A O Smith Corp (AOS) 2017 Q2 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the A. O. Smith Corporation Second Quarter 2017 Earnings Call. (Operator Instructions) As a reminder, this conference call is being recorded.

I would now like to turn the call over to your host for today's conference, Ms. Patricia Ackerman, Vice President, Investor Relations and Treasurer. Ma'am, you may begin.

Thank you, Bridget. Good morning, ladies and gentleman, and thank you for joining us on our 2017 Second Quarter Results 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, 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. (Operator Instructions)

I will now turn the call over to Ajita, who will begin his remarks on Slide 3.

Thank you, Pat, and good morning, ladies and gentlemen. Our double-digit sales growth in the second quarter was driven by continued strong demand for our consumer products in China and positive end markets for our commercial water heaters and boilers in the U.S. and Canada.

Here are a few highlights: sales grew nearly 11% to $738 million. Excluding the impact from the strengthening U.S. dollar against the Chinese currency, our sales grew 12.5% in the quarter. China sales were up 20% in local currency. A. O. Smith branded water treatment sales grew over 40% in local currency and air purification product revenue quadrupled.

Record-setting net earnings of $0.53 per share were 8% higher than our earnings per share in 2016. We continue to review our capital allocation and dedicate a portion of our cash to return to shareholders.

Through the first half of 2017, we repurchased approximately 1.3 million shares for $66 million. We announced a 17% increase to our dividend earlier this year. The 5-year compound annual growth rate of our dividend is over 25%.

Many of you are aware that A. O. Smith joined the S&P 500 Index this morning. We are honored to join this prestigious group of U.S. companies. Our inclusion is a significant milestone in our company's very rich history and a testament to the 15,000 men and women around the globe who work very hard everyday, living our values and contributing to our success.

Today marks a significant accomplishment for all of us. John will now describe our results in more detail, beginning with Slide 4.

Thanks, Ajita. Sales for the second quarter of $738 million were 11% higher than the previous year. Net earnings in the second quarter of $92 million increased 6% from 2016. Second quarter earnings per share at $0.53 increased 8% compared with 2016.

Sales in our North America segment of $471 million increased 9% compared with the second quarter of 2016. The increase in sales was primarily due to higher volumes of commercial water heaters and boilers in the U.S. and pricing actions in August 2016 related to steel cost increases and inflationary pressure on other costs. Aquasana, acquired in August of 2016, added $13 million to our North America segment sales.

Rest of World segment sales of $273 million increased 14% compared with 2016. China sales increased 20% in local currency, driven by higher demand for our consumer products in the region led by water treatment and air purification products and pricing actions due to higher steel and other costs, which were announced earlier this year.

On Slide 6, North America segment earnings of $109 million were 5% higher than segment earnings in the prior year. The favorable impact from higher sales of commercial water heaters and boilers and the pricing actions in the U.S. were partially offset by significantly higher steel cost.

Second quarter segment margin declined to 23.2% from 24.1% 1 year ago due to higher steel cost. The margin on our Aquasana products is lower than the segment average, which also contributed to the margin decline.

Rest of World earnings of $32.5 million were essentially the same as 1 year ago. Higher China sales, including the price increase, were more than offset by higher steel cost, increased selling, general and administrative expenses and a less profitable sales mix in China.

Advertising to support brand building and expansion of water treatment and air purification retail outlets in Tier 2 and 3 cities were the primary drivers of higher SG&A in China.

Currency translation reduced China earnings by approximately $2 million compared with the prior year. As a result of these factors, second quarter segment margin was 11.9% compared with 13.8% last year.

Our corporate expenses were essentially the same as 1 year ago. Our effective income tax rate in the second quarter of 2017 was 27.8%. The rate was lower than the 29.8% experienced during the second quarter of last year, primarily due to lower state income taxes and a change in geographic earnings mix. The lower effective tax rate this year compared with the effective rate 1 year ago benefited 2017 results by $0.01 per share.

Cash provided by operations during the first half of 2017 was $73 million compared with $155 million provided during the prior year. Higher earnings were more than offset by higher outlays for working capital. These factors resulted in lower cash flow in 2017.

