A.O. Smith Corporation

Ladies and gentlemen, thank you for standing by and welcome to the A.O. Smith Third Quarter 2019 results. At this time, all participants are in a listen-only mode. After the speaker presentation, there will be a question and answer session. To ask a question during the session, you need to press star 1 on your telephone. Please be advised that today's conference is being recorded. If you require any further assistance, please press star 0. I would now like to hand the conference to your speaker today, Patricia Ackerman. Ma'am, please go ahead.

Thank you, Victor. Good morning, ladies and gentlemen, and thank you for joining us on our third quarter 2019 results conference call. With me participating in the call are Kevin Wheeler, Chief Executive Officer, and Chuck Lauber, Chief Financial Officer. Before we begin, 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. 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 three.

Thank you, Pat, and good morning, ladies and gentlemen. I'm pleased to review several items regarding our third quarter performance. Sales in our North America segment increased 6%, and operating margin performance in North America improved approximately 200 basis points over last year. Our North America water heater and boiler operations continue to perform well, I'm particularly pleased with our commercial water heater performance, where we continue to outperform the market. Productivity within North America water treatment, manufacturing, and the effectiveness of our direct-to-consumer channel continue to improve, and water rights performance is right on track with our expectations. We announced a 9% increase to our quarterly dividend rate in early October to $0.24 per share, which represents a five-year CAGR of 24%. In China, while the third quarter came in where we expected, we are disappointed to see further weakness in demand and expect that to continue in Q4. Moving to slide four, please. As weakness in our end markets in China persists, we have implemented further cost reduction actions. Over the course of the last 10 months into Q1 2020, we are targeting a 20% reduction in headcount from December 2018 levels. We continue to review and rationalize brand building and advertising spend, selling expenses, travel costs, and other SG&A spend. By the end of the year, on a net basis, we will close over 700 non-productive stores. We are continuing our aggressive cost reduction programs in both manufacturing processes and product costs, and we'll continue to work with our distribution customers on programs to reduce their inventory. Total annualized savings as a result of these actions is estimated to be $38 to $40 million, of which approximately $28 million will be realized in 2019. I will now turn over the call to Chuck, who will review our third quarter results in more detail.

Chuck? Thank you, Kevin. Sales for the third quarter of $728 million were 3% lower than the same quarter in 2018. Earnings in the third quarter of $87 million declined 17% from the third quarter in 2018, and third quarter earnings per share declined 13% to $0.53. Sales in our North America segment of $515 million increased 6% compared with the third quarter of 2018. Higher water heating, heater, and boiler volumes in the U.S. were supplemented by $16 million of sales in our recently acquired Water Right business. Rest of the world segment sales of 220 million declined 20% compared with the same quarter in 2018. China sales declined 20% in local currency, primarily related to weak consumer demand and previously disclosed channel inventory levels. The weaker Chinese currency unfavorably impacted translated sales by approximately $6 million. India sales grew at 9% in local currency compared with the same period in 2018. On slide six, North America segment earnings of $122 million were 15% higher than segment earnings in the same quarter in 2018, driven by the favorable impact to profits from higher U.S. water heater and boiler volumes, as well as lower steel costs, improvement in the profitability of water right sales without water right, and incremental profit from water right. As a result, third quarter 2019 segment margin of 23.6% improved from 21.7% achieved in the same period last year. Rest of the world earnings of $4 million declined significantly compared to the third quarter of 2018, the unfavorable impact to profits from lower China sales and a higher mix of mid-priced products, which have lower margins, more than offset the benefits of profits from lower SG&A expenses in that region. As a result of these factors, segment margins declined to 1.9% compared with 14.3% in the same quarter of 2018. Our corporate expenses of $10 million were lower in the current quarter compared to the third quarter last year, primarily due to incentive-based compensation. Interest costs were higher in the third quarter than a year ago due to higher debt levels associated with the acquisition of Water Right in April. For the year, we expect interest expense to be approximately $11 million. Cash provided by operations of $280 million during the first nine months of 2019 was lower than $289 million in the same period of 2018 as a result of lower earnings, which were partially offset by a lower investment in working capital compared to a year ago. Our liquidity and balance sheet remained strong, Our debt-to-capital ratio is 16% at the end of the third quarter. We have cash balances totaling $514 million located offshore, and our net cash position is $195 million at the end of September. During the first nine months of 2019, we repurchased approximately 4.9 million shares of common stock for a total of $230 million. Approximately 4.1 million shares remained on our existing repurchase authority at the end of September. On slide 9, we expect our cash flow from operations in 2019 to be approximately $400 million, compared with $450 million in 2018, primarily due to lower earnings. Our 2019 capital spending plans are approximately $80 million, and depreciation and amortization expense is expected to be approximately $75 million in 2019. Our corporate and other expenses are expected to be approximately $46 million in 2019, essentially the same as last year. Our effective tax rate is expected to be approximately 22% in 2019. We expect to purchase our shares in the amount of approximately $300 million in 2019, and we expect average diluted outstanding shares in 2019 to be approximately $167 million. On slide 10, we continue to see headwinds in our markets in China. The fourth quarter is typically the strongest consumer demand quarter of the year. However, with continued weak year-over-year consumer demand and persistently high channel inventory levels, we are forecasting the fourth quarter in China to be similar on the top line and operating profit line to the third quarter of 2019. As a result, we revised our 2019 EPS guidance to a range of between $2.25 and $2.28 per share, a 13% decline at the midpoint compared with last year. I will now turn the call to Kevin, who will summarize our guidance and business assumptions for 2019, beginning on slide 11.

