A.O. Smith Corp (AOS) — Q4 2018 Earnings Call Transcript

Thank you, Norma. Good morning, everyone, and thank you for joining us for our 2018 results conference call. Participating in the call are Ajita Rajendra, Executive Chairman; Kevin Wheeler, Chief Executive Officer; and John Kita, Chief Financial Officer. Before we proceed with Kevin's remarks, I want to remind you that some comments made during this call, including responses to your questions, will be forward-looking statements. These forward-looking statements come with risks that may lead to actual results being significantly different. These risks include, among others, those outlined in this morning's press release. To enhance transparency regarding our operating results, we provided non-GAAP measures: adjusted net earnings, adjusted earnings per share, and adjusted effective income tax rates. For 2017, these exclude the total tax expense associated with U.S. Tax Reform. For 2018, they exclude the restructuring and impairment costs related to our plant closure in Renton, Washington. A reconciliation of some GAAP measures to non-GAAP measures is available in the appendix at the end of this presentation and on our website. Additionally, to accommodate others in the question queue, please limit yourself to one question and one follow-up at a time. If you have more questions, please rejoin the queue. I will now hand it over to Kevin, who will start our prepared remarks on slide four.

Thank you, Pat, and good morning, ladies and gentlemen. Our mid-single digit sales growth in 2018 was driven by positive end markets for our boilers, residential water heaters in the U.S. and continued demand for water treatment products in China. Here are a few highlights. Record sales at 3.2 billion grew over 6%. Record adjusted earnings per share grew 20%. We are proud of the global water treatment platform we have built over the last seven years. Beginning in 2011 with about $35 million of water treatment sales in China, we significantly grew to approximately $400 million in 2018. As we experienced rapid organic water treatment growth in China, we added several bolt-on acquisitions in the U.S. and in Europe, launched water treatment products in India and Vietnam and added water treatment engineers and technologists to our global engineering centers. We achieved exclusive supplier status for Lowe’s water treatment business in the U.S. We continue to review our capital allocation and dedicated portion of our cash to return to shareholders. In 2018, we repurchased nearly 4 million shares for approximately $200 million. We announced two dividend increases in 2018 and the five-year compound annual growth rate of our dividend is 30%. We repatriated over $300 million in overseas cash to the U.S., increasing the flexibility of our balance sheet. John will now describe our results in more detail beginning with slide five.

