A. O. Smith - Earnings Call - Q3 2020
October 29, 2020
Transcript
Operator (participant)
Ladies and gentlemen, thank you for standing by and welcome to the third quarter 2020 earnings call. At this time, all participants are in a listen-only mode. Please be advised that today's conference is being recorded. After the speaker's presentation, there will be a question-and-answer session. To ask a question during that time, you will need to press star and the number one on your telephone keypad. If you require any further assistance, please press star zero. I would now like to hand the conference over to your speaker for today, Patricia Ackerman. Thank you. Please go ahead.
Patricia Ackerman (VP of Investor Relations)
Thank you, Stephen. Good morning, ladies and gentlemen, and welcome to the A. O. Smith third quarter 2020 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 question, will constitute forward-looking statements. These forward-looking statements are subject to risks that could cause actual results to be materially different. Those risks include, among others, matters that we have described in this morning's news 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 that exclude the severance and restructuring charges related to aligning our business to current market conditions.
Reconciliations from GAAP measures to non-GAAP measures are provided in the appendix at the end of this presentation and also on our website. Also, as a courtesy to others in the question queue, please limit yourself to one question and one follow-up per turn. If 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.
Kevin Wheeler (Chairman and CEO)
Thank you, Pat. Our business has performed well in the third quarter. Continuing the pace of growth we saw in the first half of the year, our North America water treatment products grew 19%. All channels, direct-to-consumer, retail, and dealers contributed to the growth as health-conscious consumers continue to drive sales higher. Industry volumes of residential water heaters in the U.S. surged in the third quarter. Based on our September shipments, we estimate industry volumes were up mid-teens in the quarter compared with last year. We believe an overall positive tone to new residential and remodel construction activity and extended lead times driven by pandemic-related disruptions may have prompted some channel partners to build inventory during the quarter.
Due to construction project delays and postponements in North America, as well as uncertainty surrounding commercial construction, we saw commercial water heater and boiler volumes decline 9-10% in the quarter compared with last year. Consumer demand for our products in China increased by low single digits compared with the third quarter of 2019, as pent-up demand from the lockdown materialized and consumer confidence improved. We remained operational with no significant disruptions within our plants and our supply chain. We did see our North America water heater lead times extend in the second and third quarters due to self-quarantine absenteeism, which we mandated according to our COVID prevention measures. We shifted some production, added shifts, and hired temporary workers to improve our lead times, which are now approaching more normal levels.
I would like to thank our dedicated employees who tirelessly worked overtime hours and accommodated shifting schedules to take care of our customers. We have taken numerous and meaningful steps to protect our employees, suppliers, and customers in the pandemic. These important steps, in many cases reducing efficiencies, included open and regular communication with employees and customers in line with our values, planned accommodations to maintain social distancing, employee temperature taking, and regular proactive deep cleaning and sanitization of our facilities, among others. To align our business with current market conditions, a process started in the second quarter. We reduced headcount and incurred other restructuring costs totaling $1 million in the third quarter. I will now turn the call over to Chuck, who will provide more details on the quarter beginning on slide five.
Chuck Lauber (CFO)
Thank you, Kevin. Third quarter 2020 sales of $760 million increased 4% compared with the third quarter of 2019. The increase in sales was largely due to higher residential water heater volumes and water treatment product sales in North America. As a result of higher sales and cost reduction activities earlier this year, third quarter 2020 adjusted earnings of $107 million and adjusted earnings per share of $0.66 increased significantly compared with the same period in 2019. Please turn to slide six. Sales in our North America segment of $544 million increased 6% compared with the third quarter of 2019. Higher residential water heater volumes and organic growth of approximately 19% in North America water treatment sales more than offset lower commercial water heater volumes and lower boiler sales. Rest of the world sales of $220 million were essentially flat with the same quarter in 2019.
China sales were flat as higher consumer demand was offset by a higher mix of mid-price products. China currency translation favorably impacted sales by approximately $4 million. India sales in the quarter declined compared with last year. On slide seven, North America adjusted segment earnings of $134 million were 10% higher than segment earnings in the same quarter in 2019. The increase in earnings was driven by higher residential water heater volumes, higher water treatment product sales, and lower material costs. Lower volumes of commercial water heaters and lower boiler sales partially offset these factors. Adjusted earnings include $500,000 in pre-tax severance costs. As a result, third quarter 2020 adjusted segment margin of 24.6% improved from 23.6% achieved in the same period last year. Rest of the world adjusted segment earnings of $18 million increased significantly compared with 2019 third quarter segment earnings of $4 million.
In China, higher volumes, reduction in SG&A costs, and approximately $3 million of temporary social insurance contribution exemptions were partially offset by a higher mix of mid-price products which have lower margins. These results exclude $1.1 million in pre-tax severance and restructuring costs. As a result of these factors, adjusted segment margin improved to 8% compared with 1.9% in the same quarter of 2019. Our corporate expenses of $10.9 million were higher than the same quarter of last year primarily due to lower interest income. Please turn to slide eight. Cash provided from operations of $330 million during the first nine months of 2020 was higher than $280 million in the same period of 2019 as a result of lower investments in working capital which were partially offset by lower earnings compared with the prior year. Our liquidity and balance sheet remained strong.
