Ladies and gentlemen, thank you for joining us for the Third Quarter 2020 Earnings Call. All participants are currently in listen-only mode. Please note that today's conference is being recorded. After the presentations, we will have a question-and-answer session. I would like to now turn the call over to Patricia Ackerman. Thank you. Please proceed.

Thank you, Steven. Good morning, ladies and gentlemen, and welcome to the A. O. Smith's 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 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 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 4.

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 are up mid-teens in the quarter compared with last year. We believe an overall positive tone to new residential and remodel construction activity and extended lead times driven by pandemic-related disruptions may have prompted some channel partners to build inventory during the quarter. Due to construction project delays and postponements in North America, as well as uncertainty surrounding commercial construction, we saw a commercial water heater and boiler volumes decline 9% to 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. Plant 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 5.

Thank you, Kevin. Third quarter 2020 sales of $760 million increased 4% compared to 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 6. Sales in our North America segment of $544 million increased 6% compared with the third quarter of 2019. Higher residential water heater volumes and organic growth of approximately 19% in North America water treatment sales more than offset lower commercial water heater volumes and lower boiler sales. Rest of the World sales of $221 million were essentially flat with the same quarter in 2019. China sales were flat as higher consumer demand was offset by a higher mix of mid-price products. China currency translation favorably impacted sales by approximately $4 million. India sales in the quarter declined compared with last year. On Slide 7, North America adjusted segment earnings of $134 million or 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-priced products, which have lower margin. These results exclude $1.1 million in pre-tax severance and restructuring costs. As a result of these factors, 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 8. 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 remain 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 9. 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 are similar for the remainder of the year to what we are experiencing today and do 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 and $55 million; and our depreciation and amortization expense is expected to be approximately $80 million in 2020. Our corporate and other expenses are expected to be approximately $50 million in 2020, higher than 2019 primarily due to lower interest income on investments. We expect our interest expense will be $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'll now turn the call back to Kevin, who will summarize our guidance assumptions beginning on Slide 10.

Thanks, 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 new model 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 this. We continue to target the closure of 1,000 existing stores, while targeting to open 500 small store relationships in Tier 4 through 6 cities. Cost actions and restructuring activity are projected to result in approximately $30 million of savings in 2020 over 2019; $7 million of which will be realized in the fourth quarter. We expect the year-over-year declines in local currency sales of 18% and 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 is essentially complete. We expect our North American boiler sales will decline by mid-single digits this year. Commercial boilers represent 65% to 70% of our boiler sales and industry volumes are down 15% to 17% year-to-date and improved slightly in the third quarter from the second quarter. The market is competitive, and we are getting our fair share of the available market. We project 22% to 24% sales growth in North America water treatment products, which includes incremental water right sales. We believe the mega trend of healthy and safe drinking water as well as the 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 11. We project revenue will decline by 6% to 7% in 2020 as strong organic North America water treatment sales and resilient North America residential water heater volumes are more than offset by weaker North America commercial water heater and boiler volumes and lower China sales largely due to the pandemic in the first half of the year. We expect North America segment margin to be between 23% and 23.5% and rest of world segment margins to be between negative 1% and negative 2%. Please turn to Slide 12. We believe that particularly in these uncertain times, A. O. Smith is a compelling investment for a number of reasons. We have leading share positions in our major product categories. We estimate replacement demand represents approximately 80% to 85% of our water heater and boiler volumes. We have a strong premium brand in China, a broad product offering and our key product categories, broad distribution, and a reputation for quality and innovation in that region. Over time, we are well-positioned to maximize favorable demographics in both China and India to enhance your older value. We are proud of the progress and the opportunity we see in our North America water treatment platform. We have strong cash flow and balance sheet, supporting the ability to continue to invest for the long term with investments in automation, innovation, and new products, as well as acquisitions and return cash to shareholders. That concludes our prepared remarks, and we are now available for your questions.

Thank you. Our first question will come from Matt Summerville at D.A. Davidson. The line is now open.

Good morning. 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?