Sales for the year of $3.2 billion grew over 6% compared with the prior year. Adjusted net earnings of $449 million increased 19% from 2017. Adjusted earnings per share of $2.61 increased 20% compared with 2017. Sales in our North America segment of $2 billion increased 7% compared with 2017. The increase in sales was primarily due to higher volumes of residential water heaters and boilers and pricing actions related to steel cost increases. North America water treatment sales including the newly launched Lowe's business in the third quarter incrementally added approximately $29 million to our North America segment sales. Rest of World segment sales of nearly $1.2 billion increased 5% compared with 2017. China sales increased nearly 2% on a local currency basis. The Chinese currency favorably impacted the translation of China sales by approximately $23 million. In China higher water treatment sales including consumables were partially offset by lower sales of electric water heaters and air purifiers. Water heater and water treatment sales in India increased approximately $8 million or over 40% in 2018 in local currency terms compared with 2017. On slide eight, North America adjusted segment earnings of $471 million were 10% higher than segment earnings in 2017. The favorable impact from higher sales of residential water heaters and boilers and the pricing actions in the U.S. were partially offset by higher steel costs and onetime costs associated with the launch of the water treatment products at Lowe's. As a result of these factors, the 2018 segment margin of 23% was higher than the 22.5% generated in 2017. Rest of World earnings of $149 million were flat compared with 2017. The impact of profits from lower sales of electric water heaters and air purifiers, as well as higher SG&A expenses were offset by the favorable impact to profits from higher water treatment products sale and improved performance in India. Higher advertising related to brand building and higher product development engineering costs were the primary drivers of higher SG&A in China. Segment margin in 2018 declined as a result of these factors. Our corporate expenses were essentially flat compared with 2017. Our adjusted effective income tax rate in 2018 was 20.4%. The rate was lower than the 27.4% experienced in 2017, primarily due to U.S. Tax Reform and benefited 2018 results by $0.02 per share compared with our October guidance. Sales for the fourth quarter of $813 million were 6% higher than the same quarter in 2017. Adjusted earnings in the fourth quarter of $126 million increased 21% from the fourth quarter in 2017. Fourth quarter adjusted earnings per share of $0.74 increased 23% compared with the same quarter in 2017. Sales in our North America segment of $522 million increased 13% compared with the fourth quarter of 2017. The increase in sales was primarily due to higher volumes of boilers and residential water heaters in the U.S. and pricing actions related to steel cost increases. Rest of World segment sales of $298 million declined 5% compared with the same quarter in 2017. China sales were down 3% in local currency as the Chinese economy continued to weaken. Higher sales of water treatment products, including consumables were more than offset by lower sales of water heaters and air purifiers. The weaker Chinese currency unfavorably impacted translated sales by approximately $12 million. India sales grew over 25% compared with the same period in 2017. On slide 12, North America segment earnings were $128 million, which is 22% higher than the same quarter in 2017. The increase was driven by higher sales of boilers and residential water heaters in the U.S., along with pricing actions, though these were partially countered by increased steel and input costs. Consequently, the segment margin for the fourth quarter of 2017 rose to 24.4%, compared to 22.8% the previous year. In the Rest of World segment, earnings of $40 million dropped 22% from the fourth quarter of 2017. This decline was primarily due to reduced sales of water heaters and air purifiers, as well as higher advertising costs in China associated with online selling holidays, which outweighed the benefits from increased sales of water treatment products and improved performance in India. Earnings were negatively affected by approximately $2 million due to foreign currency impacts in China. Due to these factors, the segment margin decreased significantly compared to the same quarter in 2017. Our corporate expenses in the fourth quarter were lower than the corresponding period in 2017, mainly due to various miscellaneous items last year. The effective tax rate for the fourth quarter was 18.4%, lower than last year's due to tax reform. Cash provided by operations in 2018 totaled $449 million, an increase from $326 million in 2017, attributed to higher adjusted earnings and reduced working capital expenditures. Our liquidity position and balance sheet remain robust, with a debt-to-capital ratio of 11% at the end of 2018. We hold cash balances of $645 million offshore, and our net cash position stood at about $424 million at the end of 2018. Throughout 2018, we repurchased around 4 million shares of common stock for a total of $203 million. Our Board has increased the number of shares eligible for repurchase by 5 million during its December meeting. By the end of December, over 6 million shares were still available under our existing repurchase authority. This morning, we announced our EPS guidance for 2019, projecting a range between $2.67 and $2.77 per share. The midpoint of this guidance indicates a 4% increase in EPS compared to our adjusted results in 2018. Please refer to slide 15 for our assumptions for 2019. We anticipate cash flow from operations in 2019 to be between $500 million and $525 million, surpassing the $450 million generated in 2018, driven by expected higher earnings and lower working capital outlays. Our capital spending plans for 2019 are around $85 million, with depreciation and amortization expenses estimated to be about $75 million. Corporate and other expenses are expected to reach approximately $50 million in 2019, an increase from $47 million in 2018, primarily due to inflation. Our effective income tax rate for 2019 is projected to be approximately 21.5%. We plan to repurchase shares totaling around $200 million in 2019, with an average diluted outstanding share count of approximately 168.5 million.

