A O Smith Corp (AOS) 2014 Q2 法說會逐字稿

Good day, ladies and gentlemen. Welcome to the A. O. Smith second quarter 2014 earnings conference call. At this time, all participants are in a listen only mode. Later we will conduct a question and answer section and instructions will follow at that time.

(Operator Instructions)

I would now like to introduce you to your host for today's conference, Mrs. Patricia Ackerman. Ma'am, you may begin.

Thank you, Terea. Good morning, ladies and gentlemen. Thank you for joining us on our second quarter 2014 conference call. With me participating in the call are Ajita Rajendra, Chairman and Chief Executive Officer and John Kita, Chief Financial Officer. Before we begin with Ajita's remarks, I would like to remind you that some of the comments that will be made during this conference call 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 this morning (technical difficulty).

In order to provide transparency in the operating results of our business, we are providing non-GAAP measures, including adjusted earnings, adjusted EPS and adjusted segment operating earnings that exclude certain items as well as non-operating interest cost, (technical difficulty) expected return on assets, amortization of actuarial gains and losses and curtailments. Prior year results are provided on a comparable basis. Reconciliations from GAAP measures to non-GAAP measures are provided in the appendix at the end of this presentation and also on our website. Ajita, I will turn the call over you to.

Thank you, Pat. Good morning, ladies and gentlemen. Our strong performance in the second quarter was driven by solid growth and profitability across all our major businesses. Here are a few highlights. Our organic growth drove sales 8% higher to an all-time record of $595 million. China sales were up 17%with gas tankless and water treatment products growing faster than the business as a whole. Our adjusted earnings of $0.66 per share were 27% higher than the $0.52 per share record last year and were primarily driven by higher sales.

We continue to allocate a portion of our capital to returning cash to our shareholders. We repurchased approximately 1.3 million shares for $60.8 million this year through June 30. To allow us to continue to repurchase shares, our board increased its authorization by 1.5 million shares in April. We increased our dividend by 20% or more for the third consecutive year in early 2014. John will now describe our results in more detail.

Thank you, Ajita. Sales for the second quarter of $595.4 million were 8% higher than the previous year driven by higher volumes in water heaters and boilers in the US and water heaters and water treatment products in China. Adjusted earnings of $60.3 million improved 25% from 2013. Adjusted earnings in 2014 excluded after tax non-operating pension costs of $3 million.

Adjusted earnings in 2013 excluded after tax non-operating pension costs of $3 million and after tax restructuring and impairment expenses of $3.1 million. Adjusted earnings of $0.66 per share improved 27% compared with $0.52 per share last year. The effective income tax rate associated with second quarter adjusted earnings in 2014 of 27.8% compared with 31.5% for the same period last year.

The rate this year was approximately 1 percentage point lower than the rate we previously disclosed, providing a $0.01 per share benefit to second quarter 2014 adjusted earnings per share. We expect the effective income tax rate for 2014 adjusted earnings will be between 28% and 29% with the GAAP effective income tax rate almost one percentage point lower. A reconciliation from GAAP EPS to adjusted EPS is included at the end of this presentation and covers the previously discussed adjustment.

Sales in our North America segment of $410.1 million increased 5% over last year, driven by higher sales of US water heaters and Lochinvar branded products. Rest of world segment sales of $193.6 million increased 14% compared with last year. Sales in China increased 17% driven by increased demand for water heaters and water treatment products and expansion of our distribution outlets in China.

North America adjusted operating earnings of $67.1 million were 7% higher than last year and adjusted operating margin of 16.4% was up slightly. The favorable impact from higher volumes in the US were partially offset by higher steel prices. As a result of higher steel prices and other cost inflation, we announced a mid-single digit price increase in North America which was effective May 1.

Rest of world operating earnings of $29.3 million improved 30% compared with last year. Higher sales in China, lower selling and advertising costs as a percentage of sales compared with one year ago and improved profitability of water treatment products contributed to the improved operating earnings in the second quarter. As a result, operating margin improved significantly over last year to 15.1%.