Our normal lead times are about 15 days, and that's on residential, but quite a bit longer for other commercial products as well, maybe a little less. They got as high as 20 to 25 days, a little bit higher than that at certain times. So we worked it down to what we had mentioned in our remarks to more normalized levels, and we expect; a) we expect our customers to, because of our lead times coming down, they'll probably adjust some of their inventory down to the appropriate levels since they bought them up with some concerns about disruptions in our manufacturing facilities.

And then as a follow-up within China. Have you now seen sustained 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 points? Thank you.

Yes. Sure, Matt. This is Chuck. Yes. We have seen sustained year-over-year sales improvement in that low single digits. So I would say it's been pretty consistent throughout the quarter and through October where we've seen year-over-year consumer demand. So we've been pleased with kind of that, I'll call it, stability of demand coming through.

All right. Our next question will come from the line of Scott Graham from Rosenblatt Securities. The line is now open.

Yes. Hi. Good morning. Nice quarter, guys.

Thanks, Scott. Good morning.

Good morning.

So I understand now why your fourth quarter guidance is maybe a little bit held back, given some of these destocking. But 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 may be impacted a little bit by some of the destocking? That's my first question.

Yes. Scott, you're right. The third quarter was very strong. So if I do 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. And when you kind of look at the August results of the industry, we're up almost 5%. And when we look at what we saw in September, we saw continued strength. So our full-year call to be the industry of 4% does have that headwind in the fourth quarter. That's largely the reason for the swing. So when Kevin talked about lead times, we made up probably half what we were over by the end of September, and we've got a little bit more of the lead time that was made up in October, but lead times are pretty close to normal. So that headwind will be in the fourth quarter and we think some of that will carry into next year, but we also think some will come out in the fourth.

Okay. So, 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, but 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.

Yes. I mean, in the industry data, I mean, what we're seeing in the industry is customers when lead times are extended, it's fairly typical that customers will stock up and make sure they've got products on hand, particularly in the replacement market for anything that would come up. So they'll generally order stronger than they typically do to ramp up that inventory.

And Scott, I would tell you, just to give you an outlet, we're seeing some of the orders start to be reduced in October. So, again, we don't have great visibility to all the inventories of our customers, but we do believe that there was some inventory build and that there will be some destocking in Q4.

Our next question will come from the line of Jeff Hammond from KeyBanc. The line is now open.

Hey, good morning, guys.

Good morning, Jeff.

Good morning.

Just on North America commercial, so how would you characterize demand versus how you were expecting it in the quarter? And then just talk about kind of order quoting activity, and I know there's a lot of concerns about non-res into 2021. Like how do you see that shaping up?

This is Kevin. It actually shaped up about exactly how we thought it would be. The commercial market has had, with the closing of some jobs and reopening, and there's been a lot of volatility there. So the quarter was no different, and we see Q4 being no different as well. So 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. And I think the big question is going to be is, and we'll have to see how Q4 plays out. The robustness of jobs being released and moving forward, do others get delayed or not? But overall, the market's down, it came in, but we thought it was going to be, and I think Q4 will be similar as we get to the end of the year.

Okay. And then China, I think you mentioned mix shift again here. When do you think that starts to normalize? Or do you see that continuing for a bit?

Yes. I mean, it's been continuing for a while as consumer confidence, even before the pandemic, was a bit lower. We 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, but for the quarter, that headwind on sales volume is maybe in that 5% range. So it's similar to what it was last quarter and until we see consumers trading up, we would expect that we would see a little bit of headwind on that mix throughout the fourth quarter.

Just add a little bit more color to that as well is the markets, the premium markets are holding, but they're just a small piece of the pie. More importantly, that there's been no noticeable retaliation against any of the brands. So 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. And we were very pleased with how China ended up the quarter. We've been working on that breakeven point. We were above the breakeven point. We had a solid mid-single-digit quarter in China and kind of came out right where we planned. We mentioned some of the social exemption charges; there was about a $3 million help. My prepared comments on the social exemption think of that as social security type exemption, where we didn't 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, so it's been extended through the end of the year. We would 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. But overall, we're pleased with how the chatter results came in. And the stability, I guess, in what we'd say is consumer demand being positive year-over-year.

Our next question will come from the line of Nathan Jones from Stifel. The line is now open.

Yes. Good morning, this is Adam Farley on for Nathan.

