A O Smith Corp (AOS) 2013 Q4 法說會逐字稿

Good day, ladies and gentlemen. Welcome to your A. O. Smith Corporation fourth-quarter 2013 earnings conference call.

(Operator Instructions)

As a reminder this conference call is being recorded. At this time I would like to hand the conference over to Ms. Patricia Ackerman, Vice President Investor Relations and Treasurer. Ma'am you may begin.

Thank you. Good morning, ladies and gentlemen. Thank you for joining us on our fourth-quarter and full-year 2013 conference call. With me, participating in the call, are Ajita Rajendra, Chief Executive Officer; and John Kita, Chief Financial Officer.

Before begin with Ajita'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.

In order to provide improved transparency into the operating results of our Business, we are providing non-GAAP measures, which are adjusted earnings, adjusted EPS and adjusted segment operating earnings that exclude certain items as well as non-operating pension costs, consisting of interest costs, expected return on plan assets, amortization of actuarial gains and losses and curtailments. Prior-year results are provided on a comparable basis.

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

Thank you, Pat. Good morning, ladies and gentlemen. 2013 was an excellent year for A. O. Smith. We continue to see the benefits in our performance from the housing recovery in the US and our expanding consumer business in China and outstanding execution by our operations worldwide. Here are a few highlights.

Our organic growth drove sales 11% higher to a record $2.2 billion. Sales of A. O. Smith branded products in China exceeded our expectations and increased 26% compared with 2012. Our adjusted earnings from continuing operations of $2.06 per share set a record and were 32% higher than the $1.56 per share recorded last year.

Incremental margins associated with higher volumes of water heaters and boilers drove earnings higher. We celebrated the grand opening of our second water heater factory in China. This factory will increase capacity in the region by 50% when it is fully utilized. We moved production of our fast-growing gas tankless products and added an electric water heater production line to the new factory late in the third quarter.

In April, we announced a 20% dividend increase and a 2-for-1 stock split. In addition, this morning, we announced a 25% dividend increase, and this reflects our confidence in our Business.

John will now describe our results in more detail.

Thank you, Ajita. Sales for the full year of $2.2 billion were 11% higher than the previous year, driven by higher volumes of water heaters and boilers in the US and higher sales of A. O. Smith branded products in China. Adjusted earnings from continuing operations of the $191.2 million improved 32% from 2012. In 2013 we transferred our residential water heater production from our Fergus, Ontario plants to other North American facilities. As a result of the capacity rationalization, we incurred a pretax restructuring and impairment charge of $22 million in 2013.

Adjusted earnings from continuing operations in 2013 excluded after-tax, non-operating pension costs of $11.9 million, an after-tax gain of $6.8 million related to a settlement with a supplier, and then after-tax restructuring and impairment expenses of $16.4 million. Adjusted earnings from continuing operations in 2012 excluded after-tax pension costs of $4.2 million, an after-tax gain of $16.8 million on the sale of Regal Beloit stock acquired as a result of selling our motor business, an after-tax gain of $2.9 million related to a settlement with the supplier, and an after-tax gain on approximately $2 million related to an earn-out associated with an acquisition.

Adjusted earnings of $2.06 per share improved 32% compared with $1.56 per share last year. A reconciliation from GAAP EPS to adjusted EPS is included at the end of this presentation and covers the previously discussed adjustments.

Sales in our North America segment of $1.5 billion increased 6% over last year, driven by higher sales of residential and commercial water heaters and boilers in the US. Rest of world segment sales of $668 million increased 23% compared with last year, driven by increased demand for water heaters and water treatment products in China and market acceptance of our newer, higher value A. O. Smith branded products in China. We continue to innovate our product lines with features and benefits which provide value to our customers and differentiate our brand.

We introduced our eighth upgrade to our electric water heater offering in early 2013, and the products have been very well received. Other innovations launched in late 2012 that contributed a full-year benefit in 2013 include an ultra-quiet gas tankless water heater product line and water treatment products which have longer lasting filters and waste less water. The return on investment in engineering and innovation is one of our key success factors in China.