We had cash balances totaling $509 million, and our net cash position was $395 million at the end of September. Our leverage ratio at the end of the quarter was 6.1% as measured by total debt to total capital. We had $500 million of undrawn borrowing capacity on our $500 million revolver. No shares were repurchased in the quarter, and our share repurchase activity continues to be suspended. We repurchased approximately 1.3 million shares of common stock for a total of $57 million earlier this year. Please advance to slide nine. We upgraded our 2020 adjusted EPS guidance this morning with a range of between $1.95 and $1.98 per share. The midpoint of this range represents an increase of 10% compared with our prior 2020 full-year guidance. Our 2020 adjusted EPS guidance excludes $0.04 per share in severance and restructuring costs incurred in the second and third quarters.
Our guidance assumes the conditions of our business environment and that of our suppliers and customers is similar for the remainder of the year to what we are experiencing today and does not deteriorate as a result of further restrictions or shutdowns due to the COVID-19 pandemic. We expect our cash flow from operations in 2020 to be approximately $400 million compared with $456 million in 2019, primarily due to lower earnings. In 2020, capital spending plans are between $50-$55 million, and our depreciation and amortization expense is expected to be approximately $80 million in 2020. Our corporate and other expenses are expected to be approximately $50 million in 2020, higher than 2019 primarily due to lower interest income on investments. We expect our interest expense will be $7.5 million in 2020 compared with $11 million in 2019 due to lower debt levels.
Our effective income tax rate is expected to be between 23% and 23.5% in 2020. Our assumptions assume no additional share repurchase resulting in average diluted outstanding shares in 2020 of approximately $162.5 million. I will now turn the call back to Kevin, who will summarize our guidance assumptions beginning on slide ten.
Kevin Wheeler (Chairman and CEO)
Thank you, Chuck. Our outlook for 2020 includes the following assumptions. We project U.S. residential water heater industry volumes will be up 4% in 2020, driven by a positive new home and remodel construction environment and our belief that the channel added inventory due to extended industry lead times. We believe some destocking will occur in the fourth quarter as our lead times have and continue to improve. We expect commercial industry water heater volumes will decline approximately 10% as the pandemic impacted businesses and temporarily closed job sites in the first half of the year, delaying or deferring new construction and discretionary replacement installations. It is encouraging to see consumer demand for our China products slightly higher than last year over the last six months. We took additional charges in Q3 for further restructuring of the business. We believe these restructuring charges are behind us.
We continue to target closure of 1,000 existing stores while targeting opening 500 small store relationships in tier four through six cities. Cost actions and restructuring activity are projected to result in approximately $30 million of savings in 2020 over 2019, $7 million of which will be realized in the fourth quarter. We expect year-over-year declines in local currency sales of 18-19% and project mid-single-digit growth in the fourth quarter as October sellout continues to be positive compared with last year. We are encouraged to see profitable results in the third quarter, but the heavy lifting of SG&A cost reductions essentially complete. We expect our North America boiler sales will decline by mid-single digits this year.
Commercial boilers represent 65-70% of our boiler sales, and industry volumes are down 15-17% year to date and improved slightly in the third quarter from the second quarter. The market is competitive, and we are getting our fair share of the available market. We project 22-24% sales growth in North America water treatment products, which includes incremental water rights sales. We believe the megatrend of healthy and safe drinking water, as well as reduction of single-use plastic bottles, are driving consumer demand for our point of use and point of entry water treatment systems. We ended 2019 with a $2.6 million loss in India and expect a similar loss in 2020 as a result of the pandemic. Please advance to slide eleven.
We project revenue will decline by 6-7% in 2020 as strong organic North America water treatment sales and resilient North America residential water heater volumes are more than offset by weaker North America commercial water heater and boiler volumes and lower China sales largely due to the pandemic in the first half of the year. We expect North America segment margin to be between 23%-23.5% and rest of the world segment margins to be between negative 1 and negative 2%. Please turn to slide twelve. We believe that particularly in these uncertain times, A. O. Smith is a compelling investment for a number of reasons. We have leading share positions in our major product categories. We estimate replacement demand represents approximately 80%-85% of U.S. water heater and boiler volumes.
We have a strong premium brand in China, a broad product offering in our key product categories, broad distribution, and a reputation for quality and innovation in that region. Over time, we are well positioned to maximize favorable demographics in both China and India to enhance shareholder value. We are proud of the progress and the opportunity we see in our North America water treatment platform. We have strong cash flow and balance sheet supporting the ability to continue to invest for the long term with investments in automation, innovation, and new products, as well as acquisitions and return cash to shareholders. That concludes our prepared remarks, and we are now available for your questions.
Operator (participant)
Thank you. As a reminder, to ask a question, you will need to press star then the number one on your telephone keypad. Please limit up to two questions only. You may press star one to return in the queue. To withdraw your question, please press the pound key. Our first question will come from the line of Matt Somerville from D.A. Davidson. The line is now open.
