Q3 2020 A. O. Smith Corp Earnings Call
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After the speaker's presentation, there will be a question and answer session to ask that question Green Dot signed wounds the fresh BARDA. The number one on your telephone keypad. If you require any further assistance. Please press star zero I would now like to hand, the conference over to your speaker for today a teacher. Thank you. Please go ahead.
Thank you Steven good morning, ladies and gentlemen, and welcome to the A.O. Smith third quarter 2020 results conference call.
Joining me today are Kevin Mueller, Chairman, and Chief Executive Officer, and Chuck Lauber, 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 answers to your question will constitute forward looking statements.
These forward looking statements are subject to risks that could cause actual results to be materially different.
Those risks include among others matters that we have described in this morning's use really.
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 exclude the severance and restructuring charges related to aligning 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 queue. Please limit yourself to one question and one follow up per turn if.
If you have multiple questions. Please rejoin the queue.
I will now turn the call over to Kevin who will begin our prepared remarks on slide four.
Thank you.
Our businesses performed well in the third quarter continue.
Continuing the pace of growth we saw in the first half of the year, our North America water treatment products grew 19%.
All channels direct to consumer retail and dealers contributed to the growth as health conscious consumers continue to drive sales higher.
Industry volumes of residential water heaters in the U.S. surge during the third quarter.
Based on our September shipments, we estimate industry volumes were up mid teens in the quarter compared with last year.
We believe an overall positive tone to new residential and remodel construction activity and extended lead times driven by pandemic related disruptions may have prompted some channel partners to build inventory during the quarter.
Due to construction project delays and postponements in North America, as well as uncertainty surrounding commercial construction.
We saw a commercial water heater and boiler volumes decline 90, 10% in the quarter compared with last year.
Consumer demand for our products in China increased by low single digits compared with the third quarter of 2019 as pent up demand from the lockdown materialize and consumer confidence improved.
We remained operational with no significant disruptions within our plans and our supply chain.
We did see our North America water heater lead times extend in the second and third quarters due to self quarantine absenteeism, which we mandated according to our coated prevention measures.
We shifted some production added shifts higher temporary workers to improve our lead times, which are now approaching more normal levels.
I would like to thank our dedicated employees, who tirelessly worked overtime hours and accommodated shifting schedule to take care of our customers.
We have taken numerous in meaningful steps to protect our employees suppliers and customers in the pandemic.
These important steps in many cases reduce inefficiencies.
Included opened in regular communication with employees and customers in line with our values.
And accommodations to maintain social distancing.
Employee temperature, taking and regular proactive deep clean incentives decision of our facilities among others.
To align our business with current market conditions, a process started in the second quarter, we reduced head count and incurred other restructuring costs totaling $1 million in the third quarter.
I will now turn the call over to Chuck Who'll provide more details on the quarter beginning on slide slide.
Thank you Kevin third quarter, 2020 sales of $760 million increased 4% compared with the third quarter of 2019. The increase in sales was largely due to higher residential water heater volumes and water treatment products sales in North America.
As a result of higher sales and cost reduction activities earlier. This year third quarter 2020, adjusted earnings of $107 million and adjusted earnings per share of 66 cents increased significantly compared with the same period in 2019.
Please turn to slide six.
Sales in our North America segment of $544 million increased 6% compared with the third quarter of 2019 higher residential water heater volumes and organic growth of approximately 19% in North America water treatment sales more than offset lower commercial water heater volumes and lower boiler sales rest of the world.
Sales of $221 million were essentially flat with the same quarter in 2019.
China sales were flat as higher consumer demand was offset by a higher mix of mid priced products.
On a currency translation favourably impacted sales by approximately $4 million.
India sales in the quarter declined compared with last year.
On slide seven North America adjusted segment earnings of $134 million were 10% higher than segment earnings in the same quarter in 2019. The increase in earnings was driven by higher residential water heater volumes higher water treatment product sales and lower material costs.
Lower volumes of commercial water heaters, and lower boiler sales, partially offset these factors.
Adjusted earnings include 500000 pre tax severance costs.
As a result third quarter 2020 adjustment segment margin of 24.6% improved from 23.6% achieved in the same period last year.
Rest of the World adjustments segment earnings of $18 million increase significantly compared with 2019 third quarter segment earnings of 4 million.
In China higher volumes reduction than SGN, a cost and approximately $3 million of temporary social insurance contribution exemptions were partially offset by a higher mix of mid priced products, which have lower margin.
These results exclude $1.1 million in pre tax severance and restructuring costs.
As a result of these factors adjustments segment adjusted segment margin improved to 8% compared with 1.9% in the same quarter of 2019.
