Ladies and gentlemen, thank you for standing by and welcome to the Second Quarter 2020 Earnings Call. At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. [Operator Instructions] Please be advised that today's conference is being recorded. [Operator Instructions] Now, I would like to hand the conference over to your first speaker for today, Ms. Patricia Ackerman, Senior Vice President of Investor Relations Corporate Responsibility and Sustainability and Treasurer. Thank you. Please go ahead madam.

Thank you, Michelle. Good morning, ladies and gentlemen, and welcome to A. O. Smith second 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 press release and on slide 2. On slide 3, 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. Before I summarize the quarter and Chuck goes through the results, I want to express how proud I am of our global team. We faced challenges and complexities to our business that we have never faced before. Our number one goal was and remains to keep our employees safe while delivering our essential products to our customers. I say confidently that our team met and often exceeded my expectations. Thank you to the men and women in the A. O. Smith family around the world for your dedication, and your spirit you truly make A. O. Smith a remarkable company. The business performed in the second quarter is largely in line with what we saw in April. Continuing the pace of growth we saw in the first quarter, our North America water treatment business, organically grew 19%. Direct-to-consumer and retail sales were particularly strong as consumers became more health-conscious during the pandemic and the shelter-in-place orders confined many of us to our homes. As expected, industry volumes of residential water heaters in the U.S. held up notably well. Based on our June shipments, we estimate industry volumes are flat to slightly less than the quarter compared to last year. Due to construction project delays and postponements in North America, we saw commercial water heater and boiler volumes decline in line with our estimates of the industry declines of 20% to 25% in the quarter compared with last year. Consumer demand for our products in China was flat to slightly positive compared to the second quarter of 2019, as restaurants and shopping malls reopened and retail foot traffic increased. We remained operational with no significant disruptions. Our Juárez Mexico plant, which we voluntarily closed in April, reopened in May and ramped up production of the latter portion of the quarter. We have taken numerous and meaningful steps to protect our employees, suppliers and customers in the pandemic. These important steps in many cases reduced efficiencies include: continuous communication and training to our employees on living and working safely in a COVID-19 world; plan accommodations and reconfiguration to maintain social distancing; masks for all employees; implementation of sanitizing stations; temperature taking; and regular proactive deep cleaning and sanitization of our facilities. Our global supply chain remained operational. We continue to monitor and manage our ability to operate effectively as tariffs and the evolving nature of the COVID-19 pandemic and the related stresses on the supply chain and periodic marketplace disruptions impact our operation. To align our business with current market conditions, primarily in China and to a lesser extent in North America, we reduced headcount and incurred other restructuring costs totaling $6 million in the second 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. Second quarter 2020 sales of $664 million, declined 13% compared to the second quarter of 2019. The decline in sales was largely due to lower water heater volumes in China and lower commercial water heater and boiler volumes in North America driven by the COVID-19 pandemic. As a result of lower sales, second quarter 2020 adjusted earnings of $73 million and adjusted earnings per share of $0.45 declined significantly compared with the same period of 2019. Please turn to slide 6. Sales in our North America segment of $481 million declined 8% compared to the second quarter of 2019. Organic growth of approximately 19% North America water treatment sales was more than offset by lower commercial water heater volumes, lower boiler volumes and a water heater sales mix composed of more electric models, which have a lower selling price. Rest of the World segment sales of $190 million declined 24% compared to the same quarter of 2019. China sales declined 20% in local currency related to higher mix of mid-price products and further reductions in customer inventory levels. Consumer demand for our products in China was flat to slightly positive compared with the second quarter of 2019. China currency translation negatively impacted sales by approximately $6 million. Our sequential sales in China improved through the quarter and China was profitable in May and June. India sales declined significantly as the economy was shut down during the majority of the quarter to minimize the spread of the virus. On slide 7, North America adjusted segment earnings of $108 million were 12% lower than segment earnings in the same quarter in 2019. The decline in earnings was driven by lower volumes of commercial water heaters, lower boiler volumes and a mixed skew to electric water heaters. Certain costs directly…