North America adjusted operating earnings of $238 million were 21% higher than last year, an adjusted operating margin of 15.6% improved almost 2 percentage points. Higher incremental margins associated with increased volumes of water heaters and boilers in the US and lower material costs were the primary drivers of the significant margin expansion. Rest of world adjusted operating earnings of $88 million improved almost 50% compared with last year.

Higher sales and improved mix of A. O. Smith branded products in China and smaller losses in our non A. O. Smith branded water treatment business drove operating earnings higher. This was partially offset by larger losses in India due to higher costs for new product introductions and brand building in the region as well as currency devaluation.

Segment operating margins of 13.2% improved significantly compared with last year. Our adjusted corporate expenses were $53 million, an increase from the prior year, primarily due to lower interest income as well as higher expenses related to management incentive programs and acquisition due diligence.

Sales for the fourth quarter, up $559 million, were 7% higher than the previous year, driven by higher volumes of boilers in the US and higher sales of A. O. Smith branded products in China. Adjusted earnings from continuing operations of $48 million improved 11% from 2012 as a result of higher profits in North America and a lower tax rate compared with last year.

Adjusted earnings from continuing operations in 2013 excluded after-tax non-operating pension costs of $2.9 million and after-tax restructuring and impairment expenses of $2.7 million. Adjusted earnings from continuing operations in 2012 excluded after-tax pension cost of $1 million, an after-tax gain related to a settlement with a supplier, and an after-tax expense of approximately $1.9 million related to the Lochinvar earn-out.

Adjusted earnings of $0.52 per share improved 13% compared with $0.46 per share last year. A reconciliation from GAAP EPS to adjusted EPS is included at the end of this presentation and covers the previously discussed adjustments.

Sales in our North America segment of $382 million were $6 million higher than last year primarily due to an increase in sales of Lochinvar branded products. Fourth quarter residential water heater volumes were essentially flat compared with last year, as demand was favorably impacted by Superstorm Sandy in the fourth quarter of 2012. Rest of world segment sales of $185 million increased 18% compared with last year, driven by increased demand for water heaters and water treatment products in China.

North America adjusted operating earnings of $59 million were 5% higher than last year, and adjusted operating margin of 15.4% improved as well. Higher sales of Lochinvar branded products were the primary driver of the increase in profits and the margin expansion.

Rest of world adjusted operating earnings of $20 million was the same as last year, primarily driven by higher sales in China, which were offset by larger promotion and advertising spending in the region and higher depreciation costs related to the opening of a second manufacturing plant. Despite these additional costs, operating margins in China were in the mid teens, up lower than one year ago. As a result operating margins for the segment fell to 11% from 13%. Recall that our non-branded water treatment business in India are not yet profitable.

Our adjusted corporate expenses were $13 million, slightly higher than last year due to less interest income earned in the current quarter compared to last year. Cash provided by continuing operations was $282 million in 2013 compared with $172 million last year, primarily driven by higher earnings from operations and significantly a lower outlays for working capital.

During the year we repurchased approximately 1.77 million shares of common stock at an average cost of $41.62 per share, or almost $75 million, under a 10b5-1 automatic trading plan and in the open market. At the end of the year, we had approximately 1.2 million shares remaining on our existing repurchase authority from our Board.

Our liquidity position and balance sheet remains strong. Our debt-to-capital ratio was 13% at the end of December. We have sizable cash balances located offshore, and our net cash position was almost $300 million at the end of the year.

We expect our cash flow from operations in 2014 to be between $235 million and $245 million and lower than last year. Even though we expect earning to improve in 2014, we are expecting higher outlays for working capital in 2014 than in 2013. Our capital expenditures in 2013 were $98 million, which included approximately $45 million for capacity expansion in China and India to meet growing demand for our water heaters in those regions as well as the approximately $19 million related to our ERP implementation.

We expect capital expenditures to be approximately $75 million to $85 million in 2014, which includes approximately $20 million to support the ERP implementation. Our depreciation and amortization expense is expected to be approximately $65 million in 2014 compared with $60 million in 2013.

We estimate our effective tax rate to be between 30% and 31% in 2014 and higher than in 2013. Our effective tax rate of 28% percent in 2013 was unusually low primarily due to a tax benefits associated with manufacturing and research and development activities. A portion of the 2013 tax benefit related to the 2012 tax year. Our effective tax rate in 2014 will not benefit from the research and development tax credit, as they have not been extended beyond their 2013 expiration date.