Matt Summerville (Managing Director and Senior Research Analyst)
Good morning. A couple of questions. First, can you talk about what your normal North American water heater lead times look like, where they peaked, where they are now, and whether October results are consistent with your view that the channel is going to take inventory down in Q4?
Kevin Wheeler (Chairman and CEO)
Our normal lead times are about 15 days, and that's on residential, but quite frankly, on our commercial products as well, maybe a little less. They got as high as 20-25 days, a little bit higher than that maybe at certain times. We have worked them down to what we had mentioned in our remarks to a more normalized level, and we expect our customers to, because of our lead times coming down, they'll probably adjust some of their inventories down to the appropriate levels since they brought them up with some concerns if there were any disruptions from our manufacturing facilities.
Matt Summerville (Managing Director and Senior Research Analyst)
As a follow-up, within China, have you now seen sustained sort of month-to-month positivity in overall volumes, and can you talk about where your mix has been trending over the last several quarters with respect to mid-price point? Thank you.
Kevin Wheeler (Chairman and CEO)
Yeah, sure, Matt. This is Chuck. Yeah, we have seen sustained year-over-year sales improvement in that low single digits. I would say it's been pretty consistent throughout the quarter and through October where we've seen year-over-year consumer demand. We've been pleased with kind of that, I'll call it, stability of demand coming through.
Operator (participant)
All right. Our next question will come from the line of Scott Graham from Rosenblatt Securities. The line is now open.
Scott Graham (Senior Equity Research Analyst)
Yes. Hi. Good morning. Nice quarter, guys.
Kevin Wheeler (Chairman and CEO)
Thanks, Scott. Good morning.
Scott Graham (Senior Equity Research Analyst)
I understand now why your fourth quarter guidance is maybe a little bit held back given some of this stocking. I guess the other side of it is that the North American margin was quite strong. Now, does that mean that the fourth quarter North American margin maybe gets retarded a little bit by some of the stocking? That's my first question.
Kevin Wheeler (Chairman and CEO)
Yeah. Scott, you're right. The third quarter was very strong. I mean, if I just take a step back and kind of think about when we had our last call, we had projected the North America residential industry to be flat. When you kind of look at the August results of the industry, we're up almost 5%. When we look at what we saw in September, we saw continued strength. Our full-year call to be the industry up 4% does have that headwind in the fourth quarter. That's largely the reason for the swing. When Kevin talked about lead times, we made up probably half what we were over by the end of September and got a little bit more of the lead time that was made up in October.
Lead times are pretty close to normalized, so that headwind will be in the fourth quarter. We think some of that is going to carry, we think some of the channel inventory will carry into next year, but we also think some will come out in the fourth quarter.
Scott Graham (Senior Equity Research Analyst)
Okay. Essentially what I think I hear you say is now you're the industry leader, so you've got a better beat on this than anybody. Essentially what you're seeing is in the industry data that you think the market is maybe just a little bit ahead of it, got a little bit ahead of itself in the last month or so.
Kevin Wheeler (Chairman and CEO)
Yeah. I mean, in the industry data, I mean, what we're seeing in the industry is customers getting when lead times extend, it's fairly typical that customers will stock up and make sure they've got product to make sure that they've got product on hand, particularly in the replacement market for anything that would come up. They'll generally order stronger than they typically do to ramp up that inventory. Scott, I would tell you, just to give you an outlook, we're seeing some of the orders start to be reduced in October. Again, we don't have great visibility to all the inventories of our customers, but we do believe that there was some inventory build and that there'll be some destocking in Q4.
Operator (participant)
Our next question will come from the line of Jeff Hammond from KeyBanc Capital Markets. The line is now open.
Jeffrey Hammond (Managing Director)
Hey. Good morning, guys.
Kevin Wheeler (Chairman and CEO)
Morning, Jeff. Good morning.
Jeffrey Hammond (Managing Director)
Hey, just on North America commercial. How would you characterize demand versus how you were expecting it in the quarter? Just talk about kind of order quoting activity. I know there's a lot of concerns about non-resin to 2021. How do you see that shaping up?
Kevin Wheeler (Chairman and CEO)
This is Kevin. It actually shaped up about exactly how we thought it would be. The commercial market has, with the closing of some jobs and reopening, there's been a lot of volatility there. The quarter was no different, and we see Q4 being no different as well. It came in about what we thought. As we start to look at our quoting activity, there is some softness out there, but there's still activity. I think the big question is going to be is, and we'll have to see how Q4 plays out of the robustness of jobs being released and moving forward, do others get delayed or not. Overall, the market's down. It came in where we thought it was going to be. I think Q4 will be a similar view as we get through the end of the year.
Jeffrey Hammond (Managing Director)
Okay. China, I think you mentioned mixed shift again here. When do you think that starts to normalize or abate or we kind of stop talking about it? Or do you see that continuing for a bit?