Okay. Thank you, Chuck. Our outlook for 2020 includes the following assumptions: We project U.S. residential water heater, industry volumes will be flat in 2020 driven by resilient, replacement demand and similar levels of new construction – home constructions as last year. We expect commercial industry water heater volumes will decline approximately 10% as job sites and business closures, due to the pandemic delay or defer new construction and discretionary replacement installation. It is encouraging to see consumer demand for our China product similar, if not a little higher than last year over the last four months. We are also seeing sequentially quarterly improvement in market share both online and offline for water heater and water treatment products, driven by our mid-price range products. We took additional charges in Q2 for further restructuring of the business. We believe these restructuring charges are largely behind us. We continue to target 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 $35 million of savings in 2020 over 2019, $15 million of which will be realized in the second half of 2020. We expect year-over-year declines in local currency sales of 18% to 20% and protract sequential quarter-over-quarter growth in the second half of the year as China appears to be making sustainable progress in reopening their economy and keeping the virus in check. We expect our North America boiler sales will decline approximately 10% for the full year. Commercial boilers represent 65% to 70% of our boiler sales. With many job sites temporary closed during the second quarter, we believe as job sites reopen, the orders will sequentially improve in the second half of the year. We project 20% to 22% sales…

[Operator Instructions] Your first question comes from the line of Jeff Hammond of KeyBanc. Your line is open.

Hi, good morning, everyone.

Good morning, Jeff.

Good morning, Jeff.

Just want to dig in on this China dynamic. Sales down 20% and I think you said consumer demand was flat. So just help me square those two things. I know you mentioned mix and destock just maybe parse those out. And what's the expectation for this mix dynamic, and kind of inventory destocking to continue into the second half?

Okay. So, we're down – you're right it's about 20%, when you take out the FX. So right for the quarter, we're down 20%. There's two main pieces. One is mix and the other you're right is the destock. If you just kind of look at the mix of that 20% roughly a-third, less than half is related to sales mix. So you kind of -- you just get into that category of a little less than half to maybe one-third of that 20%. The rest is really destock and consumer demand. So it's -- inventories came down again in the channel inventory in China. So we were a little bit surprised it came down as much as they did. We don't project them to continue to decrease. They are now in the two to three-month range when we recalibrate to kind of what we see 2020 to be at. So on our forward looking, we think they're about as low as they're going to go they could go lower, but that's what our projection is.

And the mix dynamic in the second half, should that continue?

The mix dynamic is a little unique I think in Q2, right? So we've got -- our online sales were strong. So if you look at our online sales, they were 30% of our total revenue in Q2 and actually up quarter-over-quarter slightly, so online sales put a little bit more pressure on the mid-price products. As you know they kind of -- there's more mid-priced -- upper mid-price products on the online than there is in the offline. We would expect there'll continue to be pressure on mix going forward, but we would also hope and we expect sequential improvement in volumes and would hope that the offline market would grow a bit. And it might be a little bit improved over that, but we'll have to kind of see how that plays out.

Okay. And then just -- it looks like you got to do $30 million to $35 million in op profit in the second half in China to get your margin target. Is that strictly volume improvement from here? Or is there something else that's driving that profit improvement?

Well, it's two things. There's some volume improvement. So we've seen sequentially China improve month-over-month and we expect it to continue quarter-over-quarter. So we do expect growth in the back half of the year. We're -- if you parse out the math, we expect China to grow year-over-year in low single digits maybe in that 5% range. And then on top of that as Kevin mentioned, we've got cost reduction programs that we put in place. It's about $35 million for the year, and we expect $15 million of that to drop into the back half probably pretty even per quarter those savings.

Okay, great.

Your next question is from the line of Scott Graham of Rosenblatt. Your line is open.

Yes. Hi, good morning to Kevin, Chuck and Pat.

Good morning, Scott.

Good morning.

