Patricia K. Ackerman – VP, IR and Treasurer Ajita G. Rajendra – Chairman, President, and CEO John J. Kita – EVP and CFO.

Jeffrey Hammond – KeyBanc Capital Markets Todd Vencil – Sterne, Agee, & Leach William Bremer – Maxim Group Kevin Maczka - BB&T Capital Markets Mike Halloran - Robert W.

Baird Samuel Eisner - Goldman Sachs Robert McCarthy – Stifel Ryan Connors - Boenning & Scattergood Larry De Maria - William Blair Unidentified Analyst - Jefferies David Rose – Wedbush Securities.

Good day, ladies and gentlemen, and welcome to the A. O. Smith Corp Third Quarter 2015 Earnings Conference Call. At this time all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions]. As a reminder, this conference is being recorded.

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

Thank you, Shannel. Good morning, ladies and gentlemen, and thank you for joining us on our 2015 third 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. I will now turn the call over to Ajita who will begin with remarks on slide 3..

Thank you, Pat and good morning, ladies and gentlemen. We set earnings records again in the third quarter and sales were the second highest in company history. Here are a few highlights. Organic growth in both of our segments drove sales 7.5% higher to a third quarter record of $625 million.

Despite being a record, this is lower than our previous estimate for the third quarter as we believe a pre-buy of residential water heaters in the first quarter ultimately negatively impacted third quarter volume. In addition, the decline in the value of the Chinese currency negatively impacted sales by $5 million.

China sales were up over 13% in local currency. Net earnings of $0.82 per share were 39% higher than the adjusted earnings per share of $0.59 in 2014. We continue to review our capital allocation and dedicate a portion to return to shareholders.

In addition to our regular dividend we repurchased approximately 850,000 shares of $57 million during the third quarter. Our transition to NAECA III compliant products is complete. This was a complex project impacting approximately 80% of our U.S. residential water heaters. John will now describe our results in more detail beginning with slide 4. .

Thank you, Ajita. Sales in the third quarter of 625 million were 7.5% higher than the previous year. Net earnings of 74 million were 38% higher than third quarter adjusted earnings in 2014. As shown on slide 5, net earnings of $0.82 per share improved 39% compared with adjusted earnings per share of $0.59 in 2014.

Sales in our North America segment of 417 million increased 6% over 2014, driven by a price increases in the U.S. and Canada for residential and commercial water heaters and higher volumes of commercial water heaters and commercial boilers.

Residential volumes declined as we believe channel inventory continues to adjust to the pre-buy in the first quarter. Rest of world segment sales of 217 million increased over 9% compared with 2014. China sales increased over 13% in local currency driven by higher demand for water heaters and water treatment products.

Higher China sales were partially offset by currency translation and lower sales in India and Europe. Consistent with prior years we believe inventory levels at some of our customers in China were elevated in advance of the one week holiday in October.

On slide 7, North America operating earnings of 91 million were 61% higher than adjusted segment operating earnings in the previous year and operating margin of 21.7% was significantly above the 14.4% adjusted operating margins one year ago. Pricing actions in the U.S.

and Canada, higher sales of the Lochinvar-branded products, and commercial water heaters and lower steel and ERP implementation cost contributed to the significantly improved segment performance. The impact to profits from lower residential volumes in the U.S. partially offset these favorable factors.

Rest of world operating earnings of 27 million declined compared with 2014. Higher sales and lower steel costs were more than offset by lower sales of highly profitable commercial water heaters in China and increased selling, general, and administrative expenses.

Higher promotion cost in advance of China’s one week holiday in October as well as higher development and advertising cost associated with the 2015 launch of air purification in China and water treatment products in India were the primary drivers of higher segment SG&A expenses.

Segment operating earnings were reduced by almost 1 million due to currency translations. As a result of those factors, third quarter 2015 operating margin of 12.6% was more than the 15.1% operating margin in 2014. Our corporate expenses declined from the adjusted corporate expenses to prior year primarily as a result of higher interest income.

Our effective income tax rate during the first nine months of 2015 up 30.7% was higher than the previous year primarily due to the change in our geographic earnings met. We anticipate our effective income tax rate for the full year will be similar to earlier projections of approximately 30.5%.