I will now turn the call back to Kevin, who will summarize our guidance and business assumptions for 2019 beginning on slide 16. Thank you, John. Our outlook for 2019 includes the following assumptions. We project U.S. residential water heater industry volumes will increase between 100,000 to 150,000 units in 2019 due to continued new construction and expansion of replacement demand, as well as continued growth in tankless units. Boiler revenues grew 9% in 2018, driven by solid demand for condensing boilers and new product-related market share gains. We expect our boiler sales to grow approximately 10% in 2019. We improved profitability in India in 2018 due to scale in our water heater and water treatment businesses from losing over $7 million in 2017 to under $5 million loss in 2018. We project India water heater EBIT will be positive in 2019 and improvements to continue for water treatment. And our total India business will be profitable in 2020. The overall loss in India is expected to be $2 million to $3 million in 2019. Our forecast for the Chinese currency in 2019 is slightly weaker than it is today and over 4% weaker than last year. Almost all of the FX impact is expected in the first half of 2019. As previously discussed, we believe customer inventory in China grew in the first half of 2018, with the majority of the growth occurring in the first quarter and was relatively flat the last half of the year after a decline in the fourth quarter. We estimate 2018 sales increased at least 5% due to the customer inventory built. We are assuming continued weakness in the Chinese economy and relatively flat consumer demand for the full year in 2019. Without the impact of the 2018 China inventory build, we're projecting full-year sales to be down approximately 3% to 6% in local currency, all of which will occur in the first half of the year. Combined with an expected 4% unfavorable currency translation our 2019 China sales projection is a decline of 7% to 10%. The first quarter of 2019 faces some significant headwinds due to our estimates that the majority of the China inventory build in China occurred in the first quarter of 2018, creating a difficult comp. We project China sales in local currency will decline approximately 20%, or approximately $50 million for the first quarter of 2018. The earnings impact in the first quarter will be approximately 50% of the sales decline. As headcount and SG&A savings will unfold as the year progresses. In addition, China currency was at its strongest level for the year in the first quarter of 2018. As a result, we estimate currency translation will unfairly impact first quarter sales by approximately 7%. In addition, steel costs will be significantly higher in the first quarter of 2019 compared with 2018. Please advance to slide 17. Continued momentum in North American water heaters, boilers, and water treatment collectively expected to grow up to 7% in 2019. Our business model in China is solid and continues to achieve low-teen margins. We have near-term challenges to navigate through as the Chinese economy remains weak. We project revenue growth will be between 1% and 2.5% for the year in U.S. dollars and 2.5% to 4% in local currency. EPS is projected to be between $2.67 and $2.77. We expect North America segment margin to be between 23% and 23.5% and Rest of World segment margins to be between 12% to 12.5%. Especially in these uncertain economic times, we believe our stable defense replacement markets, which we believe represent approximately 85% of North America water heater and boiler volumes positively differentiate A. O. Smith from other industrial companies. We have a strong balance sheet poised to take advantage of strategic acquisition that add shareholder value, as well as allow us to return cash to shareholders. That concludes our prepared remarks and we are now available for your questions.

Yes. Hi, good morning.

Hey, Scott. Good morning.

So regarding China, you've shared your outlook for 2019, but the main question is, given the ongoing decline in sales guidance, how confident are you that you can clear the inventory in the channel primarily in the first half of the year? You initially thought this would be achieved by year-end. Additionally, while the housing market has been weak, retail sales in China throughout 2018 have also shown weakness, though still fairly reasonable. Do you think you are losing market share in China now?

There were a lot of questions there, Scott. I'll begin with the last one about our market share in the water heater sector. Our data indicates it decreased by about 2% to 3% in 2018, and any loss in market share was minimal. The overall water heater market is quite weak, as you pointed out. Every housing metric we examine shows weakness that has worsened. In water treatment, we had a successful year, particularly in consumables, although we did lose a few points in market share primarily because we lacked the mid-price products we mentioned on an earlier call; however, we have introduced those later in the year. Regarding your main question, we anticipated an increase for the year in October but are now seeing a decline due to several factors. Firstly, we did not reduce our inventory in the fourth quarter as much as we had expected, mainly because online holiday sales were not as strong as we had hoped. Secondly, we initially predicted that the second half of the year in China would improve, but we are no longer forecasting that since the economy appears to remain weak. Looking forward to next year, we assume our sales will be on par with 2018, which means we don't expect significant growth. We do anticipate some recovery in air purifier water treatment due to new products, but the first quarter will be challenging because last year we increased our inventory during that time.