Our liquidity position and balance sheet remains strong. Our debt-to-capital ratio was 19% at the end of the second quarter. We have cash balances totaling $741 million located offshore and our net cash position was approximately $366 million at the end of the quarter.

During the first half of 2017, we repurchased approximately 1.3 million shares of common stock for a total of $66 million. Approximately 3.6 million shares remained at our existing repurchase authority at the end of June.

This morning, we increased the midpoint of our 2017 EPS guidance by $0.03 per share for the range of between $2.07 and $2.11 per share. The midpoint of our EPS guidance represents a 13% increase in EPS compared with our 2016 results.

Please turn to Slide 9 for several 2017 assumptions. We expect our cash flow from operations in 2017 to be approximately $375 million, which is lower than the $447 million generated in 2016. We expect higher earnings in 2017, but also larger outlays for working capital due to the higher-than-anticipated cash flows in the fourth quarter of 2016. Over the 2-year period from 2016 to 2017, we expect to generate operating cash of approximately $825 million, which compares with $612 million during 2014 to 2015.

We broke ground in 2016 on the construction of a new water treatment and air purification manufacturing facility in Nanjing to support the strong growth of these products in China.

Our 2017 capital spending plans of approximately $100 million include $45 million related to this plant. Total cost for the facility, which is expected to begin production in the second quarter of 2018, will be about $65 million.

After this expansion, we expect capital spending in 2018 and beyond to be at levels equal to our depreciation plus amortization. Our depreciation expense is expected to be approximately $70 million in 2017.

As previously discussed, expenses related to our ERP implementation were $25 million in 2016 and are projected to decline to approximately $19 million in 2017.

Our corporate and other expenses are expected to be approximately $48 million in 2017, slightly higher than the $45 million in 2016, primarily due to higher expenses at our Corporate Technology Center and commissioned water treatment market studies. Take note that our interest expense will be approximately $3 million higher in 2017 as a result of higher rates, share repurchase activities and our acquisition last year.

Our effective income tax rate is expected to be approximately 28.5% in 2017, lower than the 29.4% rate in 2016. This assumption is predicated on no change to the current U.S. tax regime. We expect to repurchase our shares in the amount of approximately $135 million in 2017 under a 10b5-1 plan. We may opportunistically repurchase additional shares up to $65 million. If $135 million of our stock is repurchased, we expect our average diluted outstanding shares in 2017 will be approximately $174.5 million.

I will now turn the call back to Ajita, who will summarize our guidance, the business assumptions for 2017 and our growth strategy beginning on Slide 10.

Ajita?

Thank you, John. We project revenue growth to be between 11.5% and 12.5% in local currency terms in 2017 and 10% to 11% in U.S. dollar terms. We expect Aquasana sales will be approximately $55 million this year and slightly accretive to earnings. Aquasana sales were up nearly 20% for the first 6 months of this year compared with last year.

With the full year of Aquasana sales as part of A. O. Smith, we expect our global water treatment product sales will be over $275 million in 2017.

We project the Chinese currency will depreciate slightly from current levels against the U.S. dollars, resulting in a 4% or $38 million revenue headwind compared with the average rate in 2016.

Specific to our North America segment. We project the U.S. residential water heater industry volumes will increase approximately 300,000 units in 2017 due to new construction and expansion of replacement demand. We project U.S. commercial water heater industry volumes will be up 5% to 7% with most, if not all of the growth, in electric units.

Lochinvar-branded products grew 5% in the first half of 2017, driven by strong demand for water heaters and solid growth in commercial boilers. We expect double-digit full year boiler sales growth, driven by continued market share gains, new product introduction and energy-efficient product growth. We expect the total portfolio of Lochinvar-branded products to grow 8% in 2017.

In 2017, steel prices continue to move up. We expect steel costs in the third quarter will be the highest year-to-date. We recently announced a price increase of approximately 4% on the majority of our U.S. water heater products, effective late August. These factors lead us to expect our North American segment operating margin will be between 21.75% and 22% despite the headwind from lower Aquasana EBIT margin of nearly 40 basis points.