Our adjusted corporate expenses were $11.5 million, a decline from the prior year primarily due to significant M&A due diligence costs incurred in the second quarter last year. Cash provided by operations of $90 million through June 2014 was lower than the $105 million provided last year as a result of higher outlays for working capital in the 2014 period. We are expecting operating cash flow for the full year 2014 to be between $240 million and $250 million.

Our liquidity position and balance sheet remains strong. Our debt-to-capital ratio was 16% at the end of June 2014. We have sizable cash balances totaling nearly $500 million located off shore and our net cash position was almost $250 million, both as of June 30, 2014. During the first half of 2014, we repurchased approximately 1.3 million shares of common stock for a total of $60.8 million under a 10b5-1 automatic trading plan.

Considering the additional 1.5 million shares authorized in April by our board, we had approximately 1.4 million shares remaining on our existing repurchase authority at the end of June. Depending on factors such as stock price, working capital requirements and alternative investment opportunities, we expect to repurchase approximately one million of the remaining authorized shares in 2014 spending approximately $110 million for the year. As a result of the share repurchase activity, we expect to end the year with approximately $300 million in net cash, similar to the level at the end of last year.

This morning we announced an increase to our adjusted earnings guidance of $2.34 to $2.40 per share. The mid point of our adjusted EPS guidance represents a 15% increase in after tax earnings compared with our 2013 results. Non-operating pension costs are expected to be $0.14 per share in 2014, slightly above the $0.13 per share in 2013. Recall that our pension plan will sunset in early 2015 for almost all beneficiaries.

We expect this to result in a considerable reduction to our pension costs for 2015 and beyond. Our GAAP EPS guidance for 2014 is $2.20 to $2.26 per share. I will now turn the call back to Ajita who will summarize the assumptions in our 2014 and 2015 outlook and reiterate our acquisitions strategy.

Thank you, John. As John mentioned, the mid point of our updated 2014 guidance implies growth of 15% in adjusted earnings per share over the last year. Our outlook for 2014 includes the following assumptions. First, we continue to see strong growth in China. As many of you know, we are a consumer product business in that region and have invested significantly in brand building, innovation, safety and quality to sustain and enhance our position as the leading premium water heater brand.

The return on our investment in engineering and innovation is one of our key success factors in China along with distribution expansion and market share growth. The macro environment also provides three strong tailwinds for our business.

First, our premium consumer product with a highly recognizable brand are in the sweet spot of the government's desire to grow the consumption part of China's economy.

Second, inflation has been increasing recently and this aids the expansion of discretionary income and growth in the middle class. And third, China recently set a goal for the population to be 60% urban by 2020. This equates to 10 million to 15 million people per year moving to the cities and thereby increasing the demand for apartment and water heaters. Combining all of these factors gives us confidence that we will grow at least at two times China's GDP rate.

Please note that we expect higher advertising expenses in China in the third and fourth quarter due to a catch up in ad spending from lower spending in the second quarter and seasonal advertising and promotional spending in the second half of the year. As a result, we expect second half operating margins in rest of world to be lower than the first half operating margins.

Second major assumption: significant market acceptance of our water treatment products has supported our growth in China.

Chinese consumers are becoming much more aware of the health risks associated with poor water quality and our trusted A. O. Smith brand of reverse osmosis water treatment products fill the need. With less than four years selling these products in China, the A. O. Smith water treatment brand has achieved almost 20% market share in the organized retail channel. We added over 500 retail outlets to our water treatment distribution channel in 2014 resulting in approximately 3,400 outlets now selling our product.

Studies we have seen estimate 40% annual growth for water treatment products in China over the next five years. We continue to invest in innovation and technology to serve this vast growing product category and expect our A. O. Smith branded water treatment products to grow more than 50% this year resulting in almost $100 million in water treatment sales in China and Turkey. Our success in water treatment is a classic example of what brand, distribution and innovation driven new products can achieve in China.

