A O Smith Corp (AOS) 2012 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by, and welcome to the A. O. Smith Corporation's second-quarter 2012 earnings conference call. At this time, all participants are in a listen-only mode. Later on, we will conduct a question-and-answer session; instructions will be given at that time. (Operator Instructions). As a reminder, this conference is being recorded.

I'd also like to -- I'd like to turn the conference over at this time to Vice President, Investor Relations, and Treasurer, Pat Ackerman. Please go ahead.

Thank you, David. Good morning, ladies and gentlemen, and thank you for joining us on our second-quarter 2012 conference call. With me participating in the call are Paul Jones, Chairman and Chief Executive Officer; Ajita Rajendra, President and Chief Operating Officer; and John Kita, Chief Financial Officer.

Before we begin with Paul'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.

Paul, I will now turn the call over to you.

Thank you, Pat. Good morning, ladies and gentlemen. In the second quarter, we continued to see improvements in sales and earnings as a result of our acquisition strategy and global footprint. Here are a few highlights.

Our organic and growth and acquisitions drove sales 19% higher to $484 million. Lochinvar, acquired in the third quarter of last year, added $55 million. In China, our sales of A. O. Smith-branded products grew 17%. In addition, we implemented a price increase in the US, which became effective in June. And we experienced a pre-buy of water heaters in the second quarter, ahead of the price increase.

Our earnings improved 47% to $0.75 per share. Lochinvar continued to contribute significantly, and met expectations.

Last week, our Board approved a 25% increase to our dividend, which reflects our confidence in our business performance, as well as our strong financial position.

John will now describe our results in more detail.

Thank you, Paul. Sales in the second quarter of $484 million were 19% higher than the previous year. Lochinvar, which we acquired in August last year, added $55 million. And sales of A. O. Smith-branded products in China grew 17% to $106 million.

Earnings of $35 million, or $0.75 per share, were 47% higher than last year, when the benefited from several one-time items, which collectively resulted in a net gain of $0.11 per share in 2011, are excluded from the comparison.

Sales in our North America segment of $366 million increased 21% over last year. This segment includes our US and Canada water heater and boiler businesses. In addition to incremental sales of $53 million from Lochinvar North America, we experienced higher volumes of residential and commercial water heaters in the US as a result of the pre-buy by our wholesale customers in advance of a June price increase.

We experienced higher commercial volumes in the second quarter than any other quarter in the last four years. Lower sales of tankless products in the US, and water heaters in Canada, partially offset higher US volumes.

While it is difficult to calculate, we estimate the pre-buy impacted revenues in the second quarter by approximately $15 million. And its impact to earnings was between $0.05 and $0.06 per share. The results of our China, India, and Europe water heating businesses, and our water treatment business in Asia, are captured in our Rest of World segment.

Segment sales of $127 million increased 15% compared with last year, due to a 17% increase in sales of A. O. Smith-branded products in China.

Our retail expansion is on track; our premium brand continues to gain market share; and our newer products -- most notably, gas tankless -- are growing faster than our overall business.

North America operating earnings of $51 million were $16 million higher than last year, excluding one-time items. The Lochinvar acquisition added $10 million to operating earnings. And the effect of higher US water heater volumes from the pre-buy also contributed to the year-over-year increase.

Last year, the segment benefited from a $3 million net gain, resulting from a settlement with a component supplier and an increase to the warranty reserve. As a result of higher volumes -- in particular, higher-margin commercial water heaters, and Lochinvar's performance -- the segment's operating margin improved significantly to 14% in 2012.

Rest of World operating earnings of $12 million improved 12% compared with last year, driven by higher China sales, which were partially offset by larger losses in India, primarily due to the weaker rupee and cost to build our brand and expand our product offering in the region. As a result, operating margin fell slightly to 9.7%.

Our corporate and other expenses were $11 million, an improvement compared with last year, primarily due to interest earned on our cash, which was partially offset by higher pension costs. Total operating profit, excluding the RBC share gain in 2011, and one-time items, improved 52% to $53 million.