Our corporate expenses of 10.9 million were higher than the same quarter of last year, primarily due to lower interest income.
Please turn to slide eight.
Cash provided from operations of $330 million during the first nine months of 2020 was higher than $280 million in the same period of 2019 as a result of lower investments in working capital, which were partially offset by lower earnings compared with the prior year.
Our liquidity and balance sheet remains strong we had cash balances totaling $509 million and our net cash position was $395 million at the end of September our leverage ratio at the end of the quarter was 6.1% as measured by total debt to total capital.
We had 500 million of Undrawn borrowing capacity on our 500 million revolver.
No shares were repurchased in the quarter in our share repurchase activity continues to be suspended we repurchased approximately 1.3 million shares of common stock for a total of $57 million earlier this year.
Please advance to slide nine.
We upgraded our 2020 adjusted EPS guidance. This morning, with a range of between $1.95 and $1.98 cents per share. The midpoint of this range represents an increase of 10% compared with our prior 2020 full year guidance, our 2020 adjusted EPS Guide.
Once excludes four cents per share in severance and restructuring costs incurred in the second and third quarters.
Our 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 experiencing today and does not deteriorate as a result of further restrictions or shutdowns due to the cold at 19 pandemic.
We expect our cash flow from operations in 2020 to be approximately 400 million compared with 456 million in 2019, primarily due to lower earnings.
In 2020 and capital spending plans are between 50 and $55 million and our depreciation and amortization expense is expected to be approximately 80 million in 2020.
Our corporate and other expenses are expected to be approximately $50 million in 2020 higher than 2019, primarily due to lower interest income on investments.
We expect our interest expense will be seven.
$7.5 million in 2020, compared with $11 million in 2019 due to lower debt levels.
Our effective income tax is expected to be our rate is expected to be between 23 and 23.5% in 2020.
Our assumptions assume no additional share repurchase resulting in average diluted outstanding shares in 2020 of approximately 162.5 million.
I will now turn the call back to Kevin who will summarize our guidance assumptions beginning on slide 10.
Thank you Chuck.
Our outlook for 2020 includes the following assumptions.
We project us residential water heater industry volumes will be up 4% and 2020, driven by a positive new home and remodel construction environment in our belief that the channel added inventory due to extended lead industry lead times.
We believe some de stocking will occur in the fourth quarter as our lead times have and continue to improve.
We expect commercial industry water heater volumes will decline approximately 10% as.
As a pandemic impacted businesses in temporally coast job sites in the first half of the year delaying or deferring, new construction and discretionary replacement installations.
It is encouraging to see consumer demand for our China products slightly higher than last year over the last six months.
We took additional charges in Q3 for further restructuring of this business.
We believe these restructuring charges are behind us.
We continue to target closure of a thousand existing stores, while targeting opening 500 small store relationships in tier four through six cities.
Cost actions and restructuring activity are projected to result in approximately $30 million of savings in 2020 over 2019.
$7 million of which will be realized in the fourth quarter.
We expect the year over year declines in local currency sales of 18% to 19%.
And project mid single digit growth in the fourth quarter as October sellout continues to be positive compared with last year.
We are encouraged to see profitable results in the third quarter.
With the heavy lifting of SGN, a cost reduction essentially complete.
We expect our North America boiler sales will decline by mid single digits. This year.
Commercial boilers represent 65% to 70% of our boiler sales and industry volumes were down 15% to 17% year to date.
And improved slightly in the third quarter from the second quarter.
The market is competitive and we are getting our fair share of the available market.
We project, 22% to 24% sales growth in North America water treatment products, which includes incremental water rights sales.
We believe the megatrend of healthy and safe drinking water as well as reduction of single use plastic bottles are driving consumer demand for our point of views and point of entry water treatment systems.
We ended 2019 with a $2.6 million loss in India and expect a similar loss in 2020 as a result of the pandemic.
Please advance to slide 11.
We project revenue will decline by 6% to 7% 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 sales largely due.
To the pandemic in the first half of the year.
We expect North America segment margin to be between 23 and 23.5%.
In rest of World segment margins to be between negative one and negative 2%.
Please turn to slide 12.
We believe that particularly in these uncertain times A.O. Smith is a compelling investment for a number of reasons.
We have leading share positions in our major product categories.
We estimate the replacement demand represents approximately 80% to 85% of us water heater and boiler volumes.
We have a strong premium brand in China.
The broad product offering and our key product categories.
Broad distribution and a reputation for quality and innovation in that region.
Over time, we are well positioned to maximize favorable demographic in both China and India to enhance shareholder value.
We are proud of the progress and the opportunity we see in our North America water treatment platform.
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 acquisitions and return cash to shareholders.
That concludes our prepared remarks, and we are now available for your questions.