Third major assumption: we expect Lochinvar branded sales to grow approximately 10% in 2014, well ahead of GDP growth in the US as our Lochinvar brand is expected to continue to benefit from the transition from lower efficiency, non-condensing boilers to higher efficiency, condensing boilers. Additionally, we have received very positive feedback from the market associated with our recently announced FTXL boiler. The FTXL will launch later in the third quarter and we believe this new product could shift some sales from the third quarter to the fourth quarter.

Fourth, we are cautiously optimistic about the developing recovery in US housing. After very strong water heater industry growth in 2013, helped by improved levels of home completions and significant expansion of the replacement market, we expect residential water heater volumes in the US to be up to approximately nine million units, including tankless due to an increase in new home construction and expansion of the replacement market this year. We expect commercial water heater volumes to increase to approximately 162,000 units.

Fifth, we implemented a mid single digit price increase for wholesale water heaters in May related to higher steel prices and inflation of other costs. The price increase has been accepted.

Sixth, as we have discussed in the past, 2014 will be negatively impacted by approximately $10 million of incremental ERP implementation expense. All of the incremental ERP expense is expected to occur in the third and fourth quarter with a significant portion in the third quarter.

The strength in our profitability in our rest of world segment gave us confidence to upgrade our high level 2015 outlook. We expect 2015 rest of world margin to be 14%, up from 13% and we revised our 2015 EPS to $2.60 per share from $2.50 per share. Our revised 2015 EPS is 10% higher than the mid point of our 2014 guidance and reflects the lower estimated outstanding shares as a result of our share repurchase activity. We maintain that 2015 revenue expectation at over $2.5 billion which represents 7% to 9% annual growth.

We maintained our North American margin forecast at 16%. Our acquisition strategy has not changed. We remain focused on water heating and water treating companies around the world as well as leveraging our brand and distribution channel in China. The acquisition landscape continues to be competitive as sustained price appreciation in equity markets overall and higher leverage allowed by banks in their loans to private equity firms drive sellers' expectations higher.

We walked away from several targets primarily because of price and new names have been added to our pipeline. Our teams are energetic and engaged. Our capital deployment strategies continue to support a combination of investments for organic growth, acquisitions, share repurchase and dividends. You have seen the slides before. We show these only as another reminder that we will be a financially disciplined acquirer of companies within our stated corporate strategy. That concludes our prepared remarks and now we are open for your questions.

Certainly.

(Operator Instructions)

Our first question comes from the line of Scott Graham of Jefferies. Your line is now open.

Good morning.

Good morning.

I have two questions for you guys. The first one is about the corporate expense and the implications on M&A. Corporate expense was not only down on a year over year basis by a lot, but it's really down versus the last four or five quarters' levels. I'm wondering what that means exactly, Ajita. Was there just a lot less due diligence in the second quarter because a pipeline has thinned out? Is there any kind of read there on what the pipeline looks like? Has it weakened?

I'll talk about the numbers and Ajita can talk about the pipeline. The reason it's down from last year is we spent a significant amount of money on two potential acquisitions in the form of due diligence. We got very deep into the due diligence process and it was very expensive and it's one of the ones we talked about where we walked away and we decided to walk away from that one because of price. So I would say last year's second quarter was abnormal compared to the other quarters and we still have the same commitment in dollars, to due diligence due to acquisitions we've had over the last several quarters.

Scott, in terms of M&A activity, in fact in terms of the total market, everything we're hearing is activity level is up, quite a lot and we are seeing that too. The pipeline is very robust as it has been in the past. So there's no decline in activity or high energies behind the right type of acquisition.

Thank you. The second question relates to the ERP expenditure of $10 million heavily weighted toward the third quarter. It sounded to me like not a lot was expended in the second quarter. We know something was expended in the first quarter. I'm not sure if you gave that or not. I thought I heard you say, Ajita, that all of the incremental was going to be in the second half of the year and again I thought that we had some rung up in the first quarter. So maybe you could kind of connect those dots for us.