We have received several questions about this year's Amazon announcement last week. We manufacture water heaters exclusively for Sears with the Kenmore brand. Based on our conversation with Sears, water heaters are not part of the program with Amazon. Let me repeat that. Based on our conversation with Sears, water heaters are not part of the program with Amazon.

Specific to our Rest of World segment. We are a consumer products company in China, which distinguishes us from most industrial companies operating in China. We grew 23% in local currency in the first half of 2017, led by water treatment and air purification product. With a strong start to the year partially due to the prebuy in the first half, we expect China sales will be up low double digits in the second half of the year and approaching 17% in local currency for the year. We project improved profitability and operating margins in our Rest of World segment in the second half of the year compared to the first half due to a full year benefit from the price increase and lower advertising expenses as a percent of sales in China. We made some adjustments to the price increase in China late in the second quarter to broaden its impact.

Improved profitability in India due to the normal seasonality of water heater business will also contribute to higher Rest of World margin in the second half of the year compared to the first half. We expect Rest of World margins will be approximately 14% for the year.

Please advance to Slide #11. Our total company organic growth model continues to assume 8% growth for the foreseeable future. Especially in these uncertain economic times, we believe our organic growth potential and our stable defensive replacement markets, which we believe represent approximately 85% of North America water heater and boiler volumes, positively differentiate A. O. Smith among other industrial companies. Coupled with growth and stability, we have a strong balance sheet poised to take advantage of strategic acquisitions that add shareholder value as well as allow us to return cash to shareholders.

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

(Operator Instructions) Our first question comes from the line of Scott Graham with BMO Capital Markets.

Could you -- John, the steel inflation has gone a little tamer in recent months, but nevertheless, I'm sure we get your point here. Could you kind of once again go over how this rolls into the margin because it seems like the price increase from last summer, which I think was geared toward offsetting inflation 2, 3 quarters down the line that something in the spot market, I guess, or the percentage of your spot purchases has been an offset. Is that a reasonable characterization? But I'm just looking for you to sketch that out for us because I wouldn't have expected steel inflation to continue to offset the price increase from last summer without some kind of impetus from the spot market. Could you help me with that?

I'll try. I will tell you, our steel prices have increased every quarter this year. And clearly compared to the prior years, they're up significantly from the prior year. So when we tear apart, for example, North America second quarter, the pricing could not offset the steel increases last year. I mean, the price increase last year did not offset the steel increases in the second quarter. However, as we talked about in our script, commercial water heaters was extremely strong for us in the quarter as was commercial boilers. So those were the contributors on why we had a net positive for the quarter. So I don't know if that answers it, Scott, or not, but we've had continual increase in steel comps every quarter this year.

No, and I get that. But I'm just trying to differentiate between -- 3 quarters ago when we put this price increase after, it was supposed to be an offset. So obviously, something has happened in the spot market. What are your spot purchases and what the market...

Well, I'll take that, Scott. When we put it in, there was an anticipation in that steel prices, and we've talked about it on the year-end call that we thought steel prices would level off and maybe decline. We haven't seen that at all, and they've continued to increase. So I think that's part of the factor on why we're seeing what we're seeing is they've continued to increase higher than what...

What our assumptions were internally.

Yes.

All right. Two other questions. North American residential water heaters not talked about at all in the press release and your prepared comments. Why was that seemingly softer in the second quarter?

Well, I'd say they weren't talked about because they were flat to the year -- prior year, and you saw that certainly in the April and May data. And I'll tell you what we see -- saw in June, it was the same. So it was very flat with the prior year. And then when you look, that's down a couple of 100,000 units from the first quarter. But I'll tell you, overall, we're pleased where the industry is. It's up almost 200,000 when you include tankless year-over-year.

Yes. And I think part of it is timing because we had a very strong first half -- first quarter, sorry. And so it's just the timing of the cutoff, I think. If you look at the first half, it's about where we expect it to be.

