Q4 2020 A. O. Smith Corp Earnings Call
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Good day, ladies and gentlemen, and welcome to the a O Smith 'twenty and 'twenty results Conference call.
At this time all participants lines are in a listen only mode.
Later, we will conduct a question and answer session and instructions will follow at that time.
If anyone should require assistance during the conference. Please press Star then zero on your Touchtone telephone.
As a reminder, this conference call is being recorded.
I would now like to turn the conference over to your host Ms. Patricia Ackerman Senior Vice President Investor Relations, we are S and treasurer you may begin.
Thank you Julie good morning, ladies and gentlemen, and welcome to the a O Smith full.
Full year, 'twenty and 'twenty results conference call.
Joining me today are Kevin Wheeler, 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 questions 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 press release, please advance to slide three.
In order to provide improved transparency and to the operating results and 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 a life 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 on our website on.
Also as a courtesy to others and a question queue. Please limit yourself to one question and one follow up question per turn 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.
Okay. Thank you Pat.
Before we begin discussing our results and outlook.
On a send my deepest gratitude to the thousands of a O Smith employees who've been working under less than ideal conditions and you'll continue to keep our operations running offices open and customers and hot and treated water.
To recap 2020, better than expected fourth quarter results drove our 2020 performance above our expectations.
North America water treatment grew 14% organically driven by continued consumer demand for products promoting a safe home.
And the direct to consumer channel with our <unk> brand.
Retail outlets with our a O Smith brand and the deal a channel all contributed to solid 2020 growth.
We believe industry shipments of U S residential water heaters, including tank was surged to a record.
10 million units or 8% growth over the prior year.
And this assessment is based on our strong December shipments.
We believe the overall positive tone to new residential and safe at home remodel construction activity.
<unk> and increase and proactive replacement demand.
And channel inventories and stocking related to extended lead times resulted in above trend growth in 2020.
Due to construction and project delays and postponements and North America.
As well as pandemic related weakness and restaurant hospitality, new construction and replacement demand, we saw a commercial water heater and boiler industry volumes declined by 8% to 10%.
We maintained our market share and both of these categories.
Progressive year over year improvement and consumer demand for our products and China continued in the fourth quarter.
As a result of higher volumes and diligent efforts by our team to reduce costs and reorganize.
High single digit margins were achieved and the second half of the year.
And North America aside from the voluntary closure of our Mexican facility for several weeks and the second quarter. We remained operational throughout 2020 with no significant disruptions within our plants and our.
Our supply chain.
Pandemic related safety protocols remain in place and our facilities and our offices.
Due to strong residential water heater demand, coupled with self quarantine related apps and to use them our lead times remain above normal.
We continue to use temporary workers swing shifts and expedited logistics and some cases to take care of our customers.
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Good day, ladies and gentlemen, and welcome to the a O. Smith 2020, a result conference call at this time all participants are in a listen only mode.
Later, we will conduct a question and answer session and instructions will follow at that time.
And a west should require assistance during the conference. Please press Star then zero on your Touchtone telephone.
As a reminder, the conference call is being recorded.
I would now like to turn the conference over to your host Ms. Patricia Ackerman Senior Vice President Investor Relations C. R. S and Treasurer you may begin again.
Thank you Julie and I apologize to everyone on this call. This morning, we had.
Telephone problem and.
And so we will start over from the beginning so that you can hear all of our prepared remarks, and then we will go into questions and answers I believe you heard the introduction that I gave so we will I will turn the call over directly to Kevin Wheeler, Okay again.
Thank you Pat and our apologies for some technical difficulties here and.
And this may be redundant, but we think it's important to start from the beginning.
Before we begin discussing our results and outlook I want a spin my deepest gratitude to balance as of a O Smith employees, who have been working under lift and ideal conditions and will continue to keep our operations running office is open and customers and hot and treated water.
To recap 2020, better than expected fourth quarter results drove our 'twenty 'twenty performance above our expectations.
North America water treatment grew 14% organically driven by continued consumer demand for products from owning a safe home.
The direct to consumer channel with a <unk> brand.
Retail outlets with our a O Smith brand and a dealer channel all contribute to solid 2020 growth.
We believe industry shipments and U S residential water heaters, including Tankless surged to a record.
Exceeding 10 million units or 8% growth over the prior year.
Assessment is based on our strong December shipments.
We the overall a positive tone to new residential and safe at home remodel construction activity, including an increase and proactive replacement demand.
And channel inventory stocking related to extended industry lead times and resulted in above trend growth and 2020.
Due to construction project delays and postponements and North America, as well as pandemic related weakness and restaurant and hospitality, new construction and replacement demand, we saw a commercial water heater and boiler industry volume declined by 8% to 10%.
We maintained our market share and both of these categories.
Progressive year over year improvement and consumer demand for our products and China continued and the fourth quarter.
As a result of higher volumes and diligent efforts by our team to reduce costs and reorganize and high single digit margins were achieved and the second half of the year.
And North America aside from the voluntary closure of our Mexican facility for several weeks and the second quarter. We remained operational throughout 2020 with no significant disruptions within our plants and our supply chain.
Pandemic related safety protocols remain in place and our facilities and offices.
Due to a strong residential water heater demand coupled with self quarantine related absenteeism, our lead times remain above normal.