Cash provided by continuing operations was $30 million at the end of the second quarter, compared with cash used by operations of $105 million last year. 2011 cash flow through June included an approximately $150 million after-tax contribution to our pension plan.

Our liquidity position and balance sheet remain strong. Our debt to capital ratio declined to 20%, compared with 30% at the end of 2011. We have sizable cash balances located offshore, primarily related to the sale of electrical products. And our net cash position was in excess of $150 million at the end of June.

We project our cash flow from operations for 2012 to be between $155 million and $165 million. Our capital expenditures are expected to be $75 million to $80 million, which includes approximately $30 million for capacity expansion in China to meet growing demand for our water heaters.

Our depreciation and amortization expense is expected to be $55 million this year.

I will now turn the call back to Paul, who will summarize our outlook and acquisition strategy. Paul?

Thanks, John. Given our strong performance in the second quarter, but tempered by pressure on the third quarter from the pre-buy in the US, we raised the bottom of our expected 2012 EPS guidance to between $2.80 to $2.90 per share. Our guidance does not include the impact from future acquisitions and the gain related to the sale of our RBC shares.

Our outlook for 2012 includes the following assumptions -- first, we continue to remain positive on our growth in China. We expect our growth of A. O. Smith-branded products in the second half of the year will be at a low-teens rate compared with 18% in the first half, resulting in a full-year growth rate of 15%. The growth rate in the second half will be impacted by more difficult year-over-year comparisons, as well as our belief that some of our distributors are carrying larger inventories than normal levels, as a result of our new product introduction and a slowdown in retail store sales.

Second, we expect Lochinvar to continue to benefit from the transition from lower-efficiency, noncondensing boilers to higher-efficiency condensing boilers. Lochinvar's market-leading condensing boilers continue to offer a compelling payback in the form of energy savings. And the company has built a reputation for innovation and product quality. As a result, we expect Lochinvar's growth rate in 2012 will be over 10%, well ahead of GDP growth in the US.

I should remind everyone that Lochinvar does have some seasonality to its business, related to the product it sells for hydronic heating. Lochinvar's second half of the year typically has higher sales and profits than the first.

Third, we expect water heater volumes in the US to remain at approximately 2011 levels, due to the stable replacement and nondiscretionary nature of our products. Given the pre-buy we experienced in the second quarter, and the normal seasonality of water heaters, we expect to see in the third quarter -- we believe we will experience lower volumes in the third quarter, which will bring our customer inventory levels back in line with our 2012 volume assumptions. We project that the adjustment to our volumes, particularly our higher-margin commercial volumes, will have a negative impact on our operating margins in North America for the second half of the year.

Fourth, given the challenging macro environment in the Eurozone, I want to remind you that we have minimal exposure to that region.

And fifth, we are planning an Analyst Day on September 26 in Nashville to showcase both our water heater plant and our boiler plant. Watch for details from Pat; and we look forward to seeing you in September.

Our Lochinvar acquisition was a very positive first step in building our global water platform, and continues to meet our expectations in growth, possibility, and synergies. We continue to focus on water-related opportunities globally, and have identified a number of interesting possibilities.

You've seen this before, and we show this only as a reminder that we will be a financially disciplined acquirer. Our transactions -- we focused on creating returns for our shareholders.

We will now open the phone lines for your questions, and I'll turn it back over to David.

(Operator Instructions). Sanjay Shrestha, Lazard Capital Markets.

Thank you. Good morning, guys. First, congratulations on a great quarter. My first question is on China; so a two-part question, if I may. Given that you guys had a bit of a margin degradation in the Rest of the World business, which seems largely related to the operations in India -- but when we think about your margin performance in China, is it comparable to the last year? Is it modestly improving? Or is it kind of modestly declining? How should we think about that?

It's very comparable to the prior year.

Okay. Okay, great. Now, as it relates to some of the comments here, guys, about the second half of the year; obviously, we all read the headlines. And is there some conservatism on your part? Because that's -- the second half had the potential to accelerate a bit. It was going to be first-half slowdown; but now we think that the second half is going to be somewhat slower than previously expected. So how much of that is conservatism? And how much of that is, as you guys mentioned, about the entry in the channel being a bit larger than previously expected?

