Patricia Ackerman - VP, IR & Treasurer Ajita Rajendra - Chairman & CEO John Kita - CFO.

Scott Graham - Jefferies Mike Halloran - Robert W. Baird William Bremer - Maxim Group Noah Kaye - Northland Capital Patrick Wu - BMO Capital Markets Aditya Satghare - FBR Capital Markets David Rose - Wedbush Securities Todd Vencil - Sterne Agee.

Welcome to the A.O. Smith Corporation Fourth Quarter 2014 Earnings Conference Call. [Operator Instructions]. Now, I would like to introduce your host for today's conference call, Ms. Patricia Ackerman, you may begin, ma'am..

Thank you, Kevin. Good morning, ladies and gentlemen and thank you for joining us on our 2014 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 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 have provided non-GAAP measures, adjusted earnings, adjusted EPS and adjusted segment operating earnings for 2013 and 2014 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 curtailment.

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 now turn the call over to you..

Thank you, Pat and good morning ladies and gentlemen. 2014 was another excellent year for A.O. Smith. We continued to see the benefits in our performance from an improving economy in the U.S. and our expanding consumer business in China. Here are a few highlights; our organic growth drove sales 9% higher to a record $2.36 billion.

China sales were up 18% with gas tankers and water treatment products growing faster than the business as a whole.

Our adjusted earnings of $2.43 were 18% higher than the $2.06 per share recorded in 2013 and were primarily driven by higher sales which more than offset approximately $9 million in incremental ERP implementation costs which were incurred in 2014. We continue to review our capital allocation and dedicate a portion to return to shareholders.

We repurchased approximately 2.2 million shares for $104 million in 2014. We increased our dividend by 25% last January and last evening we announced a 27% increase to our dividend. In 2014 we returned approximately $160 million to shareholders. In 2014, we celebrated 140 years of serving our customers with honesty and integrity.

These values lie at the heart of our success and longevity and they will continue to underpin our culture well into the future. John will now describe our results in more detail..

Thank you, Ajita. Sales for the full year of $2.36 billion were 9% higher than the previous year, driven by higher sales of water heaters and boilers in the U.S. and water heaters and water treatment products in China. Adjusted earnings of $221 million improved 16% from 2013.

Adjusted earnings in 2014 excluded after-tax non-operating pension costs of $13.2 million, adjusted earnings in 2013 excluded after-tax non-operating pension costs of $11.9 million, after-tax restructuring and impairment expenses of $16.4 million and a $6.8 million after-tax gain related to a settlement with the supplier.

Adjusted earnings of $2.43 per share improved 18% compared with $2.06 per share in 2013. 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 $1.6 billion increased 7% over 2013, driven by higher volumes of U.S.

water heaters and boilers which were partially offset by lower water heater sales in Canada primarily due to the 7% decline in the Canadian dollar. Sales growth of Lochinvar-branded products exceeded 10%. Rest of world segment sales of $768 million increased 15% compared with 2013.

An 18% increase in China sales driven by increased demand for water heaters and water treatment products and our higher priced product mix was partially offset by lower sales in India resulting from weakness in the housing market and the termination of a co-branding relationship with our largest distributor.

North America adjusted operating earnings of $253 million were 7% higher than the previous year and adjusted operating margin of 15.6% was flat. The favorable impact from higher volumes in the U.S. was partially offset by higher material costs and approximately $9 million in incremental planned ERP implementation costs.

Rest of world operating earnings of $107 million improved 21% compared with 2013, driven primarily by higher sales. Operating margin of 13.9% improved from the previous year as a result of improved performance in China which was partially offset by larger losses in India.

Losses in India totaled $7.5 million in 2014 including approximately $1 million of product development and advertising costs related to our planned 2015 launch of water treatment products.

Our adjusted corporate expenses were $46 million, a decline from the prior year primarily due to higher interest income in 2014 and higher expenses related to management incentive programs and due diligence activities in 2013.

Sales for the fourth quarter of $627 million were 12% higher than the previous year, driven by higher sales of water heaters and boilers in the U.S. and water heaters and water treatment products in China. Adjusted earnings of $58 million improved 20% from 2013. Adjusted earnings in 2014 excluded after-tax non-operating pension costs of $4.3 million.

