U.S. markets open in 42 minutes

Edited Transcript of AOS earnings conference call or presentation 28-Jan-20 3:00pm GMT

Q4 2019 A. O. Smith Corp Earnings Call

MILWAUKEE Jun 6, 2020 (Thomson StreetEvents) -- Edited Transcript of A. O. Smith Corp earnings conference call or presentation Tuesday, January 28, 2020 at 3:00:00pm GMT

TEXT version of Transcript

================================================================================

Corporate Participants

================================================================================

* Charles T. Lauber

A. O. Smith Corporation - Executive VP & CFO

* Kevin J. Wheeler

A. O. Smith Corporation - Chairman, President, & CEO

* Patricia K. Ackerman

A. O. Smith Corporation - Senior VP of IR, Corporate Responsibility & Sustainability and Treasurer

================================================================================

Conference Call Participants

================================================================================

* Bryan Francis Blair

Oppenheimer & Co. Inc., Research Division - Director & Senior Analyst

* David Sutherland MacGregor

Longbow Research LLC - CEO, Director of Research & Senior Analyst

* Jeffrey David Hammond

KeyBanc Capital Markets Inc., Research Division - MD & Equity Research Analyst

* Lawrence Tighe De Maria

William Blair & Company L.L.C., Research Division - Co-Group Head of Global Industrial Infrastructure

* Michael Patrick Halloran

Robert W. Baird & Co. Incorporated, Research Division - Associate Director of Research & Senior Research Analyst

* Robert Paul McCarthy

Stephens Inc., Research Division - Former MD & Analyst

* Saree Emily Boroditsky

Jefferies LLC, Research Division - Equity Analyst

* Scott Graham

Rosenblatt Securities Inc., Research Division - MD & Senior Equity Industrial Technology Analyst

* Susan Marie Maklari

Goldman Sachs Group Inc., Research Division - Analyst

================================================================================

Presentation

--------------------------------------------------------------------------------

Operator [1]

--------------------------------------------------------------------------------

Ladies and gentlemen, thank you for standing by and welcome to the A. O. Smith 2019 results conference call. (Operator Instructions) Please be advised that today's conference is being recorded.

I would now like to hand the conference over to your speaker today, Patricia Ackerman, Senior Vice President, Investor Relations, Corporate Responsibility and Sustainability and Treasurer. Please go ahead, ma'am.

--------------------------------------------------------------------------------

Patricia K. Ackerman, A. O. Smith Corporation - Senior VP of IR, Corporate Responsibility & Sustainability and Treasurer [2]

--------------------------------------------------------------------------------

Good morning, ladies and gentlemen, and thank you for joining us on our 2019 results conference call. With me participating in the call are Kevin Wheeler, Chief Executive Officer; and Chuck Lauber, Chief Financial Officer.

Before I begin, 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.

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 for 2018 that exclude restructuring and impairment costs associated with our plant closure in Renton, Washington. Reconciliations from GAAP measures to non-GAAP measures are provided in the appendix at the end of this presentation and also on our website. (Operator Instructions)

I will now turn the call over to Kevin, who will begin our prepared remarks on Slide 4.

--------------------------------------------------------------------------------

Kevin J. Wheeler, A. O. Smith Corporation - Chairman, President, & CEO [3]

--------------------------------------------------------------------------------

Thank you, Pat, and good morning, ladies and gentlemen.

I'm pleased to review several items regarding our 2019 performance. Sales in our North America segment increased 2%, and operating margin performance in North America improved 50 basis points compared with 2018. Our North America water heater operations continued to perform well. I'm particularly pleased with our performance despite a 1% decline in residential industry volumes.

Productivity within our North America water treatment manufacturing and the effectiveness of our direct-to-consumer channel continued to improve. We expanded our North America water treatment platform with the acquisition of Water-Right, and performance is right on track to our expectations. We announced a 9% increase to our quarterly dividend rate in early October to $0.24 per share, which represents a 5-year CAGR of 24%.

In China, the fourth quarter came in, where we expected, with general inventory declining by more than 1 month. Channel inventory ended 2019 within the normal range of 2 to 3 months of sales.

I will now turn the call to Chuck, who will review the results in more detail on Slide 5. Chuck?

--------------------------------------------------------------------------------

Charles T. Lauber, A. O. Smith Corporation - Executive VP & CFO [4]

--------------------------------------------------------------------------------

Thank you, Kevin.

Sales for the year of $3 billion were 6% lower than in 2018. Adjusted earnings in 2019 of $370 million declined 18% from 2018. 2019 adjusted earnings per share of $2.22 were 15% lower than in 2018.

Sales in our North America segment of $2.1 billion increased 2% compared with 2018. The acquisition of Water-Right in April added $44 million to 2019 sales. The increase in sales is primarily due to incremental sales from recently acquired Water-Right, water heating pricing actions related to steel and freight cost increases and higher sales of water treatment products, which were partially offset by lower residential water heater volumes.

Rest of the World segment sales of $936 million declined 20% compared with the segment sales in 2018.

China sales declined 19% in local currency primarily related to weaker end-market demand, elevated channel inventory levels at the beginning of 2019 as well as a higher mix of mid-price products. The weaker Chinese currency unfavorably impacted translated sales by approximately $39 million.

India sales grew approximately 13% in constant currency compared with the same period in 2018.

On Slide 8, North America segment earnings of $489 million were 4% higher than adjusted segment earnings in 2018. The favorable impact from pricing actions, lower steel costs and higher sales of water treatment products, including the acquisition, were partially offset by the unfavorable impact from lower residential heater volumes. As a result, segment margins of 23.5% increased 50 basis points compared with 2018.

Rest of the world earnings of $40 million declined significantly compared with 2018. The impact to profits from lower China sales and a higher mix of mid-price products, which have lower margins, more than offset the benefits to profits from lower SG&A expenses and material costs. Weaker China currency translation negatively impacted earnings by approximately $3 million. As a result of these factors, segment margin declined significantly from 2018.

