Q2 2020 A. O. Smith Corp Earnings Call
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Now I would like to have the conference over to your first speaker for today Ms., Patricia Ackerman Senior Vice President of Investor relation corporate responsibility and sustainability and Treasury. Thank you. Please go ahead Madam.
Thank you might be good morning, ladies and gentlemen, and welcome to A.O. Smith second quarter 2020 results conference call.
Joining me today, our cabin Wheeler, Chairman and Chief Executive Officer, and check lover, Chief Financial Officer.
Before we begin with Kevin's remarks, I would like to remind you that some of the comments that will be made during this conference call, including asking your questions will constitute forward looking statements.
These forward looking statements are subject to risks that could cause actual results to be material would materially different.
Those risks include among others matters that we have described in this mornings press release and on life.
On slide three in order to provide improved transparency into the operating results of our business. We provided non-GAAP measures adjusted net earnings adjusted earnings per share and adjusted segment earnings that excludes the severance and restructuring charges related to align our business to current.
Market conditions.
Reconciliations from GAAP measures to non-GAAP measures are provided in the appendix at the end of this presentation and also on our website.
Also as a courtesy to others in the question Q. Please limit yourself to one question and one follow up question for churn.
If you have multiple questions. Please rejoin the queue.
I will now turn the call over to Kevin who will be dinner prepared remark on slide.
Thank you Pat before summarizing the quarter and Chuck Good results I want to express so probably some of our global team.
We faced challenges in complexities door business that we have never faced before.
Our number one goal was it remains to keep our employees say why deliberate our central products to our customers.
I'd say confidently that our team met and often exceeded my expectations.
Thank you to the men and women in the A.O. Smith family around the World for you dedication and your spirit.
You truly make A.O. Smith, a remarkable company.
The business performed in the second quarter is largely inline with what we saw in April.
Continuing the pace of growth we saw in the first quarter, our north American water treatment business organically grew 19%.
Direct to consumer and retail sales were particularly strong as consumers became more health conscious during the pandemic and the shelter in place orders can find many of us to our homes.
As expected industry volumes of residential water heaters in the U.S. held up notably well.
Based on our June shipments, we estimate industry volumes were flat to slightly left in the quarter.
Third to last year.
Due to construction project delays in postponements in North America, we saw commercial water heater and boiler volumes decline in line with our estimates of the industry declined to 20% to 25% in the quarter compared with last year.
Consumer demand for our products in China was flat to slightly positive compared to the second quarter of 2019.
As restaurant to shopping malls reopened in retail foot traffic increase.
We remain to operational with no significant disruptions.
Our war as Mexico plant, which we voluntarily closed in April reopening may and ramped up production over the latter portion of the quarter.
We have taken numerous and meaningful steps to protect our employees suppliers and customers in the pandemic.
These important steps in many cases reduce deficiencies.
Include continuous communication and training to our employees on living and working safely and co bid 19 world.
Glenn accommodations and reconfiguration to maintain social distancing.
Mass for all employees.
Implementation of Sanitizing station.
Jeff richer, taking in regular proactive deep cleaning the standardization of our facilities.
Our global supply chain remain operational.
We continue to monitor and manage our ability to operate effectively as tariffs and the evolving nature of the Kobin 19 pandemic and the related stresses on the supply chain and periodic marketplace disruptions in fact, our operation.
To align our business with current market conditions, primarily in China and to a lesser extent in North America reduced headcount in occurred other restructuring costs totaling $6 million in the second quarter.
I'll now turn the call over to Chuck who will provide more details on the quarter beginning on slide five.
Thank you Kevin.
Second quarter 2020 sales of 664 million declined 13% compared to second quarter 2019.
The decline in sales was largely due to lower water heater volumes in China, and lower commercial water heater and boiler about volumes in North America, driven by the Cobas 19 pandemic.
As a result of lower sales second quarter 2020, adjusted earnings of 73 million and adjusted earnings per share of 45 cents declined significantly compared with the same period in 2019.
Please turn to slide six.
Sales in our North America segment of 481 million declined 8% compared to the second quarter of 2019 organic growth of approximately 19% North America water treatment sales was more than offset by lower commercial water heating volumes lower boiler volumes and a water heaters sales mix composed of more electric.
Models, which have a lower selling price.
Rest of the World segment sales of $190 million declined 24% of compared the same quarter of 2019, China sales declined 20% local currency related to higher mix of mid priced products and further reductions in customer inventory levels.
Consumer demand for our products in China was flat to slightly positive compared with the second quarter of 2019.
China currency translation negatively impacted sales by approximately 6 million.
Our sequential sales in China improved through the quarter and China was profitable in May and June.