Adjusted earnings in 2013 excluded after-tax non-operating pension costs of $2.9 million and after-tax restructuring and impairment expenses of $2.7 million. Fourth quarter adjusted earnings of $0.64 per share improved 25% compared with $0.52 per share the previous 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 $431 million increased 13% over 2013, driven by higher volumes of U.S. water heaters and commercial boilers. We believe some of the increase in our U.S.

residential water heater volumes was due to the customer inventory build in advance of the NAECA 3 efficiency standard change in April 2015. Continued strong performance from our CREST family of condensing boilers drove sales of Lochinvar-branded products up over 10% from the fourth quarter 2013 levels.

Rest of the world segment sales of $203 million increased 10% compared with the previous year. Sales in China increased over 15% driven by increased demand for water heaters and water treatment products and were partially offset by lower sales in India.

North America adjusted operating earnings of $71 million were 21% higher than the previous year, primarily due to higher volumes. Adjusted operating margin of 16.5% increased significantly as well.

Rest of world operating earnings of $22 million improved 9%, compared with 2013 driven by the impact from higher China sales which was partially offset by higher advertising costs in China and a $3 million loss in India.

Operating margin was essentially flat from one year ago as a result of larger losses in India which offset margin improvement in China. Our adjusted corporate expenses were $11 million, a decline from the prior year primarily due to higher expenses related to management incentive programs in 2013.

The effective tax rate on adjusted earnings was 29% which was at the high end of our previously disclosed range compared with 26.6% for the previous year. Cash provided by operations of $265 million in 2014 was lower than the $282 million provided in 2013. Higher earnings were more than offset by higher outlays for working capital in the 2014 period.

Our liquidity position and balance sheet remains strong. Our debt to capital ratio was 14% at the end of 2014. We have sizable cash balances totaling over $540 million located offshore and our net cash position was over $300 million at the end of 2014.

During 2014, we repurchased approximately 2.2 million shares of common stock for a total of $104 million under a 10b5-1 automatic trading plan. At the December meeting our Board increased the authorized shares available for repurchase by 2 million shares.

Considering this increase, we had approximately 2.5 million shares remaining on our existing repurchase authority at the end of December.

Depending on factors such as stock price, working capital requirements and alternative investment opportunities, we expect to spend approximately $100 million on share repurchase activity in 2015, resulting in net cash levels around $300 million similar to 2014 year-end levels.

We expect our cash flow from operations in 2015 to be between $270 million and $280 million, similar to 2014. Our capital expenditures in 2014 were $86 million which included approximately $32 million related to our ERP implementation.

We expect capital expenditures to be approximately $100 million to $110 million in 2015 which includes approximately $20 million to support the ERP implementation and approximately $30 million related to capacity expansion in China and in the U.S., to support Lochinvar-branded sales.

Our depreciation and amortization expense is expected to be approximately $66 million in 2015 compared with $60 million in 2014. We successfully completed our first ERP go live milestone in August 2014. We expect the remainder of our planned sites to go live in 2015 and 2016.

ERP implementation expenses were $14 million in 2014 and are projected to be about $20 million in 2015. We estimate our effective tax rate to be between 29% and 30% in 2015 and higher than in 2014 due to one-time benefits in 2014 such as the R&D tax credit. Our corporate and other expenses are expected to be approximately $48 million in 2015.

This morning we introduced our 2015 EPS guidance of $2.65 to $2.80 per share. The midpoint of our EPS guidance represents a 12% increase in after-tax earnings compared with our 2014 adjusted results.

We expect our earnings per share in the first half of 2015 to be flat or up only modestly compared with 2014, due to the following factors; we expect to experience inefficiencies and one-time costs associated with the NAECA transition in the first half of 2015. We expect the benefits of NAECA 3 pricing will be effective about mid-second quarter.

We believe our first half volume will be impacted by the 2014 year-end pre-buy and we expect ERP costs which will be about $20 million in 2015 and spread equally over the year which results in an incremental $3 million higher expense in each of the first two quarters of 2015 compared to 2014.