The incremental, we said last year we spent about $5 million on the ERP. Much of that was in the first half of the year last year. Because then we started capitalizing the cost. The first half of this year we spent about $3 million to $4 million, again capitalizing most of the cost.

But our first go-live will be in August of this year. So then you stop capitalizing and you start amortizing. That's why we're saying the incremental year over year will be about $10 million, which is consistent: $15 million versus $5 million, but it will be basically $10 million additional expected second half of the year, most of which is the third quarter.

On the whole project we are right on track. So nothing has changed from the time we really started talking about it.

Got it. Would that imply then, John, something in the territory of $7 million to $8 million in the thirds quarter?

It's probably incrementally, probably about $6 million to $7 million I think over last year.

Understood. Thank you.

Thank you. Our next question comes from the line of Noah Kaye of Northland Capital. Your line is now open.

Thanks. Ajita, John, Pat, congrats on the strong quarter. We're hearing some very positive commentary on your China water treatment products coming out of the Aquatech Shanghai expo last month. You gave us some figures on expansion of stores, can you give us some figures on actual branded water treatment sales within China for the quarter?

Water treatment the first half of the year was up close to 70%. We're expecting that to continue the last half of the year, although there will be some tougher comps compared to last year. We said that water treatment, we think will be up at least 50% for the year.

You're right, there's been a real acceptance of water treatment in general. There's very low penetration of the consumer for water treatment. So we are very optimistic about potential growth. I mean Ajita mentioned that one of the market research companies has estimated that that market could grow at 40-plus percent bigger for at least the next five years and probably longer than that. So we are very optimistic about that.

The other thing is that if you were at Aquatech, you saw the impact that the A. O. Smith brand has in that category in China. It's one of those things that seeing it gives you the impression and gives you the right impression of the impact much better than trying to explain it. So if you were there, you can see the impact it has clearly shown as a leader in that market in China.

Right. As a follow-up, we've seen softer housing demand in China in the first half of the year. Homes targeted to affluent buyers certainly have not been immune. How do you reconcile this with your strong sales and margin growth in China and can you give us some thoughts on how you expect the housing market will impact your China sales going forward.

You're right, the housing market has been relatively weak, but I think we've been pretty consistent on how we've said we'd grow. We grow a lot of different ways. We grow by gaining market share. We did that during the quarter, specifically in the gas side, additional distribution outlets that we added.

Some of our ancillary product lines like water treatment are growing much faster than the 15% we highlighted, so certainly that's helped us. We think the replacement market continues also to grow some. So that's been a benefit. We have not been totally dependent on new housing which is good, because it has slowed down, but we think that's the potential upside for us because ultimately housing will come back there we believe.

Thank you so much. Congrats again.

Thank you.

Thank you. Our next question comes from the line of Mike Halloran of Robert Baird.

First on the residential side, could you talk about what the different channels are looking like there. Obviously you've talked about strong replacement, maybe a little bit more muted new housing, but certainly on the right path. So could you talk about what you're seeing in those two channels as well as what you're seeing through the various wholesale, retail type channels as well?

You probably saw the AHRI datas for April and May and they were relatively flat, but June was a very strong month. We have seen that. I think the wholesale has been a little bit stronger than the retail which indicates maybe that there is some new housing going on, et cetera. But we originally forecast the industry to be up about 300,000 units up to about 9 million units for the year and right now we're very comfortable with that estimate.

Makes sense. Two cost items that you've talked about in China specifically. One, could you help us triangulate on, more from a magnitude perspective, how that advertising expense will swing either year over year or as we go from the front half to the back half? And also an update on how the new facility is trending and if there's any still lingering head winds there or how that's working through.

Yes, there still are some head winds from the new facility and we expected that. Again, when you're adding incrementally right on the edge, we had capacity for two million units in the old facility and we added a million. Certainly we are not filled with capacity in the new one. It's having some head winds, which we expected. So nothing unusual there. The advertising: two things about the advertising. Historically, when we look at advertising first half to second half, the second half is 0.5% to 1% higher.