So it’s actually not what I see. There's an opportunity in this first quarter for you to essentially clear out this channel inventory.

No, I wouldn't necessarily agree with that. What we're saying is last year's first quarter had around $40 million to $50 million of inventory build, and we expect that won't happen again. So I don't think the inventory is being flushed out because we're experiencing a weak quarter. It's just a challenging comparison because we built up inventory last year and we are saying we won't do that this year. We hope to reduce it somewhat in the first quarter, but whether that will happen depends on various factors. However, I can tell you that every housing metric we look at is negative. We asked about retail sales being up 8%, but one of my advisors mentioned that retail sales also include some consumer commercial spending, not capital spending, which makes that figure less favorable in our view. The market decline in water heaters was 2% to 3%, which is very weak, while water treatment was up, and air purifiers were down by 30% to 40%. We think after the first quarter, we will reach a more stable point. Some of our new products should start contributing positively. Water treatment consumables had a great year, increasing from $20 million to $30 million, and we expect that trend to continue. So it's just a matter of getting through the first quarter. I'm not sure if I answered all your questions.

For the most part John and I very much appreciate the broadness of your answers. If I could just sneak this one in within China would the down 2% to 3% market estimate that you're suggesting here was it weaker on the electric side than it was on the gas side would you say?

Surprisingly the gas was weaker. I mean, if you would have asked me I would have thought that the electric would have been down the numbers we saw for the year was gas was down 4% electric was down about 1%.

Thanks. Just to clarify, are you talking about the channel has $50 million of excess inventory? And then A.O. Smith itself is sitting on some amount of excess inventory. Can you just sort of…

No, let me clarify that. We're only discussing channel inventory, which is why we can't be exact. I don't know the exact levels of my customers' inventory. However, I have a pretty good indication based on extensive discussions and analysis, along with our year-over-year sales projections. That's how we arrived at the 5%. Our inventory levels at A.O. Smith haven't changed at all; they are the same as before. So we're estimating based on channel inventories because we lack precise information.

Got it. Can you clarify how much you expect water treatment and air purification to grow in China for 2019? Additionally, what actions is A.O. Smith taking to reduce costs in China, and how much savings are included in the projected segment margin of 12% to 12.5%? Thank you.

We expect air purifier sales to increase from about $23 million to $24 million to the low-30s, driven by our new product introduction. We anticipate water treatment will grow in the low double digits, primarily due to strong demand for consumables. Our projections include a headcount reduction of about 10% and a decrease in advertising expenses by 10% to 15% throughout the year. A significant portion of our SG&A expenses is fixed, primarily due to labor, but we are taking steps to reduce some of it, including in store set amortization. We are actively exploring all potential opportunities to reduce SG&A costs.

Yes, I would just like to add on that, I mean, those are the three areas that we've outlined over the last couple of calls. Certainly headcount is going to be reviewed regularly so that we get the right size of the business. SG&A, constantly looking for ways to improve productivity and make those cuts that are appropriate for the business so the business continues to go forward. In the end, the store efficiencies remain high on our list as we continue to evaluate unproductive stores and take action with them overtime. But all the SG&A and all the cost reductions that we've talked about, we've implemented those over the last six months or so and we'll continue to make progress on them, but they're going to come in time. And we'll eventually get to that point where the business is right-sized to the amount of sales that we have into the market. So that's an ongoing priority for our businesses along with increasing our sell-out and driving new product sales.

Hey, good morning guys.

Good morning.

So just back on the margin in China, so I think you said down $50 million in sales and down kind of a 50% decremental on that, is that incorporate any kind of onetime restructuring charges in there or is that the true decremental? And then, I guess, with that big dip I'm just struggling on how you get back to kind of near flat margins in Rest of World?