Excluding the impact from the non-operating pension costs, our corporate another expenses are expected to be lower in 2014, at about $49 million. The impact from shorter amortization periods for management stock-based compensation is expected to incur in the first quarter of 2014 and result in estimated corporate expense for the quarter of approximately $14 billion.

This morning we announced our adjusted earnings guidance of $2.15 to $2.30 per share. The midpoint of our adjusted EPS guidance represents a 10% increase in pretax earnings and an 8% increase in after-tax earnings compared with our 2013 results.

Nonoperating pension costs are expected to be $0.14 per share in 2014, slightly above the $0.13 per share in 2013. Recall that in 2015 our pension plan will sunset for almost all beneficiaries. We expect this to result in a considerable reduction to our pension costs for 2015.

Our GAAP EPS guidance is $2.01 to $2.16 per share. Our adjusted EPS and our GAAP EPS guidance does not include the impact from future acquisitions.

I will now turn the call back to Ajita, who will summarize the assumptions in our 2014 Outlook, update our 2015 aspirations and reiterate our acquisition's plan.

Thank you, John. This year we celebrate our 140th anniversary. We think our founder, CJ Smith, would be very proud of the people, values and performance that embody our Company today.

Our outlook for 2014 includes the following assumptions. First, we see strong growth in China, which is expected to increase at a rate of two times that country's GDP. The team continues to serve our customers and introduce products that enhance our premium brand.

In 2013, we consolidated the management of water heating and water treatment in China under one management team. We made significant progress in sales growth as the team achieved over $65 million of sales of water treatment products in 2013 compared with the approximately $40 million in 2012. The business achieved a breakeven in 2013, excluding acquisition related amortization costs. Going forward, we will no longer separately call out A. O. Smith branded products sales from our non-branded products in China.

Second, we expect our Lochinvar brand to continue to benefit from the transition from lower-efficiency, non-condensing boilers to higher-efficiency condensing boilers as well as strong market acceptance of new products like our Lochinvar Crest condensing boiler line. Lochinvar branded condensing boilers continue to offer a compelling payback in the form of energy savings, and we have built a reputation for innovation, outstanding product quality and support. As a result, we expect Lochinvar branded sales to grow approximately 10% in 2014 well ahead of GDP growth in the US.

Third, we are cautiously optimistic about the developing recovery in US housing. After a strong industrial growth in 2013, helped by improved levels of form completions and significant expansion of the replacement market, we expect residential water heater volumes in the US to be up slightly to be between 8.8 million and 8.9 million units, including tankless units. We expect commercial water heater volumes to be essentially flat at 160,000 units.

Fourth, as we have discussed in the past, 2014 will be negatively impacted by higher costs associated with the new factory in China and approximately $10 million of higher ERP implementation costs. In addition, we expect our effective tax rate will be higher in 2014 than it was in 2013.

Fifth, our brand acceptance in India gained momentum in 2013 resulting in market share improvement to over 14%, and our retail footprint expanded to approximately 4,000 outlets. However, the unforeseen continued weakness in the Indian economy and the significant devaluation of the Indian rupee resulted in sales in 2013 of approximately $20 million, or at about the same level as 2012, despite sales in local currency increasing by 11%.

We remain optimistic regarding the Indian market, and we are committed to the country with the second largest population in the world, its developing middle class, and it's growing desire for quality-of-life products. In 2014, we will complete an expansion of our Bangalore facility, which will extend the range of water heaters produced locally and mitigate currency fluctuations which have challenged the business.

The expansion will also serve as a platform to launch residential water treatment products in India this year. We reviewed a number of entry strategies and decided initially to develop and market our own products. We will continue to review options that can add value to our customers and shareholders. We expect the entry into the water treatment category and continued investment in brand building activities to offset the expected performance improvement in our water heater business resulting in losses in 2014 of approximately $5 million or at about the same level as 2013.