Kevin Wheeler (Chairman and CEO)
Yeah. I mean, it's been continuing for a while as consumer confidence, even before the pandemic, was a bit lower. We didn't see as much trading up, particularly on the water heating side of the business. We see a little resilience on trading up on the water treatment side of the business. For the quarter, that headwind on sales volume is maybe in that 5% range. It's similar to what it was last quarter. Until we see consumers trading up, we would expect that we would see a little bit of headwind on that mix for at least throughout the fourth quarter. Yeah. Just to add a little bit more color to that as well is the markets, the premium markets are holding, but they're just a smaller piece of the pie. More importantly, there's been no noticeable retaliation against any of the brands.
The market's still got to play itself out. Consumer confidence is growing. We expect it to continue, but it may be some time before we start to see meaningful movement back up to the premium sector as it grows. Yeah. We were very pleased with it, and it came out pretty much where we projected with where China ended up the quarter. We've been working on that break-even point. We were above the break-even point. We had a solid mid-single-digit quarter in China, and it kind of came out right where we planned. We mentioned some of the social exemption charges. There was about a $3 million help on my prepared comments on the social exemption. Think of that as social security-type exemption where we did not need to pay into the government some of those extra tax costs or social costs.
That's a program that's been extended through the year. It's been extended through the end of the year. We'll not expect to repeat it next year. We would not expect it to be extended. It's about $3 million this quarter. It's about $1.5 million next quarter. Overall, we're pleased with how the China results came in and the stability, I guess, in what we would say is consumer demand being positive year over-year.
Operator (participant)
Our next question will come from the line of Nathan Jones from Stifel. The line is now open.
Nathan Jones (Managing Director and Industrials Equity Analyst)
Yeah. Good morning. This is Adam Farley on from Nathan.
Kevin Wheeler (Chairman and CEO)
Hey, Adam.
Nathan Jones (Managing Director and Industrials Equity Analyst)
Hey. In water treatment, going along the lines of some of these positive COVID trends, including home improvement, home remodeling, do you think this theme has legs in the water treatment business? Again, it was a really strong quarter. In that business, are you seeing any delays from Ackerman Seen Homes that could have actually dampened demand at all?
Kevin Wheeler (Chairman and CEO)
There is a couple of questions there. I do think that there is still a tailwind to water treatment in the U.S., and that will continue. For us, it will go into the fourth quarter. Just to be transparent, we do have a tough comp in the fourth quarter. We had a very large inventory build with one of our customers last year. If you look at how October is playing out, there is still quite a bit of consumer demand there. Does it translate into 2021? Probably some of it. One of the great things about the water treatment business is every time we sell a product, we get to sell a consumable later. That is going to have some legs on it as it goes forward. I do think consumers are just more health conscious today. It is not just COVID and the safety aspect of it.
I think they're more health conscious. And quite frankly, with sustainability, plastic bottles are just not probably a product for the future for a lot of people. Overall, we've been really pleased with our business, our execution across all the channels. You mentioned whether some access to houses and so forth that has been caused by the pandemic. The answer is yes. Our team has worked and learned how to, particularly our dealers. They've learned how to sell virtually, to have social distancing when they're visiting a customer, to install with a social distancing protocol. Quite frankly, our dealers are doing quite well and had a really nice quarter in Q3.
Nathan Jones (Managing Director and Industrials Equity Analyst)
We saw a nice mixed improvement from Q2 on the water treatment business because of the fact that point-of-entry products, which required generally professional installation, was a little bit stronger and had been dampened a bit in Q2 when we had less access.
That's really helpful. Turning to margins, I think you guys called out lower raw material costs as a benefit. Commodity prices generally are on the rise. Should we expect to see any headwinds to margins in the short term, or can that be covered with price? Thanks.
Kevin Wheeler (Chairman and CEO)
Yeah. I mean, the North America margins were really strong for the quarter. Some of that, to an earlier question, was when you have that type of volume go through the plant in the quarter, you get some real efficiencies on the leverage on fix. We do see some minor headwinds. If you recall, our steel, which is our largest cost, we see visibility in that 90-120 days because that's where our pricing locks in. While there's been some recent uptick in some of the spot pricing in steel, which we've seen in the last, I'll call it 60-30 days, our fourth quarter, year-over-year, it's still favorable. It's a little less favorable than it was in Q3, but it'll still be favorable year-over-year.
Operator (participant)
Our next question will come from the line of Saree Boroditsky from Jefferies. The line is now open.
Saree Boroditsky (Equity Research Analyst)
Thank you. Good morning.
Kevin Wheeler (Chairman and CEO)
Morning.
Saree Boroditsky (Equity Research Analyst)
You had a really strong margin performance in the rest of the world, but it looks like guidance assumes some set down in the fourth quarter. Could you just talk about what you think is a good starting point for us to think about the potential margins for 2021? Any puts and takes there?
Kevin Wheeler (Chairman and CEO)
We feel, I mean, we've talked about in the fourth quarter, we would see China performing mid-single-digit margin, operating margin. It's a little early for us to be thinking about 2021. We like kind of the stability of what we've seen in Q3 and what we expect in Q4 on China being the largest part. We won't see the repeat of the social insurance exemption that I mentioned earlier. When you're thinking of SG&A, that's about $7 million of SG&A for the year. That'll be a bit of a headwind. We've got India who always has the fourth quarter as our largest quarter. India has been challenged a bit on COVID-19, so we're going to have to see how India plays out in the back half of the year.