So, I just wanted to make sure just, sort of, like a housekeeper. The COVID $5.5 million, you did not pull that out. That is in your North American 22.4% right?

You are correct. It is in our -- it's in our numbers. The only thing we adjusted out was $0.03 on severance and restructuring.

Yeah, got it. I'm hoping you could maybe tell us a little bit more about the China percent of sales to premium in water heaters versus the percent to upper price point. I'm just wondering what that pie chart looks like right now?

Sure. Let me frame it. And as I mentioned just to Jeff, I mean it's a little unusual quarter because we got a little heavier mix on online. But just to, kind of, frame it let me go with the definition first though at mid-price as we're defining it for this information is on the electric it would be less than RMB3,000 and then on the gas it would be less than RMB5,000. So that's what we're considering in this kind of calculation at mid-price. If you go back two years ago, the percent of our sales that would fall into that category below those two thresholds is in that 25% to 40% range. If you, kind of, walk it forward to a year ago it is in that 35% to 55%. And then if you go to Q2, which again a little bit heavier online percentage than normal it's in the 55% to 70% range. So it's grown because we've reintroduced products into that category, which we feel now we've got the full range of products filled in there.

Scott, I would just want to dovetail on what Chuck said is, we've been working over a year plus to fill those mid-priced categories and now we're there. So as we go forward, we look for our mix to hopefully move more towards our premium sector. But it was important for us from an overall perspective to compete both online and offline to have those mid-price products, which by the way are the upper mid part of the range in our product offering. So again going forward, I think as Chuck mentioned this is probably a low point when it comes to how many mid-price or a high point for mid-priced products should we look forward to see our mix shifting back maybe not to where it was in the past, but mix in higher to premium products.

Your next question is from the line of Susan Maklari of Goldman Sachs. Your line is open.

Thank you. Good morning.

Good morning.

My first question is just can you give us some color on the mix shift in the U.S.? I noticed in your press release you commented that that's kind of turned a bit negative more towards the electric side of things on the consumer business. Can you just give us some comments on how that has been coming together and your thoughts on the back half for mix?

Yes, this is Kevin. If you look at our industry, we do have periodically some mix shifts for various reasons. The way we would look at this is from our perspective the Northeast has been one of the hardest hit. You go to New York, New Jersey, Boston those areas, Massachusetts have probably been the hardest hit when it comes to COVID-related shutdowns. That just so happens to be one of our strongest gas markets. So that could be part of it. We've also had strong growth in India with our customer base in a stronger electric markets. So the two kind of caused the shift -- the temporary shift. If I look at it though and look forward, we haven’t seen any real systemic changes in the market. And over time I would expect that our mix would normalize over the year or into next year.

Okay. That's helpful. And then just following up can you give us some color on raw material inputs? Steel prices seem to be a slight advantage for you in the quarter. But how should we think about that going out over the next few quarters as well?

Well I mean if you look at steel and 70% of our steel is cold rolled, 30% is hot rolled and we see kind of a delay in the cost of that 90 to 120 days. So if we kind of just take a data point of spot prices today and compare them to a year ago second quarter, we're down about 5%. So that kind of frames how to think about it. Steel has been lower, I guess for a couple of quarters now, but it has edged down a bit.

Next question is from the line of Bryan Blair of Oppenheimer. Your line is open. Q – Bryan Blair: Good morning, everyone. Hope you are doing well?

Hi, Bryan.

Hey, Bryan. Same to you. Q – Bryan Blair: Chuck, I believe you've mentioned breakeven revenue for China in the $55 million $60 million per month range in recent past and being profitable in May and June, would kind of validate that. Is that still the right range to think about? And then as we look forward beyond the structural savings that will come through in the back half, how should we think about incrementals as China revenue moves higher?