Continuing to use temporary workers swing shifts and expedite logistics and some cases take care of our customers.
All of these efforts result, and inefficiencies and incremental costs.
To align our business with current global market conditions, we reduced head count and incurred other restructuring costs totaling approximately $6 million after tax and 2020.
The majority of these actions took place and China.
We progress or a second corporate responsibility and sustainability report and January I'm very proud of our accomplishments since our first reported particularly and employee engagement safety resource reduction and our facilities and a product portfolio that both some of the most efficient products and their respective categories.
We introduced our first ever Covid greenhouse gas emission goal, we strive to reduce ghd emissions by 10% by 2025.
I will now turn the call over to Chuck who will provide more details on a full year and the fourth quarter beginning on slide five.
Thank you Kevin.
Full year sales of $2 9 billion declined 3% compared with 2019 and largely due to significant weakness from the China business and the first half of 2000 and <unk> as a result of lower sales adjusted earnings declined 3% to $351 million a $2 16.
Her share compared with $370 million, a $2 22 per share in 2019.
Please turn to slide six sales and our North America segment, a $2 1 billion increased 2% compared with 2019 higher residential water heater volumes growth and water treatment as well as full year, a water right sales were partially offset by lower U S commercial water heater volumes and lower boiler sales and a water heater sales.
Mix composed of more electric models, which have a lower selling price breast.
And the rest of the World segment sales of $800 million declined 14% from 2019 pandemic related lockdowns and weak and market demand primarily in China, and the first half of the year and a higher mix and mid price products resulted in lower sales.
Currency translation of China sales favorably impacted sales by approximately $9 million Indian sales were also negatively impacted by pandemic related economic disruption and declined to $31 million compared with $39 million and 2019.
On slide seven North America segment adjusted earnings of $506 million increased 4% compared to 2019. The increase in earnings was driven by favorable impact to earnings from higher residential water heater volumes growth and water treatment sales a full year, a water right sales and lower material costs.
Impact to earnings from a lower volumes of boilers, and commercial water heaters and the mix skew to electric water heaters and partially offset these factors adjustments adjusted segment earnings excluded $2 7 million and pre tax severance cost.
As a result, adjusted operating margin of 23, 9% slightly higher than in 2019.
Rest of the World adjusted segment earnings of $5 million declined significantly compared with 2019, and China and the unfavorable impact from lower sales and the higher mix, a mid price products, which have lower margins and higher price products more than offset reductions in SG&A costs and temporary waivers a required social insurance contributions.
<unk>.
As a result of these factors adjusted segment operating margin, a 6% decline from four 3% and 2019.
Our corporate expenses at a $52 million were higher than in 2019, primarily driven by lower interest income.
Turning to slide eight.
A record fourth quarter sales of $835 million increased 11% compared with the fourth quarter. A 2019 the increase in sales was largely due to higher residential water heater volumes in North America.
And a higher sales and China.
As a result of higher sales and cost reduction initiatives earlier this year.
Fourth quarter earnings of $120 million or a 74 per share increased significantly compared with 2019.
Please advance to slide nine.
Record fourth quarter sales in North America segment, a $561 million increased 7% compared with the same period and 2019, primarily driven by higher residential water heater volumes.
Rest of the World fourth quarter segment sales, a $279 million improved 19% compared with the fourth quarter a 2019.
Currency translation of China sales favorably impacted sales by approximately $14 million.
Constant currency, China sales improved 15% driven by a mid single digit growth and end market demand led by water treatment.
Based on water treatments filters and gas tank tankless water heaters, and a favorable mix between product categories compared with a fourth quarter of 2019.
On slide 10 record fourth quarter, and North America segment earnings of a $138 million increased 7% from the same period and 2019. The increase in earnings was primarily driven by higher residential water heater volumes in North America, and lower steel costs. These factors were partially offset by logistic costs.
As a result fourth quarter segment margin, a 24.6% was slightly higher than 24, 5% and 2019.
Rest of the World segment earnings of $31 million improved significantly from $1 5 million and the same quarter in 2019.
And China higher volumes reductions and SG&A costs and lower material costs drove higher earnings as a result of these factors fourth quarter segment margin improved to 11, 2% compared with 6% in 2019.
Our corporate expenses of $16 million and the fourth quarter were higher than on the same period, a 2019, primarily due to an increase and long term incentives and lower interest income and the 2024th quarter.
Advancing to slide 11.
Cash provided by operations a $562 million during 2020 was higher than 2019, lower investments and working capital in 2020 were partially offset by lower earnings compared with the prior year our.
Our liquidity and balance sheet remained strong our cash balances totaled $690 million at the end of 2020, and our net cash position was $576 million.
At the end of 2020, our leverage ratio was 6% as measured by total debt to total capital.
We are in a process of refinancing a 500 million revolving credit facility, which expires at the end of the year. We currently have no borrowings on this facility.
We expect to repurchase $400 million worth of shares in 2021 through a combination of <unk> hundred one program and open market purchases recently, our board increased the authorized shares on our share repurchase authority by 7 million shares.
Turning to slide 12.
We introduced our 2021 EPS guidance. This morning, with a range of between $2 40, and $2 50 per share the midpoint of a range represents an increase of 13% compared with our 2020 results our guidance assumed the conditions of our business environment and net of our supplier.