As previously mentioned the majority of our pension plan sunsets on December 31, 2014. GAAP pension expense in 2014 was $28.6 million of which $6.9 million was included in adjusted earnings. GAAP pension expense plus costs related to our replacement plan for the sunset pension plan are expected to be approximately $4 million in 2015.

As a result, we do not plan to report adjusted earnings beginning with the first quarter of 2015. I'll now turn the call back to Ajita, who will summarize the assumptions in our 2015 outlook and our growth strategy.

Ajita?.

Thank you, John. As John mentioned, the midpoint of our updated 2015 guidance implies growth of 12% over last year.

Our outlook for 2015 includes the following assumptions; first, we continue to expect strong profitable growth in China driven by expected overall water heater market growth, market share gains, improved product mix and water treatment product growth significantly higher than two times GDP.

Collectively, we expect these drivers to deliver growth at two times China's GDP growth rate. Second, we forecast Lochinvar-branded product sales to continue to grow at the brisk 10% pace at which they have grown or exceeded since we purchased the business in 2011. This is well ahead of GDP growth in the U.S.

as our Lochinvar brand is expected to continue to benefit from the transition from lower efficiency non-condensing boilers to high efficiency condensing boilers and new products driven by market leading innovation. The launch of our FTXL boiler line late last year has been very well received.

We're expecting similarly strong acceptance from our newly introduced expansion of the CREST boiler family which will target the 850,000 to 2 million BTU power portion of the condensing boiler market. We're showcasing this new product offering at the AHR Expo this week in Chicago.

Third, a regulatory change in the energy efficiency standards of residential water heaters sold in the U.S., governed by an update to the National Appliance Energy Conservation Act or NAECA 3, will become effective in mid-April.

Water heaters which do not meet the new efficiency standards can no longer be manufactured after April 15, 2015 impacting approximately 80% of our U.S. residential water heater SKUs, the new compliance products are more expensive to manufacture.

We have announced to our customers an average residential price increase of approximately 20% on these products to cover our costs. Fourth, we're cautiously optimistic about the developing recovery in U.S. housing and the strength in demand for commercial water heaters, driven by replacement and retrofit activity.

We estimate 2014 residential water heater industry volumes were up 6% over the prior year, partially driven by a pre-buy ahead of the NAECA 3 regulatory change. We estimate 2014 commercial industry volumes were up by a similar percentage and achieved a new high. We expect the housing market in the U.S.

to continue to recover, but due to the pre-buy in the fourth quarter of 2014, we expect industry water heater shipments in 2015 to be flat or up modestly. Fifth, we continue to seek ways to leverage our strong brand and distribution channel in China. Launching an A.O.

Smith branded water treatment product line in 2010 was our first foray into a new product category in the region. Growing A.O.

Smith-branded water treatment sales from $18 million to $75 million in the last two years continues to prove that our assets and know-how in China are very valuable and that our team in China understands the drivers required to succeed in the very competitive and crowded China marketplace.

Total China water treatment sales in 2014 were $90 million, including $15 million of sales which were not branded A.O. Smith.

China Market Money or CMM estimates that the point of use water treatment category in China will grow over 40% per year over the next five years and we're excited about the opportunity and pleased with the market share gains that we have achieved through leveraging our brand, our engineering and our distribution strength.

In China, our brand attributes include quality, reliability, safety and trust. These attributes translate very well to air purifiers, the fastest growing home appliance in category in China as measured by CMM. Partnering with a Japanese manufacturer, we expect to launch the A.O. Smith brand air purifier in China early in the second quarter in 2015.

An investment for the future, air purifier sales are expected to be less than $10 million in 2015 with losses of approximately $4 million primarily related to advertising and promotion costs.

Sixth, we remain optimistic about the long term opportunity in India and we're committed to the country with the second largest population and the second fastest growing economy in the world and its developing middle class who desire quality of life products.

India is an investment for the future and our 2014 sales were $15 million, about $5 million lower than 2013 due to the termination of a co-branding relationship with our largest distributor and contraction in the water heater market, due to weakness in the housing market.

As a result, the 2014 loss of $7.5 million was larger than the $5 million loss we incurred in 2013 and includes approximately $1 million of product development and advertising costs related to the planned 2015 launch of water treatment products.