Our corporate expenses were lower in 2019 compared with 2018 primarily due to lower incentive costs. Effective tax rate in 2019 of 21.6% was higher than the 20.4% rate in 2018 primarily due to differences in geographic distribution of income.

Our fourth quarter results begin on Slide 9. Sales for the fourth quarter of $751 million were 8% lower than the same period in 2018. Earnings in the fourth quarter of $91 million declined 28% from the fourth quarter in 2018. In the fourth quarter, earnings per share declined 24% to $0.56.

Sales in our North America segment of $523 million were essentially flat compared with the fourth quarter of 2018. Incremental sales of approximately $14 million from Water-Right and growth in water treatment sales were offset by lower boiler volumes and lower contractual formula pricing based on lower steel costs associated with a portion of our water heater sales.

Rest of the world segment sales of $234 million declined 21% compared with the same quarter in 2018.

China sales declined 23% in local currency primarily related to weak consumer demand, entering the quarter with elevated channel inventory levels and a higher mix of mid-price products. The weaker Chinese currency unfavorably impacted translated sales by $4 million.

On Slide 11, North America segment earnings of $129 million grew 1% compared with the segment earnings in the same quarter in 2018. The net favorable impact to profits from lower steel costs essentially offset the unfavorable impact to profits from the lower boiler volumes. As a result, fourth quarter 2019 segment margin of 24.5% was the same as in the fourth quarter of 2018.

Rest of the world earnings of $2 million declined significantly compared with the fourth quarter of 2018. Earnings were lower primarily due to the unfavorable impact to profits from lower China sales, a higher mix of lower-margin products and charges associated with customer support programs to reduce channel inventory along with severance and other costs in the quarter. These unfavorable impacts to profits more than offset the benefits to profits from lower SG&A expenses and material costs. A result of these factors, segment margins declined to 1% compared to 13.3% in the same quarter of 2018.

Our corporate expenses of $12 million were higher compared with the fourth quarter of 2018 primarily due to lower interest income earned on cash as a result of lower balances. Interest costs were higher in the fourth quarter than the previous year due to higher debt levels associated with the acquisition of Water-Right in early April.

Cash provided by operations of $456 million during 2019 was slightly higher than $449 million in 2018. Lower investment in working capital essentially offset lower earnings compared with 2018.

Our liquidity and balance sheet remain strong. Our debt-to-capital ratio was 15% at the end of the year. We have cash balances totaling $551 million primarily located offshore, and our net cash position was $267 million at the end of 2019.

During 2019, we repurchased approximately 6.1 million shares of common stock for a total of $288 million. Approximately 3 million shares remained on our existing repurchase authority at the end of 2019.

We expect our cash flow from operations in 2020 to be between $475 million and $500 million compared with $450 million in 2019 primarily due to higher earnings. Our 2020 capital spending plans are approximately $80 million, and our depreciation and amortization expense is expected to be approximately $85 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 and higher incentive compensation. We expect our interest expense will be $10 million in 2020 compared with $11 million in 2019. Our effective income tax rate is expected to be between 21.5% and 22% in 2020.

We expect to repurchase our shares in the amount of $200 million in 2020, and we expect our diluted average outstanding shares in 2020 will be approximately $162 million.

As weakness in our end markets in China persisted, we implemented several cost reduction actions in 2019. Over the course of 2019 and through Q1 of 2020, we reduced headcount by nearly 20% from December 2018 levels. We continue to review and rationalize brand building and advertising spending, selling expenses and other SG&A costs. We closed over 4 -- over 700 nonproductive stores on a net basis. We are continuing our existing aggressive cost-reduction programs in both manufacturing processes and in product costs, and we continue to evaluate our retail footprint and rationalize where we find nonproductive stores and redundancies. To that end, we expect to close 1,000 net stores in 2020.

Compared with 2018, total annualized savings as a result of these actions is estimated to be approximately $45 million in 2020, of which approximately $30 million were realized in 2019.

We introduced our 2020 EPS guidance this morning with a range of between $2.40 and $2.50 per share, a 10% increase at the midpoint compared with last year. Our 2020 EPS guidance excludes any potential impact to our businesses from the developing coronavirus originating in China.

I will now turn the call to Kevin, who'll summarize our guidance and business assumptions for 2020 beginning on Slide 16. Kevin?

--------------------------------------------------------------------------------

Kevin J. Wheeler, A. O. Smith Corporation - Chairman, President, & CEO [5]

--------------------------------------------------------------------------------

All right. Thank you, Chuck.

Our outlook for 2020 includes the following assumptions. And I'll start with China. China inventory levels ended 2019 between 2 and 3 months of sales, meeting our expectations after being as high as 4 months in the second half of 2018 and earlier in 2019. As we stated, our customers tell us, normal levels are between 2 and 3 months. We estimate sell-in will be modestly lower than sell-out, resulting in a modest further decline in channel inventory levels. We project China sales growth in local currency of 2.5%. Our forecast for the China currency is a modest depreciation from today's levels, resulting in a 1% increase in U.S. dollar terms.

In China, as we walk forward from the fourth quarter of 2019 to the first quarter of 2020 and with the Chinese New Year holidays earlier in the quarter and our continued focus on monitoring channel inventory, we project first quarter China volume will be approximately $40 million lower than the fourth quarter of 2019. The earnings impact in the 2020 first quarter from lower volumes is expected to be 50% of the sales decline.

In addition, also compared to the fourth quarter of 2019, we do not expect customer support programs, severance charges or other certain costs of approximately $10 million to repeat.

After a 1% decline in 2019, we project residential water heater volumes will increase 225,000 to 275,000 units in 2020 driven by incremental new construction, expansion of replacement demand in line with historical trends.