And customers are similar in 2021 to what we have experienced in recent months and does not deteriorate as a result, a further restrictions or potential shutdowns due to the COVID-19 and debit.
We expect cash flow from operations and 2021 to be between 450, and $475 million compared with $560 million and 2020, primarily due to higher earnings offset by higher investments and working capital than in prior year.
And 2021 capital spending plans are between 85 and $90 million and our depreciation and amortization expense is expected to be approximately $80 million.
Our corporate and other expenses are expected to be approximately $51 million slightly lower than in 2000 and Swan.
Our effective tax rate is assumed to be between 22, five and 23% and 2021.
Average outstanding diluted shares of a $160 million assumes $400 million worth of shares are repurchased in 2021.
I'll now turn the call back over to Kevin who will summarize our guidance assumptions beginning on slide 13, Kevin.
Thank you Chuck our businesses and the countries and which we do business continued to navigate through pandemic related challenges, particularly and supply chain and logistics.
Our outlook for 2021 includes the following assumptions.
We project U S residential water heater industry volumes will be down, 2%, a 200000 units and 2021.
We are encouraged by the positive tone and a new construction market. Although we believe some destocking will occur during 2021, as we expect industry lead times to improve throughout the year.
The timing of the Destocking is difficult to predict because we had two price increases announced one affected in February and a second one in April.
Destocking activity could be delayed until mid year due to a pre buy orders in advance at a price increases.
Further note on the 2021 price increases we have seen inflation across our supply chain, particularly steel and logistic costs.
Steel has increased nearly 50% since we announced our February one water heater price increase of 5% to 9%.
We announced a second price increase last week on water heaters effective April one.
Also between 5% and 9% depending on the type a water heater.
We expect commercial industry water heater volumes will further decline approximately 4% as pandemic impacted business delay or defer a new construction and discretionary replacement installations.
And China. It is encouraging to see consumer demand for our China products progressively improved in 2020 and into January of 2021, we.
We accomplished much in China, and 2020, which will allow us to profitably grow and 2021.
Those and content accomplishments include.
Closing, a 1000 stores and tier one and two cities, while efficiently expanding and tier four through six cities.
Implementing programs to save $30 million, and SG&A, which will carryover into 2021.
We've lapped a negative impact to earnings from mid price products, we expect positive mix and 2021 from new products.
And we execute programs, resulting in a stronger and more nimble and distributors.
We expect year over year increases and local currency sales between 14 and 15%.
We assume China currency rates remain at current levels, adding approximately $45 million and $3 million to sales and profit over the prior year respectively.
We expect our North America, a boiler sales were increased by mid single digits and 2021.
Our expectations are based on several growth drivers.
Industry growth of 3% to 4%.
We assume some pent up demand after the industry decline and the low teen levels in 2020, the CAGR per commercial condensing boilers.
And as over 50% on of the board of the revenue.
Was 5% to 6% prior to 2020.
We believe replacement demand is still 85% a potential government stimulus package targeting and infrastructure investment may free up some jobs that were postponed or a halted in 2020.
The transition to a higher energy efficient boilers will continue, particularly as a commercial buildings and improve their overall carbon footprint.
And 2020 condensing boilers were 39% of the commercial boiler industry that represents our addressable market, which provides continued opportunity for our leading market share commercial condensing boilers.
New product launches, including improvements to our flagship crest commercial condensing boiler with a market.
A differentiating oxygen sensor, which continuously measures and optimizes boiler performance and the introduction of a 1 million Btu light duty commercial night ft XL boiler.
We project 13, and 14% sales group and our North America water treatment products.
We believe the Megatrends of health and safety drinking water as well as a reduction a single use plastic bottles will continue to drive consumer demand for our 20 use now reported entry and water treatment systems.
We believe margins and this business could grow by a 100 to 200 basis points higher than the nearly 10% margin achieved in 2020.
And in India, a fourth quarter sales were similar to the prior year. We project 2021 full year sales to increase over 20% compared with 2020 and to incur a small loss of $1 million to $2 million.
Advanced a slide 14.
We project revenue will increase by approximately 10% and 2021 and strong North America water treatment and China sales enhanced by growth and boiler sales more than offset expected weaker and North America water heater volumes are 10% growth rate projection includes approximately $45 million a benefit from China currency translation.
We expect North America segment margin to be between 23, and 23, 5% and rest of world segment margins to be between seven and 8%.
Slide 15 please.
2020 was a challenging year and we're pleased with our performance through the pandemic.
Particularly in these uncertain times, we believe a O Smith is a compelling investment for numerous reasons.
We have leading share positions and our major product categories.
We estimate replacement demand represents approximately 80% to 85% of U S water heater and boiler volumes.
We have a strong premium brand in China, a broad product operating key product categories broad distribution and a reputation for quality and innovation in that region.
Over time, we are well positioned to maximize favorable demographics, and both China and India to enhance shareholder value.
We are very excited for the opportunity, we see and our North America water treatment platform.
We have strong cash flow and balance sheet supporting the ability to continue to invest with a long term with investments in automation and 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.
Yes.
Ladies and gentlemen, and we have a question at this time. Please press the star and then a number one key on your Touchtone telephone and for a question has been answered or you wish to remove yourself from the queue. Please press the pound key.