Strong performance in our North American segment in 2013 prompted us to update our 2015 aspirations for our organic business. Based on our expectations for EBIT margins driven by new construction and 10% revenue growth of Lochinvar branded products through 2015, we are revising our North American segment margin expectation to 16% from the previously reported 15.5%. Our rest of world segment margin expectation continues to be 13% by 2015 reflecting a continuation of our brand building investments in that region.

We expect organic sales will grow on average 8% per year through 2015 resulting in revenues of over $2.5 billion. Our earnings aspirations for our existing portfolio of businesses are now expected to be approximately $2.50 per share by 2015 versus the previously disclosed $2.25 per share.

This continues to be an exciting and transformative time for our Company. We have cash and borrowing capacity for additional acquisitions. Our pipeline of acquisitions supporting our stated growth strategy to expand our global footprint in water heating and water treatment solutions remains active.

You have seen this slide before, we show it only as a reminder that we will continue to be a financially disciplined acquirer of companies that fit our stated corporate strategy. You should know that while we came close to completing a handful of acquisitions over the past 12 to 18 months, we walked away for various reasons. In the end, we held fast to our financial criteria and our focus on creating returns to our shareholders.

This concludes our prepared remarks, and now we are open for your questions.

(Operator Instructions)

Charley Brady, BMO Capital Markets.

I just want to talk about the rest of world margin, in particular China, who's down this quarter, and the aspirations to get up to 13%. Was it impacted this quarter, or to what degree was it impacted by the promo spending, and if some inefficiencies in starting up that new plant? Do those -- do you get rid of those the inefficiencies in the promo spending as we move to 2014 to [galf] the margin up?

You hit on a couple of the items. One was certainly the advertising. We mentioned in the third quarter that it was artificially low because we were transferring ad agencies for our national television advertising. That moved approximately $1.5 million to $2 million; the fourth quarter was overstated compared to -- because it was up to $4 million compared to the third quarter.

The second is the plant. We've consistently said that it will have an impact and we said it will be less than 1% of EBIT. That is in the $5 million to $6 million range. We still expect that to be the case. A little higher in the fourth quarter, mainly because of what you alluded to, some start up et cetera. So, it was a little less than $2 million was the effect on the quarter.

Then, there was also some one-time items associated with adjustments for warranty et cetera. We are very comfortable with what China's margins were for the quarter and certainly for the year. They were up significantly for the year. The only impact we see going forward is the plant.

As we have talked about, if we hadn't built that plant in the fourth quarter, we couldn't have produced, because of the significant increase in demand we experienced this year. Long term, it was clearly the right decision. Short term it will have some impact.

Okay. Just so I'm clear, the fourth-quarter impact on the plant of a little less than $2 million, that is not repeated going forward? It is just a fourth quarter hit. Is that correct?

It won't be that high going forward, but on an ongoing basis it will be $5 million to $6 million a year. So, about $1 million to $1.5 million a quarter. That's primarily just higher depreciation and some overhead. If we look into 2014, I think rest of world margins were a little over $13 million. They will probably be under little under $13 million in 2014.

Great. Thanks a lot.

Matt Summerville, KeyBanc.

This is Joe Radigan on for Matt. Shifting to North America incremental margins, they have been better than expected all year. Obviously, the mix of the strong commercial units you have seen as well as Lochinvar a factor there. Generally, how should we think about the right operating leverage on the revenue growth going forward considering some of the improvements you have made in the factories?

Without a doubt, what has helped us significantly in 2013 is increased volume. The residential industry, we're guessing was up almost 600,000 units. The commercial industry, we are guessing, was up 9,000 units to 10,000 units. We have said all along that when we get that incremental volume it is going to certainly benefit us.

When we look into 2014, we said we would expect to see some improvements from the restructuring. We said about $5 million. We got about $5 million in 2013. We said the total will be about $10 million, so incremental we'll get about $5 million.

We certainly, as we look into 2014, we'll have incremental volume, which again will contribute nicely, but will be offset partially by the higher SAP costs. In addition, when we look at steal costs, when we look at the average of the current price of the index compared to the average of the index in 2013, steal costs are up about 8%. That will have an impact.

All in all, we wouldn't expect much different in the operating margin of North America, year over year, when you are all said and done. I should mention, Lochinvar grew over 10% and had a very nice margin increase and is doing extremely well.