Yes. So you're exactly right. I mean that breakeven point is in that $55 million to $60 million. We're pleased that we saw it in May and June. We'd expect we're going to be profitable going forward. So we still see that as the range. We've got to continue to look at the structure. And we have taken a look at the structure and the restructuring charge we took of about -- it's about $4 million in China will result in some savings going forward. So the incrementals are probably in that 45% -- 40% to 45% range I would say. Q – Bryan Blair: Okay. I appreciate that. And really nice growth in water treatment. Can you remind us of run rate profitability there? And structurally where you think margin can climb as that business continues to scale?

Yes. Run rate profitability Q1 we were at 9%; Q2 we're about 8%. We see it continuing to be that for the rest of the year. We're still looking at cost reductions. We've got a little SAP implementation happening this quarter. So there's some costs that are going to burden it a little bit in the back half, but we still see that just approaching 10% this year. So we're pleased with water treatment. The order rate has been strong. I mean we were up 19% to 20% for the quarter. And when we look into July, we see the same strength in orders. It's at that same rate. A – Kevin Wheeler: Yes. I'd just make another comment on that as far as the growth has been strong and it looks to be continuing. And then just keep in mind there's a consumable part of this as we go forward and continue to put out our point-of-use in order entry type of products. That seeds the consumables as we go forward over the next few years. So there's a lot of positive trends in our water treatment business. And even as you look at it today even softeners are starting to come back as our dealers are learning how to sell in a COVID environment and using digital and how they're installing and so forth. They've made a remarkable shift in their selling methods and it's proven to be effective so far through July.

Our next question is from the line of Matt Summerville of D.A. Davidson. Your line is open.

Thanks. A couple of questions. I want to get back to the electric impact. Can you -- North America was down 8%. Can you sort of parse out what the impact of that shift was on revenue? And what the operating margin impact may have been there as well?

Yes. We're just tracking down the impact of revenue. The percentage is really the same for gas or electric. So I mean the percentage runs roughly the same. It's really just a step function as far as sales dollars and then margin dollars. I don't have a good answer on mix, but I mean it's probably in that 10% to 15% of the total decrease. When you look at the decrease in margin of the 8% it's probably 10% to 15% of that.

And then have you begun to see in your order book as of late looking into June, July, any evidence that these delayed construction projects are indeed coming back online? Have you actually that take place in your order book?

I think it's too early to see that. When we look at -- and I'm thinking about Lochinvar boilers at this point. But when you look at kind of the order quoting rate out in the marketplace, it is down a bit. The quoting rate is lower than what it has been but there's still activity out there. And orders coming back online I think it's a little early. And when we look at though just commercial water heating, Kevin talked about the decline in the second quarter. We have seen some uptick in order rates on commercial water heating. So, if you look at Q2 compared to what we saw in July, we see July up about 4% to 5% on commercial orders. So that -- I mean probably it's some delayed replacement that's coming back online and we would expect that to continue. So, I mean when we kind of think about commercial and it's both commercial water heater and boilers the front half of the year looks a lot like the back half of the year. We're down roughly 10% with a lot of disruption on boilers in the second quarter, but we expect some of that to come back online and particularly since our boiler season is a little strong in the fourth quarter.

Yes, I think that's the key takeaway here. As we get closer to the colder months and so forth that's where we see again schools and businesses start to fire up their boilers. So, it's a little early. We do have a reasonably strong backlog that we're still working through and we'll probably have a better view. But if you talk to our reps who are on the ground they'll tell you that they're -- they expect the sites to reopen. They expect to see some projects move forward and that's kind of our assumption as we go forward the rest of the year.

Your next question is from the line of Ryan Connors of Boenning & Scattergood. Your line is open.

Hey, great. Thanks for taking my question. I wanted to actually talk a little bit about the sort of channel impact -- channel situation given everything that's going on. Obviously, many of your distributors are relatively smaller businesses. So, in some cases presumably there could be some balance sheet pressures and other issues. How has that impacted your wholesale business in terms of your own need to hold inventory, payment terms, et cetera? Any impact there -- anything that's evolving as this goes on with the channel?