India sales declined significantly as the economy was shutdown during the majority of the quarter to minimize the spread of the violence.
Mix skewed to electric water heaters.
Certain costs directly related to the pandemic, including temporarily moving production from Mexico to the us.
Paying employees during temporary plant shutdowns.
Facility planning.
Paying benefits for furloughed employees and other costs were 5.5 million in the second quarter.
Adjusted earnings exclude 2.2 million in pretax severance costs as a result second quarter 2020 segment adjusted segment margin for of 22.4% declined from 23.5% achieved in the same period last year.
Rest of the World adjustment segment loss of 2 million declined significantly compared with 2019 second quarter segment earnings of 22 million.
The unfavorable impact to profit lower China sales and a higher mix of mid priced products, which have lower margins more than offset the benefits to profits from lower SGN expenses.
These results exclude $3.9 million in pretax severance and restructuring costs.
As a result of these factors adjustment segment margin was negative compared with 9% in the same quarter of 2019.
Our corporate expenses of 10 million and interest expense of 3 million were similar to last year.
Please turn to slide eight.
Cash provided by operations of $179 million during the first half half of 2020 was higher than 144 million in the same period of 2019 as a result of lower investment in working capital, including deferral of our April estimated federal income tax payment to July which was partially offset by lower earnings.
Compared with that year ago period.
Our liquidity and balance sheet remains strong we had cash balances coalmining totaling 569 million and our net cash position was 288 million at the end of June.
Our leverage ratio at the end of the second quarter was 14.5% as measured by total debt to total capital.
We had 332 million of Undrawn borrowing capacity on our 500 million.
Revolver.
It's in the second quarter and our share repurchase activity continues to be suspended.
During the first half of 2020, we repurchased approximately 1.3 million shares of common stock for a total of 57 million.
Please advance to slide nine.
We reintroduced our 2020 adjusted EPS guidance. This morning, with a range of between $1.72 to $1.86 per share.
Our 2020, adjusted EPS guidance excludes three cents per share in severance and restructuring costs included.
That were incurred in the second quarter.
Our adjusted guidance assumes the conditions of our business environment and that of our suppliers and customers is similar for the remainder of the year to what we are currently experiencing and does not deteriorate as is the result of further restart restrictions or shutdown due to the Kobin 19 pandemic.
We expect our cash flow from operations in 2020 to be approximately $350 million compared with 456 million in 2019, primarily due to lower earnings.
Our 2020 capital spending plans are between 60, and 70 million in our depreciation and amortization expense is expected to be approximately 80 million.
Our corporate and other expenses are expected to be approximately 47 million in 2020 slightly higher than 2019, primarily due to lower interest income on investments.
We expect our interest expense to be 9 million in 2020, compared with 11 million in 2019.
Our effective income tax rate is expected to be between 23 and 23.5% in 2020.
Our assumptions assume no additional share repurchase resulting in an average diluted outstanding shares in 2020 of approximately 162.5 million.
Ill now turn the call over to Kevin who will summarize our guidance assumptions beginning on slide 10.
Okay. Thank you Chuck.
Outlook for 2020 includes the following assumptions.
We project us residential water heater industry volumes will be flat in 2020, driven by resilient replacement demand in similar levels of new construction home construction as last year.
We expect commercial industry water heater volumes will decline approximately 10% as job sites and business closures due to the pandemic delay are good for new construction and discretionary replacement installation.
It is encouraging to see consumer demand for our chatter product similar if not a little higher than last year over the last four months.
We're also seeing sequentially quarterly improvement and market share both online and offline for water heater and water treatment products driven by our mid price range products.
We took additional charges in Q2 for further restructuring of the business.
We believe these restructuring charges are largely behind us.
We continue to target closure of a thousand existing stores, while targeting to open 500 small store relationships and tier four through six cities.
Cost actions and restructuring activity are projected to result in $35 million or savings in 2020 over 2019.
15 million of which will be realized in the second half of 2020.
We expect year over year declines in local currency sales of 18% to 20% and protract sequential quarter over quarter growth in the second half of the year as China appears to be making sustainable progress in reopening their economy and keeping the virus in check.
We expect our North America border sales will decline approximately 10% for the full year.
Commercial boilers represent 65% to 70% of our boiler sales.
With many job sites temporary closed during the second quarter, we believe as job sites reopened the orders will sequentially improved in the second half of the year.
We project, 20% to 22% sales growth in our North America water treatment products, which include incremental water rights sales.
We ended 2019 with a 2.6 million dollar loss in India and expect a similar Washington 2020, as a result of the pandemic.
Please advance to slide 11.