Okay, thank you, Chuck. Our outlook for 2019 includes the following assumptions. First, let me start with China. We saw year-over-year consumer demand in the third quarter decline compared with first half of the year and project full-year sales to be down approximately 19% in local currency terms. Combined with our expected four points of unfavorable currency translation, our 2019 China sales projection is a decline of approximately 23%. Our forecast for the Chinese currency in Q4 is essentially level with where it is today. The sales decline of 19% local currency is roughly equally attributable to weaker consumer demand than change in China inventory year-over-year based on our projections of year-end channel inventories. Total channel inventory remained relatively unchanged from the second quarter at approximately four months. Historically, channel inventory increases in Q3, as it did in 2018, as the market prepares for the higher fourth quarter sales. This year the channel did not experience a third quarter inventory increase. While we expect that consumer demand will be higher than other quarters of the year, as the fourth quarter is typically a period of high promotion and buying in China, our assumption is the fourth quarter demand will run at a year-over-year decline similar to what we saw in the third quarter. We project that the channel inventory will be reduced nearly one month. We expect that we will exit the year with channel inventory levels remaining above normal. Normal is in the two- to three-month range. In the U.S., we project residential water heater industry volumes will be down 100,000 to 150,000 units in 2019. Commercial industry water heater volumes are expected to be up 4% to 5%. primarily driven by growth in the light service electric models. Based on boiler sales growth of 5% year-to-date, we expect our North America boiler sales to grow approximately 5% for the full year. We project India water heater EBIT will be positive in 2019, and we expect India will achieve break-even in 2020. Please advance to slide 12. We project revenue will decline by approximately 5% for the year in U.S. dollars and 3.5% in local currency. We see sales growth in North America with our water heater, boiler, and water treatment products collectively expected to grow approximately 4% in 2019, including $40 to $45 million in water rights sales. EPS is projected to be $2.25 and $2.28. We expect North America's segment margin to be between 23.5% to 23.75%, and rest of the world's segment margins to be approximately 4.25%. We are pleased with how our North America segment is performing, particularly on the water heater side on lower industry volumes. We see long-term growth drivers in water treatment solutions and boilers across North America. In the near term, the China economy remains weak and we've taken further action to right-size the business while continuing to invest in innovation. We have a strong brand, broad product offering in our key product categories, broad distribution, and a reputation for quality and innovation. Over time, we are well-positioned to maximize favorable demographics in both China and India to enhance shareholder value. Our replacement markets remain stable, which we believe represents approximately 85% of North America water heater and boiler volumes. We have strong cash flow and balance sheet, providing an opportunity to continue to invest in ourselves, acquisitions, and return cash to shareholders. That concludes our prepared remarks. You are now available for your questions.