Commercial industry water heater volumes are expected to grow 2% to 3% primarily driven by growth in electric models. We expect our North America boiler sales to grow approximately 8% for the full year. In 2019, our boiler sales were flat with low single-digit growth in condensing boilers.

Several factors underpin our 2020 forecast. We believe the transition from lower efficiency to higher efficiency boilers continues, and commercial condensing boiler volumes grow mid-single digits as they have historically. The ABI data has been recently strong and encouraging. We will enhance our product offering in 2020, such as adding O2 sensing capability on our commercial condensing boilers, which addresses a gap in our product portfolio that we believe impacted us in 2019. We continue to work with our reps to improve our visibility to track jobs. We are seeing and hearing that many projects in 2019 have been pushed into the first half of 2020.

We ended 2019 with a $2.6 million loss in India, and we are on track with our expectations to break even in that region in 2020. As the India economy has shown signs of weakness recently, we are monitoring our progress towards this goal carefully.

Please advance to Slide 17. We project revenues will increase by approximately 4.5% to 5.5% in 2020. We see sales growth in North America with our water heater, boiler and water treatment products collectively expected to grow approximately 6% in 2020, including $20 million in Water-Right sales, which was acquired in April of 2019. EPS is projected to be between $2.40 and $2.50. Our EPS guidance excludes the potential impact to our businesses from the developing coronavirus originating in China. We expect North America segment margin to be between 23.25% and 24.25% and Rest of World segment margins to be approximately 5%.

We are pleased with how our North America segment is performing, particularly on the water heating side. We see long-term growth drivers in water treatment solutions and boilers across North America.

In the near term, the China economy remains weak. We have a strong premium brand, broad product offering in our key product categories, broad distribution and a reputation for quality and innovation. Over time, we are well positioned to maximize favorable demographics in both China and India to enhance shareholder value.

Our replacement markets remain stable, which we believe represents approximately 85% of North America water heater and boiler volumes. We have strong cash flow and balance sheet, providing an opportunity to continue to invest in ourselves, acquisitions and return cash to shareholders.

That concludes our prepared remarks, and we are now available for your questions.

================================================================================

Questions and Answers

--------------------------------------------------------------------------------

Operator [1]

--------------------------------------------------------------------------------

(Operator Instructions) And our first question comes from Saree Boroditsky with Jefferies.

--------------------------------------------------------------------------------

Saree Emily Boroditsky, Jefferies LLC, Research Division - Equity Analyst [2]

--------------------------------------------------------------------------------

It may be too early for this, but just given your commentary around guidance, have you seen any disruption in your supply chain or any impact on retail sales as a result of the coronavirus?

--------------------------------------------------------------------------------

Kevin J. Wheeler, A. O. Smith Corporation - Chairman, President, & CEO [3]

--------------------------------------------------------------------------------

Let me take this in kind of the order that -- the way we think about it. First, the coronavirus -- our focus is on our employees and particularly the 7,000 employees we have in China. So we -- we're focused on safety and doing the right things to make sure that our employees are safe during these difficult times. Secondly, to answer your question, at this time, our supply chain, we see no issues currently and going forward. So as we look at it right now, no immediate disruption expected by us at all.

--------------------------------------------------------------------------------

Saree Emily Boroditsky, Jefferies LLC, Research Division - Equity Analyst [4]

--------------------------------------------------------------------------------

Great. And then given the decline in boilers in the quarter, can you just provide some color on what you're seeing in that market that gives you confidence in the rebound for 2020? And maybe what you're seeing from a backlog or quoting perspective?

--------------------------------------------------------------------------------

Kevin J. Wheeler, A. O. Smith Corporation - Chairman, President, & CEO [5]

--------------------------------------------------------------------------------

Yes. Sure. From the boiler perspective, I'm going to kind of look back on the year a bit. And first, when it -- the industry, we kept pace with the industry, particularly in the commercial boiler sector. This year, we -- as an organization, our product mix skews to more lower BTU models. And quite a few of our larger jobs this year, as I mentioned in the comments, have been pushed into the first quarter and the second half of the year. So -- and on top of that, our reps and our customers remain bullish about their activity is -- and as far as the market, job quoting and so forth remains active. And then on top of that, we are introducing a O2 sensing device that goes on to our high commercial condensing boilers. So when you put all that together, the market, the ABI index, we had an unusually skewed to lower BTUs this year, some projects that were delayed in the second half, we're -- we believe 8% is a reasonable number as we get into 2020.

--------------------------------------------------------------------------------

Charles T. Lauber, A. O. Smith Corporation - Executive VP & CFO [6]

--------------------------------------------------------------------------------

Yes. This is Chuck. I mean we still can see that the higher efficiency boilers are moving away from the less efficient, noncondensing boilers to higher efficiency, where we focus, we still see that trend.

--------------------------------------------------------------------------------

Operator [7]

--------------------------------------------------------------------------------

And our next question comes from Scott Graham with Rosenblatt Securities.

--------------------------------------------------------------------------------

Scott Graham, Rosenblatt Securities Inc., Research Division - MD & Senior Equity Industrial Technology Analyst [8]

--------------------------------------------------------------------------------

So I do have two questions around the organic guidance. The U.S. business you guys are looking for went up here looks like in the 2% to 3% vicinity. Could you -- in past conference calls, I think the last one, in particular, you talked about what your estimate was for the replacement business only. For the last 2 years, I think it was 4% each. What did that number come in on for 2019? And what's baked into your 2020 on the replacement only?

--------------------------------------------------------------------------------

Kevin J. Wheeler, A. O. Smith Corporation - Chairman, President, & CEO [9]

--------------------------------------------------------------------------------

Well, if you look back at it, the -- this year was -- our guidance was for overall replacement to come in about 100,000 to 150,000 units down this year, and we feel it's going to fall in that range once everything is published. If you look at it, you're right. 2017, 2018 were well above market average, growing 4% to 5%. It's not unreasonable to have a correction as we did in 2019. So as we go forward, we're basically saying there is a reasonable new construction activity, builders remain confident and that our historical replacement market will return to their normal levels. That's what's baked into our guidance.