Sanjay, we have a reputation for being a bit conservative, but we just try to give you the best information we can from what we see right now. There's always a lot of moving parts. And this is, essentially, our best estimate of how we see the second half.

Okay, okay. One final question then, guys. I know you're probably not going to get into a lot of details, but I have got to ask -- in your press release, you guys talked about a couple of active discussions surrounding the acquisition. Anything more you can, and would care to share at this point?

I wish we could but, we can't. And you know that.

Okay. Fair enough.

You asked the question.

All right. Fair enough. Thanks, guys. And once again, congratulations.

Thank you.

Matt Summerville, KeyBanc.

Morning. Several questions. First -- I think, John, you mentioned that commercial volumes in the second quarter were the highest in four years for A. O. Smith. Now, I would assume that includes being greater than what you experienced in the fourth quarter of 2011, with that California dynamic aiding that. Was this $15 million or thereabouts that you think was pre-bought -- was that almost solely relegated to commercial? Or, if not, what would have been really driving that big number in your commercial business?

Well, I think it was bigger than the fourth quarter this year. It is a component of the $15 million, but residential also had a very strong June and a strong May. And we believe it was the price increase on both of those that drove that component. But we were surprised on how large commercial was, because we were expecting it to be down because of the pre-buy. And we look at our numbers for the year, they are pretty close to flat, year over year.

Has your commercial business since tailed off in January in the first couple of weeks? (Multiple speakers) I'm sorry, July, yes.

In July, orders are down. And they are down compared to last year. And, again, we would have expected that because of the pre-buy that occurred.

And what was the precise timing of this price increase?

Timing was June 4, was the effective date. Orders received before June 4.

Okay. So have you started shipping units, at this point, at the higher price points? Or are you still working through the backlog of orders?

No, we are shipping units. Just a little elaboration on it -- this was a pretty significant price increase. So for our financially stable wholesalers that have cash on hand, it would be worth their while to lay in a couple of months worth of inventory. So that's why there was probably a little bit larger pre-buy. Maybe what we've had when we had low-single-digit increases in the past.

Okay. The last question on -- that the guy before me was asking about -- China and inventory there. I want to make sure I'm clear. When you say that the channel maybe has a little inventory on hand, and maybe some of that comes out, is that related to a lack of sell-through? Or is that related to sell-in around new products?

Mike, this is Ajita Rajendra. I think it's a combination of both. We see that the sell-through has come down. But what we saw -- when you look at the first half -- but the second quarter was actually a little better sell-through in China than the first quarter. So, even though -- so we're getting mixed signals coming out of China. Everyone expects things to slow down; but in the second quarter, the sell-through was a little better than the first quarter. But, overall, I think people feel that that the government is going to act quickly to turn things around; and, over the next few months, things will turn around in China.

Do you get the sense that -- well, here -- asked another way, can you give some color as to what you saw with regards to same-store sales in your Tier 1 locations versus your tier 2 and 3, and how that folds in into your second-half expectations for China?

Pretty flat, pretty flat in both.

Okay, so has that been another sequential change? Tier 1 had been relatively flat, I thought, for a while. And now you're seeing same-store sales flatten out in tier 2 and 3?

Yes.

We did see, in the second quarter, Tier 2 steady year over year; slowing down and pretty close to flat. So a decent portion of the growth is coming from our new distribution outlets, which we've been talking about adding 800 a year, per se.

Yes, and we're still on track for that, Matt, adding approximately 800 this year. There's maybe another little dynamic whereas some of the stores, maybe they're getting a little more aggressive at shutting down poor performing stores. So I don't know whether the net will be 800. But we're still on track for 800 new stores to open. That will get us up, I think, 6200 outlets in China by the end of this year.

And Suning and Guomei -- I mean I read what I can about their results. Obviously, they've been suffering a across many -- more on the electronic side, or larger household appliances. The government has talked about some new stimulus. Does that help you at all on the stimulus side of things? Or does what's happening in the other pieces of your customers' businesses, Suning and Guomei, does that hamper their thoughts on the rate of increase in outlets?