Well, that's really it. We previously mentioned that our gross margin at 41% exceeds the margin in China, as well as that of our commercial and Lochinvar boilers. The contribution margin is expected to be slightly higher. Clearly, we will benefit from headcount reductions and some cuts in SG&A, along with significant plant efficiencies compared to last year. This marks a considerable decline over the first quarter. We're adjusting our margin assumptions to the lower end, but we anticipate improvements in India. Our path involves continued headcount reductions throughout the year, cuts in SG&A, especially in advertising, and we hope to achieve a low-end estimate of 3, which would provide some volume benefits. That’s our plan moving forward.

Okay, helpful. Just on North America, do you announced any or contemplated any additional price in North America?

Pricing is always a subject that comes up on these calls. And what I would tell you is that and what we've said in the past that A. O. Smith has the history of dealing with costs and addressing those over time. And that's our position and will continue to be our position as we go forward.

Okay. And regarding the deflation in steel, when can we expect to see some benefits from these lower input costs on cold roll?

It begins a little in the second quarter, and certainly in the latter half of the year, given that current conditions remain stable. We've consulted with our advisors, and while I can't provide specific reasons, their sentiment is that we may have reached the lowest point, with expectations of rising steel costs moving forward. We will keep track of this situation. The benefits will start to materialize in the second quarter.

Good morning, everyone. How are you today?

Good morning.

Good morning.

All right, great. I guess, the first question, in terms of China and the 1Q compare, give us some sense of when do you think you're just going to have a better sense of the trajectory and visibility? I mean, do you think you'll have a comment sometime during 1Q in terms of how you're thinking about things shaking out, because obviously, your guidance is highly predicated on kind of how this all plays out in the near term, and it's going to affect the various outcomes for the full year. And obviously, bears are somewhat skeptical given the fact that you've had to take down numbers for China versus October. What gives you any greater sense of visibility? So maybe you could just talk about what you're going to be looking for and what will that allow you to cast maybe a better view on China for the full year? When will we expect an incremental update, because 1Q is really the hinge?

Well, I'll start, Kevin can add, I'm not sure we'll have an incremental update. Obviously, we're going to continue as the quarter goes along, monitoring it very closely. I think what we have to kind of see as some of the statistics come out to play. So again housing has continued to be negative there's no doubt about that. Certainly, it would be positive we think from a consumer confidence standpoint if something got resolved with respect to the U.S., China trade issues. So we certainly think that would be a positive. So those are kind of the things we're monitoring.

Okay. Just to add on to that, Q1 is normally one of our lower quarters. So spring festival is coming up and so we'll get a better read as we continue to get through March and then obviously into the second quarter, which is a busier quarter for us. And again, as we're going to look at this, it'll be by product category, by channel really looking closely at our sellout as an organization. And then also making sure that we introduce a lot of mid-price point products and in a lot of different channels and we expect those to add incremental sales to our business. So as we get into the latter part of the second half of the year, we'll get a read on the China economy. As John said, we'll get a read on tariffs, so where they're going. So there's a few things that have to kind of work themselves through for us to give you a better answer than we are today.

Okay. And then just switching gears over the longer term then. Obviously you mentioned the strength in tankless and I think in particular tankless gas in North America, that's a solid product category overall and you do have a suite of products there and a reasonable share. But that seems to be an area that seems to be gaining some strength and anecdotally it sounds like the cost of installs coming down. Are you concerned over the longer term that that product category could eat into kind of traditional tank and kind of what would be your response there? And how we manage that going forward, because it seems to be a category that could be particularly attractive in the context of the replacement cycle.

Okay. And are you talking North American or?

Talking North America tankless gas.

Our perspective remains consistent. We operate in the hot water sector, and moving forward, we will offer various solutions to consumers, including both tank and tankless options. Recently, we've had a strong year for tank products, and we anticipate an increase of 300,000 to 350,000 units this year. For tankless products, we expect a slight decline from the strong performance in 2017, but we still anticipate low double-digit growth. Overall, while installations may decrease, the costs are becoming more affordable. As an organization, we recognize that not every solution fits every consumer, and our extensive product lineup for both residential and commercial markets addresses this need. We are confident in our position to adapt to market developments, supported by our brand, distribution strength, and sales team. Overall, we feel positive about the industry's trajectory and believe A.O. Smith will continue to be a significant player and market leader in these categories.