That's really a function of prime water heater sales in September to December covering the fall festival, et cetera. When we look at those numbers, that's historically what it was. But in addition, the second quarter, our national ad spend was lower than what would be normal. We expect to pick that up because as alluded to earlier, we're going to spend more money nationally on television regarding water treatment, et cetera and making sure that our brand is recognized in that category.

So it will be higher without a doubt the last half of the year compared to the first half. When we look at the full year and that takes out some of the volatility, we started rest of world by saying it would be less than the prior year.

We said that when we got out of the first quarter -- I mean, at the end of the year. Then the first quarter we said it would be about equal. Now we're very comfortable that full year margins will be higher than the prior years. So they're making very good progress when you look at the whole year on their operating margin.

Absolutely.

Just to add one thing, that also drove us partially to improve our outlook for next year.

That absolutely makes sense. Just wanted to make sure I understood the moving pieces. Appreciate the time, gentlemen and Pat.

Thank you. Our next question comes from the line of Charley Brady of BMO Capital Markets.

Thanks. Good morning, guys, good morning, Pat. Your comment on the price increase that went through in May, do you think that had pull forward impact on Q3 sales?

Not really because it probably had a little bit of impact in April, but it would have cleaned itself out we think, by the end of May. So we really don't think at this point -- traditionally, the third quarter is less and we certainly expect that to be the case again this year, but we don't really think there was any pull-forward for the whole quarter.

There was pull-forward within the quarter from month to month, but it was contained within the quarter.

Right, right. Okay. And then back on the advertising expense comment on rest of world in Q2, you say it's below what it would normally be seen in Q2. Can you quantify -- the margins in Q2 rest of world were certainly a bit better than we had modeled it. I'm trying to square up how much of that was maybe a shift because of advertising expenses moved into Q3 from Q4. What I'm asking is, how much has the lower advertising expense in rest of world benefited margins in Q2?

Lower advertising compared to the prior year was almost down 1%. That was probably a lower run rate than we would expect on an ongoing basis. Again, the biggest factor was national TV advertising, a lower spend rate in the second quarter compared to normal, I'll say. And we'll make that up. There was, the World Cup finished in the third quarter and we were pretty aggressive with some national advertising for that, et cetera. So we'll make that up.

Okay. One more, kind of an update on India. Any change there? Any positive movement one way or the other?

I would say India is kind of at the same run rate we expected. As you know, about 75% of the sales come in the second half the year so it's really hard to gauge until we get into that. I mean, there's been some positive talk about the election and the new leader. Time will tell if that will pass through into the market. That's relatively recent though, it hasn't happened yet.

Great. Thank you.

Thank you. Our next question comes from the line of William Bremer of Maxim Group.

Good morning, Ajita, John, Pat.

Good morning.

I'd like to go right to Lochinvar. Can you give us a sense of the growth there as well as, did we have operating margins there up year over year?

Well, we had very nice growth in Lochinvar. I think we said in the first quarter it was up about 7% year over year. Now we've said year to date it's up 10%. So if the math works, it was obviously above 10% in the second quarter. The margins were relatively flat and we knew that. We're spending a fair amount on engineering and also selling associated with the new products that are coming out. But margins were relatively flat which is what we were expecting for Lochinvar. They had a very good quarter.

Just to add a little more color to that, in the first quarter, the 7%, we said it was impacted by the cold weather because people were having a hard time getting around and replacing boilers, et cetera. They caught up in the second quarter. So we are at the 10% rate that we've been talking about. And the new products that we've announced have been very, very well accepted and the reviews have been terrific.

We start shipping the new products the latter part of the third quarter and into the fourth quarter. You know, those new products as John mentioned, the investment in engineering is an ongoing process at Lochinvar. This is not the last of the new products that you're going to be seeing there. It's an ongoing process and we have some very exciting new products on the drawing board which we'll be seeing at very constant frequency out into the future.