In 2014, we completed an expansion of our Bangalore facility which extends the range of water heaters produced locally and accommodates future demand. The expansion also serves as a platform to launch residential water treatment products in India this year.

We have developed a point of use product family specifically for India, collaborating with our engineering expertise in the U.S. and in China and plan a limited product launch in India in 2015.

We expect the entry into the water treatment category and continued investment in brand building activities to offset expected performance improvement in our water heater business, resulting in losses in 2015, similar to those in 2014. Overall sales in India are expected to be $20 million to $25 million in 2015.

Seventh, we expect North America operating margins to be approximately 16%, similar to our previous disclosure and a slight improvement from 2014. Our rest of world margins are projected to be between 13.5% and 14% and will be impacted by the net investment in the launch of A.O. Smith branded air purifiers in China.

This graphic sums up the organic growth potential we see in our businesses going forward. In fact, we expect North America water heater sales will grow faster than 4% in 2015 as a result of the price increase on our NAECA 3 compliant products and result in total Company sales growth of approximately 10%.

Each of our teams understand the drivers of this growth potential and we're investing behind these drivers. 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 expensive as sustained price appreciation in equity markets, lower financing costs and the lack of organic growth for many strategic buyers have been driving prices higher.

Our teams are energetic and engaged and our capital deployment strategies continue to support a combination of investments for organic growth, acquisitions, share repurchase and dividends.

You have seen this slide before and we show this only as a reminder that we will be a financially disciplined acquirer of companies within our stated corporate strategy. This concludes our prepared remarks and now we're open for your questions..

[Operator Instructions]. Our first question comes from Scott Graham with Jefferies..

I would like to maybe if you could run us through a little bit the P&L impact of the energy efficiency standards. So you're increasing prices on 80% of your North American residential units by 20% and that starts in the middle of the second quarter.

Will that hit full run-rate in the third quarter?.

I'm not sure I heard it completely. But I guess I would say I think I heard full run-rate in third quarter.

Yes, we expect as we said in the first half of the year, we'll have some operating inefficiencies, some one-time costs and then the price increase, on average assuming there will be some pre-buy which we're trying to limit, will probably be mid-second quarter as we said. So by the third quarter, yes we should be at a full run-rate..

And it looks like your margin is going to hold up pretty well, even though it's a higher cost.

John, are you saying that you [inaudible] this year and came up with a price increase that's based on materials that you could get - so you can change that 15% margin? Is that kind of how strategy went?.

I'm not sure I heard the whole question. I mean, I guess I would say we're maintaining our margins. Clearly, there is a cost increase associated with this move and as we've talked about in the past, we have said our aspiration for North America was 16% operating margins. We were very close to that in 2014 and we expect to be there in 2015.

It's a combination of items, some of which is Lochinvar, we expect better performance. We have talked about in 2014 they were affected by higher engineering costs, higher sales costs as they brought two new products to the market and we expect better performance from them in 2015. So all-in-all--.

And since they are growing faster than the rest of North America, the mix is getting better because Lochinvar is getting to be a bigger part of our overall mix. So all that put together, we'll meet our 16% guidance that we have been giving in the past..

Our next question comes from Mike Halloran with Robert W. Baird..

So could you help on some of the pre-buy activity here? Maybe how much do you guys estimate was in the fourth quarter? And then are you expecting a comparable amount of pre-buy to occur in the first quarter?.

Our best guess is, we had a strong December. We assume the industry will have a strong December. So we would guess there was over 100,000 unit pre-buy in the fourth quarter. Our guess would be the first quarter would probably be up, the industry will be up from the prior years by maybe 100,000 units.

We certainly will limit the amount of pre-buy, but we would expect the industry could be up. But we may see the ramifications of that then in the second quarter. Obviously there is guessing going on, but that would be our best guess..

Okay and fair to assume then that whatever pre-buy you see in the fourth or first quarter probably gets pulled out of the second quarter.

As you responded to Scott's question, you should be pretty much through that inventory that built up by the end of the second quarter?.

That would be our best guess..

And then use of cash from here, you have obviously increased the dividend. You increased the buyback authorization though, I think on a year-over-year basis the level of share repurchases is expected to be the same.