It still is obviously we are monitoring it’s very close, but it still is about 8% of the total market. So, I mean, it is a small part of the total market.

Great, thank you. Just want to continue on the China topic for a minute. On some of these past calls you've talked about the issue of consumer trade down I guess and we've seen some of that all the way up to the apples of the world. And you mentioned John that you've got limited if any share loss, but can you just talk about the growth or lack thereof in the various strata of the market from the high end on down and how that's impacted you as a player presumably on the high end.

Well, I would tell you and there's no good data. But I would tell you we don't think the high end has been growing in this marketplace. You still have well-to-do people in China that there's still that group that is buying. But my guess is you're not seeing a lot of trading up going in this environment where the economy is not doing very well. But again the fact that we really haven’t lost share in the water heater, I think kind of says that that's the place so that everything's kind of stable when you look at the different strata. But that’s an estimate, we just don't have good data on that.

And I would just echo that that's kind of the feedback that we get back from our sales organization, distributors, and our store promoters that the premium market is relatively stable and not a lot of trade down. But the trade up has slowed or is not where it has been in the past.

Got it, okay. And then my other question is can you discuss the relative impact and the interplay between the deceleration in growth in China on an organic basis versus the trade issues? When you mentioned a potential trade resolution being a catalyst, I think you'd be right in terms of the stock price likely reflecting that. But how do you separate what's happening in China from discussions about a slowdown that have been going on long before these trade issues? How much of this is just a natural deceleration in the market versus being related to trade and potentially serving as a catalyst?

Yes, I would tell you from a macro perspective we don't know exactly how that would parcel out. Wonder there has been a slowing down in China, but certainly if you just take it back from a consumer point of view in tariffs or in your market starts to slow down and just simply the way we've described it is the Chinese consumer is no different than a U.S or any other consumer when their job has slowed down, when they've seen maybe some layoffs in various parts of the industry and their friends that they simply just pull back. And so, we believe that tariff has had some impact on consumer confidence on their spending patterns just for the fact that that's what we would do here in the U.S. And my comment is if the tariffs and when the tariffs get resolved it will take some time, but that will remove that one uncertainty for the consumer and that should free up. We know today based on some of the information we get back that the Chinese consumer is saving more and more and that normally is an indication of their uncertainty and again once they feel things are settled down and there's more confidence in where the economy is going to go, we believe those resources and funds will free up. So that's where we're at. Certainly, there has been a slowdown a bit from the housing side, but certainly on the other side, we really believe consumer confidence has been impacted by the tariffs and what's been going on in the recent months.

Hey, good morning everyone.

Good morning.

So first, what's the best estimate now that exiting 2018 for the splits on replacement versus new build oriented splits on China water heaters for your core business?

It's difficult to say, but I don't think we have data on the China business. I haven't seen any different information, except that it's 50%.

50% in tier 1 and a little bit less.

And nothing that is necessarily increasing. I haven't gotten any updated data.

And what percentage is replacement on your water treatment side at this point? What part is consumables?

The consumable part this year was about $30 million, which is an increase from $20 million last year. The consumables are tracking very well, and we expect that to exceed $40 million when we look at 2019. This is progressing and tracking as we anticipated.

And then in North America, just from a cadence through the year. I suppose on China as well. It seems like China you're saying stable cadence from here, if you can adjust for the inventory side. In other words, no improvement, no deterioration in market from current level. Maybe just give us some thoughts on the U.S. as well on how you're viewing the cadence of underlying trends from here?

Well from the U.S. side of the business, I'll break that out residential and commercial. We talked about our residential guidance about $100,000 and $150,000. Again you got to remember that's coming off we believe a pretty strong year of over 300,000 residential type units. So modest growth, there is some talk about some housing slowdown, but still modest growth, and of course 85% of that's going to be replacement. On the commercial front, as we talked earlier we just came back from a large industry expo AHR and the consensus from our customers, from our sales organization is that there is about a 3% to 4% growth out there. Our order book is still pretty solid. And so, we're optimistic in the first half of the year, and we're a bit more conservative in their comments in the second half. But overall both sides of the channel residential and commercial not growing, extending rapidly, but solid growth in both sections.