--------------------------------------------------------------------------------

Charles T. Lauber, A. O. Smith Corporation - Executive VP & CFO [10]

--------------------------------------------------------------------------------

If you take the mid-range of the residential units, that $250 million range, and you put 100,000 into new construction, new housing, and you add the rest to the replacement, you don't quite get back to the 2018 level. So we're kind of in between that.

--------------------------------------------------------------------------------

Scott Graham, Rosenblatt Securities Inc., Research Division - MD & Senior Equity Industrial Technology Analyst [11]

--------------------------------------------------------------------------------

That's it. That's very sharp answer. I appreciate that. So on the China business, it looks like we're going to start in the whole again the first quarter, not unexpected. But you are expecting the China organic to be up 2.5% on a full year basis. So what is your thinking as to when those sales pivot upward? Could that be as early as the second quarter? And I'm asking that with a backdrop of mix likely staying negative as well. It looks like China completions continue to run down low single -- down mid-single, which I have sensed to always be a pretty good proxy for the water heater market. So against that sort of backdrop, maybe give us a little more color around the 2.5% local currency guidance for China, if you would, particularly, if you can give us an idea of when you think it pivots to positive within that context.

--------------------------------------------------------------------------------

Charles T. Lauber, A. O. Smith Corporation - Executive VP & CFO [12]

--------------------------------------------------------------------------------

Yes. I mean let me start out with -- well, look, Q1, as we came into -- looking at next year, we thought Q1 was going to be a challenging year regardless of what you're hearing on the virus situation right now. And the reason we have a little caution on Q1 is because the Chinese New Year's festival falls into January. And any time -- it was January 25. Anytime it falls into January, what we see is more interruption in the appliance market, less traction. So as Kevin kind of outlined on his introductory remarks, even without those considerations, we see the Q1 in China to be a challenging Q1 because of the disruption of the earlier holiday. We would expect, though, going out of Q1, I think you've got a pretty spot on take on some of our assumptions, Scott. So we expect going out of Q1, we're going to see a little headwind on channel inventory still. We are really happy with the progress that we made this year, getting down into that normal range. We would expect another couple of weeks, perhaps, come out of next year through the back 3 quarters of the year. Low single digit or low single-digit declines on the water heating side are really consistent with what we've seen this year and kind of roll into next year in our assumptions. Water treatment, if we look at our outside market data, some of those numbers are slightly negative. We're a little more optimistic on the water treatment side. We really like some of the new products we put out, and we think we're going to outperform some of those projections on water treatment. So -- and then you kind of roll into that some of the other, I'll call it, less material categories that we have that -- kind of bringing up to that growth rate. I hope that's helpful.

--------------------------------------------------------------------------------

Operator [13]

--------------------------------------------------------------------------------

And our next question comes from Robert McCarthy with Stephens.

--------------------------------------------------------------------------------

Robert Paul McCarthy, Stephens Inc., Research Division - Former MD & Analyst [14]

--------------------------------------------------------------------------------

Hi, everybody. Well, first of all, good luck managing the situation. Obviously, this is going to be dynamic and the human toll is going to be pretty challenging. And I guess it's like the old John Lennon quote, "Life is what happens when you're making other plans." But how are you going to kind of come back to the market and kind of give us a sense of what you think is kind of fundamental end-market demand in China versus the disruption you're going to see? Are we going to see a nonrecurring charge in association with what happens in China? Are you going to give some kind of a midyear update on association with that?

And then part and parcel of that, what's -- what are you -- how are you going to manage recourse in the channel for inventory? I mean is there any force majeure we have to worry about? Just give us some sense about what we're going to see in terms of the disruption to what is your guide, which was clearly baked and contemplated prior to these events.

--------------------------------------------------------------------------------

Kevin J. Wheeler, A. O. Smith Corporation - Chairman, President, & CEO [15]

--------------------------------------------------------------------------------

This is Kevin. Let me take that. I -- those are all really good questions. And -- but right now, when you look at this market and you look at the coronavirus and where it stands, it's really too early to speculate. We still have many people on holiday that need to come back and we see how they're going to behave going forward. We don't know the scope of -- outside the key provinces that have been restricted right now. So if you just step back from that, we're going to have to get a lot more data on how consumers are behaving before we enter into some further guidance and speculation. It's where we're at.

--------------------------------------------------------------------------------

Robert Paul McCarthy, Stephens Inc., Research Division - Former MD & Analyst [16]

--------------------------------------------------------------------------------

It's where you're at. It's -- okay. That's fair enough. And turning to North America, obviously, you did talk about the phenomenon of a potentially lower all-in growth than you've witnessed in years past. What are you seeing in terms of your end markets in terms of the shift to tankless gas? And how are you feeling about kind of where you're positioned from a market share perspective there? And do you think that still supports kind of still reasonable kind of low single-digit growth here for the foreseeable future?

--------------------------------------------------------------------------------

Kevin J. Wheeler, A. O. Smith Corporation - Chairman, President, & CEO [17]

--------------------------------------------------------------------------------

Yes. I think on the -- look, let's just take it from the -- a market share perspective. And remember, these are shipments. These are not sell-out. But if you look at it, we were down a bit on market share residential. We were up close to 100 basis points on commercial. And as we go into this year, we just look at it returning to a more normal level. And I look at the residential business and the residential industry, within 10 years, it's been flat twice, down 3 times and up 5. So it's not this linear equation. It's -- but you look at the positive news from a new construction standpoint, you look at the water being a must-have product when again it stops operating. So our guidance is really getting back to historical levels, and I think that's a reasonable guidance as we go forward, our shares intact on both residential and commercial.