How are you thinking about that in terms of what is still going to be pretty strong free cash flow? And what would be the levers that would cause you to increase how you think about that share buyback on an annualized basis from here?.

Well, we have said there is really four capital allocation options with number one being organically. You can see we're doing relatively significant capital expenditure investment in our business, to really support the growth that we're seeing.

Number two is acquisitions, we're still very actively looking at acquisitions and think that's the best value creation and I would say in this interim period, we felt from a cash buy back standpoint that we want to hold our net cash position level.

So we're estimating that after CapEx and after everything, we'll generate about $100 million, after dividends, after CapEx and that's what we're estimating then for the stock buyback. As you said, we also increased the dividend. So those are the four options. Those haven't changed, and it still leaves us in a position to make value-added acquisitions..

Our next question comes from William Bremer with Maxim Group..

First question, let's go into Lochinvar.

Can you give us a little insight in terms of the provisioning of aftermarket as well as what you are striving to longer term there? Whether or not we start to gravitate and take this internationally has always been a question and just in terms of how many and the education that's needed there, it is a very high margin business and just wondering what the strategic plan there is going forward?.

Well the replacement market continues to be 10% or so of its business and it's also growing at about 10% a year. So it is staying right up at that level. We've talked in the past about international, we still think China is a very viable market for Lochinvar.

The education of the whole industry if you will to condensing is taking a longer time than we expected. So we're actually developing some products that will maybe be competitive in the high-end, high BTU non-condensing market which we hope we're going to be able to take to China in the second half of the year.

So we think longer term clearly China is an opportunity for their business and we'll continue to explore that..

The new product launch in terms of the air purification.

Can we go a little granular there? Is this more on the residential side? Is this more on the commercial side and what's the overall strategy there, going forward?.

Will, what we’re seeing here is as we look at China, we have some tremendous assets in China.

Primarily our brand, our distribution, our market know-how, our manufacturing capability, etcetera and we have been looking at ways in which we can leverage these capabilities in China and when we look at our brand and the strength of the brand and the attributes of the brand, behind high quality, high reliability, high level of trust and we also see in the Chinese market, the fastest growing appliance right now is the air purifier.

And so we partnered with a Japanese company to produce residential air purifiers and we see this as an opportunity. This is a niche opportunity for the Chinese market. We don't see this as being a global business for us but it is an opportunity for us to leverage the very strong assets that we have in China for to help continue our growth..

And my final question is just on commodity prices. Overall global steel prices, while they'll lower year over year, really and truly have not matched the dramatic declines that we have seen in coal and iron ore.

Can you possibly just comment on what you are looking at and what you are seeing, that may be a tailwind for you later on this year?.

Well it's hard to say, clearly steel still is at the level that is relatively comparable to last year's first quarter. There has been a recent decline but as we all know, that is relatively volatile, so it can go either way.

So at this time, we're projecting it staying at the levels it's at and maybe increasing a little bit later in the year, but we've been wrong on forecasting where steel has gone for a while..

Our next question comes from Noah Kaye with Northland Capital..

There has been a lot of attention in the market to FX, heading into next year.

Can you talk about how FX foreign exchange assumptions factored into your overall sales assumptions?.

Well, from a sales perspective, Canada, we do a fair amount of business in Canada over $100 million, so it does have an effect obviously therefrom a sales translation as well as an earnings translation and we have built that into our assumptions. China, the currency has been around the 6.20 range or so. It's gone down to 6.10, it's gone up to 6.25.

Obviously if that were to move dramatically one way or the other that would have an impact, but it's been pretty much at 6.20 for a while. Those are the two major ones. As you know, we do not have much presence in Europe, and so we do not have that concern and issue, that other companies are talking about.

So it's a factor, but not a significant factor for us..

Okay.

Again for 2015 sales assumptions, how much are you thinking about in terms of water treatment sales?.

Well as we talked about, we have had tremendous growth there over the last two years. The industry is expected to be up 40%, so that would certainly be our objective to grow that $75 million branded portion by 40%..

Okay. And then finally to return to North America, we've seen some pretty robust construction sales estimates, growth estimates for 2015. You mentioned that it is possible Lochinvar seemed to be, it's going to take a little bit more on the residential side.