Yes, good morning everyone. John, just want to go back to China and you talked earlier in the call about building representation in middle price points. So just I guess first of all just some clarification, when you talk about stable 2019 in China, are you talking about still seeing maybe some weakness in the premium market, but that you're going to pick up share in the middle price points? And as a consequence of all in that's going to provide you with your stability. Or just what are you expecting that would come incremental to your growth from participating in a segment of the margin that presumes doing a little bit better?

Well we would hope and that's what we hope the last three quarters of the year that we will what I have said is that sell-out we would expect for the year to be relatively stable. And if we can pick that up a little bit we'll be able to do two things, one either take inventories down a little bit or move from the 2% to 3% or whatever down for the year. So we don't expect basically where we are that the premium market is going to change much, we'll maintain share there. And we hope that there is some growth in the midpoint area and we have new products for that.

Can you give us any sense from a sizing standpoint, how much bigger the commercial opportunity is in mid-price point versus kind of your legacy franchise in the premiums?

I won't say it's necessarily significantly bigger, it's just when we had price increases going back kind of into 2017 and 2018, we had moved out of that market. And so, what we were trying to do so we have been in that market, the price increases we’ll get out. So we call mid-price as RMB 3,000 to RMB 5,000. And so, now this is what we're putting products back into that, which will specifically help us we think on the online, which is growing.

Thanks. I understand with China the Tier 2 and Tier 3 city footprint has how you roll out or how many places you roll out the change at all, are you guys approaching I guess expanding the locations differently or how has that been impacted?

We are definitely being more selective in our growth compared to what we experienced in the past. The pace has slowed a bit, and while we are still opening new stores and distribution points, we are also making some adjustments. Therefore, the overall increase has been quite modest over the year. Strategically, we believe there are still opportunities in Tier 2, Tier 3, and Tier 4 cities, especially in Tier 3 and 4, and we will continue to seek the right partners to expand as necessary.

And I think that's consistent with what the last couple of years have been and that we've been adding 100 to 200 to 300 net, but it's a combination of some in the Tier 2, 3, 4 and then closing some of the nonproductive stores. So we think that pattern will continue.

Yes, just to provide some clarity, we are constantly making adjustments and enhancing our displays while collaborating with our customers to boost sales. Overall, it has been implemented, and I can say the business is on track. We are looking forward to a great 2019 with Lowe’s as a partner.

Hi, thanks. Good morning, guys. Good morning, Pat.

Good morning.

Good morning.

So I'm going to continue beating the dead horse of China here for a little longer. I just want to make sure I understand the commentary around Q1 in Rest of World with China. You're saying China down 50% local currency in sales year-on-year with a 50%...

No, I think, we said $50 million, 20% in local currency, which is 20% and that's about equates to $50 million.

Okay, great. Thanks. That's helpful. Connecting with that question, my larger inquiry is about the outlook for the second half of the year in Rest of World and China. Given the visibility you have, what gives you the confidence that the market will remain flat rather than continue declining in China?

Well, again we're assuming that some of our ancillary product lines like air purification will improve a little bit. The commercial water treatment will improve, the commercial will improve, the new midpoint products we have will offset any further weakness in the market. But it's hard to say, I mean, what we are calling is for the market to really be stable to where it was or down a little bit and we have some items that will offset that decline.

Hi. Would you mind telling us specifically what the Lowe’s number was in the quarter and how much is left to go on the field that was referred to a couple of questions ago for 2019?

Yes, I would tell you that we hit the numbers that we talked about in the past. And that there's again we probably not get into specifics about certain customers, particularly Lowe’s and other public companies. So what I would tell you is that, we launched the field, there's always going to be adjustments to additional areas of our product displays and product inventory. And that the overall outlook that we had with Lowe’s is on track and again we look forward to continue in 2019.