We project revenue will decline by 7% to 8% in 2020 as strong organic North America water treatment sales and resilient North America residential water heater volumes are more than offset by weaker North America commercial water heater and boiler volumes and lower China's sales largely due to that.
Pandemic.
We expect North America segment margin to be between 22, and a half and 23% and.
In rest of World segment margins to be negative one to negative 2.5%.
Please turn to slide 12.
We believe particularly in these uncertain times A.O. Smith is compelling investment for a number of reasons.
We have leading share positions in our major product categories.
We estimate replacement demand represents approximately 80% to 85% of us water heater and boiler volumes.
We have a strong premium brand in China, a broad product offering in our key product categories broad distribution and a reputation for quality and innovation in that region.
Overtime, we are well positioned to maximize favorable demographics in 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 and automation innovation and new products as well as acquisitions and return cash to shareholders.
We will continue to proactively manage our business in this uncertain environment.
We see improving consumer demand trends emerge in China, where we were first impacted by this endemic and see China operations pivot to profitability for the remainder of the year.
In North America as the economy begins to reemerge at the economic shutdown persistent cobot, 19 cases and related potential implications to returning to a more stable environment in the market workplace in supply chain will continue to be challenging throughout the remainder of the year.
We have a strong and dedicated team, which has navigated successfully through prior downturns and I'm confident in our ability to execute formulary through cobot 19th.
That concludes our prepared remarks and now we are now available for your questions.
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Your first question comes from the line of Jeff Hammond of Keybanc. Your line is open.
Hi, good morning, everyone for joining Jeff.
Just wanted to dig in on this China dynamic sales down 21, and I think you said consumer demand was flat. So just help me square those two things I know you mentioned mix.
And destock, just maybe parse those out and what's the expectation for this mix dynamic and kind of inventory destocking that continue into the second half. Okay. So it were down you're right. It's about 20% in when you take out the FX so right for the quarter were down 20% Theres two.
Two main pieces, one is mix and the other you're right as the destock. If you just kind of looked at the mix.
Of that 20% roughly a third less than a half is related to sales mix. So you kind of you could just get into that category of less than half to maybe a third of that 20%. The rest is really destock in consumer demand. So it's.
Inventories came down again in the channel inventory in China. So we were a little bit surprised that came down as much as they did we don't project them to continue to decrease.
They are now in the two to three months range, when we recalibrated to kind of what we see 2020 to be at.
So on our forward looking we think there about as low as they're going to go that could go lower but thats, what our projection has.
And the mix dynamic in the second half should that continue.
The mix dynamic is a little unique I think in Q2 rigs. So we've got our online sales were strong. So if you look at our online sales.
They were there were 30% of our total revenue in Q2 and actually up quarter over quarter slightly.
So online sales put a little bit more pressure on the mid priced products as you know they kind of that there is more mid priced upper mid priced products on the online and there isn't the offline.
You know, we would expect to continue to be pressure on mix going forward, but we would also hope and we expect sequential improvement in volumes and we would hope that the offline market would grow bit.
And it might be a little bit improved over that but we'll have to kind of see how that plays out.
Okay, and then just it looks like you got to do 30 to 35 million an op profit in the second half in China, the kind of get to your margin target is that strictly.
Volume improvement from here or is there something else that's driving that the profit improvement.
Well, it's two things there's some volume improvements so we've seen sequentially, China improve month over month than we expected to continue quarter over quarter. So we do expect growth in the back half of the year.
Were ARPU, if you kind of parse out the mass were expect China to grow.
Year over year in low single digits, maybe in that 5% range and then on top of that.
As Kevin mentioned, we've got cost reduction programs that we putting in place.
About 35 million for the year, and we expect 15 of that to drop into the back half, probably probably pretty even per quarter the savings.
Okay great.
Your next question is from the line of Scott Graham Burleson Blocky. Your line is open.
Yes, hi, good morning, Kevin Chuck.
Why is that good morning.
I just wanted to make sure just sort of like a housekeeper.
Cold reached 5.5 million you did not pull that out that is in your North American 22.4, right. You are you are correct. It isn't it is in our non at this in our it's in our numbers. The only thing we adjusted out was.
Three cents on severance and restructuring.
Yes got it yes, I'm, hoping you could maybe tell us a little bit more about the China sort of percentage of sales to pre premium mid water heaters versus per cent to offer price point Im just kind of wondering what that pie chart looks like.
Sure let me frame.
And as I mentioned just to Jeff I mean is it's a little unusual quarter, because we got a little heavier mix on online, but just to kind of frame. It. Let me go let me go with the definition first though at mid priced as we're defining that for this for this information is on the electric it'd be less than 3000, RMB and then on the gas it would be less than 5000.