Thank you as a reminder to ask the question you will need to press aspired been the number one on your Capex phone keypad.
Just two questions on the annual pressing star one sort of thing and the key to.
We carry a question please press the pound key.
Our first question will come from the line of Matt Summerville from D.A. Davidson the lines that will open.
Couple of questions first can you talk about what your normal North American water heater lead times looks like where they peak, where they are now and whether its October results are consistent with your view that the channel is going to take inventory down in Q4.
Our normal lead times are about 15 days.
And thats on residential, but quite frankly, our commercial products as well, maybe a little less.
They've got as high as in 2025 days.
Little bit higher that may be at certain times.
So we worked it down to what we had mentioned in our remarks to more normalized level.
And we expect.
We expect our customers too because of our lead times coming down you will probably adjust some of their inventories down to the appropriate levels since they bottom up up with some concerns if the if there was any disruptions from our manufacturing facilities.
Limited as a follow up within China have you now seeing sustained sort of month to month positivity and overall volumes and can you talk about where your mix has been trending over the last several quarters with respect to mid price point. Thank you.
Yes sure Matt This is Chuck.
We have seen sustained year over year.
Sales improvement in that low single digits. So I would say, it's been pretty consistent throughout the quarter and through October where we've seen year over year consumer demand. So we've been pleased with kind of that I'll call it stability of of demand coming through.
Alright, our next question will come from the line of Scott Graham from listen that the Securities. The line is now open.
Yes, hi, guys. Good morning, nice quarter guys. Thanks, guys. Good morning.
So I was I understand now why your fourth quarter guidance is maybe a little bit held back given some of the.
Just stocking.
I guess the other side of it is that the North American margin was was quite strong now does that mean that the fourth quarter North American margin May BPX <unk>.
We are targeting a little bit by some of the Destocking.
Thats My first question yes.
Yes, EPS is Scott you're right down in the third quarter was very strong. So I mean, when I just take a step back and kind of think about when we had our last call. We had we had projected the north America residential industry to be flat and.
When you kind of look at the August results under the industry were up almost 5% and when we look at what we saw in September we saw continued strength. So our full year call to be the industry up 4% does have does have that headwind in the fourth quarter. So thats largely the reason for this.
The swing so we Kevin talked about.
Lead times, we made up probably half what we were over by the end of September and you've got a little bit more of the lead time that was made up in October but lead times are pretty close to normalize so that headwind will will will be.
In the fourth quarter, and we think some of that's going to carry we think some of the channel inventory will carry into next year, but we also think some will come out in the fourth quarter.
Okay. So essentially what I think I hear you say is now you are the industry leader, So you've got a better bead on this than anybody but essentially what youre seeing is in the industry data that you see some market is maybe just a little bit ahead of it got a little bit ahead of itself in the last month or so.
Yes, I mean in the industry data, but what we're seeing in the industry as customers getting when lead times extend its fairly typical that customers will stock up and make sure they've got product to make sure that they've got product on hand, particularly in the replacement market.
For anything that would come up so they don't generally order stronger than the than they typically due to ramp up that inventory.
Scott I would tell you know just to give you an outlook, we're seeing some of the orders start to be reduced in in October So and again, we don't have great visibility to all the inventories of our customers but.
We do believe that there was some inventory build and that there will be some destocking in Q4.
Our next question will come from the line of Jeff Hammond from Keybanc. Your line is now open.
Hey, good morning, guys Werent Marni.
Just on North America commercial.
So how would you characterize demand versus how how youre expecting it in the quarter and then just talk about kind of.
Order quoting activity and I know, there's a lot of concern about non resin to 2021, Mike.
How do you see that shaping up.
This is Kevin it's actually shaped up about exactly how we thought it would be.
The commercial market has had with.
With the closing of some jobs in reopening there's been a lot of volatility there. So from the quarter was no different and we see Q4 being no different as well so.
So it came in about where we thought and.
As we start to look at our quoting activity. There is some softness out there, but they are still there is still activity and I think the big question is going to be is and we'll have to see how Q4 plays out.
You know the robustness of jobs being released in moving forward.
A few others get delayed or not but overall the market is down it came in where we thought it was going to be and I think Q4 will be a similar view.
As we get to the end of the year.
Okay, and then China I think you mentioned mix shift again here.
When do you think that starts to normalize our bay or are we kind of stopped talking about or do you see that continuing for a bit.
Yes, I mean, it's been continuing for a while as consumer confidence even before the pandemic was a bit lower we didnt see as much trading up particularly on the water heating side of the business, we see a little resilience on trading up on the water treatment side of the business but.
For the for the quarter that headwind on sales volume is maybe in that 5% range. So it's.