Okay. Last question is on the Amazon agreement last week. I think that there are some, including myself, speculating that the agreement doesn't end here, that it starts to, at some point down the line, 1, 2, 3 years, Amazon moves quickly, so that's probably more like 1 to 2 years, starts to impact the water heater and HVAC markets and purely what would be a hypothetical, if that does happen. It would seem as if Sears would potentially stand to benefit in they're a large customer, but the flip side is that, has Amazon -- has Sears told you about any designs that Amazon might have on private label, which would probably have to be a U.S. manufacturer, which could benefit you or could not benefit you, depending upon -- again, this is speculative, but I'm just wondering what Sears has told you potentially on the water heater becoming part of that agreement, but also the potential for private label down the line.

Scott, let me answer the question from a practical perspective because I don't want to get into too much speculation. The white goods that are distributed by Sears go out of about approximately 200 different DCs around the country, okay? The water heaters that are distributed by Sears go out of about 6 DCs around the country. So the distribution network is nowhere near as close. The second point is that in most places, the water heater needs a licensed plumber to install it, whereas a lot of white goods is plug-and-play. So from a practical perspective, leaving aside the big bulky heavy relatively low-value water heaters, moving these around one at a time just becomes economically not feasible. So we are not speculating too much or don't see too much of an impact coming from them.

And the private label? What if -- is that something that Sears has mentioned that may be Amazon has spoken with them about within appliances?

I mean, we make -- we private label for Sears under the Kenmore brand. We've been doing that for many, many, many years, and that's... .

Well, obviously...

Well, I don't see the changes.

So many -- I do understand that, but what I was talking about was maybe a new private label brand.

We have had no indication to that at all.

I know this is only a speculative question. I get it, it's a hard one...

It would be -- listen, it will be very difficult to really execute on something like that.

And our next question comes from the line of Charley Brady with SunTrust Robinson Humphrey.

Just on the price increases related to steel and the new one that's going through, are you anticipating that, that new pricing will fully offset? Or is there still a net negative headwind on pricing despite the price increase?

Well, obviously, it depends where steel goes, but we would expect it will offset.

I mean, assuming the steel -- from flat from where it is today, it would offset it, correct?

Yes.

Okay. And then in terms of the China, the drop or the pullback in advertising expense, is that something that we should expect from a longer-term perspective? Or is it temporary or transitory issue? Just kind of in the back half of the year in '18, it needs to pick back up again.

Well, it probably needs to pick up in '18. You always have a situation where in the first half of the year, and we experienced that in the second quarter, you have some pretty significant trade shows where we spent, gosh, $2.5 million, $3 million at the plants electronic shows in the second quarter at the Aquatech show, at the Boiler show, et cetera. So we wouldn't expect that to repeat itself in the second half. But obviously, we've said all along, advertising is a key component of our SG&A expense as we maintain the brand and build the brand in some of our water treatment and air purification and combi businesses. But I think, given some of those expenses in the first half, that won't repeat themselves, we're comfortable advertising being down first half year to second half year.

Okay. And just one more for me then. Could you -- in terms of geographies, where you really don't play in right now, you've talked previously about potential areas you're going to and the other is where it doesn't make a whole lot of sense. Any kind of update on opportunities to expand beyond where you are geographically today?

Yes. This is Ajita. We are building a business in Vietnam, which is primarily water treatment and the potential for water heaters to follow. We are in India. We are exporting into South America and other markets. So from the point of view -- and also we have now in addition to the U.S. exports, which have been established and been there a while, we have 2 other low-cost country manufacturing locations, which we can export from, primarily India and also China, although China capacity is a little more limited for available for export. From that perspective, you could see us exporting from our current manufacturing basis to other countries. In terms of setting up factories in other countries, we don't see anything in the near future because -- just because the scale isn't there to support a manufacturing location.

Our next question comes from the line of Jeff Hammond with KeyBanc Capital.

Just back on the Rest of World margins, can you just talk about the -- I mean, it seems like first half, you were running sub-12 and you're saying 14 for the year, so maybe just bridge us first half to second half and kind of getting there.