Can you talk a little bit more about potential upside? Because I think we look back at 2014, commercial volumes obviously grew faster than what you had guided for.

How are you thinking about that for next year?.

Well, you're right. We have been conservative on commercial, we have been surprised, we actually grew 10,000 units last year, we're at an all-time high. I can assure you commercial construction is nowhere near where it was in 2007, when it was at the all-time high. And we've talked about it, it's a variety of factors.

It's retrofit where new restaurants are going in. It's redundancy. Our area of the small hotel and restaurant build is doing okay, so it's a variety of items. And at this point, since we haven't done a very good job, we've kind of punted and said we will expect it to be about flat.

We have been hearing this construction build story now for the last two or three years. It has not happened, certainly vacancy rates are down so potentially it could happen this year and that would be upside if the industry is higher than 167 because as you know we have good market share in that area..

Our next question comes from Charles Brady with BMO Capital Markets..

This is actually Patrick standing in for Charlie. Just one quick question online sales in China. I think there was commentary there was commentary that it was $50 million in 2014. What was the amount for the fourth quarter and what is the year-over-year growth for the quarter versus the prior quarter? Just trying to get better color on that..

To be honest, I don't have the quarter over quarter growth. I mean, it's been growing sequentially throughout the year. We've forecasted that next year it could approach $90 million to $100 million.

It's an area that our management team looked at very closely three or four years ago and started building up the internal capability to do it, so they have been ahead of the market from that standpoint and it's been very successful for us, but I do not have the sequential growth..

Okay.

What is the channel outlet count, in China, to end the year? And what were the incremental additions in the fourth quarter? Is there any new changes to the mix that we should be aware of in terms of Tier 1 and Tier 2s?.

The channel distribution is a little bit interesting. We were up about 500 net-stores for the year, that's to about 7500. Now that's higher than you would have heard in the past, because as we've done more looking at things, we had about 1000 stores, historically, that were small stores, Tier 3 and 4 that were not included in our count and now we're.

So the bottom line is the net stores were up about 500. We expect them next year to be up about 300 net. There continues to be the opening and closing. The distribution of stores is about 62%, so it's moving up a little bit, Tier 2 and above compared to Tier 1. But still, the majority of our sales are still in Tier 1..

If I may just squeeze in one more? For India obviously it is still an unprofitable part of the business right now.

What are your assumptions, what is the company's assumption in terms of when that may turn the corner? After $20 million to $25 million in sales, I think you mentioned for cash in 2015, what is the profile not margin there? Can we expect that to turn the corner this year or what is the outlook there?.

I think what we said is that we do expect it to improve.

We lost about $6.5 million in the water heater business last year which was about $1.5 million more than the prior year that was really driven by the termination of the distributor, mutually agreed upon by both parties which affected the sales by about $4 million to $5 million and the decline in profit.

We've also experienced because I would have to guess because of the uncertain in the whole political situation, etcetera there, coming up to the elections, the housing market was clearly down. So we saw the market down, that's the color of what happened.

What we expect to happen in 2015 is sales to grow $5 million or so on the water heater side and improve the profit by a couple million dollars as we vertically integrate and have higher sales.

Much of that will be used up though in the water treatment which is the market that is probably three times the water heater market which we think is an opportunity. So that's why we're saying net, net, net, we will be about the same.

When we look at breakeven analysis and that is always dangerous because as you are looking at currency and all other things, the water heater business was about a $15 million business, we would think we have to get to a level of $30 million to $35 million or so to get to a breakeven on the water heater..

Our next question comes from Aditya Satghare with FBR Capital Markets..

So I had two questions, one on the Lochinvar and one on the water treatment. So, on Lochinvar sales continued to increase about 10%.

How far are we from a normalized mix for the industry in terms of this continuing market share shift?.

We think we still have room to go. The last data we saw, the condensing was about 40% of the market. The estimates we have seen is that could move to 60% to 65% in the next 3 or 4 years, so we think we'll still have some tailwind there.

But the other thing that is important to realize about Lochinvar is they continue to bring out new products and the products have been very well received in the marketplace. So it is the combination I would say of the market helping us as well as the innovation of the new products..