As a reminder, to ask a question, you will need to press star 1 on your telephone. To withdraw your question, press the pound key. Please stand by while we compile the Q&A roster. Also, in the interest of time, please limit yourself to one question and one follow-up. Our first question will come from the line of Robert McCarthy from Stevens. You may begin. Your line may be on mute, Robert. Once again, Robert McCarthy, your line may be on mute. And our next question will come from the line of Jeff Hammond from QBank. You may begin.

Hey, good morning, guys. Hi. Hi, Jeff. Morning. Just on China, I guess, you know, just the lower expectation, you know, margin, top line, are you seeing that as more – more aggressive destock or weaker consumer demand? And then just on inventory, should we expect kind of first half 20 to still be under margin pressure as you guys continue to destock? And when do you think that kind of wraps up and gets back to normal?

Yeah, this is Chuck. So When we look at kind of the change from our last guidance, what we really have seen is the consumer demand, our sellout, down a bit. It's declined since it was kind of running flat year over year. That was our assumption. So we've seen a weaker decline in consumer demand of about 5% to 8%. So what that did is it pushed back a little bit our inventory reduction that we were expecting at the end of Q3. The good news is inventories did not go up. Typically at the end of Q3, inventories would go up in that 12% to 15% range. This year they remained flat. So even last year the inventories went up at that low end of that range. So as we go out the back half of the year, you know, we're looking at a bit of a weaker Q4 based upon that weaker consumer demand and the need that inventories are still going to be needing. We still expect inventories to come down by about a month, which is going to cause a headwind. So to your question of going out at the end of the year, we're looking at going out at the end of the year somewhere around three months, and as Kevin mentioned, typically it's in that two to three month range that we would have as channel inventory. So we do have a bit of a hand with heading into next year.

Okay, and I think you said commercial, North America commercial sounds better and was good in the quarter. Can you just give us the water treatment core growth And, you know, just talk about, I guess, qualitatively at least what you saw in residential water heaters.

Well, I'll take the residential water heater side of it. First, in Q3, we expected residential to bounce back a little bit stronger than it did. And although it was positive, not nearly where we expected it to be at the end. based on through August, the industry was down 194,000. We look at our September. We don't see much more of an improvement once we get that data coming out from our industry. So, overall, you know, we took the industry down 50,000 compared to what we did on our Q2 call. And simply, we just don't think in Q4 we can make up that – But when you look at it, again, you've got to remember there's 120 million households out there, and we estimate somewhere in those households is about 132 million water heaters. And so, you know, 100,000, 150,000 units, there can be some variability there from year to year. We're coming off two straight years of over 4% growth. This one looks like it's going to be down in the 1.5% range. So, you know, overall, we feel pretty good about our water heater business. We don't see going forward a replacement market remaining strong. So, you know, overall, the residential business, slight down year, but there is some variations from year to year.

And on water treatments, on the water treatment side, the North America water treatment, that is, Last year we had a bit of a tough call because we had some ramp-up going on with one of our major customers. But if you look at the base business, we grew at about 9% for the quarter. So the base business is growing nicely. We like the back half of the year trajectory on growth as well as continuing to look at improvements in operations.

Okay, thanks. I'll get back in queue.

Thank you. And our next question will come from the line of Sari Boroditsky from Jefferies. You may begin.

Thanks. Good morning. Good morning, Sari. I appreciate the commentary on North America, but wanted to see if we could dig into the results a little bit more. You talked about a 4% price increase back in August. How has this been received by the market, and are you seeing similar price increases from competitors or just in general any changes in the competitive dynamics?

We're going to be very consistent here since we're the only public company. What I will say is we announced and implemented a 4% increase, as stated, in August, and that's been implemented.

Okay. And then, you know, based on the 20% total headcount reduction in China, can you just confirm that would be another 5% reduction in the fourth quarter? And maybe – provide some color on where those headcount reductions are occurring, if you feel like the business will be right-sized for the 2020 market conditions at this point.

Yes, Siri, this is Chuck. So we've increased that percentage from 15% to 20% from the last quarter. We did that based on the continued weakness in consumer demand. You know, we'll look at whether that would be increased as we go forward. there will be some of that that goes into Q1. It's going to be over the course of probably the next two quarters that we'll see that come out. The area is impacted. It's been largely across the board. We have not, you know, what we've been very careful to do is maintain our R&D and engineering capabilities and maintain that investment so that we can continue to lead with innovative products. So we have not We have not leaned on those types of headcount reductions, but it's been pretty much across the board. Yeah, I add a little color to that.