It's similar to what it was last quarter and until we see consumers trading up we would expect that we would see a little bit of headwind on that mix were.
At least throughout the fourth quarter.
Just to add a little bit more color to that as well is.
You know the markets the premium markets, our wholly but theyre just as a small piece of the pie.
More importantly that theres been.
No noticeable recalibration against in either brand. So the market is still got to play itself out consumer confidence is growing we expected to continue but it may be some time before we start to see meaningful movement back up to the premium sector.
As it grows and we we were very pleased with it and it came out pretty much where we projected were with where China ended up the quarter.
We have been working on that breakeven point, we were above the breakeven point.
We had we had a we had a solid mid single digit quarter in China, and kind of came out right, where where where we planned we mentioned some some of the social exemption charges. There was about a 3 million dollar held on my prepared comments on the social exemption think of that as social security type exemption, where we didnt need.
To pay into the government some some of those extra tax cost or social costs.
Thats a program thats been its been extended through the year. So its been extended through the end of the year will not expect to repeat it next year, we would not expected to be extended and.
It's about 3 million this quarter, it's about 1 million and a half next quarter.
But overall, we're pleased with how the chatter results came in and the stability I guess than what we'd say is consumer demand being positive year over year.
Our next question will come from the line of Nathan Jones from Stifel. Your line is now open.
Yes. Good morning. This is Adam Farley on for maximum payout.
Hi.
In water treatment.
Going along lines of some of these positive credit trends, including.
No home improvement home.
Okay bottling.
Do you think this team has legs in the larger business again, it was a really strong quarter and then.
In that business are you seeing any delays the scrum accessing homes spec could have actually dampened demand at all.
Well, there's a couple of questions Eric.
I do think that there is still a tailwind to water treatment in the us.
And that will continue and for us it you'll go into fourth quarter, but just to be transparent we do have a tough comp in the fourth quarter. We had a very large inventories built with one of our customers last year, but if you look at how October is playing out there's there's still.
Quite a bit of consumer demand there.
And this would translate into 2021, probably some of it.
One of the great things about the water treatment business is every time, we sell a product we get to sell a consumable later, so that's going to have some legs on it as it goes forward, but I do think.
Consumers are just more health conscious today, it's not just.
Covidien and the safety aspects to that I think we do more health conscious and quite frankly with sustainability plastic bottles or just not.
Probably a product for the future for a lot of people. So overall, we've been really pleased with our.
Our business our execution across all the channels.
And so then you mentioned, whether some access to houses and so forth that has been caused by the pandemic and the answer is yes.
But our team has worked and learn how to particularly our dealers.
Weren't how to sell virtually have social distancing linear visiting a customer to install with the social distancing protocol and quite frankly, our dealers are doing quite well and had a very nice quarter in Q3.
And we thought we saw a nice mix improvement from Q2 on the water treatment business because of the fact that point of entry products, which required generally professional installation was little bit stronger and it had been dampened a bit in Q2, when we had less access.
That's really helpful and then turning to margins.
He has called out lower raw material costs.
Benefit.
Commodity prices generally they are on the rise should we expect to see any headwinds margins of the short term order to not be covered with price mix.
Yes, I mean, the North American margins were were really strong for the quarter or some some of that to an earlier question was when you. When you have that type of volume going through the plants in the quarter you get some real efficiencies on the leverage on fixed we do see some we do see some minor headwinds if you if you recall.
Our steel, which is our large largest costs, we see visibility in that 90 to 120 days, because that's where our pricing locks and so while there has been some recent uptick in some of the spot pricing in steels, which we've seen in the last call. It 16 to 30 days.
Our fourth quarter year over year, it's it's still favorable it's a little less favorable than it was in Q than it was in Q3.
But it will still be a favorable year over year.
Our next question will come from the line of sorry for the key from Jefferies. Your line is now open.
Thank you good morning.
Yeah, really sharp margin for congressional gridlock, but it looks like guidance assumes some set down the fourth quarter can you just talk about what you think is a good starting point for US I think about the potential margins for 2021 any puts and takes there.
You know, we we feel everything we've talked about in the fourth quarter, we would see China performing mid single digits margin operating margin.
It's a it's a little early for us to be thinking about 2021, we like kind of the stability of what we've seen in in Q3, and what we expect in Q4 on China being the largest part.
We won't see the repeat of the social insurance exemption that we've that I mentioned earlier and that when you thinking of SGN, a that's about $7 million of SGN inc. for the year.
So that will be a bit of a headwind.
But we've we've got India, who always has the fourth quarter is our largest quarter, India has been challenged a bit uncoated 19. So we're going to have to see how India plays out in the back half of the year. So it's a little early for us to talk about 2021, and we'll be ready to do that when we come out in January is just another.