Maybe so thats what working we're considering in this kind of calculation at mid price. If you go back two years ago the percent of art. So our of our sales that would fall into that category below those two threshold is in that 25% to 40% range.
If you kind of Wocket forward to a year ago is in that 35% to 55% and then if you go to Q2, which again a little bit heavier online percentage than normal it's in the 55% to 70% range.
So it it's grown because we reintroduced products into that category, which we feel now we've got to full full range of products kind of filled in there.
You know Scott I would just want to dovetail with Chuck said is we've been working over a year plus to fill those mid price categories and now were there. So as we go forward, we look for our mix due to hopefully move more towards our premium sector, but it was important for us from an overall pursue.
Active to compete both online and offline to have those mid mid priced products, which are buyer why the way our upper mid part of the range.
And our product offerings. So again going forward I think as Chuck mentioned this is probably.
The.
A low point when it comes to how many bid price or high point for mid priced products and we look forward to see our mix shifting back maybe not to where it was in the past that vaccine higher to premium products.
Your next question is from the line of Susan Mcclary of Goldman Sachs. Your line is open.
Thank you good listening when it's Marty.
My first question is can you give some color on the next fiscal year Wes I noticed in your press release, you commented that that's kind of turned a bit negative more towards the electric side of things on the consumer business can you just give us some comments on how that has been coming together and your thoughts on the back half for mix.
Yeah. This is Kevin.
If you look at our industry, we do have periodically.
Some mix shifts foot for various reasons.
The way we would look at this is from our perspective, the northeast has been one of the hardest hit to go to New York, New Jersey, Boston those areas, Massachusetts.
Pipe in the hardest hit when it comes to Covidien shutdowns that just so happens to be one of our strongest gas markets. So that could be part of it. We've also had strong growth in India with our customer base and a stronger electric markets. So the two kind of.
Cost of the shift the temporary shift if I look at it though and look forward.
Yeah, I don't see any any real six tend to changes in the market and overtime I would expect that our mix with normalized over the year or into next year.
Okay. That's helpful.
And then just following up you know can you give some color on raw material inputs steel prices seem to be a slight advantage for you in the quarter, but how should we think about that.
Going out over the next few quarters as well.
Well I mean, if you look at steel.
And in a 70% of our steel as coal rose, 30% is hot rolled and we see kind of a delay in the cost of that 90 to 120 days. So if we kind of just take a data point of spot prices today and compare them to a year ago.
Second quarter, we're we're down about 5%.
So thats kind of frames, how to think about it still has been lower I guess for a couple of quarters now, but it has edged down a bit.
Next question is from the line as Brian Blair of Oppenheimer. Your line is open.
Good morning, everyone will be dunleavy.
Hey, Brian same deal.
Hi, Chuck I.
I believe you've mentioned breakeven revenue for China in the 50 560 million per month range on recent past and being profitable in May and June which was kind of validate that is that still the right range to think it down and then as we look forward.
Beyond the structural savings will come through in the back half how should we think about incrementals as China revenue much higher.
Yes, so you're exactly right the in that that breakeven point is in that 55 to 60. We're pleased that we saw it and in May and June we would expect we're going to be profitable going forward. So.
We still we still see that is the range. It we were going to continue to look at you know the structure and we have taken a look at the structure and the restructuring charge. We took of about a pump. It's about 4 million in China will result in some savings going forward.
So the incrementals so.
Yes, Incrementals are probably in that 45 to 40, 40% to 45% range I would say.
Okay appreciate that and really nice growth in water treatment.
Can you remind us of Runrate profitability, there and structurally where you think margins in Cline as that business continues to scale.
Yes, sorry run rate profitability Q1, we were at 9% Q2 were about 8%, we see a continuing to be that for the rest of the year. We're still looking at cost reductions, we've got a little Sep implementation happening. This quarter. So there is some some costs that are going to burden it a little bit on the back half, but we still see that just.
Approaching 10% this year. So we're we're pleased with water treatment. The order rate has been strong I mean, we were up 20, 19% to 20% for the quarter and when we look into July we we see the same strengthen orders. It's it's at that same rate.
Yes, I did just make another comment on that as far as.
The growth has been strong and it looks to be continuing and then just keep in mind Theres a consumable part of this that as we go forward and continue to put out our point of use importer entry type of products.
Thats seeds the consumables as we go forward over the next few years, so theres a lot of positive trends in our water treatment business and even as you look at it today, even softeners are starting to come back as well.
Our dealers are learning how to sell any cobot environment and using digital and.
How they are installing and so forth.
They made a remarkable shift in and they're selling methods and has proven to be affected so far through July.
Your next question is from the line us much Summerville of the Davidson Your line is open.