Sure. Well, let's talk about the second quarter first, so you'll understand what happened because sales were up and not much drop to the bottom line. What we had is about 2/3 of our sales increase came from water treatment and air purification. We spent pretty significantly on SG&A and grew the distribution and advertising, so their profits, even though -- 2/3 of the sales were about flat. Our most profitable major SDU water heaters was actually flat in the second quarter, which, quite frankly, we expected because of the prebuy that happened in the first quarter. But what we didn't expect is their profits would actually be down, and it was a combination of conversion cost, but also some mix. We alluded to mix in the press release, and what it was, was some of the high-end electric fully featured was a smaller percent than the total for the quarter compared to the prior year. So then we also spent on a new product that we're bringing out the point-of-use, softener. We spent about $1 million on that, had a loss of $1 million. So what happened is the higher sales that we got from commercial, that we got from combi, that we got from parts, which parts business is doing very well, kind of offset those losses so we ended up neutral. Now when we look to the second half of the year versus the first half of the year, what we have is we're going to get the full benefit of the half year price increase. And as we alluded to, in Ajita's comments, we expanded that price increase in June. And so we expect to get significantly more price the second half of the year than the first half of the year. If you recall, we basically got nothing in January -- I mean in the first quarter from a price standpoint. And then two, as we said, SG&A, we expect advertising will be down first half -- second half compared to the first half, et cetera. So that's kind of the major pieces of the bridge from the first half to the second half as well as what happens to the margin in the second quarter.

Okay, great. And then Lochinvar, I think you said, Ajita, is up 5% year-to-date. I think you're still saying 8% for the full year. So what kind of second half visibility for that step-up?

I think we are seeing the boiler business pick up some of the things we talked about in the first quarter in terms of lots of quoting activity, but the projects being kind of slow. We see that picking up. We are picking up market share because we were up in the first half, and we -- best information we have is that the market was about flat. And we have some really interesting new products coming out. So combination of all of that gives us confidence in terms of continuing to that growth trend in the second half.

Our next question comes from the line of Alvaro Lacayo with Gabelli & Company.

Just 2 quick questions regarding pricing on -- in North America, the 4%, that's going to be across all product lines. Just wondering or if it's going to be only specific to certain areas. And then in China, with the price adjustment that was mentioned on the call, if you could maybe just provide a little more color on terms of -- is it from a magnitude standpoint? Or is it going to be extended across other products? And then I didn't really hear a size in terms of how much that price increase or how it will impact in the second half, that would be great.

So the -- I'll start with China. In China we did expand it to encompass more products, so it included commercial and it included combi. We also adjusted some of the prices on some of the existing products that were -- we raised in the first quarter. So to give you a percentage, it kind of varies by SBU. I couldn't even give you an average right now. But we did expand it and we also added to some of the existing increases we had in the first quarter. With respect to North America, it would cover the majority of the products, but it wouldn't -- we did not raise it on things, such as tankless and specialty water heaters, such as heat pump, et cetera. So there was not an increase on that. And as you know, some of our customers have a passthrough for steel. So it didn't effect those.

Our next question comes from the line of Matt Summerville with Alembic Global.

Just a couple of follow-up questions. First, on the commercial side of the business, I think you guys, in the Q&A early on, gave some color as to what you saw in the residential market in June. I was wondering if you could provide that same color for the commercial markets. And then also remind us, sort of a -- between gas and electric, what your relative market share is on the commercial side, and I guess how that electric side has been progressing post that efficiency standard change.

Well, I'll tell you the first part, which is commercial. June was very strong for us, and we assume for the market. So if you looked at the first 2 months commercial was flat, but we saw a very strong -- and quite frankly, we were up in the -- first 2 months even though the market was flat, and then we saw a very strong June. So that's with respect to commercial water heaters. And as Ajita alluded to on the boiler side, if you look at our commercial boiler business, it was actually up high teens. The residential boilers were down partly because of a difficult comp last year. And also, as we bring out our new product, the -- getting the heat exchanger was going a little slower than we thought, but we had a very strong commercial boiler business in the second quarter. So commercial right now -- and I know there are mixed signals out there, the Dodge Index is good, the architectural index is good. But are starting to say adjustments could slow in the second half of the year, but we're certainly not seeing it.