And then on the water treatment, could you maybe talk about some of the similarities or differences between the Chinese and the Indian market and what lessons from China could you potentially apply as you go into India in that market?.

With respect to water treatment?.

That's right..

Well, we're certainly using the design people in China to coordinate with the people in India to develop a product specific for India. One of the biggest differences is China is primarily a below the counter type product, while in India it's an above the counter type product.

In India, reverse osmosis is significant, but also other components like UV, UF are bigger than what they are in China. So there are differences in the marketplace. Membrane texture, etcetera is different can be - certain things, the water in India isn't as uniform throughout the country, that creates some issues.

So there are differences between the markets. As we have said though, it's a large market, there are formidable competitors there, but we think we can be successful in it..

And I think you know, just to add some color to that, we continue to see India as a tremendous long-term growth opportunity and that's why we continue to invest in India. The water treatment category as John said is about three times the size of water heaters and the distribution is very similar.

So by getting into a new category, we can leverage the sales force, the advertising, etcetera in a similar type of distribution network. And we see again, tremendous long-term potential, but we need some help from the economy which didn't come in 2014 and we hope that will come, certainly will come in the future..

Our next question comes from David Rose with Wedbush Securities..

Just a couple of follow-ups, maybe it wasn't clear to me the CapEx break out between India and China as it relates to water treatment and how much you are spending in Lochinvar? And maybe at a higher level, Ajita, maybe you can discuss what you've seen in India, in terms of the potential enablers from the Modi government to make your business a little bit more attractive? And then structurally in India, lastly, how you are spending your resources to reduce costs at the same time growth of business and maybe you can provide some specific examples?.

Well I'll do the CapEx and you can do the remainder. What we have said is we really don't have a lot of CapEx in India in 2015. What we said is about $30 million of CapEx associated with China expansion as well as Lochinvar expansion.

So those are the two components that are, I'll say bricks and mortar different than in the past and then also the ERP expenditure. So I think we really do not expect to put much more capital in India..

In China as it relates to the expansion in China, how much of it is pure water heaters treatment and then you have the expansion of the Lochinvar piece in China?.

I'm sorry. The Lochinvar piece is in the U.S..

It's all U.S.? Okay..

They have run out of space because whenever you are growing at 10% a year, they have run out of space. So we've added and that will be an over $10 million expansion that we're in the process of doing, the China one is a little bit unique in that it is primarily combi boilers.

We were in a position where we were asked by the government to leave our location of combi boilers so we had two options.

We could have squeezed it in to the new Nanjing 2 plant or we have, I'll call it exclusive right to that adjacent land for us, for a short period of time and we're taking the opportunity to build a facility to accommodate the combi boiler plant as well as new labs etcetera for our instantaneous business which has been growing very quickly..

And then maybe you can follow-up on the question in India in terms of--.

Maybe just add a little bit in terms of Lochinvar expansion.

What we're also doing in Lochinvar with that expansion is expanding our lab capability and we're actually doubling the size of test stations that we have because innovation and as John mentioned earlier, the new product capability and the drive for new products and innovation is a big part of the growth of that business and we continue to see opportunity there, so we're again investing in ourselves and doubling our capacity for engineering and testing at Lochinvar.

In terms of India we have, you know consumer confidence has certainly gone up with the new government and everyone is very hopeful that things will improve. I know as much as anyone else because I read the same news releases.

I can't point to any concrete things that the government has done that is going to specifically impact our industry but consumer confidence is up. We hope to see the housing market improve. Last year it declined, our estimates by about 15%. 25% plus in some of the larger cities, but we're hopeful that things will improve.

In terms of the operations in India, we take an approach anywhere we go. We're a very frugal company in terms of when it comes to people and when it comes to driving costs out of our operations and we have processes that focus on lean and continuous improvement and all of the programs that have made us a successful manufacturer in the U.S.

and Europe and China are applied in India. And the improvements are ongoing and there are specific programs, continuous improvement programs like anywhere else in the world. So I think those areas we're comfortable with and frankly when I look at India, last year was a disappointment in terms of the overall results.

You have heard me say that before and we know the drivers of the downside. On the positive side, we're building our brand, the brand is getting better known and better recognized.