Okay. You said industry-wide, residential units are up about 600,000 in your estimation. That is significantly more than the delta in housing completions this year. So, obviously, and you have talked about the residential replacement market growing.

When you would look at your guidance for 2014, what is the home completion number you are using? I guess what I'm getting at, are you factoring in continued growth in that replacement market, or is it is based just on what you think new housing is going to do in 2014?

It is basically the latter. You are right, the 600,000 was much higher than what we had expected. That comes up with about a 400,000 plus growth in the replacement market in 2013. We have talked about the possibility, as you have the alluded to, that happening. Because if you look at our industry in the late 1990s to 2000s, it grew significantly with the new housing build and average water heater last 12 years.

We have said that was a possibility. I don't know if that is the biggest impact this year, but obviously we were surprised by the growth. We're guessing the industry was about 8.7 million units for 2013. We're forecasting a.8.8 million to 8.9 million, which would represent that the replacement business stays strong but does not grow, and that completions are in that 150,000 range.

Thanks, John. If I could just get one more in on China? Revenue was up almost 20% in Q4 despite a tough comp. I think you benefited last year from -- at least a from somewhat of a pre-buy ahead of volume related incentives.

Was there anything in there this quarter that pulled demand forward? Maybe a little color? Because I think that was stronger, I mean it increased sequentially. I think it was stronger than what you are looking for out of China, maybe some color on what you're seeing there demand-wise?

It definitely was. We had a stronger quarter revenue-wise than we thought. When we look at our major customers' inventory, they aren't up significantly compared to what they have been. I think it just attributes to what they have accomplished with the new products they brought out. We alluded to in the script, we had three significant new product introductions that we got a full-year benefit in 2013, and all of them were very successful.

Okay. Thanks, John.

William Bremer, Maxim Group.

Can we --? Let me understand the operating margins in rest of world again. We get a $2 million hit from the new factory, roughly. That's going to be, going forward, about $5 million to $6 million throughout 2014. When do you expect that to cease?

I think as you get more volume and as totals gradually go down as we progress over the next 2 to 3 years. Clearly, you're starting up a new plant with $5 million or so incremental depreciation just by itself that now has to be absorbed.

How is pricing there? How is pricing in China?

Pricing has held up very well in China. We had announced increases in 2011 and 2012. Then, I think what we have been able to accomplish is bring out higher-value products with a higher price point, which gives a higher average price.

Again, to repeat myself, we are very comfortable with the mid teens margins that were experienced in China. For the year they are up year over year, and they had extremely good year.

I think, Bill, just to add to that -- this is Ajita. The whole formula and business strategy in China just continues to work very well. There is a combination of things that help us there. We have a strong management team. We have a very strong brand, and we continue to invest behind the brand.

That is why you saw the added SG&A expenses in the fourth quarter, because we were a little light in the third quarter. You saw the margins higher in the third quarter because of that. We went back and invested heavily in the fourth quarter because we really believe that continued investment behind the brand is an essential ingredient in the success that we have in China. We will continue to do that.

The new products have been, as John mentioned, have been very successful. We have a tremendous pipeline of new products that we have been bringing out. That has really helped us continue to grow our market share.

We grew our market share in both the water heating business and the water treatment business in China. It is all of these things together that have helped us considerably outgrow the market in China. What we did with the new factory is, in anticipation of continued growth, the new factory increases capacity by our capability and capacity by about 50%.

Obviously, it won't be full day one, but we do have the full load of depreciation day one. As we fill that factory, we are going to be absorbing those costs and it's going to become a non factor as we go a long. The lines that we have moved in there, some of the lines, the electric line for example, has also shows considerable productivity improvements because we have been able to laid out efficiently.

The tankless line is about the same because that is essentially an assembly operations, so there isn't quite the opportunity for productivity improvement. New factory gives us productivity improvements and additional capacity for growth in the future. All of it put together is what helped us grow at 20% plus last year.

That's switch to Lochinvar. Nice quarter. Can you speak a little about the aftermarket there and how that's increased? John mentioned margins up materially year over year. Have we rolled it out aboard, or are we making introductions there? What is the status there?