And to go back on tankless, that's an area that we continue to look at growing, expanding. We will be introducing some new innovative product lines this year. And that category actually has declined 3 years in a row the -- its growth rate. So overall, I think we're in good position as we head in. I think the guidance is kind of getting back to a normal year that we basically didn't have in 2019.

--------------------------------------------------------------------------------

Operator [18]

--------------------------------------------------------------------------------

And our next question comes from Michael Halloran with Baird.

--------------------------------------------------------------------------------

Michael Patrick Halloran, Robert W. Baird & Co. Incorporated, Research Division - Associate Director of Research & Senior Research Analyst [19]

--------------------------------------------------------------------------------

So first on China, just some thoughts on how you think the market share trends are on both the water heater side as well as the treatment side in China, what you could point to? And then any delineation between how you think you're doing in -- on the water heater side in the upper tier versus the middle tier where I know you've been introducing a higher and mid-tier product?

--------------------------------------------------------------------------------

Charles T. Lauber, A. O. Smith Corporation - Executive VP & CFO [20]

--------------------------------------------------------------------------------

Yes. Let me just start out with that one, Mike, on the share. So yes, we looked at it online, off-line, all the caveats that we've heard before. We used a couple of different triangulations to get there, and not all of our stores are covered in the specialty side. But on the off-line, what we're really looking at is quarter-over-quarter, if you take heating, both gas and electric were relatively flat quarter-over-quarter. You move into water treatment, we're up a couple of hundred basis points quarter-over-quarter. So we're pleased with that little movement up on the water treatment side for the year. On the off-line, it's down a couple of hundred basis points on heating collectively, and we've held our share in water treatment. If you go to online, heating, both the residential -- I'm sorry, both electric and gas is relatively flat for the quarter, and we're up about 100 basis points on water treatment. For the year, if you look online, we're down about 1 point on all 3 categories. So we're pleased with the water treatment, in particular, and we're fairly holding on the other category.

--------------------------------------------------------------------------------

Kevin J. Wheeler, A. O. Smith Corporation - Chairman, President, & CEO [21]

--------------------------------------------------------------------------------

And Michael, also just to expand, you asked on the upper tier premium market. I look at Q4, there wasn't a lot of change, the upper tier state where it was, and so it's down about a couple of hundred basis points. And that's been pretty consistent throughout the year. As important, from a brand perspective, there's been no real retaliation towards a foreign or American brand. So really, we came to Q4 relatively kind of the same as we thought with no real changes other than we have filled in our medium price points, and we feel good about that going into 2020.

--------------------------------------------------------------------------------

Michael Patrick Halloran, Robert W. Baird & Co. Incorporated, Research Division - Associate Director of Research & Senior Research Analyst [22]

--------------------------------------------------------------------------------

Appreciate that. And then on North America side, maybe some update on the treatment business. You sound pretty constructive on progress you've made. So any thoughts on how the channel build's going and customer receptivity at this point? And how you think the buildout of that market's going? Because it's still in the early stage of a buildout.

--------------------------------------------------------------------------------

Kevin J. Wheeler, A. O. Smith Corporation - Chairman, President, & CEO [23]

--------------------------------------------------------------------------------

It is in early stage. We had a very good year, mid-teens growth. We saw core growth in all segments, that's our direct-to-consumer, that's the professional water quality dealer, retail and wholesale as well. So overall, we feel pretty good about the way the business is moving forward: increased productivity, as I mentioned in my remarks; in our plants, on-time performance is up. And again, part of our thesis is that water quality is becoming a bigger issue with consumers. And we see that continuing not only with lead, but PFOAs and a number of other contaminants that are in the market. And we feel comfortable because we have the products that can remove all these chemicals. And so the business is in good shape, had a good year, and we look forward to building on it in 2020.

--------------------------------------------------------------------------------

Charles T. Lauber, A. O. Smith Corporation - Executive VP & CFO [24]

--------------------------------------------------------------------------------

Yes. From a numbers perspective, we're right on track to what we've been talking about. Going into next year, we look at revenues in the $170 million to $180 million range. We look at the -- our operating margins in double digits. So we're pleased with the continued progress.

--------------------------------------------------------------------------------

Operator [25]

--------------------------------------------------------------------------------

And our next question comes from Jeffrey Hammond with KeyBanc.

--------------------------------------------------------------------------------

Jeffrey David Hammond, KeyBanc Capital Markets Inc., Research Division - MD & Equity Research Analyst [26]

--------------------------------------------------------------------------------

I just want to make sure I'm clear on the guidance. So I think you're saying a 4.5% to 5.5% growth. And it just seems like a lot of these numbers are kind of low single digits, your commercial res, China. So like what's kind of growing above average outside of Lochinvar to kind of get you into that 4.5% to 5.5% growth range?

--------------------------------------------------------------------------------

Kevin J. Wheeler, A. O. Smith Corporation - Chairman, President, & CEO [27]

--------------------------------------------------------------------------------

Yes. I mean so Lochinvar goes back to growth. So we see Lochinvar at that 8% next year. So that helps in walking it forward. We also have growth in North America water treatment. So we expect North America water treatment to grow in that low teens year-over-year, and that's starting to become a more meaningful base. India, we expect to grow also. India is in that low teens range that we expect to continue to grow. So that's the major component. The rest -- China is rather modest, but we'll be positive. Or at least our assumptions are that it will be positive.

--------------------------------------------------------------------------------

Jeffrey David Hammond, KeyBanc Capital Markets Inc., Research Division - MD & Equity Research Analyst [28]

--------------------------------------------------------------------------------

Okay. And then just a couple of questions on China. One, it looks like -- I think you closed 700 stores in '19, you're going to close another 1,000 in 2020 I think is what you said. Can you just talk about where stores are versus peak? And just any kind of revenue impact do you think you have from all those store closures? And then just any plans for repatriating cash from China this year?