Hey, Adam.

Yes. In water treatment, going along the lines of some of these positive COVID trends, including home improvement and remodeling. Do you think this theme has legs in the water treatment business? Again, it was a really strong quarter. And then in that business, are you seeing any delays from occupancy in homes that could have actually dampened demand at all?

Well, there are a couple of questions there, right? I do think that there's still a tailwind to water treatment in the U.S. and that will continue for us into the fourth quarter, but just to be transparent, we do have a tough comp in the quarter. We had a very large inventory build for one of our customers last year. But, if you look at how October's playing out, there's still quite a bit of consumer demand there, and this translates into 2021, probably some of it. One of the great things about the water treatment business is every time we sell a product, we get to sell a consumable later. So that's going to have some legs on it as it goes forward. But I do think consumers are just more health-conscious today. It's not just 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 of the future for a lot of people. So overall we've been really pleased with our business, our execution across all the channels. And so, and then you mentioned where there's some access to houses and so forth that has been caused by the pandemic? And the answer is yes. But we have worked and learned how to particularly our dealers, they have learned how to sell virtually to have social distancing when they're visiting a customer to install with a social distancing protocol. And quite frankly, our dealers are doing quite well and had a really nice quarter in Q3. We saw a nice mix improvement from Q2 on the water treatment business because of the fact that point-of-entry products, which generally require professional installation was a little bit stronger and it had been dampened a bit in Q2 when we had less access.

That's really helpful. And then, turning to margins 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 for margins in the short-term, or can that be covered with price?

Yes, I mean, the North American 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 and the quarter, you get some real efficiencies on the leverage on fixed. We do see some – we do see some minor headwinds. If you recall, our steel, which is our largest costs, we see visibility in that 90 days to 120 days, because that's where our pricing locks in. So while there's been some recent uptick in some of the spot pricing and steel, which we've seen in the last call it 60 days to 30 days. Our fourth quarter year-over-year is still favorable. It's a little less favorable than it was in Q3; but it'll still be a favorable year-over-year.

Our next question will come from the line of Saree Boroditsky from Jefferies. The line is now open.

Thank you. Good morning.

Good morning.

You had a really strong margin performance from rest of the world, but it looks like guidance assumes some setback 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?

We feel, I mean, we've talked about in the fourth quarter, we would see China performing mid-single digits margin – operating margin. It's a little early for us to be thinking about 2021. We liked kind of the stability of what we've seen in Q3 and what we expect in Q4, and China being the largest part. We won't see the repeat of the social insurance exemption that we – that I mentioned earlier in that when you're thinking of SG&A, that's about $7 million of SG&A for the year. So that'll be a bit of a headwind. But 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. So it's a little early for us to talk about 2021, and we'll be ready to do that when we come out in January.

Just another quick comment, the amount of uncertainty every quarter just changes. And so as we're heading into Q4, we have spikes across the U.S. Chuck just mentioned, India goes in and out of lockdown dependent on certain regions. Europe, so we're going to manage through the uncertainty in each month that goes by and each time we get a better picture of what the future looks like is helpful. So to talk about 2021 right now would not be in our best interests and would probably just be speculation. So we'll manage through Q4 and as we get on our call next year in January, we'll give you our best guidance to what we feel the business is going.

I appreciate that. Then the second question is on the energy platform that talks about increasing appliance efficiency. Could you just talk about what that would really mean for you guys and how it will be impacted by that?

Well, let me take that and then maybe Chuck can jump in as well. There's a lot of discussion about electrification. We refer to it more as decarbonization, greenhouse gases and as we look at it, we're in favor of reducing greenhouse gases. But at the same time, we are talking to the policymakers to make sure that there isn't a one-size-fits-all type of solution. We really believe it's a combination of many, many different types of products and technologies. So as we go forward and you look at it from the water heater business, we have full lines of condensing product that lets you know leading boilers and leading water heaters, and those have a major impact into carbon reduction going from non-efficient to efficient. We have a full line of electric water heaters, both standard and electric – standard electric, as well as heat pump. Heat pumps are a terrific value proposition and could be part of the solution going forward. Then on the commercial side of the business, we have a full line of again, electric commercials, but also we recently introduced a full line of commercial heat pumps. So when you look at how the energy policy is going forward, we're fully aware of it and are engaging with policymakers, as well as the various agencies. We're positioned well and we continue to bring products to market that we think are going to address this issue; and even to the point of utilities, many of our products are going to be able to be connected. So if there's a grid solution, we're going to be part of that. So overall, we're positioned well, how it moves forward. That's going to be something we'll have to keep monitoring, but the big key for everybody on this call is we're involved, and we're helping to drive that as an industry leader, and our products and our factories are prepared for any direction that it takes.