Thanks couple of questions I want to get back to the electric impact to commute North America was down 8% can you sort of parse out what the impact of that ship was on revenue and what the operating margin impact may have been there as well.
Yeah, we're just tracking down the impact on revenue yet the percentage. This percentage is really the same for gas or electric some in the percentage.
Runs roughly the same it's really just a step function as far as sales dollars and then margin dollars.
You know.
I don't have a good.
To answer on mix, but I mean, it's.
It's probably.
It is probably in that.
10% to 15% of the total.
The total decreased 10, when you look at the decrease the margin of 8% is probably 10 10 to 15 of that.
And then have you begun to see in your order book as of late looking into June July any evidence that these delayed construction projects are indeed coming back online if you actually seeing that take place in your order book.
You know I think it's too early to see that when we look at when we look and I thinking about my thinking about lochinvar whalers at this point, but when you look at kind of the order are quoting rate out in the marketplace. It is down a bit.
Floating rate is is is lower than what it has been.
But theres still activity out there.
And orders coming back online I think I think it's a little early on when we look at though just commercial water heating.
And Kevin talked about the decline in the second quarter revenue, we have seen some uptick in order rates on commercial water heating. So if you look at Q2 compared to Q.
Compared to what we saw in July we see July up about 4% to 5% on commercial orders so.
Not yet we probably is some delayed.
Replacement, that's coming back online and we would expect Thats continues. So I mean, we tend to think about commercial commercial and it's both commercial and water heater again boilers.
The front half of the year looks a lot like the back half of the year were down roughly 10% with a lot of disruption.
Lot of disruption on boilers in the second quarter, but we expect some of that to come back on line and particularly since our boiler season is a little stronger in the fourth quarter, Yes, I think thats. The key takeaway here as we get closer to the the colder months and so forth, that's where we see you know us again Scott.
Rules and businesses start to fire up their boilers. So it's a little early we do have a reasonably strong backlog that we're still working through and.
We'll probably have a better view, but if you talk to our our our reps and who are on the ground they'll tell you that they are they expect the sites to to reopen they expect to see some some projects move forward and Thats kind of our assumption as we go forward to address to the year.
Your next question is found in line with Ryan Connors of mining in scattered did your line is open.
Okay, great. Thanks for taking my question.
It actually talk a little bit about the sort of.
Channel impacts channel situation, given everything that's going on obviously many of your distributors are.
Relatively smaller businesses. So in some cases, presumably there that could be some balance sheet pressures and other issues.
How is that impacted your wholesale business in terms of your own need to hold inventory.
Payment terms et cetera, and any any impact there anything that's evolving as this goes goes on with the channel.
Well most of our customers if not all of our customers in the channel are essential businesses remained open like we did and continued to operate maybe with curbside pickup and other and other activity. So we've been we've been fortunate that most of our customers have fared pretty well are well from the perspective of they've been able to operate in a difficult time.
We haven't seen significant impact on payment terms or any any other ability of our customers to pay.
Some of the smaller ones can qualify for loans. So so there there's opportunities for them to.
To do that so at this point, we we fared pretty well our customers a third early pretty well we have seen.
We have seen on particularly on the commercial side. Some destocking. So we've seen our customers work on.
Maybe taken a little bit of their balance sheet down of cutting a little bit on the and inventory side, particularly with the higher cost commercial product.
We believe some of the some of what we've seen in order rates, maybe will it has been impacted by that maybe in the industry to just some adjustments within.
Within inventory within the channel I would just add onto that I mean, you talked about construction, we talked about reopening and of course some.
All of our distributors or are also good is that business and balancing their inventories so.
Wonder I would tell you that all of our distributors for the most part are are managing through it they feed into the financial crisis and they've come out of it.
And at the same time, they're going to adjust their inventories to the current demand.
And so as we go forward and can demand does pick up I would expect them to adjust those inventories appropriately going forward. So overall, we have a tremendous.
Customer base with legacies of 2030 40 years.
Strong positions in the market and and their navigating through fairly well based on the information, we'll get from our sales organization.
Got it.
And then my follow up was just.
Really following up on that earlier discussion of water treatment really seems like you are building some pretty strong momentum there at this point in terms of the organic growth can you talk about just what is driving that is that more the market growth given all the p. foster concerns and led and all that or is that or is that share gain with your big box channel.
Where's that growth coming from if you can kind of give us some flavor there, we actually outlined it pretty well.
I think it's coming from all the things that you mentioned certainly the pandemic has heightened people's awareness.
But I would tell you at the same time.
I believe our water treatment team is executing very well through the process. We have updated websites our consumer engagement process is much better.
We have a telesales activity. So theres a number of foundational things that we put into improve ecommerce to improve our dealer network on top of the consumer becoming more aware of some health issues and particularly on water treatment.