It's a little early for us to talk about 2021, and we'll be ready to do that when we come out in January.
Saree Boroditsky (Equity Research Analyst)
Just another quick comment. The amount of uncertainty every quarter just changes. As we are heading into Q4, we have spikes across the U.S. Chuck just mentioned India goes in and out of lockdown depending on the certain regions, Europe. We are going to manage through the uncertainty. Each month that goes by and each time we get a better picture of what the future looks like is helpful. To talk about 2021 right now would probably be not probably in our best interest and probably would just be speculation. We will manage through Q4. As we get on our call next year in January, we will give you our best guidance to where we feel the business is going.
I appreciate that. The second question, the Biden Clean Energy Platform talks about increasing appliance energy efficiency. Could you just talk about what that would really mean for you guys and how you would be impacted by that?
Kevin Wheeler (Chairman and CEO)
Let me take that and then maybe Chuck can jump in as well. There is a lot of discussion about electrification. We refer to it more to decarbonization, greenhouse gases. As we look at it, we are in favor of reducing greenhouse gases. At the same time, we are talking to the policymakers to make sure that there is not a one-size-fits-all type of solution. We really believe it is a combination of many, many different types of products and technologies. As we go forward and you look at it from the water heater business, we have full lines of condensing product, as you know, leading boilers, leading water heaters. Those have a major impact into carbon reduction and so forth, going from a non-efficient to an efficient. We have a full line of electric water heaters, both standard and electric, standard electric, as well as heat pump.
Heat pump is a terrific value proposition and could be part of the solution going forward. On the commercial side of the business, we have a full line of, again, electric commercials, but also we recently introduced a full line of commercial heat pumps. When you look at how the energy policy is going forward, we're fully aware with them. We're fully engaged with policymakers as well as the various agencies. We're positioned well. This issue, and even to the point of utilities. Overall, we're positioned well. Keep monitoring. The big key, I think, for everybody on this call is we're involved. We're helping to drive that as an industry leader. Our products and our factories are prepared for any direction that it takes.
Operator (participant)
Our next question will come from the line of Bryan Blair from Oppenheimer. The line is now open.
Bryan Blair (Managing Director and Senior Analyst)
Thanks. Good morning, everyone.
Kevin Wheeler (Chairman and CEO)
Good morning.
Bryan Blair (Managing Director and Senior Analyst)
Chuck, I think you previously cited higher. Just trying to gauge the jumping-off point for 2021.
Kevin Wheeler (Chairman and CEO)
Yeah. I would say it's still valid. I mean, I mentioned on an earlier question that we saw a strong mix for the quarter, which typically has a higher price, higher margin product and point of entry. For the quarter, we were just above that 10%. We're on track. We're on track.
Bryan Blair (Managing Director and Senior Analyst)
Okay. Very good. A higher-level one. We know your team does a lot of work tracking and modeling the replenishments. How should we think about that base level of demand going into 2021 and then looking out to 2022?
Kevin Wheeler (Chairman and CEO)
You're certainly right. We've done a lot of work on it, and we've shared it in prior calls that we just don't see a big drop-off. We see a gradual decline over the years in that 1-2% range. Quite frankly, we've been focused on the pandemic. We really haven't dug into this last quarter and projected it out. Something that we'll look at, obviously, as we go forward. The initial assumptions and the work that we've done, we still think are valid as we go forward, and it will have that same position going forward.
Bryan Blair (Managing Director and Senior Analyst)
Okay. Thank you.
Operator (participant)
Our next question will come from the line of Susan Maklari from Goldman Sachs. The line is now open.
Susan Maklari (Vice President and Lead Equity Research Analyst)
Hey, everyone.
Chuck Lauber (CFO)
Good morning.
Kevin Wheeler (Chairman and CEO)
Morning.
Susan Maklari (Vice President and Lead Equity Research Analyst)
My first question is, can you talk a little bit about pricing in North America as we think about some of the inventory that has built over the quarter? Perhaps you're going to head into 2021 with a bit more inventory in the channel. What does that mean as the industry starts to think about pricing for next year?
Kevin Wheeler (Chairman and CEO)
Yeah. I mean, as the only public company, we do not comment on pricing, particularly go forward pricing. We do look at going into next year with a projection that there will be some inventory in the channel. Some will come out in Q4, but we think that there will be some left in the channel early next year.
Susan Maklari (Vice President and Lead Equity Research Analyst)
Yeah. I would just say on that, and probably going to sound a bit like a broken record, but historically, given time, we've been able to address inflation. That's kind of where we stand with any of these type of cost questions and pricing questions.