Comment might have uncertainty every quarter just changes.
And so.
As we're heading into in into Q4, we have spikes across the us.
Chuck just mentioned, India goes in and out of walk down depending on the CIRT regions Europe. So we're going to manage through the uncertainty in each month that goes by in this and each time, we get to a better picture what the future looks like.
Is helpful. So to talk about 2021, right now would probably be not not probably in our best interest and probably would just be speculation. So we're we'll manage through Q4 and as we did on our call next year in January we'll give you our best guidance to what we feel the business is.
Going.
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I appreciate that.
The next question the Biding Korean actually platform tough sledding Sina pine.
Christian teaching talk about what that really means you guys. How do you think.
The impact.
Well, let me take that and then maybe check can jump in as well.
There's a lot of discussion about.
Electrification, we refer to him work to de carbonization greenhouse gases.
And as we look at it were in favor of reducing greenhouse gases and.
But at the same time, we are again, we are talking to the policymakers to make sure that there isn't a one size fits all type of solution. We really believe it's a combination of many many.
Different types of products and technologies.
So as we go forward and you look at it from the water heater business.
We have full lines of of condensing product as you know leading boilers, leading water heaters and those have a major impact into carbon reduction and so forth going from a non efficient too inefficient. We have a full line of electric water heaters, both standard in electric sender electric as well as heat pump the pump is.
He is a terrific value proposition and.
Could be part of the of the solution going forward then on the commercial side of the business. We have a full line of again electric commercials, but also we recently introduced a full line of commercial heat pumps. So.
So when you when you look at how the.
Energy policies going forward, we're fully aware with them we're fully engaged.
With with policymakers as well as the various agencies, we're positioned well and we continue to.
You know bring products to market that we think are going to be.
Address this issue and even to the point of utilities.
Many of our products are going to be able to be connected. So if there's a grid solutions, we are going to be part of that so overall, we're positioned well.
How is how it moves forward that's going to be something we'll have to keep monitoring but the big key I think for everybody on this call is were involved.
And where where we're helping to drive that as an industry leader and down and our products and our factories are prepared for any direction that it takes.
Our next question will come from the line of Brian Blair from Oppenheimer. Your line is now open.
Thanks, Good morning, everyone. Good morning.
Chuck I think you previously cited North American water treatment margins were running high single digit range in the first half outlook for around 10% for the year is that outlook still valid or is your own growth driving driving margin a little bit higher just trying to gauge the jumping off point for 2021, Yeah, I would say, it's still valid I mean, we.
Mentioned.
An earlier question that we saw a strong mix for the.
For the quarter, which typically has higher priced higher higher margin product and point of entry and so for the quarter were just above that 10%.
So we're we're on track we're on track.
Okay very good.
A higher level one we know your team does a lot of work tracking and modeling the replacement cycle on the resi side.
If you're willing to comment on this how is the pandemic impacted your assumptions and how should we think about that base level of demand going into 21, and then looking out to 2002.
Well, you're certainly right we've done a lot of work on it and we've shared in prior calls that we.
That we just don't see a big drop off we see a gradual decline over the years in that one or 2% range I'm quite frankly, we've been focused on the pandemic. So we really haven't dug into this last quarter and projected out something that we'll look at obviously as we go forward, but the.
The initial assumptions in the work that we've done we still think are valid as we go forward and ended this blip it turns out to be a blip.
I guess is that we'll have that same position going forward.
Okay. Thank you.
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Our next question will come from the line of Susan Mcclary from Goldman Sachs Line is now open.
Hi, everyone. Good.
Good morning, good morning.
My first question is can you talk a little bit about pricing in North America, and what do we think about some of the inventory that has built over the quarter and perhaps you're going to head into 21 with a bit more inventory in the channel what does that mean as the industry starts to think about pricing for next year.
Yes, I mean as the only public company were not we don't comment on pricing.
Particularly go forward pricing.
We do we do look at going into next year and with a projection that there will be some inventory in the channel.
Some will come out in Q4, but we think that there will be some left in channel early next year.
Yes, I would just say on that in and probably going to sound a bit like a broken record but.
Historic historically, given time, we've been able to to address inflation then and.
And Thats kind of where we stand with any of these type of cost questions and pricing questions.
Okay. All right. Thank you and then.
One is on China, you mentioned that you're in the process of opening those 500 stores in the tier four to six cities.
Look at some of the recent data you can see that the online sales in China and water heaters, both gas and electric have accelerated 2030, 40% in August and September.