Well, most of our customers if not all of our customers in the channel our essential businesses remained open like we did and continue to operate maybe with curbside pickup and other activities. So, we've been fortunate that most of our customers have fared pretty well from the perspective that they've been able to operate in a difficult time. We haven't seen significant impact on payment terms or any other ability of our customers to pay. Some of the smaller ones can qualify for loans. So there's opportunities for them to do that. So, at this point we fared pretty well. Our customers have fared pretty well. We have seen on -- particularly, on the commercial side some destocking. So, we've seen our customers work on maybe taking a little bit of their balance sheet down, cutting a little bit on the inventory side, particularly with higher cost commercial product. And we believe some of what we've seen in order rates and maybe it has been impacted by that maybe in the industry too just some adjustments within inventory within the channel.

Yes, I would just add on to that. I mean you talked about construction talked about reopening. And of course all our distributors are also good at business and balancing their inventories. So, I wonder I would tell you that all of our distributors for the most part are managing through it. They've been through the financial crisis and they've come out of it. And at the same time they're going to adjust their inventories to the current demand. And so as we go forward and demand does pick up I would expect them to adjust those inventories appropriately going forward. So, overall, we have a tremendous customer base with legacies of 20, 30, 40 years, strong put positions in the market and they're navigating through fairly well based on the information we're getting from our sales organization.

Got it. And then my follow-up was just really following up on the earlier discussion of water treatment. It really seems like you are building some pretty strong momentum there at this point in terms of the organic growth. Can you talk about just what is driving that? Is that more the market growth given all the PFOS concerns and lead and all that? Or is that share gain with your big box channel? I mean where is that growth coming from? If you can kind of give us some flavor there?

Well, you actually outlined it pretty well. I think it's coming from all the things that you mentioned. Certainly, the pandemic has heightened people's awareness. But I would tell you at the same time I believe our water treatment team is executing very well. Through the process we've updated websites, our consumer engagement process is much better. We have a telesales activity. So, there's a number of foundational things that we put in to improve e-commerce to improve our dealer network. On top of the consumer becoming more aware of some health issues and particularly on water treatment, we're also executing, I think, at a higher level than we were last year, which I think is critical for us to go forward. And our close rates are up and that kind of ties in with our sales as well. So, overall, the water treatment business is doing well, but it's not just a combination of the market. It's a combination of execution as well. In water treatment, we don't have the data that we have, say, in water heaters. But if you look at -- we do get some information on water quality from our water quality association that tracks softener balance in tanks. Now that is a little old, because of the pandemic they haven't been able to update it. But we're up 20% plus in the market at the time that we had the data, which is, I believe, in February was flat. So, we are taking -- I believe, we're taking some share. We'll need some more time to validate that. But, yes, it's going well, but it's a combination of market and our team executing at a much higher level than we had in the past.

Yes. This is Chuck. I mean, I mentioned earlier that we've seen July demand continues strong and we've seen a better mix of some of our installed products, as people are more comfortable with installers, dealers getting into home. So if you kind of look through kind of the end of June or July time frame, the softener mix in some of the larger products, we've just seen that come back a bit.

Your next question is from the line of David MacGregor of Longbow Research. Your line is open.

Hey, good morning, everyone.

Good morning.

Good morning.

I wanted to ask about Lochinvar. And you'd mentioned that quoting activity was down a little at this point, although, there's still some uncertainty, I suppose, with where that's going according to your comments. But under that situation or that scenario, one might sort of expect a higher level of competitive pricing pressure and just a more vigorous level of competition from some of the other players in the space. So, I wonder if you could just talk a little about what you're seeing on that side of the Lochinvar story? And also, to the extent you could talk about what you're seeing in terms of the mix of units sold within Lochinvar? And what might be changing there?