Okay. All right. Thank you. My second question is on China. You mentioned that you're in the process of opening those 500 stores in the tier four to six cities. As we kind of look at some of the recent data, you could see that the online sales in China in water heaters, both gas and electric, have accelerated 20%-30%-40% in August and September. Offline sales seem to be down 15%-20% at the same time. Can you talk about how you're thinking about the dynamic that's going on there, how you're positioning yourselves to capture that kind of growth that's coming through, especially in the online channel, and maybe what the opening of these stores kind of means within this framework?
Chuck Lauber (CFO)
Let me take a shot at this. There are two questions in there. One is online and then one is about the smaller tier four to six tier businesses. One, we are opening those. Actually, we are opening a bit quicker than we thought. Long term, there is a good growth opportunity in those tier four and six cities and having the right products and the right relationships. We have been working pretty diligently on that and have been quite successful opening the stores. We will continue to do that as we go forward. If you look on the online side of it, we have even enhanced our online e-commerce capabilities and some of the mid-price products we have added and some of the digitalization and digital marketing that we are in the process of executing or have executed. Online is going to be certainly a growth engine in China for the next few years.
We are positioning ourselves in that category appropriately. Again, remember, a lot of the online is in the very lower price range where we do not participate. There is a segment that fits our mid-price to a premium segment. We are engaging in that. It is a number one priority for our business. We are continuing to execute on our plans to capture our fair share of the online sector.
Operator (participant)
Our next question will come from the line of Ethan Buchbinder from Citi. The line is now open.
Eitan Buchbinder (Equity Research Analyst)
China appears to be continuing a year-over-year mixed shift towards mid-price products. Can you tell us how far along are you in optimizing the cost structure of mid-price products to get it more in line with higher price products from a margin % perspective?
Kevin Wheeler (Chairman and CEO)
Yeah. I mean, we're still working on how far along. It's going to take a while. I mean, our priority over the last 18 months is to make sure that we're reinserting products into that upper mid-price category. Then we do the cost reduction. I would say we're in the early stages of that. We're going to be working through that over the next year or year and a half to get better at the margin line. It's going to take a bit of time.
Chuck Lauber (CFO)
Yeah. I would just add cost reduction in that activity is in our DNA across all of our businesses. There is never a point where our first goal was to get the mid-price into the market. I think we have essentially done that. They have been accepted very well and doing well in the market. Every year, we are looking at ways to drive productivity, drive material costs out, redesign products. That is not only in China, but that is across all of our businesses. We will continue to do that. We always believe there are cost reduction opportunities in all of our products and throughout our processes. That includes China as well as the other parts of our business. Cost reduction is just what we do on a regular basis.
Eitan Buchbinder (Equity Research Analyst)
Thank you. That's helpful. With that, the capital ending the quarter at about 6.1%. Given the strong balance sheet, what are you seeing in terms of M&A opportunities in the water treatment space? What would you need to see to start the share repurchase program?
Chuck Lauber (CFO)
Let me start with the share repurchase. I mean, we suspended the program in the first quarter. We are going to hold off into the rest of the year and come back and talk about it at the beginning of the year. With the disruption of COVID, we just felt it was the right thing to do. We typically size the repurchase to not grow cash. We feel pretty comfortable with where we are going through the year here with our cash projection. We are going to hold off until the first part of next year in our January timeframe and talk about that. On the M&A front, we are continuing to absolutely be active. We look at the targets that are out there. Difficult time the last couple of months and quarters to transact anything. The M&A market is more active. It is certainly more active.
There may be some opportunities coming out of this timeframe for some of the companies that are on our target list that may be more interested in transactions. We can continue to remain active.
Kevin Wheeler (Chairman and CEO)
Yeah. I think some of that. I 100% agree with what Chuck just said. Our targets and then our reach-out programs. Of course, opportunities come across our desk. In reality, I think more of the opportunities will come as we get through the parts of this pandemic and get more stable. Again, we're active. We have the cash to take advantage of any good opportunity that comes our way.
Operator (participant)
Our next question will come from the line of Damian Karas from UBS. The line is open.
Damian Karas (Senior Equity Research Analyst)
Hi. Good morning, everyone. Thanks for taking my questions.
Kevin Wheeler (Chairman and CEO)
Good morning, Damian.
Damian Karas (Senior Equity Research Analyst)
Good morning. We've already covered quite a bit of ground here. Appreciate all the insight you've been able to provide. Just wanted to touch back on the rest of world margins. You addressed them already to some extent. It sounds like you're not quite ready to give an outlook for 2021. Once you factor in all the moving pieces like the restructuring benefits, some of those temporary SG&A and other costs that might be coming back, and then product mix, just wondering how much volatility you kind of expect to see quarter and quarter out with respect to the statement margins. Obviously, they've kind of been all over the place the last couple of years. Do you think you maybe see a tighter range from here? How are you thinking about that?
Kevin Wheeler (Chairman and CEO)
Yeah. I mean, we like what we saw in Q3. We feel pretty comfortable about Q4. That range has been, we hope, firmed up with the help of some year-over-year consumer demand being more stable. Thinking about that range going forward, the only caveat I would say to that on a bit of a quarter over quarter is the first quarter is always very tough. You have the Chinese New Year and the festival and the shutdowns. That is just a quarter that when you're thinking about kind of sequentially which quarter is the most challenge, it's Q1. For the long term and for kind of what we've seen today and what we see in the next couple of months, we feel like that has stabilized a bit. We feel like we've got a decent floor to work from.