Off line sales seem to be down 15, 20% at the same time can you talk about how youre thinking about the dynamic that's going on there how you're positioning yourselves to capture that kind of growth that's coming through especially in the online channel and maybe what the opening of the stores kind of means within this framework.
Well, let me let me take a shot at this.
Just to put their theres two questions in there one is online and that one's about the smaller.
Tier four to six year us businesses.
One we are opening those actually were opening a bit quicker than we thought in his long term, there's a good growth opportunity.
In those tier four and six cities in having the right products and the right relationships and working pretty diligently on that have been quite successful opening the stores.
And we'll continue to do that as we go forward.
If you look on the online side of it we've enhanced our online.
Commerce capabilities and.
Some of the mid priced products Weve added in some of the digitalization in digital marketing that we are in the process of executing or have executed online is going to be.
Certainly a growth engine in China for the next few years and we are positioning ourselves in that category appropriately again remember a lot of the online is in the very lower price range, where we don't participate but there is a segment that that fits our mid price to a premium segment and we're we're engaged.
Aging in that it's a number one priority for our business and we're continuing to.
Executing on our on our plans to capture our fair share of the online sector.
Our next question will come from the line Us Ethan move binder from Cds that I guess I will open.
So China appears to be continuing a year over year mix shifts towards mid priced products.
Can you tell us how far along are you in optimizing the cost structure of mid price products to get more in line with higher price products from a margin percent perspectives.
Yes, I mean, we're we're still working our way how far long, it's going to it's going to take a while I mean, our priority over the last 18 months is to make sure that we're reinserting products into that upper mid price category and then we do the cost reduction. So we're I would say we're in the early stages of that we're going to be working through that over the next year or are.
Year, and a half to get better at the in the margin line. So it's going to it's going to take a bit of time, yes.
Yes, I would just add cost reduction in that activity is in our DNA across all of our businesses.
So there is never a point, where our first goal was to get the mid priced into the market and I think we've essentially done that.
And they've been accepted very well and doing well in the market.
And then but every year, we're looking at ways to to drive productivity price material cost out redesign products and thats not only in China, but that's across all of our businesses and we'll continue to do that we always believe theres cost reduction opportunities in all of our products and throughout our processes and that.
Includes China as well as the other parts of our business. So again cost reduction is just what we do on a regular basis.
Thank you that's helpful and but that's the capital ending the quarter at about 6.1% so given the strong balance sheet.
What are you seeing in terms of M&A opportunities in the water treatment space and what would you need to see to start the share repurchase program.
Well, let me start with the share repurchase I mean, we suspended the program in the first quarter.
We weren't that we're going to hold off and to the rest of the year and come back and talk about at the beginning in the year. So.
With the disruption of coal that we just felt it was the right thing to do we typically size the repurchase the macro cash and we feel pretty comfortable with where we are going through the year here when our cash projection, but we just we're going to hold off until the first part of next year and on January timeframe to talk about that.
M&A front, we're continuing to absolutely be active we look at targets that are out there difficult time, the last with the last couple of couple of months and quarters to transact anything but mm.
The market is more active.
It's sort of a more active there may be some opportunities coming out of this timeframe for some of the companies. There are on our target list I think may be more interested in transactions, but we can continue to remain active yes, I think some of that.
100% agree with Chuck just said our targets and then our retail program through the course opportunities come across our desk.
But in reality I think more the opportunities will come as we get through the parts of this pandemic and get more stable, but again, we're active and.
We're.
We have the cash to take advantage of any good opportunity that comes our way.
Our next question will come from the line of Daniel Cardenas from you. Yes. Your line is open.
Hi, good morning, everyone. Thanks for taking my questions. Good morning, good morning.
So we've already covered quite a bit of round care appreciate all the insight you've been able to provide.
Just wanted to touch back on the rest of world margins.
Some already to some extent and sounds like you are not quite ready to give an outlook for 20 straight line.
But once you factor in all the moving pieces like the restructuring benefit yes, some of those temporary EPS DNA.
Other costs that they might be coming back and then product mix.
Wondering how much volatility.
You kind of expect it see quarter in quarter out with respect to the segment margin obviously, they might have been all over the place last couple of years.
Could you maybe get tighter range from here how are you thinking about that.
Yes, I mean, we like that we like we like what we saw in Q3, we feel pretty comfortable about Q4, so that range has been.
We hope firmed up with the help of some year over year consumer demand beings more stable.
Thinking about their range going forward I mean, the only caveat I would say to that on a bit of both a quarter over quarter is the first quarter is always very tough you have the Chinese new year in the festival in the shutdowns and that's just a quarter that when you're thinking about kind of sequentially, which quarter is that most challenge.