The aftermarket, I do not have the specific numbers, but clearly the fourth quarter is traditionally their strongest in the aftermarket. I would expect that is the case. Their margins, as I said, year over year we published last year. We separated out Lochinvar. I think they're operating margins were about 23% last year. Those improved nicely in 2013. They're doing extremely well.

The rollout in China is taking longer than expected and the primary factor there is getting the approvals et cetera. We will be introducing the residential side, I think early this year. The real benefit, ultimately, will probably be on the commercial side, which is taking longer than expected.

Why is that?

The primary reason is just getting the licenses. The licenses have some requirements of suppliers, et cetera, that we are not able to get at this time.

Okay. Thank you, gentlemen.

Scott Graham, Jefferies.

I would like to get underneath two things, the North American resi water volume assumptions and the M&A outlook. On the water heater market, is it fair to say that tankless is still about 4% to 5%, which represents 400 --?

It's roughly 400,000 units.

How many? 400,000?

400,000 units. Yes.

That would suggest that you're, if we were to take that number out of your assumption here, that you're expecting the storage market itself to increase essentially 2.5%?

The midpoint would be about 150,000 to 175,000 units, which would be complete.

Whereas residential construction spending is running double digit and is now apparently starting to move into kitchen and bath areas. I am just trying to get to -- there is this piece that we have always talked about, there is the replacement market. There is the new, and then there is the discretionary. It seems as if within this assumption the discretionary has been assumed to be zero?

What we do not know, Scott, -- you are right. All we're building in is completions. What we do not know is the replacement/discretionary, whatever you want to call it, grew over 400,000 units in 2013. What we are assuming is that is going to stay the same, that is going to hold and stay the same.

We could be surprised on the upside, if there is that continued growth. But that was a significant increase year over year. We talked about it, that we expect to have some growth in the replacement because of what I alluded to earlier. It grew by 450,000 units probably in 2013. We are assuming that is going to hold. The upside would be that grows.

Okay. Is there any reason why you think that your competitors last week, at the AHRI show, are both same 5% or better? Do you think that they think that they are going to take share, or again is it just that you are not considering the discretionary?

I would say the it's the latter. All we can be pretty comfortable with is the completions are going to continue to grow and that is what we have built into our estimates.

Fair enough. On the M&A side, obviously it's been quite some time and we have passed on a number of transactions, which I would probably have of course of agreement that that's a good thing. At the same time, you guys have been hitting the pavement now for awhile. Can you size, in any way you can, what you're comfortable with?

The funnel, is it we're looking at several large multiple small? I guess I would have thought at least a couple of smaller ones would have closed by now. Or, are you not looking at smaller ones? Could you maybe size that for us?

Scott, this is Ajita. Let me put it this way. We are satisfied with what we have in terms of the opportunities we are looking at. With the large or small, don't really matter as long as it is strategically relevant and strategically fits.

Like I have consistently said, we're going to be very disciplined about this process. We want to make sure that we are in that small minority of acquisitions that actually add value to the buyer in addition to adding value to the seller. We are being disciplined about our process, happy with the opportunities ahead of us and nothing has really hit like we have said.

We have gone to the due diligence stage a number of times, but pulled back because it didn't quite fit or we found something, due diligence did its job and we found things that we didn't like and we were not happy with.

The only additional comment I would make, Scott, is to your size of it. I think we have passed on some smaller ones that just won't have an impact because in a lot of ways it's as time-consuming to integrate a small one as a big one. We are not actively looking at the $10 million to $15 million ones. I'll say that doesn't mean we won't do it.

The only other comment I want to make as a good example is India. We have talked about our entry into water treatment there. We had looked seriously at opportunities there. We were just very uncomfortable with the valuations that would have had to have been paid.

I believe starting out, greenfield, may have more of a hit to the P&L than if we had made an acquisition, but we think long term it's going to provide rewards to our shareholders because the all-in cost will be less. When we look at acquisitions, we are looking at it compared to greenfield all the time.

Understood. I'm a little bit surprised to hear your comment that you are really not looking at smaller ones. I don't know what you mean by smaller, but I guess that surprises me a little bit because it would give a deployment of capital into bringing some balance sheet earnings onto the P&L so to speak.