Cash provided by continuing operations during the first nine months of 2015 was 232 million compared with 165 million provided in 2014 driven primarily by higher earnings and smaller outlays for working capital in the 2015 period. Our liquidity position and balance sheet remains strong. Our debt to capital ratio was 15% at the end of September 2015.

We have cash balances totaling more than 600 million located offshore and our net cash position was approximately 345 million at the end of September. During the first nine months of the year we repurchased approximately 1.6 million shares of common stock for a total of $104 million under a 10b51 automatic trading plan and in the open markets.

We had approximately 900,000 shares remaining on our existing authorization authority at the end of September.

Depending on factors such as stock price, working capital requirements, and alternative investment opportunities we expect to spend approximately 128 million on share repurchase activity in 2015 resulting in net cash levels similar to 2014 year-end levels. This is consistent with our stated capital allocation strategy.

Please turn to slide 9 for several full year assumptions. We expect our cash flow from operations in 2015 to be approximately 300 million.

We expect capital expenditures to be between $85 million and $90 million in 2015 which includes approximately 17 million to support the ERP implementation and approximately 30 million related to capacity expansions in China and in the U.S. with the U.S. portion in support of Lochinvar-branded sale.

Our depreciation and amortization expense is expected to be approximately 65 million in 2015. We successfully completed our first two ERP go live milestones in August 2014 and May 2015. We expect to convert the majority of our North America plant sites by the end of 2016.

ERP implementation expenses were 14 million in 2014 and are projected to be about 17 million in 2015. Our corporate and other expenses are expected to be approximately 43 million in 2015. This morning we increased our 2015 EPS guidance to be between $3.08 and $3.12 per share.

The midpoint of our upgraded EPS guidance represents a 28% increase in EPS compared with our 2014 adjusted results. I will now turn the call back to Ajita who will summarize the assumptions in our 2015 outlook and our growth strategy beginning on slide 11. Ajita. .

Thank you, John. Our China business grew 15% in local currency through the first nine months of 2015. Many of you have seen our China growth model. In the past we have used a multiple of China GDP as a simple proxy for our China growth.

We do not believe that China GDP is the only driver of our growth, nor does it adequately reflect our potential in China. We are a consumer product company in China which distinguishes us from most industrial companies operating in China today.

We have three growth drivers underpinning our China business which gives us the confidence to continue to project an annual growth rate of approximately 15% in local currency for the foreseeable future. The first driver is overall market growth which we believe is impacted by household formation and a growing replacement market.

One factor that might not be obvious when looking at our China business for the first time is that a developer is very unlikely to install water heater or water purification products in apartments offered for sale. In fact about 80% of high rise apartments in China are sold without water heaters or other appliances.

The newly formed households essentially buys an apartment with four walls and decorates it or finishes it after purchase. We view the unsold apartments as a major opportunity in China which is very different than in the U.S.

Our focus therefore is not on new apartments that have been built but on the sales of apartments to individual home owners which by the way is increasing. The three months moving average year-over-year growth rate of new apartment square footage sold was in the mid-teens in July and in August.

The other proxies we used to track water heater and water treatment appliance sales growth are retail sales as well as growth in the consumption portion of GDP. The IMS forecast for China consumption growth which was published in August is 7% this year and almost 8% next year.

With continued urbanization, growth in the middle class and a replacement and upgrade markets of 50% in the larger cities, this is based not surveyed, we expect strong market growth to continue in China for quite some time into the foreseeable future. The second growth driver is market share gains and the increases in average price.

We have a strong market position by value in the electric wall hung category. Our position in gas tankers while a leader is less than 20% by value. We see opportunity to gain more share in our well accepted and patented super quite models.

Our commitment to engineering resources will continue to result in new product with features and benefits in which consumers be valued and for which they are willing to pay an incrementally higher price. This results in a favorable mix impact and increases the average price per unit sold.

The third growth driver is fast growing ancillary product category, the most significant example of which is water treatment. A. O. Smith branded water treatment added 5 percentage points of growth to our total China volume in each of the last two years and is expected to grow from $75 million last year to over $105 million this year.

In addition we expect to sell approximately $8 million in air purifiers in 2015, after launching the A. O. Smith branded category in March of this year. The combination of A. O. Smith branded water treatment and air purifiers will add over 5 percentage points of growth this year.