I think the government hasn't done a stimulus yet. If they do, we don't know what that will be. Our product is doing okay. We are not down 20%, 30% like some of the numbers you're reading about on the electronic side and everything else. So we'll just wait and see, and see what happens. And, obviously, we track it on a daily basis.

That 800 is coming from a variety of sources. We were expecting Suning open about 200; Guomei to open about 200. We would add specialty stores of about 200, and then other retail customers adding 200. So it's a fairly diversified growth in outlets that we are expecting.

Yes, I think the government is talking about adding subsidies on energy-efficient appliances. I don't know if that applies to water heaters or not. I didn't know if you guys had thoughts on that.

We don't know yet; it's still being talked about. When we find out, we'll let you know. But we don't know.

Okay, thanks, guys.

Mike Halloran, Robert W. Baird.

Morning, everyone. Obviously, fantastic margins in the quarter, so I just want to dig through some of the pieces on that side. So first on the Lochinvar side, margins near that 20% range -- very, very healthy there. Anything that's not sustainable in the quarter? And, maybe the better way to think about it is -- as volumes improve seasonally, should those margins get a little bit better as we trek through the year here?

Yes, we would expect those margins to get better as their volume grows.

And then, when you think about the other piece of the business -- more moving parts on the US residential and commercial sides -- could you talk a little bit about how the expectations for a little bit softer volume working through the back half of the year; how that -- plus maybe a little bit mix shift off with a lower commercial volumes expectations -- how that gets balanced with the price increases you put in, and probably a little bit better price/cost curve as you work through the year here?

I guess the only way to say it is, a lot of moving parts. There was a pretty significant pre-buy, which means our customers have more inventory than they would normally have. We're going into the third quarter, which is traditionally our weakest quarter for our residential water heater sales and commercial water heater sales. It's just a lot of things moving. Yes, the margins ought to be up because of the price increase, although our costs have been going up, too. And it's not just steel. We're talking about a lot of costs relative to healthcare and regulatory, and I could go on and on -- gasoline spikes; we get fuel surcharges.

We try to factor all that in, Mike, and try to come up with what -- our best estimate of what's going to happen for the second half of the year.

Makes sense. And then, when you think back to previous price increases you put in, how long of an impact on the flipside is? In other words, a price increase is put in place on June 4, and there's a little bit of excess inventory in the channel. It is it about two months that it takes to bleed that inventory out? A little bit longer, a little bit less? What's the historical precedent been?

Historically, it's been four or five weeks. But that's when we had 3% or 4% price increases. So this price increase was upper-single-digits. So, I know some of our wholesalers have a couple of months of inventory. Some of them that maybe don't have the liquidity, and didn't want to do that. If they're a good credit, it's worth their while to put a couple of months of inventory in, in order to get product that they can essentially add 8 points of margin to, because of the price increase; selling it two months later. That's the math they go through when they make those decisions.

That makes a lot of sense. And then, last one, are you seeing any differentiation in trends in the US wholesale channel versus the retail channel, at this point?

This is Ajita. Not really; right now, the retail channel is running a little slower than the wholesale channel. But, overall, the mix is staying about the same.

Great. I appreciate the time, as always.

Thanks.

Scott Graham, Jefferies.

Good morning. I just wanted to ask, I guess really two questions -- one is really for Ajita. North American residential water heaters has been running at this replacement level for some time, and I know you guys have been very constructive on that market in the guidance. We get a pre-buy in this quarter; make sure you take it out of the next quarter because, overall, on the year, things are flat. I guess what I'm wondering though, Ajita, is that some of the housing indicators are starting to improve now a little bit. And we've been running at this number for quite some time, this replacement number.

And, really, if you go back before even the bubble, back into the 1990s when housing was maybe more normal, we are still way below those levels as well. Admittedly, of course, that units have gotten more efficient and are lasting longer; but I'm talking 10, 12 years ago type of -- being below those levels. I'm just wondering, what are you thinking? What type of market analysis do you do with your team? And maybe talking to your customers about when this market actually starts to respond to what seems to be modestly improving residential conditions?