To your point, we've taken out a lot of costs on SG&A. We're right on track for all our restructuring programs. Some of that may come back as we see growth. There's opportunities and some investments like deferred advertising and brand building that we could bring back into the business should we see some opportunities to do that as we go into next year.
Damian Karas (Senior Equity Research Analyst)
Okay. No, that makes sense. Thanks. I wanted to ask you about the North America water heaters market. Obviously, a lot of discussion around there on some new competition. I was wondering if you're seeing or hearing anything at this point related to the new market entrants. I also wanted to ask you just in this recent surge in the industry shipment, curious what kind of trends you might be seeing in tankless.
Chuck Lauber (CFO)
Okay. Why don't we start with tankless? I mean, I would say tankless has been last year, it was up about 6%. Historically, it had been growing double digits. What we've seen tankless this year is it's also growing above 10% this year. So tankless is growing about that double-digit range. New entrants, thinking about new entrants, not much has been not much activity. I guess we haven't heard a great deal different than what we had on the last call. There really hasn't been any new significant information that's been in the marketplace. It's been rather quiet.
Kevin Wheeler (Chairman and CEO)
Yeah. Again, I would tell you from just more of a macro level where we take all competitors seriously. This has been a topic that we've discussed on a couple of calls. We'll always continue to monitor the market. More importantly, we take care of ourselves. If you look at through this pandemic and you reach out to our customers and the service levels and what we've done demonstrates the ability that A. O. Smith has to be a long-term partner. Our focus certainly, we'll watch our competitors, but our focus has always been on taking care of our customer. Nothing proves that than some type of crisis or a pandemic. That's our focus. Again, if anything, I would really check on the competitor front. There's not been much with the new entrants.
If there is, we'll adjust it appropriately and comment if and when it happens.
Operator (participant)
Our next question will come from the line of David MacGregor from Longbow Research. The line is now open.
David MacGregor (President)
Hi. Good morning, everyone. I wanted to ask you about, yeah, good morning. I wanted to ask you about China. Certainly, you guys have accomplished a lot there. There has been a lot of progress in terms of just getting the costs straightened around and the inventories down. You are talking about mid-single-digit growth in the fourth quarter. I just wanted to understand the composition of that growth. Is it coming from water treatment rather than from water heaters? I mean, you talked about the premium segment being stable. I am assuming that we are not seeing a lot of growth in the premium segment. While there is maybe some growth from the mid-price point, my sense was that there was a little more of a struggle going on there. Help me understand just the composition of that mid-single-digit growth.
What's the potential that maybe there's upside to that number, I guess?
Kevin Wheeler (Chairman and CEO)
Yeah. I mean, the mid-single-digit growth is really a combination of consumer demand for our entire portfolio. You're right. It's not all equal. We are seeing water heating sides under some pressure for year-over-year demand. We are pleased with water treatment. For the quarter, water treatment performed very well in China on a per-unit basis. Actually, the biggest drivers in water treatment for the quarter in China were our commercial business, which we do not talk about a lot. Last year was about $20 million in sales. The commercial business grew nicely quarter over quarter. Consumables, that repeatable business of consumables that we have, which is approximately 15% of the total, grew very, very nicely too. In total, our China water treatment business was up over 10% for the quarter. You're right.
We're looking pretty favorable at that segment of the business as we go through the fourth quarter. On the margins, the rest of the products, we've got range hood products at a smaller level and some other products that are doing quite well. We would see consumer demand for our portfolio continuing in that year-over-year improvement. To your point, we're pleased with how water treatment performed for the quarter.
David MacGregor (President)
Great. Is there anything on the horizon in terms of innovation or some change in terms of market construct that would draw the Chinese consumer back to the premium price points that would create a growth story there again?
Kevin Wheeler (Chairman and CEO)
There's always innovation in the background. That is across our three major product categories for sure. That is water heating and gas water heating, electric, and of course, on water treatment. Nothing that I would tell you that we can announce today. We always have our hundreds of engineers working on what's new. It's a requirement. As a premium brand, we have to bring new innovative products out there. We have a portfolio of ideas. We will probably launch a few of them in the upcoming year like we always do. As a consumer brand, it's important that we have some new products come to market that match our premium brand and what they expect from our brand, which is innovation and quality.
Chuck Lauber (CFO)
Yeah. I mean, the most recent product that we launched that comes to mind on the water treatment side is the hot water tap that has a filter built into it. It is a hot water tap that you would have on your countertop. It has filtered and boiling, if you would like it, hot water at the same time. That was probably one of the more successful products that has some innovation in the products that we have launched recently.
Operator (participant)
Our next question will come from the line of Scott Graham from Rosenblatt Securities. The line is now open.