Understand. And then just this last one for me. So at the Investor Day, you guys talked about a couple of different initiatives that you're going to pursue. And I was hoping you can kind of update us on them with respect to what the plans are for 2019? Specifically tankless, your desire to increase your penetration there and also in digital.

Well, I'll take both of those. Tankless, I'm not specifically understand exactly where it's going, but on the tankless side of the business we are going to continue to expand our product offering bringing new products to market with features and benefits to be more competitive. We've talked about that, we look to be doing that in the second half of the year. And as far as digital, I think we're one of the premier companies, particularly in the water heater and the water treatment side, where digital has been an ongoing program for us for over a decade. We continue to enhance our websites, our e-commerce business, our ability to create demand through various digital media and marketing activities. And that's going to continue to move forward by both parts of our organization whether we are in water heating, boilers or quite frankly in water treatment. That was a very generic answer, but that's about I think where we're going to be at with any more specifics.

Yes. Just on North America, just wanted to kind of unpack. I mean it seems like you're implying kind of 5% to 10% growth on that business for the year. Is that the right way to think about it?

Yes, I think it’s close to low, between 6% and 7%.

Okay. And then just what kind of growth rates are you expecting for water treatment all-in?

We will benefit from a full year of Lowe’s, and we're anticipating an increase in our other businesses, projected to rise about 40% from the previous year. With the full year of Lowe’s included, we're also expecting solid growth from our other operations. Additionally, Lochinvar is expected to see its boilers grow by 10%. It's worth noting that Lochinvar had a strong quarter, with the boiler market up 15% in our fourth quarter, making it a very successful period. Their backlog looks promising as we approach the first half of the year.

Okay, thanks.

Got a few follow ups. If you can hear me right?

Yes, we can.

Yes. So China, can you talk about just kind of in terms of the organic growth rate for the fourth quarter and for the first quarter. Any directional view of kind of the pricing impact, and how we should be thinking about it across your product portfolio?

I mean, I have not heard of any significant price adjustments at all. And I don't know, Kevin if you have. But talking to our China people, I don't think there has been significant price adjustments by any means.

As you've noted, organic growth would not indicate a negative price variance. Now, regarding the tankless gas market, I believe your current market share is in the high-single digits to low-double digits in the U.S. You do have some products in that segment, but I wonder if you foresee a point where you might consider whether to develop a technology in-house or acquire it, potentially using your brand. Could that be an area for future acquisitions?

We are always seeking potential acquisitions that can enhance our value. Regarding the tankless segment, we have outstanding products and are consistently launching new offerings with our partners. It's important to emphasize that this is one of our solutions, not the only one. While our market share is currently in the low-double digits, we expect that to improve. We are making progress in gaining market share and expanding our product range. Overall, we are continuously exploring ways to enhance our business in areas such as products, manufacturing, logistics, and customer collaboration. Our strategy remains focused, and we will continue to execute it as we have successfully done in the past.

The last question concerns North America. One of your potential areas for capital investment has been, and will continue to be, U.S. residential filtration products. Can you discuss the total addressable market there and your intended role in it? It appears to be a challenging market with many alternatives and low consolidation. Do you see opportunities for capital investment and a long-term business presence there?

Certainly, long-term in the North America water treatment we see a significant business. We look at it somewhere as an opportunity when it’s fragmented bringing somebody like us to be able to maybe do some consolidations and so forth in the right areas. I have said many times that this has opened a lens of our acquisitions possibilities and we continue to go down that path whether it’d be capabilities, products, distribution dealers and work in our acquisition pipeline it certainly we’re very active in that space. So, yes, 100% for sure that we believe there is a viable and going market in North America water treatment and we believe there’s lots of opportunities for A.O. Smith and our brand.

Okay, thanks.

Thank you for joining on our call today. We have one conference in the first quarter, we’ll participate in the Boenning & Scattergood Conference in London on March 14. Have a great day.