Our next question will come from the line of Bryan Blair from Oppenheimer. The line is now open.

Thanks. Good morning, everyone.

Good morning.

Chuck, I think you previously stated North American water treatment margins were running high single-digit range in the first half outlook for around 10% for the year. Is that outlook still valid, or is strong growth driving margins a little bit higher? Just trying to gauge the jumping-off point for 2021?

Yes. I would say it's still valid. I mean, I mentioned in an earlier question that we saw strong mix for the quarter, typically has higher price, higher margin product and point of entry. And so for the quarter, we were just above that 10%. So we're on track.

Okay. Very good. A higher-level one. We know your team does a lot of work tracking and modeling the replacement cycle on the residential side. If you're willing to comment on this, how has the pandemic impacted your assumptions and how should we think about that base level of demand going into 2021 and then looking out to 2022?

Well, 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% or 2% range. Quite frankly, we've been focused on the pandemic. So we really haven't dug into this last quarter and projected it up, something that we'll look at obviously as we go forward. But the initial assumptions and the work that we've done, we still think are valid as we go forward. And if this blip turns out to be a blip, my guess is we'll have that same position going forward.

Our next question will come from the line of Susan Maklari from Goldman Sachs. Your line is now open.

Everyone.

Good morning.

Good morning.

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, and 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?

Yes, I mean, as the only public company, we don't comment on pricing, particularly going forward pricing. We do look at going into next year and with a projection that there will be some inventory in the channel, some will come out in Q4, but we think that there will be some left in the channel early next year.

Yes, 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 and that's kind of where we stand with any of these types of cost questions and pricing questions.

Okay. All right. Thank you. And then my second question is on China. You mentioned that you're in the process of opening those 500 stores in the Tier 4 to 6 cities. As we 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, while 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 yourself 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?

Well, let me take a shot at this. Just – there are two questions in there. One is online and then one is about the smaller Tier 4 to 6 Tier businesses. One, we are accelerating the opening a bit quicker than we thought and in the long term, there's a good growth opportunity in those Tier 4 and 6 cities and having the right products and the right relationships. And we're working pretty diligently on that and have been quite successful opening the stores. And we'll continue to do that as we go forward. If you look on the online side of it, we've enhanced our online e-commerce capabilities and some of the mid-priced products we've added and some of the digitalization and digital marketing that we're in the process of executing or have executed. Our online sales are certainly a growth engine in China for the next few years. And we're positioning ourselves in that category appropriately. Again, remember a lot of the online is in the very lower price range where we don't participate, but there is a segment that fits our mid-price to the premium segment. And we're engaging in that. It's a number one priority for our business, and we're continuing to execute on our plans to capture our fair share of the online sector.

Our next question will come from the line of an unidentified caller. Your line is now open.

So, China appears to be continuing a year-over-year mixed shift towards mid-priced 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-priced products from a margin percent perspective?

Yes, I mean, we're still working on how far along it is. It's going to take a while. I mean, our priority over the last 18 months is to make sure that we're reinserting products into that upper mid-price category, and then we do the cost reduction. So, 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 – in the margin line. So it's going to take a bit of time.

Yes, I would just add that the cost reduction in that activity is in our DNA across all of our businesses. So there's never a point where our first goal is to get the mid-price into the market, and I think we've essentially done that, and they've been accepted very well and doing well in the market. But every year we're looking at ways to drive productivity, drive material costs down, redesign products, and that's not only in China, but that's across all of our businesses. And we'll continue to do that. We always believe there's cost reduction opportunities in all of our products throughout our processes, and that includes China as well as the other parts of our business. So again, cost reduction is just what we do on a regular basis.