Your first question comes from Jeff Hammond with Keybanc.
Hey, good morning, good morning, Jeff Good morning.
So just on the China business.
Clearly you have a really easy comp and the first quarter, just trying to get a sense of how youre thinking about.
Seasonality is it back to normal and then.
Just on a margin cadence and rest of world you kind of were putting up high single digits, even above your guidance. So maybe just talk about margin cadence through the year for rest of world.
Yes, sure I can do that yes, we were really pleased with the fourth quarter.
Back to double digits from Q4 had a really nice favorable category mix and some decent online volume in China. So we're pleased with the fourth quarter. When we look when we look at 2021.
Think we're back to a more normal cadence.
And it always Q1 is a challenge for us So Q1 O b the lowest quarter.
I would expect that we're going to progress progressively through the year like we have and the VAT and the in the past, maybe 2021 might be 45% of the revenue and the first half of the year, a 55% and the back.
And our best quarter, It will be Q4 again and in 2021, so probably starting out a year.
Youre right last year is not a it was a pretty easy comp right. So we would expect revenues and the first quarter to potentially double last year's revenues.
Low single digit margins and progress from there throughout the year.
Okay. That's helpful and then.
Just on.
Just on North America I guess.
Youre a unit volume expectation is down and most commercial and res I think your guidance maybe implies mid single digit growth is that is that largely a function of price or are you baking any any kind of share gains or mix within North America. Thanks.
What we're really making and is that there'll be some destocking.
And into 2021 so.
And just came up a record year.
For the industry and as we look forward, we're as we said and our comments, we're very excited about the new home construction market. We think we still think there's going to be quite a bit of a proactive activity at the DIY level.
But embedded in there is some some inventory that is industry lead times us kind of move back to normal we see that.
Declining and bringing the industry down from this last year by a couple hundred thousand units.
Yes, and then kind of the offset to that little bit of a headwind on a destocking is.
And we do have boilers and projected to be favorable next year and Kevin's comments earlier talked a little bit about some of the new products coming out potential.
Potential some help on infrastructure, we do see the industry with replacement being somewhat resilient and maybe some of the work pushed back last year rolls into 2021 water treatment, we project kind of a back to back for a 13% to 14% increase and water treatment over tapping that and and yes, we do expect price roll.
Going into next year. So we've got we've got a steel costs, particularly leading our costs for 2021, and we've got the two price increases one on February one and <unk>.
And then one on April one.
Rolling into next year.
Yes.
Thank you.
Yes.
Your next question comes from Matt Summerville with D. A Davidson.
Thanks, Good morning.
And with respect to China can you talk about.
And the outgrowth you achieved in the fourth quarter relative to the market. I think you said you were up kind of mid teens constant currency the market up mid single digits, maybe parse out that GAAP to the upside and your business.
Yes, there's a couple of things. So if you look a kind of industry data and look at share and some of the other metrics out there what they're not capturing as what's happening and our specialty stores and and we're really pleased with what what kind of performance. We had on our specialty stores and Q4. So that was that was strong consumer demand overall, we saw on the mid <unk>.
Single digits, and a strong mid single digits.
But the product category mix that we saw in Q4 was really helpful. So we had a higher product you get higher and higher sales cost on gas tankless, our water treatment products have higher sales price.
And decent commercial business and the quarter. So the mix between categories and was very helpful to our growth.
So that's probably the biggest pieces I mean, we're really pleased about the fact that our mix we've talked in the past about some headwind on mix and we're really kind of lap that as we said on our comments, where we really want and expect a negative headwind on mix and China.
Going forward, we would expect it to be neutral or slightly positive. So we're we're kind of a at a stable a stabilized point, we believe on the mid price products and <unk>.
Positive to neutral going forward.
And just add a couple of things under that we've done a lot of work on our mid price products.
And our cost structure, and so forth and quite frankly, and some really.
Terrific products that are a bit.
And to be launched and are have launched.
A high input and our electric water heater category, we're going to be the only brand out there with a category and a great one noise level on our tankers, which is a.
Huge factor for consumers in China, a noise is always an issue because it's inside the home and.
Our water treatment.
Products have been doing quite well and we have a number of new ones coming up that will continue to expand our our higher flow rates and along with.
Heavy and providing hot water so great work on the mid price but.
We haven't lost sight on a premium clients with all three that I just mentioned on the premium category.
And then with respect.
From my follow up with respect to the price increases you're putting in place Kevin does that cover you guys.
Relative to where spot prices are today or I mean, given if you just look at steel prices had gone like parabolic on them I'm sure you're well aware a bet. So with this the second increase youre putting in are you effectively covered a today at today's spot prices or do you need to contemplate later in the year, maybe a third increase thank you well, let me start out as Chuck said and give you some and some of the deal.
Sales, but as you know we tend to trail.
A cost, but we always take action and we have demonstrated that we can do that over time, what we are going to be trailing for a while and it can be Chuck and give you. Some comments on on how we see the price increases.
Working their way through the market, yes, I mean, our outlook our outlook and our guidance assumes that we're steel pricing stays kind of at where it is for the index right now and carriers throughout the end of the year.
And then of course, we talked about our price increases so.
When we look at next year we.