What's important for us as we're going forward and making the adjustments for the current environment that we're in, that the business overall, whether it be in operations, manufacturing, engineering, we're still in position when the economy turns that we can ramp up quickly. So it's a very strategic way that we're doing it. We know the economy is going to come back. We just don't know exactly when. And we want to position our cost structure to the environment, but also the ability for us to ramp up when the economy comes back and be able to service our customers at the appropriate level. So it's a balance here, and we're looking at it from all sides.

I appreciate the color. Thank you, guys.

Thank you. And the next question comes from Mike. Howard from Baird. You may begin.

Good morning, everyone. Good morning, Mike. So just some thoughts on China here from a competitive dynamic market share perspective. Last couple quarters, you've given some good detail about how you think you're tracking versus the market, both at the high end as well as kind of overall. Maybe you can just give us an update there and then specifically talk about how you think you're performing versus the market as well as competitive situation.

Yeah, this is Kevin. Let's just talk Q3 because we look at this quarter by quarter, and it does vary. In Q3, our gas tankless share, we held our share. And on wall-hung electric and water treatment, we were down slightly, about 200 basis points. On the water heater electric side of it, we know exactly where the share decline was in a couple regions. We'll take some action there. And you got to remember in Q2, we also talked about that we had improved our market share in Q2, so we gave a little bit back. But again, there's variation from quarter to quarter. We don't see any issues there. We expect to recover our share over time, and we have the products, the distributions to handle that. With regards to competition, you know, certainly every – China's been a competitive market for the past 20 years. We have people that have entered into our space on the premium side, and we have to compete, and we're competing on a regular basis. Now, again, we're in a market that's a little bit down, and so we have some mid-price point products that have done fairly well, and we have some premium products that continue to provide value to consumers, but there's a balance there. So overall, when you step back, our share – is continuing to be in line with our expectations, and you'll tend to see a little bit of up and down quarter to quarter.

And I think, Mike, on your comments or your question about high end of the market, you know, on the water treatment side, when we look at this year today compared to 2018, we've seen it pretty stable. We haven't seen any decline. Consistent with what I think we've talked about in the other quarters, on the water heating side, both gas and electric, we saw a the high end comes down a couple hundred basis points as far as the total market, percentage of market.

Okay, that makes sense there. And then the margins in the fourth quarter, you know, I think, Chuck, you said about consistent with the third quarter. I think the math I ran was closer to break-even. Just confirm that one way or another. And then more importantly, just maybe talk about some of the puts and takes going into the fourth quarter to get to that margin profile. How much of this is just really volume deleverage versus, You know, maybe including severance or some of these other one-off kind of cost items, any kind of color on the puts and takes and factors there would be helpful as well.

Yeah, so the Q4 volume, I mean, it's largely volume. Hold on a second here. Yeah, it's largely volume, Mike. The puts and takes compared to last year, You know, think of it in terms of, you know, 50% channel inventory carve-out that's going to hurt our volume and the other 50% of it being part of just lower consumer demand. The puts and takes on the headcount reduction and those other costs, I mean, we still have some costs going into headcount reductions and severance in Q4, although those benefits are higher than the cost that we've incurred. We've got a little bit of the plant inefficiencies that occur at the low end of that rate also. So those two kind of offset each other. But the risks on kind of the Q4 number probably relate more along consumer demand and what happens to channel inventory, because we're forecasting channel inventory to come down by about a month.

That's super helpful. I appreciate it. Thank you.

Oh, and back to your question on Q4, yeah, we think of it as being pretty much a break-even quarter for the fourth quarter in China to be pretty much break-even.

Great. Chuck, I even forgot about that. Thank you. Appreciate it.

Thank you. And our next question comes from the line of Damon McRabber from Longbow. You may begin.