Thank you. That's helpful. And with debt to capital ending the quarter at about 6.1%, so given the strong balance sheet, what are you seeing in terms of M&A opportunities in the water treatment space? And what would you need to see to start the share repurchase program?

Well, let me start with the share repurchase. I mean, we suspended the program in the first quarter. We're going to hold off into the rest of the year and come back and talk about it at the beginning of the year. So with the disruption of COVID, we just felt it was the right thing to do. We typically size the repurchase to not grow cash, and we feel pretty comfortable with where we're going through the year here with our cash projection, but we just – we're 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're continuing to absolutely be active. We look at the targets that are out there, difficult time, the last couple of months in quarters to transact anything, but the M&A market is more active. It's certainly more active. There may be some opportunities coming out of this timeframe for some of the companies that are on our target list, but may be more interested in transactions, but we can continue to remain active.

Yes, I think some of that – I 100% agree with what Chuck just said, our targets and then our reach out programs, and of course opportunities come across our desk. But in reality, I think, more of the opportunities will come as we get through parts of this pandemic and get more stable, but again we're active and we have the cash to take advantage of any good opportunities that comes our way.

Our next question will come from the line of Damian Karas from UBS. The line is open.

Hi, good morning everyone. Thanks for taking my questions.

Good morning, Damian.

Good morning.

So 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 the World's margins. You addressed them already to some extent. It sounds like you're not quite ready to give an outlook for 2021. But 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. I am just wondering how much volatility you'd kind of expect to see quarter in, quarter out with respect to the segment margin. Obviously, they kind of fell over the place the last couple of years. Do you think you might get tighter range from here? How are you thinking about that?

Yes, I mean, we like what we saw in Q3 and we feel pretty comfortable about Q4. So that range has been we hope firmed up with the help of some year-over-year consumer demand 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 and that's just the quarter that when you're thinking about kind of sequentially, which quarter is the most challenged, it's Q1. But for the long term and for kind of what we've seen today and what we see in the next couple of months is we feel like that 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. And 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.

Okay. So that makes sense. Thanks. And then I wanted to ask you about the North American 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 entrance and also wanted to ask you just in this recent surge in the industry shipments, I'm curious what kind of trends you might be seeing in tankless.

Okay. Let me start with tankless. Damian, I would say, tankless has been – last year it was up about 6%. Historically, it had been growing double digits. This year, we're seeing tankless growing. It's also growing above 10% this year. So, tankless is growing about that double-digit range. New entrance, thinking about new entrance, there hasn't been much activity. I guess we haven't heard a great deal of 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.

Yes. Again, I would tell you from just more of a macro level where we take whole competitors seriously, and this has been a topic that we've discussed on a couple of calls and we always continue to monitor the market, but more importantly, we take care of ourselves. And 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. And so, our focus certainly will watch our competitors, but our focus has always been on taking care of our customer. And nothing proves that than a crisis or a pandemic. And so that's our focus. And again, if anything, I would agree with Chuck on the competitive front. There's not been much with the new entrance. And if there is, we'll adjust it appropriately and comment if and when it happens.

Our next question will come from the line of David MacGregor from Longbow Research. The line is now open.

Good morning, everyone.

Good morning.

I wanted to ask you about China, and certainly you guys have accomplished a lot there. There's been a lot of progress in terms of just getting the costs straightened around and inventory is down. But you're talking about mid-single digit growth in the fourth quarter. And I guess I just wanted to understand the composition of that growth. Is it coming from water treatment rather than from water heaters? I mean, you talked about the premium segments being stable. So I'm assuming that we're not seeing a lot of growth in the premium segment. And while there may be some growth from the mid-price point. My sense was that there's a little more of a struggle going on there. So help me to understand the composition of that mid-single-digit growth. And what's the potential that maybe there's upside to that number, I guess.