We're also executing I think at a higher level than we were last year, which I think is critical for us to go forward and our close rates are up.
And that kind of ties in with our sales as as well. So overall the water treatment business is doing well, but it's not just a combination of the market. It's a combination of execution as well.
In the water treatment, we don't have the data that we have same water heaters. So, but if you look at we do get some information on water quoting from our water quality Association that tracks softener valves and tanks.
That is a little old because of the pandemic they haven't been able to update it but were up 20% plus and the market at the time that we had the data which is I believe in February was flat so.
We are taking I believe we're taking some share will need some more time to validate that but yes, it's going well, but it's a combination of market and our team executing at a much higher level than we had in the past.
Yes. This is Chuck I mean, I mentioned earlier that we've seen July demand continues strong and we've seen better mix of some of our install products.
As people are more comfortable with installers dealers getting into homes. So.
Kind of look through kind of the ended June or July timeframe, the softener mixed and some of the larger products. We've just seen that come back a bit.
Your next question is from the line is David Macgregor of Longbow Research. Your line is open.
Hey, good morning, everyone for and I wanted to ask about to lock in park and you'd mentioned that quoting activity was down a little at this point, although there's still some uncertainty as suppose where thats going.
And your comments, but.
Thats situation that scenario, one might sort of expect a higher level of competition competitive pricing pressure and.
So more vigorous level competition from some of the other players in the space. So what have you could just talk a little about what you're seeing on that side of the lock of our story and then also.
To the extent you could talk about what you're seeing in terms of the mix of units sold was in lockup are and what might be changing there.
As far as from a from a competition standpoint that we deal with that on a regular basis.
We haven't seen much change from how we quote and how we can go to market we've had to get a little creative about how we do sales calls and engineering calls on June but overall.
Not much change there we've had a nice mix toward some of our crest boilers, which are the higher VP you type products, which are in module application. So we you saw that come back this year quite quite quite quite well. So yes. Overall again I go back to the business, we're heading into our stock.
Longer half of the year.
There's still some uncertainties there that we've outlined but we're in position.
To capitalize as the markets do open up I think it's really important as we've been working our way through the pandemic, we've kept our operations ready to be prepared to come out of it.
As sales grow and as the markets reopened so overall operational were positioned to take care of our customers and and normally there is a little bit of emergency activity happens in the second half of the year, where people new things right away and we're positioned ourselves to take care of that as well.
Maybe just a little more color on mix to Kevin's exactly right you've seen some of the larger boilers in them a little heavier in the mix in the second quarter, we talked before about residential being light so and we look at residential in Q1. It was a warm a warmer winter and it was pretty it was pretty light for us in the industry.
Second in July activity is really kind of hard to read Weve always we typically we've done it this year again as Weve got to early by program. So early by program to specifically for residential boilers and.
That's that's running we're seeing orders come in.
Pretty well were fairly pleased with how that how that is typically playing out so.
Hard to read what's happening in July, but the residential orders on the early like program might be running slightly less than last year, but it's not done yet and we're pretty pleased with how thats playing out.
Thanks for that color.
Just second question on China, and you'd mentioned the the shift towards more medium price points. So thanks, very much for providing the detail on that mix.
No it's something we've discussed in the past.
I guess the question is with regard to capacity utilization rates, which I'm guessing right now you've got plenty of headroom, but as you shift more medium price point, what impact does that have on capacity and you need to invest capex and those facilities.
I would tell you right now there's.
We do have plenty of capacity and operating leverage going forward.
As you probably know we have three large facilities and and in China.
Being where we're at today.
From.
Our topline sales, where we were.
A couple of years ago, we have plenty of.
Capacity to handle it. So there is there we see no need for really additional capital from the production side of the business going forward for for several years.
Your next question is from the line US Nathan Jones from Stifel. Your line is open.
Good morning, everyone.
Hi, good morning.
I just wanted to follow up a little bit on on Ryan's questions on onboard a quality.
That's a pretty fragmented market here in the U.S. can you talk about where do you think your market share is what kind of market share targets, you would have and strategically thinking is this more of that build versus buy an organic growth versus roll up the market or do you see opportunity to to go about consolidate.
During this market and they're big advantages to that scale.
Well, let me I mean, it's tough for us to get a detail handle on share right and you're right. It is a fragmented market I mean, we think the addressable market. When we kind of look at a couple of different ways is about a $2 billion market. So clearly there is opportunity for us to continue to continue to expand our position.
It's both when you when you say is it a build versus versus buying I think there's opportunities on.
On both we've entered our strategy is we've gotten into leveraging the channels that we're in so we've got the direct to consumer channel through Aquasana, we intend to Amazon channel through Aquasana. We've also got.