Good morning, everyone. I want to just start off by, while we're on China, parsing out, if we can, sort of the difference between what you might be seeing in your mid-price point product versus your premium price point product. And if we're able to talk about that four months of surplus inventory, are you able to parse out how many months are you on terms of just if we isolate the premium? Because it seems like the mid-price point is probably turning relatively well, given where the market's migrated and maybe the concentration of that might be in premium. So if it's four months on the aggregate inventory, what would it be on the premium?

Yeah, I mean, I'll say that right now in Q3 and Q4, what we're seeing as sell-in to the channel is more heavily weighted towards the bid price, lower margin product. The channel does have more of the higher price product that's taking longer to move in this sort of an environment. To parse it out and split it, We don't have that kind of clarity exactly right now. I will say we see it changing over time because we know that we're selling mostly, and that's why our margins are lower in these two quarters, we're selling a larger percentage of mid-price product with lower margins. As far as the months, so we've got about four months of inventory, and I want to help define that a little bit. So four months, think of it in terms of, The guidance we gave, so down 23% from last year, and we're thinking of four months as you take that number and divide it by 12, and that's roughly the number of dollars we kind of have in the inventory. So I wanted to frame it a bit because we're not looking at it as the next three-month sellout. We're kind of looking at it as the 12-month average and working to get that down. So as the total year volume goes down, that That hurdle got a little bit more aggressive, but it's about four months looking to go to about three months by the end of the year.

Okay. Thanks for that. And then I guess as a follow-up, just maybe talk about the boiler business. And I guess, you know, you've reduced guidance twice so far this year. Can you just talk about performance in the third quarter with maybe a little more granularity? And also, I guess, any color you can provide in terms of just the backlog dynamics. Are you seeing backlogs up or down the boiler business? And just what does quoting activity look like in the boiler business in

Yeah, the boiler business is kind of a mixed message I'm going to send here. The activity, bidding, quoting has been very active, and it's been that way throughout the year. It actually spilled in from last year, and we're getting a lot of activity there, much more than actually turning into orders right now, where we're seeing more and more jobs being delayed or postponed, and we can make some speculation around labor shortages and things of that nature. But when you look at it, the 5% that we're forecasting, we're gaining share in most of our categories that we compete in. But we have this backlog of quoting that just hasn't been released as we expected it. The good news is we do expect it to be released over time. But there's just a kind of a delay between much further delay between quoting and actually turning into orders than we've seen in the past. But overall, the commercial business seems to be good, and we're getting our fair share of the jobs that are being turned into orders, and we look for that to carry over into next year.

Thank you. And our next question will come from the line of Robert McCarthy from Stevens. You may begin.

Can you hear me? We can.

Wow. It's amazing when you can operate a phone.

It's all happened to all of us. Don't worry about it.

Well, thankfully, I'm better on the numbers. Nevertheless, you know, I guess one thing thinking about China. I mean, you know, one thing we can say and I'm not trying to be impolitic, but, you know, clearly there's there's a bit of a visibility issue here, understandably, with respect to the channel channel. and what's occurring just given the fact that you've taken down your assumptions consistently and then obviously, you know, certainly QQ versus 3Q. But I think next year is the year of the rat as opposed to the pig, and New Year starts on the 25th. But are you going to be in a position to really guide with any granularity or visibility or conviction when you report fourth quarter for China, given just the dynamic nature of what we're seeing right now?

Well, let me take that. You know, we've been asked more than once, are we at the bottom? And we kind of said, hey, we hope so. But we really don't know. The data is a little bit unclear. And what we're going to look at is we're coming off a difficult Q3. Consumer demand was down, as we talked about. We're going to look at Q4, and that's going to give us kind of the vision into 2020. But it's one of these markets that we have to take month by month, quarter by quarter, and hopefully we get through Q4. Maybe there's a phase one of the China agreement that may help going into 2020, but we don't know. What we do know is that we're trying to give you our best view based on the data we have today. And Q4 is going to be a critical quarter as we set up going into 2020, and we're in the middle of our planning process right now. But we just need to see how Q4 plays out. All right.