Yes, I mean, so the mid-single-digit growth is really a combination of consumer demand for our entire portfolio. So you're right. It's not all equal. We are seeing the water heating side under some pressure for year-over-year demand. We are pleased with water treatment. For the quarter, water treatment performed very well in China on a per-unit basis. So, actually, the biggest drivers in water treatment for the quarter in China were our commercial business, which we don't talk about a lot, but last year was about $20 million in sales. And the commercial business grew nicely quarter-over-quarter consumables that repeatable business of consumables that we have, which is approximately 15% of the total grew very, very nicely too. So, in total, our China water treatment business was up over 10% for the quarter. So 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 a range of products at a smaller level and some other products that are doing quite well. So, we would see consumer demand for our portfolio continuing in that year-over-year improvement. And then – and to your point, we're pleased with how water treatment performed for the quarter. There are always innovations in the background and that's across our three major product categories for sure and that's water heating and gas, water heating and electric, and of course on water treatment. Nothing that I would tell you that we can announce today, but 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. And we'll probably launch a few of them in the upcoming year like we always do. And as a consumer brand, it's important that we have some new products come to market as that match our premium brand and what they expect from our brand, which is innovation and quality.

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. So, it's a hot water tap that you'd have on your countertop and has filtered and boiling water, if you'd like, at the same time. So that was probably one of the more successful products that has some innovation in the products that we've launched recently.

Our next question will come from the line of Scott Graham from Rosenblatt Securities. The line is now open.

Yes. Hi. Good morning. I got cut off before. I want to ask a couple, but everyone asked some pretty good questions here. So I just do have a couple.

Okay.

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 different dynamics. But 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.

Yes, 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 want to say that we've seen much change. On commercial water heating, when we're looking at order demand, I would say, October was very similar to what we saw in the third quarter, so not a substantial change. It's been pretty much the same as we go through that. I really - well, yes, it's been pretty much running the same through until October.

Scott, we've talked about a little bit on the call is you do have jobs opening and closing. Quite frankly, you still have trade issues out there with a shortage of the skilled labor. And so the market, as we had mentioned, we see a similar Q4 and we'll have to keep our eyes on how we get into Q1, but again I'll be a little bit repetitive, we are seeing activity. It's a little bit slower than it has been, but there's still activity in the commercial market.

Our last question will come from the line of Larry De Maria from William Blair. The line is now open.

Hi. Thanks everybody. Two quick questions. First, India. Obviously, there's an impact from COVID there and a setback. But what do we need to see for India to get back to breakeven, or even start turning a profit? I don't know if 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 breakeven given that's kind of obviously been a bit of disappointment?

Yes, to think it's a breakeven and beyond, it is volume-related as we scale up—water heating has been scaled pretty well. Water treatment, we're still scaling. And I've mentioned this before, yes, some really nice momentum over the last couple of years taking out chunks of the losses $2 million and $3 million each year. Really had a nice path going forward to breakeven in 2020, and just unfortunately the pandemic hit hard and has continued to hit it. But 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 moving in a positive direction, 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, but when it's all said and done, primarily it’s volume. We need to have the economy improve, and we need to take share in some categories; put the combination together, and it leads to breakeven, and then a move forward position for us.

Are we 5% to 10% volume from that? Is that fair to say? Or is it a bigger number?

Yes. So last year, our volume in India was about just under $40 million, so about $39 million. This year our projection is we're going to be down 20% to 25% off of that number. So as we were coming into this year, we're expecting to be breakeven, and we expect the growth rate in India to be in that double-digit range. So, 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 breakeven. So 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.

Okay. That's great color. And then last question obviously in restaurants, hospitality, hotels, et cetera, not surprisingly a headwind. Just curious as the economy sort of started opening up a bit in 3Q. Did you start to see any sequential increase in that sector for replacement? I'm just kind of trying to understand how sensitive that can be towards reopening or closing?

I think reopening is key. I think you've hit 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 with the mandate only 25% restaurants and tourist capacities. And so, I think it's too early. But as you go forward, as that does open up, that plays well to us as those restaurants start getting people in, washing dishes, and using the hot water as well as the hotels, but it's a bit early to make that statement.

There are no further questions. Patricia Ackerman, please continue.

Thank you all for joining us today. We plan to participate in two virtual conferences in the fourth quarter: Robert W. Baird on November 10th and Northcoast on November 16th. Enjoy your day. Thank you.

This concludes today's conference call. Thank you for participating. You may now disconnect.