We would see that those price increases are probably going a lag a little bit on what we're going to see on the costs, we get a little bit of a runway of 90 to 120 days, but to your point steel pricing has gone up so dramatically. So quickly that we're probably going to be chasing low margin a little bit as we go forward.
And without commenting specifically on.
In particular achievement and price I would just say historically over time, we've been able to cover that.
Great. Thank you.
Your next question comes from Eaton Bookbinder with Citi.
Okay.
Hi, Good morning, Thank you for taking my question.
Good morning.
Great you mentioned stability and North America water heater manufacturing lead times.
Talk about your visibility to the level of residential water heater customer inventory levels and at the <unk>.
And lead times and potential pre buy ahead of price increases and how should we think about that affecting seasonality and 21.
Let me take that I mean.
And as the industry on residential is up about 8%.
Over 2019, and I think you really kind a have to think about or I think about the jumping off point in 2019, which was down about 2% from the trend line. So I mean, the industry up and 2020 is really 6% to 8%. When we look at inventories. We think about the fact that it's probably half of that might be changing and IP inventories that a bit.
So if you are in that three 3% to 4% of that increase is inventories in the channel and not all of that is going to come out a 2021, we don't think so if it's 4% and a portion of that comes out of 2021 were maybe down to that 2% headwind that we see helped a little bit by what we think will be encouragement and the housing <unk>.
Set on that and we still see proactive demand on water heaters being pretty strong so.
And we kind of arrive at that 2% when you think about kind of the cadence for the year we.
And we don't believe the price increases that have been announced pulled much if any interest into sales into 'twenty and 'twenty, but the first quarter effective February one and effective April one we would expect some increased demand on on the price increase driving some volume into Q1.
Okay.
That's helpful. Thank you and.
And I can kick off.
China saw a healthy growth, 15% constant currency can you give us an update about how do you expect a 500 store openings and tier six cities are performing and what are your expectations for a store openings or closings and China during 'twenty one.
Well, let me touch on that and then Chuck will give you some figures.
One.
And you start to look out and tier 4% to six tier cities.
I want to caution and make sure that we described these are a these are small calendars. If you will they are really not the type of stores that youre talking about and CE tier one and tier two cities.
So I.
And I just wanted to calibrate as we open up those stores there.
And it really kind of a counters with Lin.
Limited volume, but.
The ability to sell a product across those.
And as growing cities from a standpoint check on our forecast.
And as.
Yes, so so low tier four to tier six cities and.
We're kind of parsing there stores, a little different than what we have and the path. So we've talked historically about 9000 or <unk> 9500 stores and.
And we're parsing it really tier one and tier two and then back to a Kevin said tier three tier six and the tier one and tier two cities. If you go back to 19 that had been a little over 7000 stores and those categories and and the tier four to six is around 2000, and so you kind of split it up into those two categories and you get to the 9000 9500 stores.
On the tier one a tier two our focus is really efficiency looking at store efficiencies and we're and we've talked about closing a thousand stores and we have so we went from about 7400 stores at the end of 2019 at the end of this year about 6400 stores.
We've accomplished kind of where we were set out to do the closing and 1000 stores.
And when we look into next year not much changed we would probably have a little bit.
We're continuing to look and evaluate and efficiency, but we did not expect much change and that tier one to tier two cities tier.
Tier three or I'm, sorry tier four through six as Kevin said.
It's a different selling model and our expectations are different.
And how we're really measuring that is less about how many counters our footprints, we have and more about the volume of sales going through there. So that's what we will probably be talking about more going forward. We've opened up more than 500 stores at a target and when I say opened up we've got relationships and counters and significantly more than a 500 stores and were.
And going to be just kind of looking at volume through those stores going forward.
Thank you very much I'll pass it on.
Thanks.
And your next question comes from Damon Erez with UBS.
Hi, good morning, everyone. Good morning.
Wanted to ask you a follow up question on <unk>.
On the China business and.
And rest of world margin in particular.
And making some really nice progress there.
And you talked about some of the factors there with mix starting to come back just wondering kind of thinking longer term.
And where you are on a basic pay I mean are there any structural reason why you think you wouldn't be able to get back to kind of a low double digit margins on a consistent basis.
Or is that achievable over time, and if so kind of.
And what's it going to take you to get there.
Well I would tell you I believe and we've talked about getting back to those.
Mid to low teen margins and certainly we think we can get there on structural changes no.
If you look at our strategy our strategy is going to stay consistent.
We're a premium brand used innovation to drive a products into the consumers and.
A market.
We invest and high service levels with a high quality company that foundational part of our business is not not going to change it back.
<unk> enhanced however, it is a market is changing you have some online going.
Getting larger.
You have some changes and in the retail sector and tier one tier two and what we're going to do is we're going to remain nimble and like we have adjusted and our model as far as store openings and how we go to market Youll see a big part of digital.
Sure.
A big driver for us as we engage customers going forward the day of going out and having somebody and every <unk>.
Store as a promoter and <unk> talked about and are probably going to be limited.
And we will use digital more and we'll continue to expand into the other markets that those four and six tier cities. One day are going to be tier one tier two tier three cities and we need to have a position there. So overall I mean, our strategy where we're at.
Getting getting to those tech on margins, we think are doable over time and we've been taking the steps in 2020, we will continue to take those steps in 2021 and beyond.
Yes.
I'll just add that volume really does matter.
