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Text: Undoubtedly these are unprecedented times.
With safety and well-being of our employees as the highest priority I am extremely proud of our entire team supporting our customers with the central water heating and water treatment products to combat this virus.
As a result of the COVID-19 pandemic and in support of continuing our manufacturing efforts during this time we have undertaken numerous meaningful in some cases extraordinary steps at our manufacturing plants to protect our employees.
These steps include plant accommodations and reconfigurations to maintain social distancing mask availability to all employees deep cleaning quarantining individuals with positive tests or potential exposure to the virus for 14 days and restricting access to facilities among others.
While these steps result in lower manufacturing efficiencies in some cases our focus is on safety first.
The majority of our office personnel have been working from home and have done a great job in maintaining productivity and support of the business.
As offices have reopened in China and will soon in other countries and in the U.S. we have implemented return to office protocols which include bringing back office staff in waves over a two month period making maks available more frequent cleaning of common areas sanitizing stations throughout the office areas and limiting use of conference rooms for small group meetings to maintain social distancing.
Our long-term relationships in many cases decades-long and strength of our partners within various channels including wholesale distributors DIY retail hardware stores plumbing supply and independent reps are particularly important as we provide the essential water heating and water treatment products critical to uninterrupted operations of hospitals clinics grocery stores food service companies and many more including the households that many are now using to conduct business and education.
Our global supply chain management team proactively monitors and manages the ability to operate effectively and identify bottlenecks.
To date we have not seen any meaningful disruption in our supply chain.
We engaged in ongoing communication with our supply chain partners to identify and mitigate risk including multi-sourcing and managing inventory at higher levels.
Our recent implementation of SAP has provided improved management tools and visibility into our supply chain.
Additionally we have improved our manufacturing flexibility as a result of water heater tank standardization projects over the last five years.
Standardization greatly improves our ability to shift manufacturing from one plant to another should the need arise.
The stability afforded by the replacement component in residential and commercial water heater and boiler demand which we estimate at 85% of the U.S. unit volume puts us in a position of strength as we navigate through this pandemic.
We estimate replacement demand is 40% to 50% in China.
While we are in a position of strength similar to 2008 and 2009 time frame we expect to see lower demand for the majority of our products and have been proactive in managing costs.
We have increased our cost-reduction programs in China and we continue to monitor the North American environment and customer demand to potentially take further actions such as furlough programs and other restructuring.
A. O. Smith is in a solid financial position with positive cash flow and a strong balance sheet.
While A. O. Smith has a strong balance sheet and capital position we are proactively managing our discretionary spend and cash position.
To that end we suspended our share repurchase program in mid-March in addition while we continue to focus on strategic investments including new products and production efficiency.
We have reprioritized and reduced our capital spend plans for 2020 by approximately 20%.
Through April we have completed $200 million of dividends out of China and we have repatriated $125 million to the U.S. As of April 30 2020 we had approximately $850 million in liquidity consisting of cash cash equivalents marketable securities and borrowing capacity on our credit facility which remains in place throughout 2020 and 2021 expiring in December 2021.
We continue to focus on rightsizing the cost structure of our China business.
We have achieved a 20% headcount reduction compared with December 2018 and we will continue to assess the need for additional workforce reduction.
We are targeting 1000 net store closures this year in China along with further cuts in advertising and other costs.
Total savings are expected to total $55 million an increase of $10 million from our estimate in January of which $30 million was achieved in 2019.
Our debt maturity schedule is shown on slide five.
The next major maturity date is at the end of next year in December 2021 when our revolving credit facility expires.
We are in compliance with all covenants in our credit facility.
Our leverage ratio is 17.5% gross debt to total capital at the end of March was significantly below the 60% maximum dictated by our credit and various long-term facilities.
I will begin comments about the first quarter on slide six.
First quarter 2020 sales of $637 million declined 15% compared with the first quarter of 2019.
The decline in sales was largely due to a 56% decline in China local currency sales driven by the COVID-19 pandemic.
As a result of lower sales in China first quarter 2020 net earnings of $52 million and earnings per share of $0.32 declined significantly compared to the same period in 2019.
Sales in our North America segment of $533 million increased 2% compared with the first quarter of 2019.
Incremental sales of $16 million from the Water-Right acquisition purchased in April 2019 organic growth of 17% in North America water treatment products and higher water heater volumes drove sales higher.
These factors were partially offset by water heater sales mix composed of more electric models which have a lower selling price and lower contractual formula pricing associated with a portion of water heater sales based on lower steel costs.
Rest of the World segment sales of $110 million declined 53% with the same quarter in 2019.
China sales declined 56% in local currency related to weak consumer demand driven by the pandemic.
China channel inventories declined slightly from the levels at the end of 2019 and remained in the normal range of two to three months.
On slide eight North America segment earnings of $127 million were 10% higher than segment earnings in the same quarter in 2019.
The improvement in earnings were driven by lower steel costs incremental profit from Water-Right and improvement in the profitability of the organic water treatment sales which were partially offset by the mix skew to electric water heaters and lower contractual pricing.
As a result first quarter 2020 segment margin of 23.9% improved from 22.2% achieved in the same period last year.
Rest of the World loss of $42 million declined significantly compared with 2019 first quarter segment earnings of $12 million.
The unfavorable impact to profits from lower China sales and a higher mix of mid-price products which have lower margins more than offset the benefit to profits from lower SG&A expense.
As a result of these factors the segment margin was negative with compared with 5.3% in the same quarter in 2019.
Our corporate expenses of $15 million and interest expense of $2 million were essentially flat as last year.
Our effective tax rate of 23.6% in the first quarter of 2020 was higher than the 20% tax rate in the first quarter of 2019 primarily due to geographical differences in pre-tax income.