Got the dealer channel through that water right acquisition, along with the Hegh acquisition.
We've introduced product into wholesale and we were in retail through low. So we've entered all the channels and we would expect to continue to grow that out on channel expansion within those channels over the next several years.
M&A, it's certainly an area that we've got our eyes open and we're looking at so we think theres opportunities in both.
Yes, I, just add a little bit more onto Thats, Kevin here certainly on the M&A front I think there's plenty of opportunity out there again, it's got to fit to work where were taken our strategy but.
If you look out I've always said on on any color on investor meeting that.
The opportunity for on the water treatment front is as I think area that we're going to spend a lot of time and there's there's opportunity there and there's the waste for us to leverage and consolidate over the long haul and again A.O. Smith is.
Always looking to make the industry better.
And raise it up and we think theres going to be opportunity.
Overtime to continue to find those right pitch for our business.
Okay.
A question on China, I mean, you guys talked about the mid tier price product being low margin into premium.
Product.
That's a relatively do introduction few into China is there opportunity through operational improvement.
Wrapping up the productivity of does line for you to close that margin gap between.
It may tier in premium TV price products without just leveraging volume.
Yes, there is opportunity we're we're working on cost reduction programs within the product.
Also work on cost reduction programs has been the manufacturing process. So certainly you're right volume would help us but were coming at it from multiple for multiple angles.
And just one quick one on capital allocation you guys had started this year ways at 200 million dollar target fair share repurchase.
Based on your projection for the back half of the cash flow, you're probably going to have about 500 million of cash on the balance sheet at their balance sheets going to be a little inefficient.
Can you talk about why do you think it would be appropriate to reinstate the share repurchase program. If thats next year would you look to kind of catch up a little bit into 2020 spending to go a long way to 2021 program. If we assume that the market during reasonable condition.
Yes, I mean, its little early for us to reach out and make that call right. Now I mean, we're watching where we typically frame that program you historically did not grow cash known and then in this environment. We do have a cash projection and you're right. We're pleased with.
Projecting $350 million for the year and we feel that right now, though there's there's enough.
Uncertainty uncertainty out there that we want to just watch it for the next quarter and we'll be back probably talking about it next quarter. Yeah. I would just add onto that is we still believe there's better opportunities in the market acquisitions all was.
Our preferred method to invest in.
I would like to see how things come out of the the pandemic and we're going to keep us keep an eye on that and again.
We expect to be some opportunities we want to be prepared from cash position to capitalize if they.
If they arise.
Your next question is from the line of Scott Graham Appeals and lots your line is open.
Hey, Scott.
Those guys are you there.
Yes, I'm, sorry about that I was on a muted myself.
Just a follow up follow up question on China, So were shrinking the number of sites there.
I think by about a thousand this year.
And here, we are with the channel.
Destocking unexpectedly.
Could one would be the causes the other how is that and how are you managing that second reduction how is that going.
Yes.
Well.
I don't think they're related Scott to be honest with you have one.
The the thousand stores that we keep referring to has to do with unproductive stores and and.
There is and we've done that over the years, we've had to close some stores reopen other stores and so forth. So.
That to me is a productivity market issue.
Because if there is a heck of lot of costs into offline sales and with promoters and so forth. So.
We because of the economic environment, there certainly its enhance this but.
So that's an independent.
Thing that we do on a regular basis evaluate our stores and closed an open appropriately.
As far the stocking, it's really up to our distributors to determine what the they need in their inventory and and again I don't think a quarter. A month is something we should really be surprised of some shift it wasn't a big shift we're still in that two to three month range of inventory and it's what's important is that they have the right.
Products should in stock and that we're driving business to the consumers. It's a solid we're in great position I think our distributors are in.
Significantly better positioned than they were say six months to a year ago.
And our sales are growing the opportunity to.
To sell more products.
As the economy Reopens is positive we had the capacity the lead times to take care that so again I think the inventories or just more of a separate business management by our distributors and and where we're taking care that the retail stores because it's the right way to to manage our cost of sales.
Gotcha, and then last one on.
Back to the North American business with.
Commercial which includes restaurant lodging looks like lodging certainly in spots is coming back fairly strongly but I think you have to emerge from this with some.
We're going to merge with a smaller restaurant footprint at least for the time ebay always seem to grow down back of the out years, but.
Is there a need here to maybe.
Come back to North America, and cut some costs on the commercial side, both water heaters and boilers.
Given that on a post covert basis, how are you looking at that.
Yes, I mean, we think a lot of that.
Demand that we're seeing in the second quarter in into July is postponement of some replacement going forward.