Yes. And just one final clarification on the residential comp. We've brought on a large new customer last year, so it was -- there was a buy-in.

Understood. And then just a follow-up with respect to China. You mentioned sort of the base water heater business was flattish in Q2, likely the result of the prebuy you saw in Q1. So that's fairly understandable. Have you started to see, 3, 4 weeks into the third quarter? Have you started to see that base water heater business from a volume standpoint begin to rebound?

One, I don't know. And two, I'm not sure we'd really comment if we knew. I mean, I think I'll say we're tracking where we thought we were going to be in July.

Our next question comes from the line of Ryan Connors with Boenning and Scattergood.

I appreciate all the color earlier on the new arrangement with the Sears Amazon. But I wonder if you could actually touch on the other shift and channel strategy that you mentioned on the last call, which is the new arrangement with Lowe's, and if you could give us any color there on how that's progressed in terms of sell-through, any competitive update there in terms of how that's impacted the wholesale side, if at all. Just any update there would be great.

That whole changeover is on track. It's gone about as expected. And all the stores have the product, and we haven't seen any major shift. So it's kind of as expected, on track.

Yes, we are comfortable the inventory levels are where they should be. So that's a positive. So they've been able to get -- to sell off the old, if you will, and so the inventory levels are where we wanted to be.

Okay. And no sign that there's any impact on a wholesale side in terms of losing the parity there of being a wholesale brand and so forth?

No.

Okay. And then the other quick question was on air purification in China, really seems like that is gaining some pretty significant steam here. I know it's a small base, but at this pace, it could be material pretty quickly. So could you give us an update there in terms of sizing that and whether that's -- whether you envision that now, becoming a more significant material contributor to the overall picture in China?

I guess, I'd say it's tracking where we thought. Last year, we sold about 25 million. This year, we expect to sell about 45 million. You may -- we did say it was 4x, and that's true. But last year, it was $2.5 million in the second quarter. So it's about $10 million in the second quarter this year, which is -- that's not the prime seasons. The prime seasons are the fourth quarter and the first quarter. I would tell you and Ajita may disagree, but the estimates for the growth are not as good as what they are for the water treatment. I think most of the estimates are high teens versus water treatment. Clearly, it's 30-plus and -- but air purification, we're trying to get a position in the marketplace. So we've spent on advertising, et cetera, and to build the brand and try to develop products that we think can differentiate it. So I'd say we're tracking where we thought we were going to be.

Yes. And I think in terms of just looking out into the future and the potential, it does certainly have the potential to be a much larger business than it is today. But it does -- it is a seasonal business. There's about half a year that it sells has robust sales. And then during the summertime, it isn't as much. Whereas water treatment in comparison is a year-round product and just because of the reasonably low household penetration of water treatment products, frankly both products, we see lots of room for both of those businesses to grow.

And our next question is from the line of David McGregor with Longbow Research.

Robert Aurand on for David today. Quick question on the pricing in North America. You say it's going into effect in late August this year. First, I believe it was August 1 last year. How should we think about that gap in terms of profitability here in early 3Q?

I'll try to answer. There is a gap between August and September. We wouldn't expect there would be much prebuy. It'll happen mostly within the quarter because we'll try to limit it to a month or so. So we wouldn't expect there'll be pretty much prebuy effect on the quarter, but yes, there is a gap in the pricing of [bottom line].

Okay. And then looking at China, we had -- maybe heard that some of the domestic manufacturers there are getting more aggressive in the high end of the market. Are you seeing that? And if so, what kind of impact might that have on ASP realizations there?

The -- your statement is true, but it's not a new phenomenon. It's always been that way. So from the perspective of any change, we'd really don't see a change. I've always said China is one of the most competitive markets in the world because you have every manufacturer in the world there and fighting for space. So we don't see -- we don't really see a change. It is very competitive.

And then I think our competitive advantage of having built up that infrastructure from an engineering standpoint and being first to market with products and features that the consumer wants, that's still very much an advantage.