Q4, we had a decent volume and we get that kind of volume we got a double digit margin in Q4. So over time, we would expect that we would continue to see consumer confidence driving driving demand and and looking at kind of.
Hopefully, we get back to the point, where we've got more trading up to a more high.
A high premium products, which by the way this year and we saw some positive trading up and water treatment and the water heating side with stable to up slightly so we're optimistic about getting back to double digit margins, probably we're not we don't have and and our outlook for next year, but we see a path.
Okay got it thanks.
And then.
And you did a nice job.
Walking through your expectations for the U S residential market.
And I was wondering if you could perhaps.
Give us a sense on how we should think about the cadence for the commercial market and share.
I mean that that down 4% or are you sort of expecting declines through the year or.
Maybe growth and returning at some point, how should we think about that.
The way and we'll go ahead and.
I think about and the way we think about it is.
We still need to see economies opening up mid restaurants capacities and open up and.
And hotels and travel so.
We have a 4% a decline built into our model.
We hope as the vaccine comes out and.
And a herd immunity starts getting closer and closer and we see the restrictions and those type of restaurants and hotels to be less and less companies start opening up and traveling so if anything we see more improvement maybe in the back half of the year than we do and the first half as we continue to.
A work through the pandemic and.
And of course, the vaccines being transmitted to the number of people that needs to be.
Okay. Thanks, so much a good luck with it I'll pass it along.
Thanks.
Your next question comes from David Macgregor with Longbow Research.
Yes, hi, good morning, everyone.
Just a question on the.
Good morning, just a question on the inventories in North America, and you've provided quite a bit a color around that so that's greatly appreciate it but what's the opportunity to.
A throttle up downstream kind, a demand creation and 2021 as a way of.
And a burn through that.
That inventory surplus a little faster.
Okay.
And I would tell you that.
The inventories are going to be.
Moving to faster is really just from the economy open up.
And and again.
We could see more improvement and the DIY side of the market where people are doing more to their homes as we saw in 2020.
And of course, a new construction and depending on labor on the market. There is a lot of things that can happen that can.
And that can drive demand.
One of the biggest challenge for the construction business has been labor. So those are two things as things progress and again I keep going back to you as the economy opens up and as Hell.
We haven't had salespeople travelling for a year other than under emergency conditions, where we're not spending time and the market as much as we like to do all of that is going to matter as force for us to drive demand. Both from just the economic side, but also from from us and looking at gaining some share so.
Yes.
There's more.
And there's more action and have to happen, but they also have to be some economic and and some opening up a the economy for us to move that forward and bring the inventories down.
Okay understood. Okay. Thanks for that and then secondly, just on a boiler business and you walked through quite a bit a detail on.
And why you were feeling confident in that mid single digit growth number for next year, so that as well as appreciate it but I was just wondering if you could.
Could talk a little bit about what youre seeing and the backlog for that business that may be giving you confidence or is this more just kind of assembling all of these drivers and a theoretical construct and and this has got a lead to a better growth there.
Are you seeing hard evidence in terms of orders and backlog now and that's giving you that confidence.
I can tell you what we're seeing today, we didn't see the delay and postpone a projects as we saw back in.
Last year.
That's number one.
And the number two the activity and the market is lower but there's still activity going on there.
And so.
And as we go forward, it's not just about some of the private and speaking being released and.
And the economy growing there is a component of new product launches that we have that are going to be important to our growth. So it's a combination of those what I would tell you and we were excited about the crest boiler with the OTI. <unk> is is an important part of what we're going to do and we actually introduced several new products and 2020 debt.
And it got lost and the mix of the pandemic that I believe are going to help.
Help our business as we go forward.
Yes.
With regard to your specific question on backlog.
Backlog is pretty similar to what it was at the end of last year before the pandemic so backlog.
The backlog is pretty solid.
Okay.
And is there anything is there anything incremental to the distribution story on boilers that would be helping you next year.
Nothing specific we still a strong distribution of course, we have our our rep network, but I would say nothing that would be material to talk about today.
Right right, Okay. Thanks, very much gentlemen.
Thanks.
Your next question comes from Susan Mcclary with Goldman Sachs.
Thank you good morning, good morning.
My first question is on the water treatment side of things I know you highlighted that you expect some cash.
And really elevated sales there over the course, a 'twenty one can you talk a little bit about the margins I know that you have.
Made some progress there over the last couple of quarters, but how youre thinking about that on a go forward basis.
Any kind of pressures or benefits that we should be aware of and that.
No and we were pleased with the expansion of about 200 basis points a margin. This year. So we're just under 10% and 2000 and 2020.
Going forward with the help of leverage on some growth. So next year, we tend to see that growth being a 13% to 14% again.
And continued work on costs, we would expect margins to expand over actually over the next couple of years in net one hundreds a 200 basis points. So we do expect forward progress on that as we continue to grow the base and continue to look a cost out and wood.
Just add citizen volume.
Volume matters there too.
So as that business continues to grow we get to leverage our facilities the operating leverage within them.
And which will also help.
And as to improve margins on a long term basis.
Okay. That's helpful. And then my second question is just you mentioned that.
You are starting your share buyback program. This year I think you on you.
And kind of earmarked for 100 million or so for that and.
Color in terms of.
And the kind of cadence of that how we should be expecting it to come through and then kind of any appetite at the higher the lower end of that $400 million.