The last two drivers I mentioned are primarily in our control as we continue to invest behind them. The first is a function of the growing replacement market and urban household formation especially at the income levels in which consumers typically buy our products and which is forecasted to increase significantly over the next few years.

Combining these three growth drivers gives us the confidence that we will continue to grow at approximately 15% annually in local currency for a number of years into the future. On the next slide I will describe our portfolio growth model. We believe our 8% organic growth potential for the next several years differentiates A. O.

Smith among other industrial companies. We are comfortable with our projected China growth rate of approximately 15% in local currency as I have explained. Sales of Lochinvar branded products grew over 9% during the first nine months of 2015 which included commercial boilers growing at a faster rate.

Given the strength in our end markets we continue to believe sales of Lochinvar branded products will grow approximately 10% per year. The residential water heater industry continues to transition through the NAECA III regulatory change as channel inventories built in the first half of the year continue to run off.

Based on our volumes through the first nine months of the year, we believe the industry volumes will be flat for the year, slightly less than the pace year-to-date. Our estimate for industry volumes of commercial water heaters is 178,000 or 6% increase over last year, and also slightly less than the pace year-to-date.

We expect sales in India will be approximately $15 million, down from our earlier projection of $20 million due to decline in new home sales that is a result of lower than expected sales of water heater and water treatment products. Losses are expected to be slightly higher than the prior year.

Slide 13, the next slide outlines our four options for capital allocation. One, we continue to invest in ourselves. As John mentioned earlier, we expect to spend approximately $85 million to $90 million this year on capital projects.

Two, we have borrowing capacity and cash to support over $1 billion worth of acquisition and our strategy has not changed. We remain focused on water heating and water treating companies around the world as well as business which will leverage our brand and distribution channels in China.

Three, we will deliver a growing, sustainable, and competitive dividend. We have increased our dividend by 20% or more in each of the last four years.

And four, we are satisfied with the cash and borrowing capacity we have for acquisitions therefore we are comfortable repurchasing shares in 2015 in an amount slightly less than the free cash flow after dividends or approximately $130 million. This concludes our prepared remarks and now we are open for questions. .

[Operator Instructions]. And our first question comes from Jeff Hammond of KeyBanc Capital Markets. Your line is now open. Please go ahead. .

Can you hear me?.

Can now. .

Okay, can you just -- I mean the margins are exceptional in North America, can you just talk about any aberrations to the good and just talk about sustainability of those margins?.

Well, as we have talked in the past there are several significant items. We have had price increases that we have talked about in commercial and residential and also in Canada. Lochinvar sales were up in the third quarter and their historically back half of the year is much stronger than the first half of the year so that significantly helps margins.

Commercial volumes were also up and so it is kind of a series [ph] and material cost were down. So it is a series of many items. Now, the current margins were over 21% in North America.

Again our health buy Lochinvar in the second half of the year, we talked last quarter and he said that on an ongoing annual basis flat 19% to 20% has reached the current commercial level pricing and deferred levels. .

Okay, and then just real quick on residential, what is your assessment of kind of inventory that was pre-bought being kind of rung out and then along those same lines any kind of feedback from distributors or the channel that consumers are reacting negatively to kind of the higher price point products around kind of the NAECA increase?.

Well, so the first one is inventory levels. We said at the end of June they were slightly elevated. I guess now in hindsight they were probably a little more elevated than what we thought. If you look at what happened, the trend during the quarter in July and August thus far residentials were down about 5% -- 4% to 5%.

We are expecting in September they were down closer to 20%. Now part of that is a very difficult comp with the prior year but the other part was still meaningful adjustments of inventory levels. And I think when you go back on what we have said, when we started the year we said that we thought there was a pre-buy of 100,000 units in 2014.

Then we rolled forward to the first quarter and the first quarter volumes were up 300,000. In the second quarter we said we assumed residential was going to be down about 10% and it was flat and we were surprised by that and we -- I will say prematurely then took our estimates for the industry up by about 150,000 units.

I think we are right back to where we started with our original projections saying we think the industry is going to be flat for the year and part of that is going to come out of September and October. So that would be our best guess. I will comment on consumer pricing and I haven’t heard anything.