--------------------------------------------------------------------------------

Charles T. Lauber, A. O. Smith Corporation - Executive VP & CFO [29]

--------------------------------------------------------------------------------

Yes. So the store closures -- and think in terms of the stores that are kind of in the same geographic region. So it's really rationalizing stores that are pretty close to another -- one another. So from a sales loss perspective, we don't view that as significant. What we view -- our job to do is to make sure we draw those shoppers into the stores that exist within the geographic region that's there. In some of the built-out years, we had probably a little redundancy in some local areas. So the peak was about 9,800. And today, we'll be...

--------------------------------------------------------------------------------

Patricia K. Ackerman, A. O. Smith Corporation - Senior VP of IR, Corporate Responsibility & Sustainability and Treasurer [30]

--------------------------------------------------------------------------------

9.

--------------------------------------------------------------------------------

Charles T. Lauber, A. O. Smith Corporation - Executive VP & CFO [31]

--------------------------------------------------------------------------------

About 9,000. Yes. So about 9,000. So going forward, that extra 1,000 stores that we're looking at is probably not a significant impact on sales. And just a reminder, there's -- some of those are specialty stores, some of those are retail outlets. The cost for those -- we do incur costs to support some of those stores, but it's our customers' storefront. So the closure costs and some of those are just not very significant.

--------------------------------------------------------------------------------

Operator [32]

--------------------------------------------------------------------------------

And our next question comes from Bryan Blair with Oppenheimer.

--------------------------------------------------------------------------------

Bryan Francis Blair, Oppenheimer & Co. Inc., Research Division - Director & Senior Analyst [33]

--------------------------------------------------------------------------------

Following up on Scott's initial line of questioning, asking from a slightly higher level, where do you think we stand in terms of the long-term replacement cycle? Is there a risk of an accelerated move off of peak there? And any differences between the resi and commercial side you would call out?

--------------------------------------------------------------------------------

Kevin J. Wheeler, A. O. Smith Corporation - Chairman, President, & CEO [34]

--------------------------------------------------------------------------------

We did quite a bit of analysis on this and reviewed it in our Investor Day and continue to watch it, quite frankly. The bell curve on a replacement cycle on water heaters is really elongated. We have water heaters that can go out within 5 years and others that can last 25 years. So as we've looked at it, we see that bell curve smoothing out. And we don't see -- and I'll use the word because people have used it in the past, equip, we see it going out to 22, 23, maybe a slight decline, but nothing of any dramatic nature. We're even seeing some of our products even last even a little bit longer. We've been using 14 years and then they're moving out to 15 years. So it's -- from our perspective, it's out a few years, and the impact will be within that 1 or 2-point range.

--------------------------------------------------------------------------------

Charles T. Lauber, A. O. Smith Corporation - Executive VP & CFO [35]

--------------------------------------------------------------------------------

And I guess as a follow-up, Bryan, you mentioned commercial. The cycle on commercial is shorter, so we really just don't see the same tracking as residential. It's just a shorter life cycle.

--------------------------------------------------------------------------------

Bryan Francis Blair, Oppenheimer & Co. Inc., Research Division - Director & Senior Analyst [36]

--------------------------------------------------------------------------------

Got it. That's helpful. Moving to China. Obviously, there's a P&L hit to start the year, then borrowing spillover effect from the virus, it seems like there will be a decent reset, at least into the back half. How should we think about ROW margin cadence throughout the year netting to that mid-single-digit range?

--------------------------------------------------------------------------------

Kevin J. Wheeler, A. O. Smith Corporation - Chairman, President, & CEO [37]

--------------------------------------------------------------------------------

Well, typically, in China, our strongest quarter is Q4. So I think you can look at it that way. It was the strongest quarter this year for us even though it was down a little bit from consumer demand compared to last year. But we're pleased with where we ended the year on channel inventory, where our customers ended the year on channel inventory. We would not expect in Q1 to cause that inventory to go up. And we would feel pretty good about coming into the back 3 quarters of the year in that inventory position compared to last year. But as far as cadence, I mean, the fourth quarter is always our strongest.

--------------------------------------------------------------------------------

Operator [38]

--------------------------------------------------------------------------------

And our next question comes from David MacGregor with Longbow Research.

--------------------------------------------------------------------------------

David Sutherland MacGregor, Longbow Research LLC - CEO, Director of Research & Senior Analyst [39]

--------------------------------------------------------------------------------

You may have mentioned this and I may have missed it, but could you just talk about raw material prices in your guidance assumptions? And how you're thinking about lower steel prices in terms of the benefit to the P&L?

--------------------------------------------------------------------------------

Kevin J. Wheeler, A. O. Smith Corporation - Chairman, President, & CEO [40]

--------------------------------------------------------------------------------

Yes. For 2020, we're looking at lower steel pricing than what we have this year. Just as a reminder, we see steel costs kind of 90 to 120 days hit us. So if you kind of look at where the market is today, we expect steel pricing next year to be just slightly lower than where the market is today.

--------------------------------------------------------------------------------

David Sutherland MacGregor, Longbow Research LLC - CEO, Director of Research & Senior Analyst [41]

--------------------------------------------------------------------------------

And again just -- so can you -- is there any way of quantifying that back into the margin guidance for the EBIT guidance?

--------------------------------------------------------------------------------

Kevin J. Wheeler, A. O. Smith Corporation - Chairman, President, & CEO [42]

--------------------------------------------------------------------------------

We typically don't, but you can kind of get a projection just by looking at kind of pegging it to the market.

--------------------------------------------------------------------------------

David Sutherland MacGregor, Longbow Research LLC - CEO, Director of Research & Senior Analyst [43]

--------------------------------------------------------------------------------

Sure. Sure. And then just with respect to China, can you just talk a little bit about your online sales there? And I guess to what extent you may expect to see that accelerate as a consequence of the coronavirus? But I'm more interested in just how you feel you're positioned in terms of market share or channel share on that platform.

