularly paying employees and doing all the right things that we did for safety.
So it was not easy to make quick action or take quick action in Q1.
But the 50% decrement hold held pretty pretty true in Q1.
We curtailed all the advertising that we could and promotions because it just didn't make sense to promote well people were not in the retail environment. So we as I mentioned earlier Q Q1, 50% before the festival and then sequentially better. So we're watching we're watching the orders in April very closely we're going to watch as we go.
Go into made to see kind of what we can look we can expect as the year progresses.
Your next question line, a Ryan Connors with Goldman Sachs Scattergood.
Great. Thanks for taking my question hopeful well.
Thanks, Yes, I'm wondering if you could.
Talk about the impact of all this on your channel partners.
And sort of the channel inventory situation in North America in many of your distributors are small businesses.
Certainly the professional plumbers that they serve or small businesses so presumably.
Their financial Wherewithal to hold inventory may have been compromise in many cases, so how does that impact you.
It will there be some requirement that you utilize more of your balance sheet to finance inventory going forward or any thoughts on on that.
Yes. So many of our customers are also essential businesses in today's environment and continue to operate we know that their volumes are lower because they have had to adjust to curbside pickup in some cases and other other scenarios, which is the hurt their business certainly water heaters are very important.
Part of their business also very important part of the replacement business. So thats more studies in some of the other discretionary spending that that people would have for the other products that the Kerry.
We're watching and close if you go back to kind of the recession and use that as our experience level, we saw very very little.
Interruption during the recession, we would hope and expect to some of the smaller distributors or customers that we serve would been able to get some assistance through the government programs that are out there.
But we're watching it very close at this point in time, we haven't seen any indications have been slow up or any issues in our channels, but we certainly are watching you close. Okay. So you don't see you don't see any structural change in terms of.
The the you have an hold more inventory at year level as opposed to the inventory capability of the channel itself.
Hi, This is Kevin.
If anything.
Oh wait when great recession hit there has been even more consolidation to some some of our larger customers over that decade or so.
And quite frankly these are the same customers that navigated through the great recession and they basically almost every one of our customers has been deemed essential.
And their customers have been deemed essential so plumbers and so forth, yes. Some of some sales are down but.
There has been we've had to make no really adjustments to the way, we do business with them other than and making sure that they have product to serve the consumer and the commercial entities when when necessary and they've been navigating through and pretty well and again, we stay close to them our salesforce is virtually.
Are you talking them on a pretty regular basis, but yes, as a whole I think I would be very comfortable saying most of our distributors and retailers and even our dealers are navigating through this current environment and again, we'll have to see how it plays out the rest of the year, but for the most part everybody some do.
In business.
Eight modified business, but nothing exceptionally different.
Your next question line of Susan Mcclary with Goldman Sachs.
Good morning morning learning.
My first question is can you talk a little bit to the decremental margins in North America, and especially as we think about it from a residential perspective as well as the commercial just given the varying trends that you talk to there.
Yes, when we look at the margin a decrement incremental end decremental margins is about 30% roughly on the residential side commercial would be a bit higher.
This is a little different right because some some of this disruption is pretty abrupt some of it stop start some of it is.
A little bit more costly, but thats ballpark.
Okay. That's helpful and then.
Turning up on that you mention that did the rate of decline that you saw during the housing downturn in 2008 can you talk to the mix shift that you also see with that and maybe how youre thinking about mix shifts in the us coming through as we exit virus and get into more of that recessionary period.
[music].
Bakken back at that time, I don't believe we saw much of the mix shift at all.
There may have been a slight depending upon where the housing was located.
Typically some of the stronger markets are our electric markets. Currently when you go to Florida and some of those other geographic areas, but we just we went to expect a significant mix shift it's typically a like for like exchange in the water he decided on the residential side.
And your next question lineups for reproductive with Jefferies.
Good morning. Thanks, taking my question. So you talked about the impact from construction site closures closures on commercial water heaters and boilers.
But any color on what you're seeing in regions with extreme shutdowns in North America, such as the northeast first regions that are less impacted by the shutdowns.
Yes, I would tell you this is Kevin.
We're seeing it you just said to up in the northeast New York that area.
Okay aggressive measures to shut down a lot of their job sites, we're seeing some of that on the west coast as well in California, and so those are the areas and quite frankly.
We're starting to see some of those start to.
Be released and coming back to work, but it was very regional and particularly.
Very heavy in the areas as you would expect like New York, where the co bid 19 was heavy media serious impact.
Is there anyway to quantify.
There were some other regions Henderson.
Get a sense of what underlying demand could be very close at 19 impacts.