I think its little early for us to predict if theres a great deal of change in the footprint.
Those types of customers as a portion of where our water heaters and boilers do go.
But we'll continue to watch that so we'll continue to watch as it goes forward and see what happens right now we expect that just delayed and there will be replacement as those businesses start up yes. Scott is that it's a fair point in the FERC Fair question, but I think it's a little bit early.
And so if you look at.
Where our sweet spots are you hit it restaurants hotels and so forth.
Certainly the closures have delayed some of that but again going forward, depending how we reopened.
We'll have to see how that plays out but again the replacement market will be there.
And want to see what size. It is as we come out the other end.
Your next question is from the line, it's Kevin Hocevar Northcoast Research your line is open.
Hey, good morning, everybody.
On the water treatment guidance, I guess I want to understand a little more for the full year, 20% to 22% sales growth.
It seems to imply a fairly sizable slowing in the growth rate in the back half of the year, but it sounds like the DIY will that the organic growth in the second quarter seems to be carrying forward into July and want to companies that have seen DIY strength seemingly said that that.
Slowing, but still very quite robust and carrying forward and it sounds like the contractor based products seem to be getting a bit better. So I guess I just want to understand what.
Is there a reason to assume that there should be.
Reasonable slowing is there some conservatism in there just trying to connect the dots there and understand.
The guidance there going forward for water treatment, yes. It's good question I mean, we saw some fair strength coming into the second quarter, we think a lot of that or some of that we talked a little bit Kevin talked little bit before about the to strengthen the businesses is consumer awareness than maybe the shutdown people thinking about the water a little bit more.
The DIY channel you're right, it's been very very strong so.
The second quarter and into July we see a lot of.
A lot of activity on water treatment a lot of strength will that continue as people kind of get hopefully get back to a little bit more normal and and back to work.
I have to see how that plays out.
So you're right I mean, if you kind of do the do the math, we're expecting it to soften a bit in the back half and not be exactly that 20% to high order rates that we're seeing in the current in the current environment.
Okay got it and then on the I guess I just wanted to clarify in your opening comments I think you guys mentioned that.
Based on where you see your water heater shipments in June that you think the industry is.
Flat to slightly up was that a.
Just a month of June comment or was that the full quarter, because I guess, if it's a full quarter would imply June was.
Quite a robot month.
Offset the slowness in April and May.
Sure I shipments and and curious how you felt A.O. Smith has done versus the industry.
The second quarter and into July.
He is it that that comment implies the full quarter.
And again, we we did see a strong Jim.
So.
That's that's the into this going forward and then as you look at it we've always felt.
You know people will do without a water heater 24 hours that's about it so that that replacement market still going to be there and then we've seen.
Decent new construction still holding up over the over.
The various market. So you put those two together that's we came up with the.
A forecast of residential volume being relatively the same as last year.
But you're right. It comes off the strong Jim strong June and just orders carry forward into July we still see we still see that playing out. Similarly, so residential orders have been had been healthy.
In market share.
Latin American market shares the same there's really no shift in market share.
Your next question is from the line them Susan Mcclary of Goldman Sachs. Your line is open.
Thank you I guess you follow up questions. The first as you mentioned your commentary it during the process of establishing 500, new relationships store relationships in China can you give us a little more color on that it sounds like it into tier three tier stick city and then how does that kind of balanced against a thousand store closures that you've done there.
Well, the it's tier four to six cities and Thats, where a lot of the growth is.
And we have.
Those are much smaller stores.
But.
They are there in the areas that are growing so we're working with our customers to establish those relationships is to make sure. They have the right selling tools and products for that particular environment and we see the 406 tier cities, playing a bigger roll off particularly in the new construction part of the business and housing.
So that that's moving comparing the thousand to the 500 is is difficult, but again that there's really not a comparison to the thousand or underproductive stores not performing.
Got you know covering their costs and so courseware, we're just lean enough that part of our business, where the the 500 stores, which we've been expanding into your imports six cities for for a while now. Our addition opportunities they will be certainly less sales volume going through a tier four six cities.
Store, then obviously in a tier one tier two specialty store or retail store. So they're they're really two separate actions on our part one is more growth in once more cost control.
And so should we expect it they'll come online over the course of 2020 is that more they 2021 impact in terms of the revenues coming through and some of the benefit.
We expect those to come on throughout 2020.
I'm showing no further questions at this time I would now like to turn the conference back to Mr. Patricia Ackerman.
Thank you for joining us today, we plan to participate in Q virtual conferences in the third quarter.
Freeze on August fit and D.A. Davidson conference on September 22nd have a great day.
Ladies and gentlemen, this concludes today's conference call. Thank you for participating you may all disconnect.
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