--------------------------------------------------------------------------------

Kevin J. Wheeler, A. O. Smith Corporation - Chairman, President, & CEO [44]

--------------------------------------------------------------------------------

So our online sales last year were $207 million, really pretty flat to the year before. We've got our assumption in 2020 to grow at mid-single digits. So we've talked about reintroducing mid-price products. So we feel pretty good about our position with mid-price products, which we do see more of on online sales. And our share, we still think there's opportunity to grow that share on the online side. So it's $207 million this year, and we'd be growing mid-single digits. We feel pretty good with where we enter into 2020.

--------------------------------------------------------------------------------

Operator [45]

--------------------------------------------------------------------------------

Our next question comes from Larry De Maria with William Blair.

--------------------------------------------------------------------------------

Lawrence Tighe De Maria, William Blair & Company L.L.C., Research Division - Co-Group Head of Global Industrial Infrastructure [46]

--------------------------------------------------------------------------------

First question, the price actions you guys took the second half of '19, how do they hold up through the rest of '19? I don't know if there's any pushback in the market, et cetera. And how you're thinking about price in 2020?

--------------------------------------------------------------------------------

Kevin J. Wheeler, A. O. Smith Corporation - Chairman, President, & CEO [47]

--------------------------------------------------------------------------------

Pricing question is always fairly sensitive to us. As we announced, we did put an increase through last year, up to 4%. And really, after that, we're really the only public company, and we just don't want to comment any further on any pricing actions with regards to market conditions.

--------------------------------------------------------------------------------

Lawrence Tighe De Maria, William Blair & Company L.L.C., Research Division - Co-Group Head of Global Industrial Infrastructure [48]

--------------------------------------------------------------------------------

Right. Well, I know you guys have always been historically sensitive to that, but I'm curious if it held up through the rest of '19 or if there was pushback in the channel, broadly speaking, on price.

--------------------------------------------------------------------------------

Kevin J. Wheeler, A. O. Smith Corporation - Chairman, President, & CEO [49]

--------------------------------------------------------------------------------

Yes. Again, we're just not going to comment on price with any detail like that.

--------------------------------------------------------------------------------

Lawrence Tighe De Maria, William Blair & Company L.L.C., Research Division - Co-Group Head of Global Industrial Infrastructure [50]

--------------------------------------------------------------------------------

Okay. And then secondly, in China, can you talk about that 2 to 3 months of inventory that you guys over the -- this channel. Is that high-end inventory, mid-tier inventory, first of all? And secondly, as it relates to the coronavirus, which, obviously, originated in Wuhan, I think some of your competitors are there with fairly big production plants. You guys said that no big impact to your supply chain thus far, but are you seeing or potentially seeing any interruptions in the market from -- potentially in the industry from competitors because of what's going on in Wuhan?

--------------------------------------------------------------------------------

Kevin J. Wheeler, A. O. Smith Corporation - Chairman, President, & CEO [51]

--------------------------------------------------------------------------------

Just to start with the channel inventory. So our channel inventory, I'll call it, it's a relatively even mix of higher-end product, mid-price product. As you know, we've introduced quite a few mid-price products in the last 2 to 3 quarters. So it's maybe -- it's -- I'll call it 50-50. So we think we're balanced on where it falls out in the channel inventory. With respect to -- I would say, with respect to competitors and like I had mentioned before, it's really too early to understand. I mean what I'd tell you from our supply chain, we did reach out to our suppliers and so forth and got feedback. And we're comfortable with it, but we just don't have the information nor are we going to speak to any of our competitors' conditions.

--------------------------------------------------------------------------------

Operator [52]

--------------------------------------------------------------------------------

And our next question comes from Susan Maklari with Goldman Sachs.

--------------------------------------------------------------------------------

Susan Marie Maklari, Goldman Sachs Group Inc., Research Division - Analyst [53]

--------------------------------------------------------------------------------

I just wondered if we could talk a little bit about what are you seeing in terms of the new construction side of the U.S. market, especially on the residential piece of reporting some good order growth? And how are you thinking about that coming through?

--------------------------------------------------------------------------------

Kevin J. Wheeler, A. O. Smith Corporation - Chairman, President, & CEO [54]

--------------------------------------------------------------------------------

From a residential new construction, again, you look at, there's been some positive information with builders. Certainly, there was a spike in starts in December. So if you look forward, it looks like from a new construction standpoint, it's a positive. It's a tailwind. To what extent, Chuck talked about 100,000 units. On the commercial side, again, things have been active there. However, there's just been a -- items there being pushed out. Labor is still an issue, I would tell you, on both the residential and the commercial side of the business. So it's -- it looks positive to us to the degree that we can get things in the ground and finished. We think it's within our guidance of the range we gave on residential and our guidance that we gave on our commercial and boilers.

--------------------------------------------------------------------------------

Susan Marie Maklari, Goldman Sachs Group Inc., Research Division - Analyst [55]

--------------------------------------------------------------------------------

Okay. All right. And then, obviously, your balance sheet remains in a really strong position with the net cash balance there. Can you just talk about maybe what you're seeing in terms of some of the M&A opportunities? And how you're thinking about some of the capital allocation, things that could come up over the course of 2020?

--------------------------------------------------------------------------------

Kevin J. Wheeler, A. O. Smith Corporation - Chairman, President, & CEO [56]

--------------------------------------------------------------------------------

Normally, we're -- on the M&A side, we're always actively engaged in looking for opportunities. And until we have any of that really materializing, we just don't talk about them. However, we are -- we do have a nice balance sheet that when those opportunities come along, we can execute. When it comes from our cash allocation, I'll let Chuck just comment on.

--------------------------------------------------------------------------------

Charles T. Lauber, A. O. Smith Corporation - Executive VP & CFO [57]

--------------------------------------------------------------------------------

Yes. I mean we're looking to repurchase next year. So as we've talked about before, we always invest in ourselves. We've got some good capital programs that we're planning for next year. We're looking at repurchasing about $200 million. That $200 million is really based on what we look at for generating cash for the year, our dividends, net of CapEx. The fort -- the goal, what we're looking just to size that, borrowing an acquisition would be just a necro cash for 2020. So that's kind of how we're sizing that up.