Its Q1, but for the for the long term and for kind of what we've seen today and what we see in the next couple of months is we feel like Thats stabilized a bit we feel like we've got a decent decent Florida work from to your point, we've taken out a lot of costs on SDMA, we were right on track for all our restructuring programs some of that May come back.
As we see growth in when there's opportunities and some investments like deferred advertising and brand building that.
We could bring back into the business and should we see some opportunities to do that as we go into next year.
Okay now that makes sense. Thanks.
And then I wanted to ask you about the North American water heater market, obviously flight.
Slide discussion around there.
On some new competition.
Wondering if you're seeing or hearing anything at this point related to the new market entrants.
And.
I also wanted to ask you Jeff.
Recent surge in the industry shipment.
Curious what kind of trends you might be seeing in Pangea west.
Okay.
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Let me start with Tankless Permian period, I would say Tankless has been.
Last year. It was it was up about 6% historically it had been growing double digits, what weve seen taco to Sears, it's growing it's also growing above 10% this year. So.
Tankless is growing about that double digit range.
New entrants I.
Thinking about new entrants, maybe Matt lunch has been.
Not much activity I guess, we haven't heard a great deal different than what we had on the last call there.
There really hasn't been a new.
Significant information that's been that's been in the marketplace lending rather quiet yes.
Yes, again I would tell you from just more of a macro level, where we see how competitors seriously and this has been a topic that we discussed on a couple of calls and we will always continue to monitor the market.
But more importantly, we take care of ourselves in and if you look at who's pandemic and you reach out to our customers in the service levels and what we've done.
Demonstrates the ability to A.O. Smith has to be a long term partner and so our focus certainly we'll watch our competitors, but our focus has always been on taking care of our customer.
And now.
Nothing proves that than a some type of crisis, where a pandemic and so thats, our focus and again, if anything I would agree with Chuck on the on the competitive front, there's not been much with the the new entrants and if there is we'll we'll just an appropriately and comment now if and when it happens.
Our next question will come from the line of David correctly, Some Longbow research triangle Cielo.
Hi, good morning, everyone.
Wanted to ask you about yes.
Good morning, I wanted to ask you about China and certainly you guys have accomplished a lot there there's been a lot of progress in terms of just getting the costs straightened around inventories down.
But you're talking about mid single digit growth in the fourth quarter and I guess I just wanted to understand the composition of that growth.
Is it coming from water treatment rather than from water heaters, I mean, you talked about the premium segments being stable. So I'm, assuming that we're not seeing a lot of growth in the premium segment that it's.
And while there's maybe some growth in the mid price point.
My sense was that there was a little more of a struggle going on there so.
Help me understand just the composition of that mid single digit growth and what's the potential that maybe there's upside to that number I guess.
Yes, I mean, so that mid single digit growth is really a combination of consumer demand for our entire portfolio. So you're right. It's not all equal and we are seeing water heating side is under some pressure for year over year demand.
We are pleased with water treatment for the quarter water treatment performed very well in China.
On a per unit basis, so actually that the biggest drivers in water treatment for the quarter in China were our commercial business, which we don't talk about a lot, but last year was about $20 million in.
In sales in the commercial business grew nicely quarter over quarter consumables that repeatable business of consumables that we have which is approximately 15% of the total grew very very nicely too. So in total north our China water treatment business was up over 10% for the quarter. So you're right, we're looking pretty favorable at that site.
But as a business as we go through the fourth quarter.
On the margin for the rest of the products. We've got a range of products that are smaller smaller level and some other products that are doing quite well. So we would see consumer demand for our portfolio continuing in that in that year over year improvement and then and to your point, we're pleased with how water treatment performed for the quarter.
Right.
Is there anything on the horizon in terms of innovation or some change in terms of market construct that would draw the Chinese consumer back to the premium price points that would create.
Gross story there again.
Others always innovation.
In the <unk> and in the background.
And that's across our.
Our three major product categories for sure and Thats water heating.
Guess, what any electric and of course.
On water treatment.
Nothing that I would I would tell you that we can announce today, but we always have to our hundreds of engineers working on what's new it's a requirement as a premium brand we have to bring new innovative products out there we have a portfolio of ideas and we'll we'll probably launch a few of them in the upcoming year like we always.
New and as they.
Consumer brand, it's important that we have some new products come to market is that match, our premium brand and what they expect from our brand, which is innovation and quality, yes, I mean, the most recent product that we launched that comes to mind in the water treatment side is the hot water tap that has a filter built into.
So it's a it's a hot water tap that you have on your countertop.
And Scott filtered and boiling if you'd like to have water at the same time so.
That was proud that that's one of the more successful products that has some innovation in the products that we've launched recently.
Okay.
Our next question will come from the line of Scott Sam from Rosenblatt Securities. Your line is now will thing.