Couple of things, Scott. You're right, the replacement market -- the products are lasting a little longer. And so that's impacting the replacement market. But the other phenomenon that we saw during this turndown is that there is a discretionary component to that replacement market, where people replace their water heaters because they are looking for more hot water, even though it's not broken or unusable. And so we saw the recession impact that that portion of the replacement market also. So when things come back, we expect both those markets to come back in a more robust manner, and get back to what would we would call normal levels of replacement. As to the timing, it's very hard to tell. I've predicted it a few times, and it hasn't happened. So, it's hard to tell.

Yes, all of us. I guess the other question would be really, at Paul. And it's a simple one. I know not being able to comment on the M&A pipeline more than what you have; just simply, Paul, would you be disappointed if you did not close an acquisition in the second half?

Well, I don't think I would be disappointed, because if we don't, it would be because we couldn't find the right shareholder returns in the deals that we're working on. If we find the right shareholder returns, we're going to do it. And as always, Scott, we just can't predict when we might have an announcement coming out. I'm always optimistic, and always want to make things happen as quickly as we can. But we're going to be disciplined about it, and we'll just see. It takes somebody willing to sell at a reasonable price. You've heard me say it before -- you're not going to be reading about a 15 times multiple attached to an A. O. Smith acquisition. Time will tell. Just sit back and watch, and give us a grade when we do it.

Fair enough. Thank you.

Robert Kelly, Sidoti.

Good morning, gentlemen. Just a question on the cadence of volume for North America in 3Q and, then, maybe even 4Q, if we could go that far. Last year's third-quarter, you saw an inventory rebound thing around your customers. So the comp has got to be fairly easy. Do you expect to be down against even the July and August rebalancing story from a year ago? And then what happens in 4Q, because you had to rebalance again when they restocked back to normal? Can you just talk about your expectations for North America?

Well, you're right, last year's third quarter was weak. But because of the pre-buy, right now we're thinking the third-quarter volumes will be similar to maybe even down a little bit, compared to last year's third quarter. And that's driven specifically by that pre-buy that happened in the second quarter. And when you get to the fourth quarter, certainly we expect commercials to be down compared to last quarter, because of that pre-buy that happened; and fourth quarter volumes from the residential side, again, we would say would be flat to maybe up a little bit. But that's hard to call in the fourth quarter. So that's kind of what we're seeing right now.

Okay. Yes, because I'm -- you have to be -- in one of those quarters, up I guess, to be flat for the year, right? If you're going to be down in 3Q?

(multiple speakers) -- and that's why I would say, in the fourth quarter, we would hope volumes would be up some.

Okay, fair enough. And just as far as the shareholder reward story, you had a big dividend increase -- last week announced -- and surprised by the magnitude of it, I guess. Is that some sort of signal that if you do not find attractive acquisition candidates, you amp up the shareholder rewards?

No, that's just a sign of us doing what we said we were going to do. We've always said that 20% to 30% of our profits would be dividended out. And we want our yield to be between 1.5% and 2%. And we had fallen below both of those because the Company's performance had been strong. So we just brought them in line.

Fair enough. Thanks so much.

This dividend is $7 million of additional cash this year. As John went through the cash story a while ago, our cash situation is very strong. And it's going to continue to strengthen. And we just think it's appropriate to reward the owners of the corporation when that happens. Any more questions?

That's it for me, thank you.

William Bremer, Maxim Group.

Good morning, Paul, John, Ajita and Pat. How are you?

Fine.

Hey, great quarter. All right, I want to go right into Lochinvar here. Can you give us a breakdown here of how much of the pre-buy, the $15 million, was on the commercial side versus residential, first?

For Lochinvar?

Just in general.

I think Lochinvar had very little of the pre-buy in the second quarter.

Okay, so if I remember correctly, the second half of Lochinvar -- primarily the fourth quarter -- is this strong, as followed by the third?

That's correct.

Okay, so I could still hold that assumption true for the end of 2012 here, right?

Yes, we believe so.

Okay. And then, looking at -- I want to bring this over to, say, the India marketplace. Is India exclusively, right now, targeted as residential?

Yes, primarily residential.

Okay. What's in the cards, then, to possibly go at that on the commercial side?