--------------------------------------------------------------------------------

Operator [58]

--------------------------------------------------------------------------------

And our next question comes from Robert McCarthy with Stephens.

--------------------------------------------------------------------------------

Robert Paul McCarthy, Stephens Inc., Research Division - Former MD & Analyst [59]

--------------------------------------------------------------------------------

Yes. Just back in queue with a couple of follow-ups. The first would be just in terms of looking at historical trends in the residential channel in North America. I mean obviously, historically, I hear your point about the fits and starts in terms of how you're thinking about the kind of the replacement cycle evolving. But you did go through a period of pretty significant price increase with that standard change 5 years ago, which created a different margin structure, which could attract new entrants in the market. So I mean how do you think about prospectively the threat of new entrants in the context of the replacement cycle maybe challenging your historical assumptions about how the cycle is going to play out?

--------------------------------------------------------------------------------

Kevin J. Wheeler, A. O. Smith Corporation - Chairman, President, & CEO [60]

--------------------------------------------------------------------------------

Well, let me just take it how we look at it. One, to be a market leader in this industry, you have to have a broad line of products, both residential and commercial. And that investment -- and that's not only in the products, but in the technologies: condensing, noncondensing, heat pump, non-heat pump, gas tankless, electric tankless. All the commercials we have are tanks. So for me, a new entrant, that's always possible. And quite frankly, Haier has announced that they're going to come in the market with some electric products. But as we look at it, what we do is we try to provide the best value proposition to our customers. And it's based upon this broad portfolio, it's based upon driving value, not only with products, services and also what we do in the -- with engineers and specifications. And then on top of that, if you really step back, we've got 60 years of long-term relationships in all channels.

So we're going to do the things that we believe make us the preferred brand of choice. And so that's how we look at it. And as other people come in, it's going to take a broad portfolio. It's not an easy hurdle to come in and provide these broad portfolio of products and services that we have.

--------------------------------------------------------------------------------

Robert Paul McCarthy, Stephens Inc., Research Division - Former MD & Analyst [61]

--------------------------------------------------------------------------------

And then the final question for me is, I mean, I think with the exception of probably Lochinvar, most of the growth initiatives or the positive growth variance to get the kind of 4% to 5% growth or the mid-single-digit growth are going to be in decent growing businesses, businesses that you're investing in, but clearly going to be a challenging margin mix profile for you as a whole, at least on a normalized basis for China and certainly, for North America. So are you concerned about that, particularly in the context of what could be a rougher traffic coming in China that the nature of the growth that you're going to see is dilutive and may create some incremental earnings risk or headwinds even to your base outlook?

--------------------------------------------------------------------------------

Kevin J. Wheeler, A. O. Smith Corporation - Chairman, President, & CEO [62]

--------------------------------------------------------------------------------

Yes. You're correct in the fact that some of these growth businesses right now have lower operating margins than the lesser growth business going forward. China is difficult to peg as far as -- we peg China, we said what our growth rate would be next year and that -- so in China, we expect to continue to reduce product costs. We expect to continue to look at our costs and expect to expand the margin in China at the pace at which the consumer confidence in market allows us to grow. In India and water treatment, we feel like we're making good progress in India. We expect to be breakeven next year. Water treatment, we're looking at 100 to 200 basis points improvement in the next couple of years to get that margin closer to North America water heating. So we feel like we're making progress on all those areas.

--------------------------------------------------------------------------------

Operator [63]

--------------------------------------------------------------------------------

And our next question comes from Jeffrey Hammond with KeyBanc.

--------------------------------------------------------------------------------

Jeffrey David Hammond, KeyBanc Capital Markets Inc., Research Division - MD & Equity Research Analyst [64]

--------------------------------------------------------------------------------

Just to -- I want to go back on the repatriation. Any plans to repatriate cash from China this year?

--------------------------------------------------------------------------------

Kevin J. Wheeler, A. O. Smith Corporation - Chairman, President, & CEO [65]

--------------------------------------------------------------------------------

In the last 2 years, we've repatriated $150 million each year. We're going through that process and looking at the things that are in front of us. We would expect to repatriate some cash. And when we come up with the appropriate number as we go through that process, we'll be talking about how much we bring back. But we would expect to -- and we have in the last 2 years brought back $150 million each year.

--------------------------------------------------------------------------------

Jeffrey David Hammond, KeyBanc Capital Markets Inc., Research Division - MD & Equity Research Analyst [66]

--------------------------------------------------------------------------------

Okay. And then -- okay. Great. And then on your North American margins, your range is typically like 25 to 50 bps, but this year, you have a 100 basis point range. And just I wanted to understand the change or if there's any moving pieces that would support the wider range?

--------------------------------------------------------------------------------

Kevin J. Wheeler, A. O. Smith Corporation - Chairman, President, & CEO [67]

--------------------------------------------------------------------------------

It's mostly within our range. It's mostly just based on volume assumptions. That's what drives the most of the volatility.

--------------------------------------------------------------------------------

Operator [68]

--------------------------------------------------------------------------------

And I'm not showing any further questions at this time. I will now turn the call over to Patricia Ackerman for any further remarks.

--------------------------------------------------------------------------------

Patricia K. Ackerman, A. O. Smith Corporation - Senior VP of IR, Corporate Responsibility & Sustainability and Treasurer [69]

--------------------------------------------------------------------------------

Great. Thank you for joining us on our call today. We will participate in one conference in the first quarter, that's the Boenning & Scattergood conference in London on March 12. Have a great day.

--------------------------------------------------------------------------------

Operator [70]

--------------------------------------------------------------------------------

Ladies and gentlemen, this concludes today's conference. Thank you for participating. You may now disconnect.