Yes, hi, good morning, I get cut off before I want to ask a couple but everyone asked us some pretty good questions here. So I tend to have a couple of quick.
Could you talk a little bit about sort of how commercial.
Trended and maybe differentiate commercial water heaters versus for others because those markets are so.
Really different dynamics, but sort of how they trended during the quarter as you did they end up strongest year over year in September was it more even if you could help us out.
Yes, I would say that it was in the where were down for the quarter on boilers about 7.5% I mean, it's pretty even when you go into October I don't see that we see much change.
Commercial water heating so when we're looking far heating when we're looking at kind of order demand I would say October was very similar to what we saw in third quarter, so not a substantial change.
It's been pretty pretty much the same as we go through that I would.
And there are not.
Well, that's a pretty pretty pretty much running the sector into into October.
Scott the we talked a little bit on the call it as.
You do have jobs opening and closing.
Quite frankly stub trade issue out there with a shortage of skilled labor so the market.
As we had mentioned to you we see a similar Q4.
And a lot will have to keep rise and how we get into Q1, but again.
I'll be a little bit repetitive, we are seeing activity, it's a little bit slower than it has been but there's still activity in the commercial market.
Understood. Thank you I wanted to also maybe talk little bit about sort of the guidance because I'm not sitting here listening to others I'm, just circling around to model and to get to your.
Operating income operating margin guidance for North America, it really kind of presupposes or a pretty.
Down hard fourth quarter margin and.
In the in the territory of two to 300 basis points a.
Would you agree with that be what can you do about it.
Yes, I mean, we were really strong in Q in Q3 in Elk and when you have that kind of volume that goes through the plants. Our margins were really really strong.
So we're coming off of that.
So it's it's about that's about it's in that range, maybe not quite as large as your projection is but it's in that range of down.
Strong strong Q3, so cute Q4 were.
We're we're looking at a little bit of headwind on conversion costs compared to Q3.
All right. Our last question will come from the line of lagging EBIT Maria from William Blair. Your line is now open.
Hi, Thanks, everybody.
Two quick questions first on India.
Obviously.
As an impact from cold weather and a setback, but what do we need to see for any to get back to breakeven or even start turning a profit is it volume growth into next year or is it do we have to adjust the cost base just curious how you're thinking about getting that to to breakeven given that it's kind of obvious disappointment.
Yes to to get to breakeven and beyond it is volume related.
As we scale up.
Water he's been scaled pretty well water treatment, we are still scaling.
I've mentioned this before we had some really nice momentum over the last couple of years taken out chunks of the losses, two and $3 million each year and really had a nice path going forward to breakeven in 2020 and just unfortunately, the pandemic has hit it hit India.
Hard and it's continued to hit it but you look at it being able to do some of the cost reductions that we've that we've done this year and if that India can turnaround in heavy its economy moving in a positive direction and we can drive some volume.
The chances are we probably won't add in all the costs that we've taken out and we will be able to do some leverage there, but when it's all said and done previous volume we need to have the economy improvement and we need to take share in some categories. You put the combination together it leads to a breakeven and then move forward position for us.
We are 5% to 10%.
From that.
Fair to say or is it a bigger number.
Also last year, our volume in India was about just under $40 million is about 39 million. This year in our projection is we're going to be down 20% to 25% off of that number. So as we were coming into this year, we were expecting to be breakeven, we expect the growth rate in India to be in that doubled.
Digit range so.
As Kevin said, we kind of look at the cost balance in just a little bit more volume off of where we were last year you get to that breakeven. So decide it's not a huge leap from from last year, but we've got to build back up from where we are in the current environment.
Okay, that's great color and then last question.
Restaurant hospitality hotels et cetera.
Not surprisingly headwind just curious has the economy sort of start to open up a bit in Threeq. You did you start to see some sequential increase in that sector for replacement just.
Just kind of trends, you're seeing how sensitive that can be towards reopening or closing.
I think Reopenings key I think you hit it on on a major part of particularly on the restaurants that.
The hotels.
I think it's too early.
I, we we still see spikes across the country, we still have orders I'll give you one here in Wisconsin.
Mandate only 25% in restaurants and at first capacities and so I think it's too early.
But as you go forward as that does open up that plays well to us as the as those restaurants start getting people in Washington dishes and use in hot water as well as the hotels, but it's it's a bit early to make that statement.
Okay. Thanks, very much good luck.
There are no further question Patricia Ackerman continual.
Thank you all for joining US today, we plan to participate in Q2, our conferences in the fourth player Robert W. Baird on November 10 at an art code on November.
Enjoy your day. Thank you.
This concludes today's conference call. Thank you for participating you may now disconnect.
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