The example I used was $10 million to $15 million.

Okay, fair. Here is my last question on this. At what point does the lack of acquisitions start to have the Company rethink, a little bit more aggressively, share repurchasing? I don't say that in a balance, you guys, the balance sheet is so liquid, it doesn't have to be all or none. It can be a balance.

When would you expect to maybe rethink where you are on share repurchases, not just what you have on the current authorization remaining, but perhaps something a little bit more balanced with what has been a little bit of a shortfall in M&A activity?

I think we clearly have thought about it. We purchased back stock of $75 billion worth in 2013. We purchase stock back in 2012. We have said there is more capital allocation options for us. One is organic growth. We are investing in India. We're investing in China. We're investing domestically.

The second is M&A, which we actively look at. The third and fourth are returning cash to shareholders. We have had our third consecutive 20% plus increase in dividends, and we bought back stock. I think buying back stock will still be one of the four that we will certainly continue to look at.

Okay. That's really all I had. Thanks a lot.

Samuel Eisner, Goldman Sachs.

When you look at the 26% growth rate in China for this year, can you talk about how that compares to last year, and particular maybe breaking out the difference between pricing and volume or maybe price mix and volume? Just want to understand the components of the growth that you are expecting for 2014 and how to perform in 2013 as well?

I do not have the data. I can make some general statements. Clearly, market share helped and it was the super quiet growth in the instantaneous market that helped. That was a contributor. The average selling price of the super quiet is higher, so we got some average selling price benefit there.

The electric model we talked about, the increase in price was 4% to 5%. When we bought out that new series 8, that was a benefit because it had value-added features. That contributed to higher, average selling price. Quite frankly, the water treatment grew, as Ajita alluded to. The A. O. Smith brand has more than doubled.

It was a combination of higher price, higher unit sales and higher watt ancillary businesses like water treatment, combi boilers, et cetera. All of those contributed to the growth. We also had a distribution growth. We probably went from 5,500 units to about 5,900 units.

Now, when we turn to 2014, when we talk about the 15%, we won't have those year-over-year benefits for those three major product launches that we talked about because we had full-year benefit in 2013. What we will have is we expect to still gain market share in both water treatment and the instantaneous. We will probably grow our distribution outlet some, and more importantly we will grow them larger and close some of the non-efficient ones. The net to growth may not be significant, but the ultimate growth will benefit.

We expect to still have unit growth because the replacement, upgrade market that's happening in China, we think will continue to happen. As we have said, we have grown a lot of different ways in China and we think that will continue.

When you think about the cadence of 2014, maybe going through the different quarters here, obviously, you had some very tough comps in the middle part of the year where your comping against 35% growth rates. Can you maybe just talk a little bit about how you think the year will play out? Do we think that 15% is pretty constant through out the year? Or do you think, obviously with those tough comps, it's going to be much weaker during the middle part of the year?

If you look at China and you look how it proceeds during the year, the first quarter is always the weakest quarter because of the spring holiday, Spring Festival. That is always the weakest quarter. When we look out throughout the year, though, we would still expect the 15% growth, plus or minus a little bit, being pretty consistent across the quarters.

Great. On the new ERP system, I think you called out $10 million or so in the press release, but $15 million on the slide. I'm just trying to understand the difference in the two numbers?

Also, in terms of the payback, what specifically are the investments that you're making in the ERP system? When do expect to receive the payback and the timing for that? Just trying to get some more information behind the ERP system?

The answer to the first one is the total cost in 2014 will be $15 million, but we had about $5 million of expense in 2013. So, the incremental is about $10 million year over year.

When we look at pay backs, this is going to be an ERP system we're putting initially through North America, completely through North America. As we look at the pay backs, the installments will start third quarter this year and carry into 2015. We have done internal IRRs and we expect to pay back this investment, but it really won't start paying back until late 2015 and going forward because that is when the full install will be done.

Great. Lastly on water treatment, particularly in China, is the expectation -- obviously, you broke even this year, but is the expectation that you will be profitable next year in that segment? Just want to understand the year-on-year difference?

We had, as we mentioned, we were breakeven before amortization, and amortization was about $3 million. So, it lost a little less than $3 million on an operating basis. We would expect that to be total break even, i.e. an improvement of $3 million plus.