Well, as far as, from a competition standpoint, we deal with that on a regular basis. We haven't seen much change from how we quote and how we can go to market. We’ve had to get a little creative about how we do sales calls and engineering calls on Zoom. But, overall, not much change there. We've had a nice mix towards some of our crest boilers, which are the higher BTU-type products, which are in larger applications. So we saw that come back this year, quite well. So, yes, overall, again, I go back to the business. We're heading into our stronger half of the year. There's still some uncertainties there that we've outlined, but we're in a position to capitalize as the markets do open up. And I think it's really important, as we've been working our way through the pandemic, we've kept our operations ready to be prepared to come out of it as sales grow and as the markets reopen. So, overall, operational, we're in position to take care of our customers. And normally, there's a little bit of emergency activity that happens in the second half of the year, where people need things right away and we're positioning ourselves to take care of that as well.

Maybe just a little more color on mix too. And Kevin is exactly right. We've seen some of the larger boilers a little heavier in the mix in the second quarter. We've talked before about residential being light. So when we look at residential in Q1, it was a warmer winter and it was pretty light for us in the industry. Second, July activity is really kind of hard to read. We've can always -- typically, and we've done it this year again as we've got an early buy program. So, early buy program is specifically for residential boilers and that's running. We're seeing orders come in pretty well. We're fairly pleased with how that is typically playing out. So hard to read what's happening in July, but the residential orders on the early buy program might be running slightly less than last year, but it's not done yet and we're pretty pleased with how that's playing out.

Okay. Thanks for that color. Just a second question on China. And you had mentioned the shift towards more medium price points. So thanks very much for providing the detail on that mix. I know, it's something we've discussed in the past. I guess, the question is, with regard to capacity utilization rates, which I'm guessing right now, you've got plenty of headroom, but as you shift more to medium price point, what impact does that have on capacity and your need to invest CapEx in those facilities?

I would tell you right now, there's -- we do have plenty of capacity and operating leverage going forward. As you probably know we have three large facilities in China. And being where we're at today from our top line sales where we were, say a couple of years ago we'd be a plenty of capacity to handle it. So, there is -- we see no need for really additional capital from the production side of the business going forward for several years.

Your next question is from the line of Nathan Jones of Stifel. Your line is open.

Good morning, everyone.

Good morning, Nathan.

Good morning.

I just wanted to follow-up a little bit on Ryan's questions, on water quality. That's a pretty fragmented market here in the U.S. Can you talk about where you think your market share is? What kind of market share targets you would have? And strategically thinking is this more of a build versus buy an organic growth versus roll off the market? Or do you see opportunities here to go about consolidating this market? And are there big advantages to that scale?

Well, I mean, it's tough for us to get a detailed handle on share, right? And you're right it is a fragmented market. I mean, we think, the addressable market when we kind of look at it in a couple of different ways, it's about a $2 billion market. So clearly there's opportunity for us to continue to expand our position. It's both, when you say, is it a build versus buy, I think, there are opportunities on both. We've entered -- our strategy is we've gotten into leveraging the channels that, we're in. So we've got the direct-to-consumer channel through Aquasana. And the Amazon channel through Aquasana. We've also got the dealer channel through the Water-Right acquisition along with the Hague acquisition. We've introduced product into wholesale and we're in retail through those. So we've entered all the channels and we would expect to continue to grow that out on channel expansion -- within those channels over the next several years. M&A, it's certainly an area that we've got our eyes open and we're looking at. So we think there's an opportunity in both.

Yeah. I'll just add a little bit more on to that, its Kevin here. Certainly on the M&A front I think there's plenty of opportunity out there. Again, it's got to fit to where we're taking our strategy. But if you look out I've always said on any call any investor meeting, that the opportunity for -- on the water treatment front is I think an area that we're going to spend a lot of time in. There's opportunity there and there's still ways for us to leverage and consolidate over the long haul. And again A. O. Smith is always looking to make the industry better and raise it up. And we think there's going to be opportunity over time to continue to find those right fits for our business.

Okay. Another question on China, I mean you guys have talked about the mid-tier priced products being lower margin than the premium, tier product. That's a relatively new introduction for you into China. Is there an opportunity through operational improvement and ramping up the productivity of those lines for you to close that margin gap between the mid-tier and premium tier price products, without just leveraging volume?