We're building our distribution points in India and all of these are investments for the future and what we believe is going to be a tremendous growth market out in the future..

Our next question comes from Todd Vencil with Sterne Agee..

For fourth quarter, I think you gave the year, but what was the ERP drag in the fourth quarter?.

The ERP drag in the fourth quarter was I think $2 million or $3 million..

Okay.

Was there any drag in 4Q or the prior year? Or was that all incremental?.

It was all incremental the prior year. 2013..

On the price increase I know there was some question about the technological solutions that your competitors are going to come out with.

Is 20% standard in the market at this point? Have your competitors come out yet?.

Todd, we certainly talk about our pricing and what we've done in the marketplace, but I would hate to speculate on what the competition is doing because we just don't fully know and what we've gone out with is about a 20% price increase which covers the cost..

Can you talk a little bit about the Lochinvar expansion that you mentioned here that you are going to be spending some money on this year and just what the plans are there? And just a little more color?.

Like I said, we're expanding our manufacturing area and also our lab space and part of that involves actually literally moving a parking lot and taking over some of the existing parking lot to accommodate this expansion because again, we see tremendous opportunity in this business, certainly today in the North American market.

And out in the future in global markets, although the global part of it is coming slower than we expect, but it certainly - we have high confidence it's going to be there. Like John said we've changed our focus a little bit on the global part because we see the condensing part of the global growth being slow to get there, especially in China.

So we switched some of the resources to go after some of the high input innovative, non-condensing products, specifically for the Chinese market and they will be out somewhere at the end of this year..

Final question this is a bit, but just as a reminder the ERP expenses for this year, that runs through operating profit in the North American operations right?.

Yes..

Our next question comes from Scott Graham with Jefferies..

So my question is, off of a comment that you made during your discussion Ajita, that asset prices had actually gone up? And I was wondering if you would elaborate on that and how you are looking at the M&A in 2015 with currency on your side?.

I'll elaborate on my comment and it's what we're hearing in the marketplace is that with capital being available a lot of companies especially strategics seem to be going after growth and paying premium prices for growth opportunities and so that seems to be driving prices up and that's what we're hearing in the marketplace.

I don't have any statistics to quote that but we're hearing that consistently in the marketplace and with our portfolio of 9% to 10% growth, we don't feel the need to go after growth segments at a premium price. So we're looking at our criteria has not changed.

We're looking at the same disciplined approach that we have had in the past, but the comment was based on what we're hearing about and frankly seeing happening in the marketplace..

And then sort of the part two of that, when you have currency maybe on your side now, is that a partial offset? How are you looking at that?.

I think that you know, when we look at our currency and look at what we have in terms of offshore cash, certainly that would make an offshore acquisition give it, in our criteria which we have published and looked at and that would give an offshore acquisition an advantage and make it look more attractive..

Okay, so it's not like as if you have stepped up your efforts because of currency? Nothing has changed, but maybe more things are streaming better?.

No, I think that our efforts are at a high level as they have been. So from our perspective, nothing has changed..

Okay. Last question is on India.

How much of that $7 million loss in 2014 can you reverse in 2015?.

Well I think as I said, Scott and you probably couldn't hear it, is the water heater business lost about $6.5 million and we invested about $1 million in the water treatment business. We expect the water heater business can go down to probably about $4 million or something loss.

But because of the investment in water treatment, it's going to offset much of that. So we're assuming some volume increases in the Indian market for water heaters as well as more vertical integration which takes out some of the currency exposure we have had there in the past.

So we do expect to see the water heater improve, but the total business will probably lose close to that $7.5 million..

And let me just elaborate a little bit on that Scott. When we talk about the loss in water heaters that includes the expenses for brand-building activities.

So it's a combination of all of that and we continue to invest behind the brand because we believe like I've said a number of times in the long-term viability and attractiveness of the Indian market..

And I'm not showing any further questions at this time. I would like to turn the conference back over to our host..

Thank you all for joining us today. We always welcome your inquiries and if you have further questions, please do not hesitate to contact me..

And one last comment, those of you especially in New York and Boston and Philadelphia who made it in thank you. Kudos to you..

Thank you..

Ladies and gentlemen, this does conclude today's presentation. You may now disconnect and have a wonderful day..