We continue to invest significantly on the SG&A side. We are in about 2,900 stores for water treatment in China. We expect that to grow by 600 or 700 stores. We are in that period of rapid growth, but we are reinvesting from an SG&A standpoint. As an entity, we expect it to be above break even, even including the amortization next year.

Sam, I think that last point is a key point, because what we are driving the water treatment business in China is not to get to profitability as quickly as possible, but to make sure that we're making the right investments behind the brand and also making the promotions and advertising to make sure that the Chinese consumer knows that we are in this new category. All of that is what helped us grow market share.

Those investments are continuing, and it is all included in the numbers that you're seeing in terms of the profitability of the business. We're continuing to invest for the long term in that business.

Are you expecting another 50% to 60% growth rate in that business from a revenue standpoint?

If we have a business of $65 million of which we said about $45 million is non-branded and say $20 million is the legacy, we would expect the branded to grow by 50% or so. Yes. The $65 million should go to $85 million or so next year.

Great. Thanks so much.

Michael [Porner], [Lorem Ipsum].

My question is from the growth of gas heating in China over the next several years. Specifically, China is on the cusp of a massive migration from centralized coal heating, in many parts of the country, to gas heating, given some of the air pollution. About 90% of heating in China is coal based and gas heating is only about 3%. Most other economies, it's 50% to 70% gas.

My questions to you are the following. Number one, do you see this transition occurring from coal to gas heating in China? If so, how is AOS positioned to benefit? Specifically, do you have products, or what is the product plan to take part in this transition?

Number two, can you help quantify the market size of potential growth? I have seen numbers as much is 1.6 million gas-fired wall hanging furnaces sold in 2013, projected to double by 2016. Would be interested in your view?

We have -- I don't have data on the base heating market. I will say we do have products, we have combi boiler products, which in full space heating and potable hot water. It is a relatively small business, but it basically doubled last year to over $10 million. We have that product for the residential side.

The product we are talking about four Lochinvar would be residential and commercial boilers for space heating purposes, so we have the products there. I think where we very possibly could see some benefits moving off the space heating is we are the market share leader in gas tankless water heating. As the country moves more to gas, we think we are very well positioned from a tankless product standpoint.

I don't have any of the data on the market size. As we have talked, China has some big migrations. They're going to a consumer driven economy, which will certainly help us as they go to gas. We certainly think we are positioned from a product line. I think those are some of the benefits we think that are going to help us continue to grow nicely in China.

Okay. Thank you.

Ted Wheeler, Buckingham Research.

Great results. I wanted to probe a little bit on the aspirational margin in rest of world. I guess I am hearing progress in India, losses improving at water treatment, you have got a big plant where absorption should be rising. These are things that normally drive margins quite a bit higher, and I don't quite get how we get, essentially the guidance is flat margins through 2015. I wonder if you could fill me in on some other aspects?

I think I alluded to it a little bit earlier. I think rest of world margin was a little over 13% in 2013. We expect that to probably be a little under 2013 for 2014, and that is going to be driven primarily by the new plant. We don't expect to see improvement in India because of the investment we are making in the water treatment will offset the investment that we are seeing in the improvement that we are seeing in water heaters. As Ajita has said before, we are going to continue to invest in the business and that investment is in the form of promotion --

I guess I was thinking in 2015 though, these issues -- I would think that the impact of the issues and the improvement in the areas that are dragging the Company, by 2015 should give you some margin lift. I am wondering why you are sticking with that 13% margin for 2015?

As we go under 13% the margin assumption for aspirations assumes we will get back to 13% or above, so we will start seeing some improvement in India. Although, India water treatment will continue to be an investment we are going to make for the long term. It is an advertising driven type business, so we'll continue to invest in SG&A. That is why we say we will be below 13% next year and we expect to be 13% or above the following year.

I guess Lochinvar, there might be some margin headwinds as you enter China? Is that also part of it?

Right.

Thank you.

Thank you, and I am showing no further questions in queue at this time.

Okay. Thank you very much. You, all, have a great day and if you have follow-up questions, you know how to get a hold of us. Thank you.

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