No I mean, I would peg it at 400 right now I wouldn't really go higher lower and we're probably looking at throughout the year is what we're kind of thinking of the cadence would be pretty evenly throughout the year.
Okay.
And your next question comes from Bryan Blair with Oppenheimer.
And.
Thanks, Good morning, everyone, Hey, Brian Good morning.
Chuck and I apologize if you've provided this detail on you have offered a loss, but if we keep other variables constant for the year, what's the margin impact of normalizing residential volumes from 2021, just trying to parse that out.
And that's <unk>.
Relative to hit knowing there are some offsets elsewhere.
And then.
There are so many I mean.
It's hard to say that it's going to be stable right. There's so many moving parts of our cost have gone up so dramatically and the in the last a short period of time and when you look at those costs going up.
Look at Youre right Theres, a theres a little bit of a decremental margin impact.
Impact when you've got a couple of hundred thousand units coming on to the industry.
So yes, there is some headwind there, but theres. So many moving parts. It's hard to say I think we're going to we're just going to and we're going to be chasing our cost a bit next year.
As he said the costs have gone up so dramatically.
And that theres going to be at least and the first half of the year, a little headwind on North American margins.
Okay understood.
And great to see the momentum in your North American water treatment business.
How is your.
M&A pipeline and looking particularly when it comes to targets to continue to scale that platform.
And I would tell you that as we always do we try to be active and we.
Certainly a target that.
We continue to stay close to and contact with them.
And the pandemic has made that a little bit more challenging but.
We remain active and reaching out to the appropriate people and and has begun on the pack.
And this pandemic I think theres going to be some opportunity but.
And as active as we have always been and looking for opportunities that make sense to our core business.
And your next question comes from Nathan Jones with Stifel.
Good morning, everyone.
Nathan.
I just wanted.
And wanted to follow up a little bit on that and the rest of world margins. A comment that you don't have double digit margins sales into the model for 2022 on.
On a conversations we've had that you targeted getting a mid mid price product margins and China up to that.
On the premium tier module by the end of 2021 with volume retarding pretty nicely in our Gaba a year.
Why is a net debt you could get to double digit margins in 2022, and what are the top one or two things that would need to happen for you to achieve that double digit margin in 2022.
Yes, the fourth quarter is always a strongest quarter and China. So if you kind a look at the fourth quarter you take out currency you multiply it by four we're back to a $1 billion business and the year just doesn't play out that way in.
Q1 is always weaker.
And so Q1 is just is it just going to be challenged on that so if you look and kind of the quarters.
Building through the year, we're just not quite there yet on the volumes and on the cost out now the margins you are absolutely right. Our goal is to get the EBITDA.
Contribution margins backup to a similar percentage to the premium side of the product that's going to take a little time. It takes a couple of things it takes cost out, which we're working on overtime and we won't we won't be on that position and 2021, but we are working on it and it's going to take volume to help us kind of leverage that through the through the footprint in China.
And just a question on <unk> 'twenty North America, you guys had anticipated some channel destocking in <unk> 'twenty.
And does it look like that happened can you talk about what led to that happening was that just customers deferring destocking that because a new price increases to a calming fundamental demand picked up sell through we picked up just any commentary you can provide on on what changed between your assumptions like you were giving for Q2 'twenty guidance.
And im not sure I could describe a better than you just did.
Good morning.
And all said and done.
Yes, when we were talking about Destocking, we didn't have a pricing piece coming up and quite frankly, a demand stayed there.
And I think as.
And we look back on and our distributors probably want to build a bit heavy right now on their on their inventories just to make sure. They can take care of their their customer demand. So there's a few things that happened you described zone.
We expect that sometime in 2021, probably in the latter half of the year Youll start to see what we had said in the prior quarter actually.
Happen.
Your next question comes from Scott Graham with Rosenblatt Securities.
Good morning, Scott.
Scott Your line is open.
Scott are you there Hello.
I'm here can you hear me, we can hear you net okay.
They happen there.
Okay, well congrats on a quarter so.
First question is on China could.
Could you give us that percentage of sales.
For the business, which I know you load up everything and there was a award treated and everything.
Premium versus upper middle and a quarter yes.
Yes, it really hasnt changed much and.
And it's pretty it's pretty consistent with what we've been talking about so we still see the majority and the upper mid price.
Part of the segment of a market and not a lot has changed since the prior quarters.
Got it. Thank you and then on the best and North American business.
I wanted to just trying to square away some commentary on mix.
Stay on them.
I think you said that last year residential was units industry worked up about a but you kind of a call that a normalized 6% to 8% and debt.
The inventory build was maybe half of that.
Not all of that will come out this year. So it sounds to me like.
Minus that's.
A 2% headwind does that a fair.
Yes, that's fair I mean, we think we will get a little bit of a help on new construction potentially in that category too. So.
That's a best exactly the way, we're thinking about it and and our outlook.
Alright, well I only repeat a few words and I just wanted to make sure I got it right.
Those are very very clear comments and I mean.
Paul a question from that is if I may is.
Yes.
If youre thinking that the industry is down too and it's essentially because of that reason.
I guess I'm, just wondering why you wouldn't expect sort of let's call it normalized.
Why would you expect it to be only flat residential conditions are quite strong. This year I know you answered David's question earlier about.