Yesah there is opportunity. We're working on cost reduction programs within the product, also working on cost reduction programs within the manufacturing process. So certainly you're right, volume would help us but we're coming at it from multiple angles.

And just one quick one on capital allocation, you guys had started this year with a $200 million target for share repurchase. Based on your projections for the back half of the year cash flow, you're probably going to have about $500 million of cash on the balance sheet. So the balance sheet is going to be a little inefficient. Can you talk about when you think it would be appropriate to reinstate the share repurchase program? If that's next year would you look to kind of catch-up a little bit of the 2020 spending to go along with the 2021 program, if we assume that the markets are in reasonable condition?

Yeah. I mean it's a little early for us to reach out and make that call right now. I mean we're watching -- well we typically frame that program historically to not grow cash. And then in this environment we do have a cash projection. And you're right, we're pleased with projecting $350 million for the year. And we feel that right now though there's enough uncertainty out there that we want to just watch it for the next quarter and we'll be back probably talking about it next quarter.

Yeah. I would just add on to that is we still believe there's better opportunities in the market. Acquisitions always are preferred method to invest in. I would like to see how things come out of the pandemic. And we're going to keep an eye on that. And again, we expect there'll be some opportunities. We want to be prepared from a cash position to capitalize, if they arise.

Your next question is from the line of Scott Graham with Rosenblatt. Your line is open.

Hi Scott. Hello, Scott, are you there?

Yeah. I am sorry about that. I was on -- I muted myself.

Okay.

So just a follow-up question on China, so we're shrinking the number of sites there I think by about 1,000 this year. And here we are with the channel destocking unexpectedly. Could one be the cause of the other? How is that? And how are you managing that site reduction? How is that going?

Well, I don't think they're related Scott to be honest with you. One, the 1,000 stores that we keep referring to has to do with unproductive stores and there -- and we've done that over the years, but we've had to close some stores reopen other stores and so forth. So that to me is a productivity market issue because there's a heck of a lot of costs into offline sales and with promoters and so forth. So we -- because of the economic environment there -- certainly it's enhanced this. But -- so that's an independent thing that we do on a regular basis evaluate our stores and close and open appropriately. As far as the stocking it's really up to our distributors to determine what they need in their inventory. And again, I don't think a quarter or a month is something we should really be surprised of some shift. It wasn't a big shift. We're still in that 2 month to 3 month range of inventory. And what's important is that they have the right products in stock and that we're driving business to the consumer to sell-in. We're in great position. I think our distributors are in significantly better positioned than they were say six months to a year ago and our sales are growing. The opportunity to sell more products as the economy reopens is positive. We had the capacity and the lead times to take care of that. So again I think the inventories are just more of a separate business management by our distributors. And we're taking care of the retail stores because it's the right way to manage our cost of sales.

Got you. And then last one on -- back to the North American business with commercial which includes restaurant lodging. It does look like lodging and certainly in spots is coming back fairly strongly. But I think you have to emerge from this with -- we're going to emerge with a smaller restaurant footprint at least for the time being. They always seem to grow back in the out years. But is there a need here to maybe come back to North America and cut some costs on the commercial side both water heaters and boilers given that on a post-COVID basis? How are you looking at that?

Yes. I mean we think a lot of that demand that we're seeing in the second quarter and into July is postponement of some replacement going forward. I think it's a little early for us to predict if there's a great deal of change in the footprint of those types of customers. That's a portion of where our water heaters and boilers do go. But we'll continue to watch that. So we'll continue to watch it as it goes forward and see what happens. Right now we expect that's just delayed and there'll be replacement as those businesses start-up.

Yes Scott I think it's a fair point a fair question, but I think it's a little bit early. And so if you look at where our sweet spots are you'd be hitting restaurants and hotels and so forth. Certainly the closures have delayed some of that. But again going forward depending on how we reopen we'll have to see how that plays out. But again the replacement market will be there. And we'll have to see what size it is as we come out the other end.