I don't think we can get that granular with you as far as.
Again, as we've talked about even our backlog that we have which is a nice backlog those dates continue to move.
We've seen contact with with our customers in our buy sell reps to get the best view going forward, but it's really early until these key markets really open up not just gradually open up.
We're going to need to see some kind of run rate here before we can really give you a definitive response.
Your next question line of Nathan Jones with Stifel.
Good morning, everyone morning line.
So it's a follow up to comment you made I think it was to Rob's question about reacting on on cost in China, and how difficult that was due to the abruptness at the shutdown on that happens that quickly could you contrast that with your ability to.
The adjusted cost structure, North America, depending on what we say going forward.
Yes.
The biggest contrast in my mind as we wouldn't expect that big of a drop in North America because of the replacement business being larger percentage of the business in China. So I want to just kind of start start with that statement.
And we've got a little bit more flexibility, probably when you look at some of the programs that Kevin outline as we go forward to make adjustments so that would probably be our ability to maneuverable quicker in China. We made we paid everybody a 100% in Q1.
Very very difficult restart the country was pretty hard closed for longer periods of times and we're going to have I mean, we'll have to see what happens in the us hopefully we won't experience.
Surgeons and hopefully that will we'll see the country continue to open up.
Okay. That's helpful and then a question on cash flow.
Working capital for the remainder of the year would you assume that that's going to be a source of cash.
Twoq through Fourq here.
And any out any guidance you can give us on what you think kind of cash conversion numbers are going to look like for 2020.
I'm not going to frame it from a fair amount split working capital.
We're not going to pressure our pressure inventories a great deal right now in this environment, we're going to make sure. We're carrying inventory is adequately to cover our needs. We made an increased a bit in certain areas, where we would like to make sure we've got safety stocks.
In China, we would expect that there would be some growth because we've got.
Expectation that we're going to see a little bit of growth over the course of the course of the year. So you know not affirm number but working capital I wouldn't expect a lot of health working capital for the back half year, but we'll watch it closely.
Your next question comes from the line Robert Mccarthy with Stephens.
Sorry, I'm almost 11 for punishment.
So.
Hi, I guess the next question is maybe just comment qualitatively I know store fleet. Your gross margin in China has always been higher than North America, even with the price increases we saw no seriously over the last four or five years, but clearly given what you've been seeing now Ami.
Can you structurally still make that statement or are we starting to see some material dilution in gross margin in China.
Q1.
The gross margin in China was lower than our historical 40%. So Q1, certainly was there's a couple of things driving and it's the dramatic volume shift Thats number one and the cost associated with that.
We've been talking about some of the mid price pressure on margin. We've introduced a lot to mid priced products or a number of upper upper mid priced products that were very very happy about that are being well received however, we've got some cost out programs there still yet to come on a couple of those.
So I mean, when you look at Q1.
China, China actually was lower than our historical average gross gross gross margin gross profit.
And do you think is still credible it means 11, you've been talking about the replacement cycle, China developing over time and obviously.
Up until.
Two months ago, you just have incredible success story in China.
But you talked about replacement market caused developing and I think the replacement market. Maybe if memory serves is and I don't know 40, 40% to 50% maybe 40% of the market as of I don't know 12, 18 months ago, but given.
The interventions midsize product.
And what's going on I mean isn't suffice to say that perhaps you can take a pause here or is it isn't even.
The right thing to think about a replacement market. When you have this kind of switching to two of lower priced product.
Well.
I'll do my best to try to answer that one of the replacement market.
It's about 40% to 50% so.
We are in line there and fit these in the tier one tier two cities and you get out the other.
Lower tier cities, it's about 40.
And again I would go back to we still have again products for mid price up to premium we continue to.
Drive both sides of the business are bringing new products to market both in gas electric and of course water treatment, but on the water heater side, there's a there's a strong preference for like for like and that's no different than in the US if you take out of product.
You're you're probably leaning towards putting one similar in so.
The way I look at the replacement market. It's it's again, it's a nice buffer for us that.
Well not relying on new constructions, and so forth and and we think it's going to be today's 50%. We believe is going to be a.
Real advantage for us as that continues to grow throughout the year. So I don't see the mid price point and the.
Premium price point.
At odds with each other that theyre, just studying different types of consumers.
And there are no other questions I'll now turn the call back over to Patricia Ackerman.
Thank you, ladies and gentlemen for joining us today that concludes our session and have a great day.
Okay.
Ladies and gentlemen, this concludes today's conference call. Thank you for participating you may now disconnect.
[music].
Yeah.
[music].