Cash provided by operations of $54 million during the first quarter of 2020 was higher than $22 million in the same period of 2019 as a result of lower investment in working capital including timing of certain volume incentive payments which was partially offset by lower earnings compared with the year ago period.
Our liquidity and balance sheet remained strong.
We had cash balances totaling $552 million and our net cash position was $209 million at the end of March.
During the first quarter of 2020 we repurchased approximately 1.4 million shares of common stock for a total of $57 million.
During April we saw differing levels of impact from the pandemic across our major product lines and geographies.
In North America our average daily orders for residential water heaters declined low single digits compared with the first quarter pace.
Commercial average order rates in April were down 30% to 35%.
It is difficult to interpret order rates in April as customers are likely adjusting inventory levels as they manage their inventory investment dollars.
In China the pandemic had a significant impact on our volume in the first quarter.
50% of our sales volume occurred before the Chinese New Year shutdown on January 24.
With manufacturing government offices restaurants and schools now largely reopened and the majority of installers able to access apartments in China we have seen sequential improvement in sellout and orders in April compared with February and March.
Consumers remain cautious and it's too early to determine when consumers will return to normal levels in retail environments.
A portion of the improvement could be pent-up demand.
In North America demand for residential boilers has remained soft following a warm winter.
And we have delayed our early buy incentive program in this environment.
Our commercial condensing boiler backlog has doubled from levels at this time last year but some orders have extended delivery dates.
With construction sites closed in some states timing of delivery is difficult to project.
Safety and security of drinking water is a high priority for consumers during this time.
The North America water treatment end market strength we saw in the first quarter continued in our direct-to-consumer product portfolio which skews to lower price easier-to-install products.
In April we experienced some challenges in parts of the country with installed in-home products.
In India our water treatment products are considered essential.
But our manufacturing plant is closed as worker transportation is difficult in this environment.
We believe the current environment does not allow for the forecast of performance with reasonable precision.
And as a result we continue to suspend our 2020 full year guidance.
As the depth of the disruption and pace of recovery in our end markets become clearer we look to return to our practice of providing a current year outlook.
In Mexico similar to other companies we temporarily suspended operations as governmental agencies continue to sort through the industries designated as essential and allow to continue operate as well as the conditions and safety measures under which businesses deem essential are allowed to operate.
We temporarily shifted manufacturing from Mexico to the U.S. to minimize disruption of our customers.
Each day we move closer to an understanding of when we'll resume production and believe that we will be in a week or two and at a reduced manning and capacity.
These lower rates coupled with the U.S. output are expected to support demand for customers over the coming months.
Our global supply chain team has been proactive from early in the first quarter and continues to monitor and manage availability of components.
Again to date we have experienced minimal disruptions in our global supply chain.
Our largest suppliers in Mexico which are in different states than our boilers plant are now reopened but at reduced capacity.
While the disruption has been minimal we have experienced reduced safety stock levels on certain items and our supply team is in ongoing communication with our suppliers to mitigate operational risk and manage inventory levels.
We believe replacement demand for water heaters and boilers in the U.S. is approximately 85%.
In 2006 through 2009 which captured the Great Recession peak to trough industry shipments of residential water heater volumes declined 18%.
The decline was primarily driven by a $1.5 million decline in new homes constructed.
During that period we were able to flex our operations to maintain margins.
At 1.3 million new homes in 2019 we do not anticipate the new home construction impact will be as great as the Great Recession.
The replacement base of our core U.S. products provides a stabilizing buffer to the economic downturn expected in the remaining three quarters of 2020.
After being closed for several weeks in February in compliance with local orders our three plants in China are open and operating.
Foot traffic in our retail network in China remains low and we are building to order at lower-than-normal operating capacities.
Our suppliers are open and we are now and we are not experiencing disruptions.
Customers continue to prefer products with fewer features continuing the trend we saw last year as you would expect in this environment.
Our mid-price products are positioned for this trend.
Despite reduced headcount retail footprint and advertising costs we continue to invest in R&D in the region.
Product development continues with a focus on taking costs out of our most popular new products to improve contribution margins.
Product development has been one of the pillars to our success in China and we are committed to our investment in engineering resources in China and around the world.
After a hard closure of the economy in the first quarter China is slowly returning to business.
While we have seen April orders and -- incrementally improve from February and March it's too early to predict if the recent improvement is the result of pent-up demand or by consumers slowly returning to the market.
In North America we have previously experienced in weathering through difficult economic conditions most recently in the 2008 recession.
However with the massive and abrupt impact to jobs and end markets like restaurants hotels and hospitals it is difficult to predict this current state of shelter-at-home and state-by-state closures will play out similarly to the 2008 recession.
While we would expect that our replacement business in both water heating and boilers will provide a buffer in the same manner as we have seen before the impact to construction and discretionary spend and closure of certain job site activity is difficult to predict for the remainder of 2020.
In India it is clear that our targets breakeven in 2020 will be pushed out as the country battles COVID-19.
We believe that particularly in these uncertain times A. O. Smith is a compelling investment for a number of reasons.
We have leading market share in our major product categories.
We estimate replacement demand represents approximately 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 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 acquisition and return to cash and returning cash to shareholders.
We will continue to proactively manage our business in this uncertain environment as we've seen consumer demand trends emerge in China where we were first impacted by the pandemic and now in North America as the current economy begins to reemerge after the economic shutdown.
We have a strong team which has navigated successfully through prior downturns.
I'm confident in our ability to execute through COVID-19.

user
a. o. smith suspends 2020 outlook.
q1 earnings per share $0.32.
sales in quarter ended march 31 were approximately 15 percent lower.
2020 outlook suspended.
company suspended its 2020 full year outlook.
believes it is in a solid financial position with sufficient liquidity to navigate through today's challenging business environment.

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