And thank you for that. I appreciate that. And then moving on to kind of back to North America, and obviously, you know, I think there's some limit to what you want to talk about given competitive dynamics or whatnot. But Just in terms of the granularity, I mean, is there anything you can say about kind of the relative growth rates, you know, in the near term for tank versus tankless? And have you seen a pronounced shift there given the fact that particularly some applications of tankless, the all-in cost is coming down? There seems to be, you know, at the margin more of a preference for it. It is historically over the last couple of years been a better growth rate in association with it. What can you give us? Because clearly, you know, underneath the hood, you know, we are seeing, you know, a little bit of a different growth rate for North America. And I just highlight the fact that you did miss consensus numbers for third quarter, and you did take down some of the assumptions for fourth quarter. So any kind of visibility as to if there's a potential sea change going on there in the fourth quarter would be helpful in terms of granularity.

Yeah. Let me try to take some of that. As far as seed change, no. But we don't see a seed change. And if you look at the tankless side of the business, it's growing certainly faster than the tank type. That delta has changed quite substantially. I mean, we're down about 1.6% on tank, and tankless is up maybe in the 3.5% range. So there's, if anything, there's a contraction between the two. And so there's no meaningful change. Again, you look at this quarter to quarter. I've been in this industry 30 years, and it's difficult to predict these swings because, quite frankly, when you look at it, a couple hundred thousand, 150,000, 100,000 units, that's a relatively small number when you bake it into the millions that we sell. So what I'll come back to is we believe our North American tank replacement market remains solid. We are still a participant in the gas tankless business and have low double-digit share that we're continuing to improve. We're going to be filling gaps in that category, the tankless category, in 2020. So no changes. Our distributors seem to still feel fairly confident going into the quarter, into next year. So overall, That was a long way to say that it's pretty much status quo has been from the beginning of the year.

And Rob, I want to come back to China real quick here and mention about visibility into the channel inventory in China. We think we have good visibility into the channel inventory. What we're a little bit struggling with is sell-out and consumer demand. That's really the change in our estimate quarter over quarter. And just remembering that we don't control the channel inventory. It's our customer's inventory. We certainly work with them to try to help them move it through the channel. We have promotion programs and work with them closely. But the delta and variable from the last outlook is really the step down in consumer demand.

Thank you. And our next question will come from the line of David McGrath from Longbow. You may begin.

Yeah, thanks for taking the follow-up. I just wanted to ask about you filed an 8K back earlier in October just looking at amendments to the Articles of Incorporation. And I was just wondering if you could just talk about the motivation for incorporating these various defensive measures. Sure.

David, this is Pat.

Hi, Pat.

Hi. The amendment was basically to bring our charter and bylaws up to our peers and current standards. So it was really just some benchmarking that we had done and looked at what, you know, best practices for shareholder proposals and for director nominees. So it really was benchmarking and best practices that drove the amendments.

Got it. Thanks for for addressing that. And then just follow up question. I asked you last quarter about the sort of the split between mid price point and premium price point in China. And you said you'd get back to us with that. So just wondering if we could follow up with that question again, and give us a better sense of proportion in the Chinese business. And and I guess, you know, if there's anything you could be doing longer term to improve the contribution margin on the middle price point product other than just scale.

Yeah, so this is Chuck. So we don't necessarily have granularity into the change of mid-price point. We have introduced many more products, not many more products. We introduced more products in the $3,000 to $5,000 RIV range, which, like we said before, the contribution margin isn't as high as the contribution margin in the high end of the market. But we are working on cost reduction programs like we always do, We have cost reduction programs to lower product costs as well as improve productivity and process improvement. So we continue to work on that. Right now, it's a heavier mix towards what I'll call the high-end of the mid-price products because of the fact that the channel has more higher-end products in it today than it does mid-price. But those newer models are really well-received in the marketplace right now, and our customers – continue to want to introduce those at the same time, work diligently to, over time, take down the channel inventory on some of the higher price models that are in the market.

Thank you. We have a follow-up from the line of Jeff Hammond from QBank. You may begin.

Hey, good morning. There's been a recent news article about higher entering the North America water heater market and building a plant. Can you just speak I mean, clearly the market's pretty rational, few players, good returns. Just what are you seeing out there, and what are your expectations from that new entrant? Thanks.