Labor and what have you I mean, it's a quickbooks.
Try.
Try to get a contractor and your house you can how you have to pay hard currency.
And kind of saying I understand that but is it a labor day or are you just maybe being a bit conservative on that number.
I guess I think a it's Scott.
We continue to expect to see some pretty decent consumer demand next year and proactive demand to be only down too so and this year being up six to eight.
And next year being down two and you still have that kind of a baseline proactive replacement and strong residential.
Replacement.
Some potential of growth year over year, I think and our numbers. So we do still expect it to be.
Consumer demand pretty fairly strong relatively strong similar to what we saw this year on that underlying proactive replacement.
And that would also tell you we're coming off a record EBITDA.
And what we're we're forecasting is going to be one on the strongest years and the past decade.
And there's still a lot of optimism out there, but we still believe there is some stock that's going to come out there is going to make a difference.
Yes, I mean really.
The big variable on how we look at next year is that 2% destocking.
200000 unit Destocking.
Your next.
And comes from Saree <unk> with Jefferies.
Hi, good morning, Thanks for fitting me in.
Good morning, just talk through what Youre, seeing and pancreas market in North America, and if your IP and any other areas and today's legislation from meta, California, liquid and gas Houston residential homes, and how could that impact sales going forward.
Well take was having had a good year, we believe is going to be up low.
Low double digits.
So it kind of a line with the with a tank and so forth. So.
It's kind of what we expected and the tankless market and so forth now as far as.
We have a California, you're talking about de carbonization and and.
And so forth and and I'm not going to talk specifically about <unk> I would just talk about our position.
And when you look at and for US. It's important that we are a part of the conversation we believe that.
And.
<unk> emissions and residential and commercial buildings, we want to be part of a reducing those and we're constantly talking to policymakers just to make sure that.
They're they're keeping in mind the technologies and.
There isn't a one size fit all.
Here like California that they wanted to just go a completely electric.
We don't think a one size policy and fit all is the right way to go we think multiple paths are there so.
So thats going to navigate its way through and we're going to be part of the conversation to make sure that.
<unk> technologies are including performance of the products included in cost to the consumers included.
And from and Ao Smith perspective, I think we're positioned well.
We have a full line of residential electric and commercial products.
And the market today, we have a full line of heat pump residential and commercial which are the highest efficient.
Electric water heaters out on the market and I never want to.
Forget that we have leading positions in condensing products gas condensing, which can make a big difference and lowering ghd emissions just by going from a standard to a high efficiency model. So wherever the market is going to go on we're in a position again I would tell you it was part of the.
<unk>, but we're also positioned well so we can be nimble in and where the market goes we have the products that can.
And can meet the demand for the consumer and of course, the commercial market as well.
Okay.
Thanks for that color and on the commercial you talked about some uncertainty around that business, obviously forecasting a down for this year from Mr. Help us understand from a historical perspective have there been many times where demand has declined.
And could this forecast prove conservative.
No I don't.
And Pat Pat has taken a look and weather and the answer is no I mean, it probably hasnt been down two times.
A year in a row, but I think that the <unk>.
And debit and the impact to I'll call It restaurant and hotel some of that a higher and higher usage categories that we participate in and it's really spreading across two years right. So it started Q2 and it's still going so I think a is down year over year is more related to the pandemic than than anything.
And we May see and mean kevins comments earlier about how that might play out I think we're going to have to wait and see what the back half of the year shows and.
And where we're at and a pandemic disruption.
And your last question comes from Larry de Maria with William Blair.
Hi, Thanks, Hey, Larry Hey.
And.
Thanks, Tom I know you talked about this kind of almost AD nauseam about day inventory destocking and Sir but just to be clear and then net.
Pre buy.
Are you expecting sales the comp first half comp down second half or can we sort of get closer to a flat because of the price increases can you just kind of clarify that a little bit.
No.
I guess.
And it's kind of a hard to it's kind of a hard to parse it out that way I will say, we expect unit volume to be up and Q1 and that's because we do have the two price increases out there and typically there is a pre buy before that.
And then historically the back half of the year is stronger than the front half of the year.
So when you kind a look at it that way I think.
I think maybe that'll that'll help kind of framed a model.
Okay.
Perhaps and then maybe.
Residential book placements in North America commercial.
I have some headwinds there.
Is there a how do you think about that market getting towards a bottom is that potentially bottoming on a.
And nothing else easier comps later this year and start to think about maybe comping up off a low base or do we expect that to be down all year.
I think it is going to come down to how the economy opens up.
Been a lot a positive.
Hackers from governors that had been.
And shutting down economies and realizing now that they have to open them up but again it comes down to <unk>.
Restaurants have to be open up they have to be moving 25% capacity.
Hotels have to have people who are traveling so.
I do think the pandemic is going to be a a a factor and how the commercial market returns.
And we will have to wait and see how that plays out throughout the year.
And I am showing no further questions at this time I would now like to turn the call back over to the host.
Thank you everyone for joining us today, we plan to participate and two virtual conferences and the first quarter Citibank on February 18, and Robert W. Baird on February 2000, and have a great day.
Okay.
Ladies and gentlemen. This concludes today's conference. Thank you for your participation and have a wonderful day you may all disconnect.
Okay.
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