Nice color, Ajita. Can I expect the second half to be greater again than the first half?

Again, we expect sales for the year to be 10%. So I would say yes, we'll expect sales to grow. There will be the margin impact from the engineering and the selling associated with the new product, but they'll have a good year.

You will have the normal seasonality, with the first half versus the second half, the second half being a little stronger.

My final question regarding Lochinvar is just the international strategy going forward there and then timing of that.

It's moving forward. Like we said, the market in China is not quite ready for the condensing type products that Lochinvar sells and has clearly the chief position in but, you know, it's coming. There are indications it's coming. It's been a little slower than we anticipated when we made the acquisition, but clearly the market is evolving.

Okay, great. Thank you. I appreciate it.

Thank you. Our next question comes from Sam Eisner of Goldman Sachs. Your line is now open.

I want to go back to the SG&A comment on the rest of world segment. On a dollar basis, how much was there a benefit from lower advertising expense this quarter?

This quarter the advertising spend was pretty similar to the prior year, but as a percent of sales, because we had a 17% increase, it was significantly less as percent of sales.

And then in regards to Shanghai water treatment, is that business going forward now fully profitable? I know that, I think last quarter you were break even or slightly profitable. I'm curious what the expectations for that and then looking out to 2015, what is the expected profitability for that business now that you're raising guidance by about 100 basis points?

What we really said, Sam and we said it at the end of the year, that when we looked at our full water treatment business last year, it lost about $3 million and that was primarily amortization of customer lists associated with the acquisition. Then we said earlier this year that we thought it would be about break even.

Now we're confident it could be nicely above break even. So we would anticipate this year, even after the $3 million of amortization, the entire water treatment business will be a $2 million to $3 million P&L benefit. That's a pretty big swing from the prior year.

Just to add something to that, Sam, we're not trying to maximize the profitability of the water treatment business right now. Because we are investing in terms of advertising and new products, all the things that are required to drive the growth in that business. The other point is, and we don't -- the gross margin of that business is very nice. So we know that long-term profitability of that business is going to be right in line with the rest of our product lines in China.

Understood. Then as it relates to the 2015 expectations, the 100 basis point increase, is that all because of the water treatment business or are there other benefits in there as well?

I think it's just evolved. Certainly that's a positive, but we've leveraged some of our SG&As. We've gotten larger and the contribution from the higher volume that we expect next year; we still are comfortable when we look to next year at two times GDP. So that's that 15% or so. That will obviously contribute nicely. I think it's all of those factors.

Great. Lastly on India, given its back half way and I think, John, I think you alluded to this in an earlier question, just curious as to what the expectation is for profitability of that business. I believe in the last few years it's been break even or maybe even slightly down because of currency. I'm curious how you guys are thinking about that into the back half of this year.

When we said, Sam, at the end of last year I believe, that India lost about $5 million in total in 2013. We also said at that time that we expect to lose a similar amount. I think as we look at 2014, we'll probably lose maybe a little bit less, but certainly in that $4 million to $5 million range again.

Great. Thanks so much.

Thank you. Our next question comes from Matt Summerville of KeyBanc.

A couple of questions first on the commercial side of the business in North America. You gave a little bit of granularity in terms of the month of June on the residential side. Could you provide some qualitative or quantitative comments on what you saw in your commercial business in June and why you're obviously embedding in your guidance only 3% growth in commercial? Year to date it's tracking comfortably north of that. Can you help reconcile that?

If you look at April and May, I think the industry was up 10% or 11% or something. We saw similar type numbers in June. So, yes, commercial has been very strong. Anecdotally when we talk to the people in the field, it's a combination of replacement, repair, remodel, retrofit. There are some pockets of new construction. So it's all of those things contributing.

We're calling for the last half of the year right now to be flat to down a little bit. That's a potential upside. Again, we don't have quite as good of information to forecast that. The architectural index has turned positive a little bit. So time will tell. But you're right, it has been running better than that year to date.