That's in the plans. Just remember, we only opened the plant two years ago, so we're just started in India. And we're now exporting water filtration there; we will be making it in-country next year, and it's natural. The same thing we did in China; we went to China with residential product and established a very good beachhead there with residential before we put a commercial line in. And we'll be doing the same thing, similar to that, in India.

Now, Paul, if I'm under the assumption -- India, there's not much gas there, right? It's mostly electric? So I guess some modifications on the commercial side may be needed.

There isn't much gas there, but they do have an aggressive program to expand gas distribution, just like China has. And China has been doing it, and we expect India will do it.

And Lochinvar is primarily not gas, correct?

Lochinvar is gas.

Okay. Okay.

Lochinvar currently sells very little product into Asia. And we have a program to increase that piece of their sales rather significantly over the next several years.

Now you called out India here in this quarter. Can you give us a little more color of what is happening there? How long is it going to take you, in terms of what is needed to start to bring this to the forefront, to really drive sales and to really drive that market for you?

There's two things -- one is, we could be profitable now, except we are establishing the brand. We're running thousands of as ads -- print, broadcast, et cetera, to get the brand recognition out there. The rupee devaluation has cost us $6 million. If that hadn't happened, we would be in a much better position. So there's a lot of things. We expect it'll cost us $6 million by the time the year is out.

So we're not disappointed in India at all. It took us seven years to get to profitability in China. We could be there now; we're quite confident we will be within the next few months, be it at a breakeven and then beyond.

(multiple speakers) the other thing that's important to remember -- I think we have talked about it -- is, sales in India are last-half driven. So 70% to 80% of their sales are in the last half of the year. And I think we've talked about bringing product in from China; and also good, better, best strategy; so our engineering costs in the second quarter are quite a bit higher than last year. So some of those costs aren't being helped, because sales are not that high and we expected them to not be high the first half of the year.

Okay, can I add just one more thing to that, too -- is that the sell-through rate that we are seeing of our product selling through at retail is very high and on track; it's what we expected.

Okay, great. Thank you.

Shawn Severson, JMP Securities.

Thank you, good morning. I'm wondering if you could talk a little bit about the strategy, if you look into Asia and expanding into other emerging markets, I guess, specifically on the margin side. The things you looked at, be it the peripheral products on the water treatment side or another acquisitions, would you expect China today to be a benchmark for what you think the margin profile of businesses would be, expanding abroad into other markets?

Well, the answer is yes. The last acquisition we did, Lochinvar, has margins actually higher than China. But I think we are looking for emerging markets. We'd like to see GDP growth rates above 5% in some of these markets as being a place where we could not only come in with a returns to shareholders in a reasonable period of time, but also some growth.

And what about in other peripheral water treatment acquisitions? I assume you've looked at a few. Are the margin profiles on some of those peripheral products at China today or better?

Yes, that is one of the things that is on our target list. I can't comment on whether anything is closed or not and what the margins are. But that is something that we would consider if we could find an opportunity out there. And if it's got margins in the mid-teens, then that would be an attractive one that we would pursue.

Great. And then just last question -- we looked at the magnitude of recovery in residential construction, and has pretty good numbers again today. What do we have to get to where you think that really starts to have a significant impact on your business versus the replacement market? I'm just trying to gauge some scope here.

Well, internally, as we talk about it, right now we're looking at housing starts around 700,000. That is well below what is necessary to be sustainable in this country. We use numbers between 1.2 million to 1.5 million housing starts. When we get back to that level, then that would be an area that we would consider normal. And as Ajita mentioned earlier, there is a discretionary piece that we would expect to pick up as the economy turns around, too. And that could be several hundred thousand units a year. I call it the teenager effect; it's where people have teenagers and they're tired of taking cold showers, because their kids take long, hot showers. But those things can happen.

The only comment I'll make -- I'm not trying to predict when that's going to happen, because I, frankly, don't know. There's so much uncertainty right now, I don't think anybody can predict. But when it happens, we are well-positioned -- we have the capacity; our fixed costs are not going to go up; our contribution margin is going to, essentially, fall straight through; and we're certainly looking forward to those days.