Well, what I can tell you is what's been publicly announced is that they are going to – they've indicated and announced that they're going to enter the electric water heater market and that they have an investment in South Carolina of about $60 million. We have not seen any product in the market. and we don't know, quite frankly, much more than what they published. What I would tell you is that, regardless, we always have competition, and A.O. Smith has a longstanding relationship with customers. We have the broadest portfolio of products in the market, technology, high service levels, and And we have long-term relationships and leading market share. So at the end, there will be, it looks like, another competitor with a partial line. And if and when that starts to materialize, they're talking about next year, Q4, we'll deal with it, as we have with all of our other competitors. So there's not much to say other than what you read, and I think what we bring as a value in our market share and our broad products of both residential, commercial, tankless, and so forth, that we're in good position to continue to move forward and be successful in our markets.

Okay, great. And then just back to the water treatment. Chuck, was the 9% that bad? Did that exclude that large customer or that would have included that tough comp?

That excluded the load in of ramp up of the large customer because we had an unusually high ramp up of a customer. So the 9% we've used more as kind of the baseline growth of the base business.

Thank you. And we have a follow-up from Robert McCarthy. You may begin. Thank you.

Yeah, no, I mean, I guess a question I would have is can you give us any kind of updated and vetted expectation for the relationship with Lowe's, and has anything changed there in terms of what is kind of translated into your guidance for this year and thinking about next year?

No, really we can't. We're not going to talk about specific customers going forward, particularly on performance. Overall, our water treatment business, as we said, continues to improve, and that's in all categories, whether it be our dealer network, our direct-to-consumer retail and wholesale. So overall, the business is improving. We're becoming more productive. Margins are moving up, and the business is moving in the right direction as we continue to penetrate these market segments.

And then just to follow up on the entrance of GE and higher, I mean, I guess it stands to reason, though, that you worked through a pretty material price increase several years ago. It worked out, but that was in the context of, I guess, a tacit oligopoly. I mean, clearly, do you think going forward, if it gets a more competitive environment with more players, that does lead to lower return thresholds and definitely could put a cap or put some pressure on North American margins. How do you think about trading profitability versus growth in North America going forward if the market changes?

Yeah, one, I don't think they're mutually exclusive and we don't trade. But let's just take this from a much more macro picture, okay? And I'm not going to get into specifics regarding this potential competitor. But if you look at the investment that they've announced making $60 million, I can tell you from our perspective, we're 10x that. It takes a lot of investment, engineering, and relationships, sales organizations to be a major player in this market. And we feel we're in great shape. We've invested, like I said, about $600 million in building this business over the last 60 to 70 years. And it's one that we feel good about going forward, and we think we have the pillars to, whether it be product, manufacturing, engineering, and so forth, to compete down the road. And that's what we're going to do. That's what we've done for the last 60, 70 years, and we'll continue to do that in the future.

Thank you. And we do have a follow-up from David. You may begin.

Yeah, thanks for taking the other call. The other question. We haven't talked much on this call about raw materials. And you did indicate in your prepared remarks and your press release that it had been a positive influence on North American margins. Can you just talk about, I guess, the extent to which that contribution could grow going forward? I mean, steel markets from a price standpoint have come down pretty substantially. I'm not clear to what extent your contract versus spot exposed in the U.S., but your indirect is probably coming through favorably as well. How should we think about the margin contribution from ROS as we move through 4Q and into the first half of next year?

Well, for Q4, we'll just kind of talk about those still costs are set, you know, in advance. You know, we kind of have a 90 to 120-day contract. lag on when we when when we see those steel costs whether to go up or down so you kind of can look back and and look at q4 and it's a it's our best cost position in q4 on steel for 2019. um so in keeping in mind though just on the margin side so we do have some large retail customers that have formula pricing that also move the other way so while there's some margin expansion certainly opportunity when steel goes down there's also that corresponding headwind on pricing that offsets it. So, you know, looking through the end of the year, it is our best steel position Q4. Okay.

Thank you. Thank you. And I'm not showing any further questions at this time. I'd like to turn the call back over to Patricia for closing remarks.

Thank you all for joining us on our call today. We will participate in several conferences over the course of the fourth quarter. The first is the Baird Conference in Chicago. We will be there on November 5th and in the morning of November 6th. And we'll participate in the Stevens Conference in Nashville on November 14th. Have a great day.

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