We hope you're right. Second half is strong.

On the ERP items, will that be reported through the North American segment or will some of that hit corporate? How should we model it?

The majority of it will go through north America.

And then lastly, with respect to China, two questions: what's the magnitude of FX head wind that you're encountering in the rest of the world and how does that compare to how you would have originally thought about it heading into the year? Is there, in percentage terms, can you break down as you sit here, year to date in China how much of your revenue is coming from water treatment versus legacy electric versus newer products like gas instantaneous?

What I can say is all of them are certainly water treatment and instantaneous because I mentioned we've gained some market share up there the most, but electric is also up nicely for the quarter and year to date. The first part of the question was -- oh, FX. Are you talking on the sales side? Clearly on the sales side, FX has had a negative us for because when we did the planning for the RMB, we did it at 6.05 and it's running at 6.20 so that's a head wind of a couple percent right there.

So we're modeling 620 for, I believe, the third quarter, 615 for the fourth quarter. From a standpoint of cost, it hasn't been too significant this year because the Rupee has appreciated a little bit comparable to RMB. So we haven't had big head winds from a cost standpoint. Where we are having some head winds quite frankly and we talked about it, is Canada purchases. We closed the Fergus plant last year, they're buying from the US. The Canadian dollar continues to be weak so that has had some negative impact on earnings the first half of the year.

John, maybe one more. Is there any sort of early information you can give us regarding 2015 and the ERP implementation, quarterly cadence or first half, second half cadence of any incremental spend you anticipate next year?

As we look at it, we said this year the expense will be about $15 million and we would guess next year the expense will be about $15 million also. That will probably be more the first half than the second half. You know I'd be guessing, but I'd say let's say $10 million first half, $5 million second half or so would be my best guess at this point in time. But we expect it to be relatively level year over year. So we won't have that head wind that we have this year of the incremental $10 million.

Got it. Great. Thank you.

Thank you. Our next question comes from the line of David Rose of Wedbush Securities. Your line is now open.

Good morning. I think most of mine have been answered. Maybe just a couple small ones. On the water treatment side, do I understand you're selling to Turkey. Is that correct? I'm assuming that's not meaningful, but is that somewhere you're getting a little bit more traction?

Turkey was actually down. Turkey is kind of the C&I market so it's more project sales. In the quarter they were down less than $1 million. That can fluctuate from quarter to quarter. So we've purchased them, I guess a year ago January. Sales were projected to be around $10 million. I think they'll track pretty close to that, maybe down a little bit below $10 million. I think it's proceeding okay.

Yes, it's proceeding on track.

Okay. That's helpful. Are you starting to get any replacement business from your RO membranes?

When we talked to our people, the consumable numbers for this year are expected to be $3 million to $4 million. So it's starting to come in. As we've talked about, one of the advantages of this product is the main membrane doesn't have to be replaced. The main filter doesn't have to be replaced for almost up to three years. But some of the filters -- other filters -- there's four or five of them in there, get changed periodically. Annually, for example, on a couple of them. So we'll see a little growth in consumables this year, year over year so we're expecting $3 million to $4 million.

And then lastly, you didn't call on internet sales. Is that something that is starting to get still more momentum? Can you give us a number?

Internet sales did extremely well. First half of the year they were almost $20 million. Last year the entire year was about $15 million. So we're expecting that number to at least double year over year and that's a combination of water heating and water treating. So internet sales are doing extremely well.

We expect that trend to continue out in the future.

Okay. Fantastic. Thank you very much.

Thank you. At this time, I'm showing no further questions in the queue. I would like to turn the call back over to management for any further remarks.

Thank you for joining us today. If you have any follow-up questions, please reach out to us and I'll be happy to spend a little more time with you about the business. On behalf of Ajita and John and myself, enjoy your day. Thank you.

Ladies and gentlemen, thank you for your participation on today's conference. This concludes the program. You may now disconnect. Everyone have a great day.