Great, thank you.

Davis Rose, Wedbush Securities.

Good morning, this is David Rose. I was hoping that we can go over a little bit -- I may have missed it a bit, on the SG&A numbers -- if you can break down what you think is, from your perspective, is discretionary SG&A that you put in the second quarter? And what incremental SG&A should be in the back half of the year, so we can model on a quarterly basis?

Well, much of the increase year over year is Lochinvar, which we didn't have last year; and then China -- we've talked about China. Their incremental SG&A, in order to maintain market share, they are committing a fair amount to advertising, so they have -- much of their SG&A, I'd say, is more variable. So that's primarily the increase; certainly there has been some here in North America, because of the larger volumes that we saw, and we would -- when those volumes go down, there would be some reduction in that. But, primarily, the increase year over year is Lochinvar and China.

Maybe, John, we can go back and sequentially -- the differential in SG&A; can you break it down for us? How that falls into the different buckets? India, China, pension?

I don't have that right here, David. First-quarter SG&A was actually about the same, right? A little bit less?

Right.

And sales were a little bit up. So there's not a huge amount of difference. Lochinvar SG&A is fairly similar to the first quarter, up a little bit. And I think China SG&A also is fairly similar, to up a little bit. And those are the two biggest buckets. Pension is constant, quarter to quarter, so that really didn't have an effect.

Do we start to see more leverage in SG&A in 2013? Or can we possibly see some of that by the fourth quarter?

Well, I think, year to date, our SG&A percent is about 22.5%, I think, when you do in the math. And I think we're expecting to be at that run rate for the end of the year; pretty close to that. And, again, as we talked about, we're not leveraging the SG&A as much because of our commitment in China; the investment we continue to make to maintain the brand, et cetera.

And as Paul and Ajita have said, we could certainly leverage that if we wanted to. But it would be at risk of losing market share and brand. And we're not willing to do that at this point in time.

Okay, that's fair. And then the last question, more housekeeping than anything else -- on the call, on your prepared remarks, you had indicated that Lochinvar had $55 million in sales. And the press release said North America was $52.7 million, so the difference there is China?

No, it's England. It's UK. We have a small operation in UK, which annualized sales of about $8 million to $10 million. That's the difference.

Okay, that's helpful. And do you have a number for us for last year for Lochinvar?

No.

We acquired the company August 26, so --

I know. I was just trying to get year over year.

No, really, the only numbers (multiple speakers) we've said publicly is we expect them by the end of the year, year-over-year, to be at 10-plus percent, and that's really the number we talked about.

(multiple speakers) They are growing double digits, and have been.

Okay. Great. And the margin profile on Lochinvar, would you have any sense of what it was, year-over-year increase?

I don't have those numbers, mainly because you've got a fair amount of noise in there. You have so much amortization of customer lists, but we've also experienced the synergies. But my guess would be the margins are as good or better; and much better when you take out the customer lists and that sort of noise that's in there, from an accounting standpoint.

Okay. Great. Thank you very much. And I guess we'll see margins improve in the second half, as you indicated -- for Lochinvar.

For Lochinvar, yes.

Right. Okay. Thank you very much, great quarter.

Todd Vencil, Sterne.

Hey, good morning. Following up on that last comment -- so you said, you we expect Lochinvar sales to grow over 10% this year. Given that we don't have the comp for the first half, are you looking for a 10%-plus growth rate in the back half of the year? Is that fair to assume?

Yes.

Okay, good, good. And then, how can we think about the magnitude of the impact? You mentioned, obviously, that margins go up. Is there any way to help us think about the magnitude of how much more margins can come from the additional sales?

We really haven't spoken about that. I think the margins are 20%. And we certainly think it would be a nice increase over that 20%, driven by their incremental volume, assuming that we have every expectation that will take place.

Got it. Got it. Thanks for that. And then, you sort of touched on this, but if we look at what's going on in housing, we had another good housing starts number today. If you think about non-residential construction, that's been going well, although the API is pointing to a bit of slowdown there. But have you started to get comments or see signs that you are going to -- I realize you have a lag -- but are you seeing signs that you're going to potentially see better flowthrough in the US there, on the construction side?