Scott Graham (Senior Equity Research Analyst)
Yes. Hi. Good morning. I got cut off before. I wanted to ask a couple, but everyone asked us some pretty good questions here. I just do have a couple. Could you talk a little bit about sort of how commercial trended and maybe differentiate commercial water heaters versus boilers because those markets are so really different dynamics? Sort of how they trended during the quarter, did they end up strongest year-over-year in September? Was it more even? If you could help us out on that.
Kevin Wheeler (Chairman and CEO)
Yeah. I would say, Scott, it was, I mean, we're down for the quarter on boilers, about 7.5%. I mean, it's pretty even when you go into October. I don't see that we see much change. On commercial water heatings, when we're looking at water heating, when we're looking at order demand, I would say October was very similar to what we saw in third quarter. So not a substantial change. It's been pretty much the same as we go through that. I would not that, well, yeah, it's been pretty much running the same through into October.
Chuck Lauber (CFO)
Yeah. Scott, we talked about a little bit on the call is you do have jobs opening and closing. Quite frankly, you still have trade issue out there with a shortage of skilled labor. The market, as we had mentioned, we see a similar Q4. We will have to keep our eyes on how we get into Q1. Again, I will be a little bit repetitive. We are seeing activity. It is a little bit slower than it has been, but there is still activity in the commercial market.
Scott Graham (Senior Equity Research Analyst)
Understood. Thank you. I wanted to also maybe talk a little bit about sort of the guidance because in sitting here listening to others, I'm just sort of playing around the model. And to get to your operating margin guidance for North America, it really kind of presupposes a pretty down hard fourth quarter margin and in the territory of 2-300 basis points. A, would you agree with that? B, what can you do about it?
Kevin Wheeler (Chairman and CEO)
Yeah. I mean, we were really strong in Q3. And when you have that kind of volume that goes through the plants, our margins were really, really strong. We are coming off of that. It is about, it is in that range. Maybe not quite as large as your projection is, but it is in that range of down. Strong Q3. Q4, we are looking at a little bit of headwind on conversion costs compared to Q3.
Operator (participant)
All right. Our last question will come from the line of Larry De Maria from William Blair. The line is now open.
Larry De Maria (Equity Research Analyst)
Hi. Thanks, everybody. Two quick questions. First, India. Obviously, there's an impact from COVID during a setback. What do we need to see for India to get back to break even or even start turning a profit? I don't know. Is it volume growth into next year or do we have to adjust the cost base? Just curious how you're thinking about getting that to break even given that it's kind of obviously been a bit of a disappointment.
Chuck Lauber (CFO)
Yeah. To get to break even and beyond, it is volume related. As we scale up, water heating has been scaled pretty well. Water treatment, we're still scaling. I've mentioned this before. We had some really nice momentum over the last couple of years, taking out chunks of the losses, $2 million and $3 million each year, and really had a nice path going forward to break even in 2020. Just unfortunately, the pandemic has hit, and it hit India hard. It is continuing to hit it.
If you look at it, being able to do some of the cost reductions that we've done this year, and if India can turn around and have its economy move in a positive direction and we can drive some volume, the chances are we probably won't add in all the costs that we've taken out, and we'll be able to do some leverage there. When it's all said and done for India, it's volume. We need to have the economy improve, and we need to take share in some categories. You put the combination together, it leads to a break-even and then a move-forward position for us.
Larry De Maria (Equity Research Analyst)
Are we 5%-10% volume from that? Is that fair to say? Or is it a bigger number?
Chuck Lauber (CFO)
Yeah. Last year, our volume in India was just under $40 million, so about $39 million. This year, our projection is we're going to be down 20%-25% off of that number. As we were coming into this year, we were expecting to be break-even. We expect the growth rate in India to be in that double-digit range. As Kevin said, when you kind of look at the cost balance and just a little bit more volume off of where we were last year, you get to that break-even. It's not a huge leap from last year, but we've got to build back up from where we are in the current environment.
Larry De Maria (Equity Research Analyst)
Okay. That's great color. Then last question. Obviously, restaurants, hospitality, hotels, etc., not surprising a headwind. Just curious, as the economy sort of started to open up a bit in 3Q, did you start to see any sequential increase in that sector for replacement? Just kind of trying to understand how sensitive that can be towards reopening or closing.
Chuck Lauber (CFO)
I think reopening is key. I think you've hit it on a major part of particularly on the restaurants and the hotels. I think it's too early. We still see spikes across the country. We still have orders. I'll give you one here in Wisconsin. They mandate only 25% restaurants and historic capacities. I think it's too early. As you go forward, as that does open up, that plays well to us as those restaurants start getting people in, washing dishes and using hot water as well as the hotels. It's a bit early to make that statement.
Larry De Maria (Equity Research Analyst)
Okay. Thank you very much. Good luck.
Operator (participant)
There are no further questions. Patricia Ackerman, please continue.
Patricia Ackerman (VP of Investor Relations)
Thank you all for joining us today. We plan to participate in two virtual conferences in the fourth quarter: Robert W. Baird on November 10 and Northcoast Research on November 16. Enjoy your day. Thank you.
Operator (participant)
This concludes today's conference call. Thank you for participating. You may now disconnect.