Your next question is from the line of Kevin Hocevar of Northcoast Research. Your line is open.

Hey. Good morning, everybody.

Good morning.

On the water treatment guidance, I guess, I want to understand a little more for the full year 20% to 22% sales growth. It seems to imply a fairly sizable slowing in the growth rate in the back half of the year. But it sounds like the DIY -- well the organic growth in the second quarter seems to be carrying forward into July. And a lot of the companies that have seen DIY strength have seemingly said that that's slowing, but still quite robust and carrying forward. And it sounds like the contractor-based products seem to be getting a bit better. So I guess, I just want to understand what is there a reason to assume that there should be a sizable slowing? Is there some conservatism in there? Just trying to connect the dots there and understand the guidance there going forward for water treatment.

Yes. That's a good question. I mean we saw some fair strength coming into the second quarter. We think a lot of that or some of that and we talked a little bit -- Kevin talked a little bit before about the strength in the business is. It's consumer awareness and maybe the shutdown people thinking about their water a little bit more. The DIY channel you're right has been very, very strong. So the second quarter and into July we see a lot of a lot of activity on water treatment a lot of strength. Will that continue as people kind of hopefully get back to a little bit more normal and back to work? We'll have to see how that plays out. So you're right. I mean if you kind of to do the math we're expecting it to soften a bit in the back half and not be exactly that 20% to the high order rates that we're seeing in the current environment.

Okay. Got you. And then on the -- I guess I just wanted to clarify in the opening comments I think you guys mentioned that based on where you see your water heater shipments in June that you think the industry is flat to slightly up. Was that a just a month of June comment? Or was that the full quarter? Because I guess if it's the full quarter it implies June was quite a robust month to offset the slow in April and May's AHRI shipments. And curious how you felt A. O. Smith has done versus the industry in the second quarter and into July?

Yes. That comment implies the full quarter. And again we did see a strong June. So that's the impetus going forward. And then as you look at it we've always felt people will do without a water heater for 24 hours that's about it. So that replacement market is still going to be there. And then we've seen decent new construction still holding up over the various markets. So you put those two together that's why we came up with a forecast of residential volume being relatively the same as last year, but you're right it comes off a strong June.

Strong June. And just orders carried forward into July, we still see that playing out similarly. So, residential orders have been healthy. And market share is the same. There's really no shift in market share.

Your next question is from the line of Susan Maklari of Goldman Sachs. Your line is open.

Thank you. I just have a few follow-up questions. The first is you mentioned in your commentary that you're in the process of establishing 500 new relationships -- store relationships in China. Can you just give us a little more color on that? It sounds like it's in the Tier 3 to Tier 6 cities. And then how does that kind of balance against the 1,000 store closures that you've done there?

Well, the -- it's Tier 4 to 6 cities and that's where a lot of the growth is. And we have -- those are much smaller stores, but they are in the areas that are growing. So we're working with our customers to establish those relationships to make sure they have the right selling tools and products for that particular environment. And we see the 4 and 6 Tier cities playing a bigger role particularly in the new construction part of the business and in housing. So that's moving. Comparing the 1,000 to the 500 is difficult, because again, there's really not a comparison. The 1,000 are underproductive stores not performing not recovering their costs and so forth. So we're just leaning up that part of our business where the 500 stores, which we've been expanding in Tier 4 and 6 cities for a while now are additional opportunities, they will be certainly less sales volume going through a Tier 4, 6 city store than obviously in a Tier 1, Tier 2 specialty store or retail stores. So there are really two separate actions on our part one is more growth, and one is more cost control.

And so should we expect that they'll come online over the course of 2020? Or is that more of a 2021 impact in terms of the revenues coming through and some of the benefits?

We expect those to come on throughout 2020.

I am showing no further questions at this time. I would now like to turn the conference back to Ms. Patricia Ackerman.

Thank you for joining us today. We plan to participate in two virtual conferences in the third quarter Jefferies' on August 5th and D.A. Davidson's conference on September 22. Have a great day.

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