Only from the things you're seeing; when you talk about housing starts, remember what drives our business is housing completions. Because the water heater is one of the last things installed. We're seeing the same things you are -- we've seen some decent -- better than we've seen. I think I'm still shocked that housing starts are under 1 million. But the fact is, they are, and we have adjusted our business and are slowly expanding our margins, even with the lower volumes. But any time there's good news on the housing starts front, we know that, from a few months from now, we're going to see a benefit from it.

Okay, so good general indicators, but nothing flowing through in the commentaries from your customers yet?

No. No, it's too early for them to start jumping up and down and getting excited.

Okay, thanks a lot.

Samuel Eisner, William Blair.

Thanks very much. Just a couple of cleanup items here -- regarding China, the commentary that the growth rates are slowing from 18% in the first half and going down to the low teens, is that low teens number really just new store openings? And if that's the case, how is the commentary from Guomei and Suning? If they are each adding 200 stores, has that changed recently with the profit warnings that those companies have been giving?

It's largely new stores opening. It's hard for us to say what percent of it is what. But the biggest piece of the growth is new store openings right now, because the economy has slowed in China.

And in your planning process, has there been any deviation -- if you were saying that the store openings were about a quarter Guomei; a quarter Suning; a quarter A. O. Smith; and a quarter of other stores, has that mix changed at all in the last, maybe, 3 to 6 months?

No. Sam, this is Ajita. No, it really hasn't changed. If anything has changed in that equation, it's that everyone has taken the opportunity to shut down the less productive stores, or the unproductive stores, at a little faster rate. So the net increase is maybe a little smaller, but it's going to be a more productive group of stores. And we see that as a positive sign.

Okay. And then in the Rest of World segment, obviously, I don't think we've really talked about water treatment. But you lost about $10 million in that business last year on the EBIT line. What is that business doing right now in terms of revenue and profitability? And is that -- is that contributing to the margin degradation year on year?

Yes, it is. It's still losing money at the operating margin line. But we're still committed to it, and remain convinced of the strategy. The A. O. Smith-branded product continues to do better than we thought it would. And we're just moving forward. But when the year is over, it will still have a negative margin for this year, but we're excited about it for the long term.

Their sales and earnings performance is better than what it was last year, so it's improving. But, as Paul said, it will still be a drain this year.

All right. And then, on India -- I realize a lot of that investment is, as you said, advertising and building up the brand. Is there a way to quantify what that losses were in that business? I know you mentioned that it should be about a $6 million hit. Is that a topline number or is that an EBIT number?

That's the rupee devaluation. (technical difficulty) -- topline, but obviously when we translate earnings, it will hit there. India is going to be near breakeven this year, maybe a slight loss. We're not -- it's not something that we are that -- we're still committed to it; we're doing the factory expansion. We're bringing new products to market, and we're very excited about what's going on there.

Okay, great. Thanks very much.

(Operator Instructions). Matt Summerville, KeyBanc.

You may have just answered, and I don't know how to get out of queue, but I'll just make sure -- the $6 million hit in India, that is topline that is forecast for the entire year? That is not a second-quarter number, correct?

That's a rupee devaluation estimate for 2012.

(multiple speakers) I'm sorry if I cut you off, John.

It is top line. And we have talked about having sales in the $30 million range, a little over $30 million in India. But due to this devaluation, we would now be talking closer to probably $25 million; so that's $5 million, $6 million top line that we're talking about. And that's primarily second-half-of-the-year affected.

And how much of that $6 million drops to operating profit?

Well, they certainly have margins in the 20%, 25%, at least. So that would be the portion that would drop to the bottom line.

So it's a couple sent headwind, it's not gigantic? Okay.

We are breakeven; it doesn't matter what the rupee is.

That's a fair point. All right, guys. That's all I needed, thank you.

And there are no other questions at this time. Please continue.

Okay. Thanks, everybody, for your time and attention. We're going to go back to work.

Ladies and gentlemen, that does conclude our conference for today. Thank you for using the AT&T executive teleconference service. You may now disconnect.