Right. And so the engineer, the advertising, the brand building, all of that, that supports premium brand position is intact and we keep strengthening it.

Our next question is from the line of Larry De Maria with William Blair.

As far as, air treatment on water purification Rest of World, which is obviously mostly China. Can you remind us maybe the profitability even in the quarter on on an annual basis and if they're losing money this year and if they can swing to positive next year if we continue to grow like this given those mid-teens and 30% plus growth rate you talked about that we should swing positive next year? Can you just discuss the profitability of those businesses?

Sure. I'll start with air purification. We lost about $5 million last year. We'll lose probably about $2 million this year, but I think our run rate at the end of the year will be breakeven. So we expect to be breakeven for the year next year or profitable in air purification. Water treatment, we are profitable and have been. I think that the litany of our water treatment is a good example of how we try to leverage the high gross margins that we have in this product to ultimately get them to profitability. So when we started water treatment, we probably lost $10 million, then we lost $6 million, then we had made $3 million. And last year, we were at about low double-digit margins. So it's a nicely profitable business for us, not at the average for the business, but certainly progressing that way.

That's great. And can you just size that business for us as well like you did for the treatment business?

Well, I think we've said that water treatment will be about $185 million or so in China with A. O. Smith brand.

And the $275 million I referred to was worldwide.

Yes, that's worldwide.

And our next question is from Bhupender Bohra with Jefferies.

Congratulations in getting the stock into S&P 500 here, so...

Thank you.

Thank you.

Yes. And my questions was around the -- Ajita, you talked about the retail expansion in the release you have talked about like Tier 2 and Tier 3, especially in the water treatment side. Could you update us on the retail stores you have in China today, and I don't know if you are doing anything different specific to water treatment on air purification on the retail side.

Go ahead.

Well, to give you an idea, we're over 9,000 stores in the water heater, so about 9,400, 9,500. We would be over 7,000 stores. We've grown that pretty dramatically this year, probably about 900 units were sold this year in the water treatment. So we're over 7,000. And air purification, we're probably at about 3,000 stores or so. Now again, those last 2 would probably have a higher percent online. But from a store standpoint, we're continuing to do what we've always done is, we'll be the first to tell you, there are some underperforming stores. We evaluate those stores quarterly. And ultimately, if we're not comfortable with the forecast of being able to get them to a reasonable level, we'll shut them. And we'll continue to prune stores and add stores. So I think it's a consistent philosophy we've had for the last several years.

And also in terms of the new category getting into the stores, it's always an evaluation of the cost of getting in, which is training the people, getting the merchandising, the fixturing and all of that for a new category versus what we expect in terms of revenue and profitability. So it's that balance and evaluation that we make whenever we go into a new store versus not. So that's what our process is. It's an ongoing process.

Okay. And was there any specific portion to Tier 2 and Tier 3 cities. I mean that's what I think is specified in the release here in the quarter.

I think that's where the area of expansion is. That's where the growth in new housing, I'll say, is occurring, and so we've been moving into that for the last couple of years.

Okay, got it. And just to follow-on on the Aquasana headwind. I think you mentioned, for this year, it's going to be about like 40 bps. It seems like that's a little less than 50 bps on the last quarterly call you mentioned. So things are looking -- progressing well, I guess, on the Aquasana side. Can you give us come color, like how the cost-selling synergies, which you have talked about are coming through?

Yes. Well, I think we had said approximately 50 -- less than 50. I think it's progressing well. Year-to-date, we're up 20% in sales and the cost synergies that we forecast, I'd say, are probably a little bit ahead.

The revenue synergy is probably slightly behind.

Behind, right.

But overall, we are very happy with the performance and where we are strategically with that acquisition.

Yes, and I'd say their P&L impact is -- had not really changed. They're on plan meeting the expectations from a P&L standpoint.

(Operator Instructions) I'm not showing any further questions. I'll now turn the call back over to Pat Ackerman for closing remarks.

Thank you all for joining us today. Please take note that we will participate in the Jefferies Conference in New York City on August 9. Have a wonderful day.

Ladies and gentlemen, this does conclude the program. You may now disconnect.