I will make the comment that from an end consumer product, the price is very reasonable. You get a six year warranty, you get a very energy efficient product that is going to last 12 to 14 years. So, in the appliance world it is a very reasonably priced end product that I guess -- I haven’t heard any push back if you will. .

I think that is very accurate. There has been no push back we are hearing in the marketplace in terms of from the end user. .

Okay, thanks guys. .

Thank you and our next question comes from Todd Vencil of Sterne, Agee. Your line is now open. Please go ahead. .

Hey, good morning guys. .

Good morning..

Speaking with North America residential for a second, if we look at the margin is there any way to kind of -- I think the three big categories you sort of decided there were -- that we would think about were the mix really down and the higher margin commercial and Lochinvar up.

There has got to be some production incremental going on there and then price cost, on the price cost obviously you had the price increase but the new units were more expensive, have you actually seen an improvement in your price cost spread there that you can tell?.

Well the only comment I’ll make is fuel cost have come down somewhat. But otherwise I think you summarized it pretty well. It is a combination of price increases and non data and commercial both in the U.S. and Canada. We have higher margin dollars associated with the NAECA product.

We had a very strong again commercial which helps both our Lochinvar and our commercial water heaters. And we have lower material cost. It’s the variety and then on top of it compared to the prior year we had about 5 million less ERP cost. So it’s a variety of several items. .

Got it, thanks.

And I think you just said this but I will just ask this it is really a way to make sure the 20% increase you guys put it on the NAECA products that hold up even in the face of the declines in volumes that you have seen in the third quarter?.

In the declines in volumes in the third quarter, as we stated in the past we did increase prices for the new NAECA III products on average 20% and we have been very transparent with what the NAECA pricing increase is. We really can't comment any further on pricing as we’re the only public company in our industry. .

Got it, fair enough.

Switching to China just to make sure you said, Ajita I think that in the first nine months of the year China growth ex-currency was about 15%?.

Yes. .

Okay, and then the inventory issues that you mentioned heading into holiday are we through those at this point do you think. .

Well I don’t think we necessarily said we had inventory issues. I mean we said that inventory levels in the third quarter were up consistent with the prior year and we think that was driven primarily by the holiday that comes in late September and goes through October. So at this point I don’t think we are uncomfortable with the inventory level. .

And as John said, the increase we saw was in inline with the increase we had last year. .

Got it, understood, thanks for that.

And then final words from me, if we think about the China business and I just want to make sure I am thinking about the math the right way, you mentioned that water accumulated filtration I think added, I think you said more than 5 percentage points to the growth rate, should we take from that the growth rate on water heaters is around 10%?.

I mean so when we break it into the three buckets we really say that the first bucket is the water heater market and our expectation is its going to grow about 7%. And I say that’s about what we’re seeing and we now have the formal number for last year and as we look at numbers and then we’re seeing that’s about 70% of our business.

So that ends up being about 5 points. And then the third bucket is the one you are eluding to when you look at our water treatment for the last two years that went from 18 to 43 to 75, that added 5 points by itself.

This year 73 to over 105 is going to add 4.5 points or whatever and with the air purifier it will add or take us over about 5 points of growth. So I mean that’s how we kind of break it up and then there is the second bucket which Ajita alluded to. .

Got it, okay. Thanks for that. .

And I think just another point to add to that is that we hear lots of obviously news about GDP dropping and it has gone, the forecast has gone for 72, 6.9 but what impacts us more is consumption because unlike a lot of companies we are manufacturing in China for the Chinese market and the Chinese consumer.

And so the consumption portion of GDP is what impacts us more and the forecast -- IMA forecast for that component is growth of 7% to 8% in the next couple of years. So it is very consistent with what we’re seeing and what you are hearing from us. .

Got it, thank you very much..

Thank you and our next question comes from William Bremer of Maxim Group. Your line is now open. Please go ahead. .

Good morning Ajita, John, and Pat. .

Hey Bill. .

Good morning. .

My first question is where steel prices are currently is now the time that the Board thinks about locking in for the foreseeable future, how do you look at that given the balance of your growth? And secondly China, can you give us a sense on the how much more investment is needed specifically on the air purification, is that just basically being targeted for your stores and then just an update on the store rotations in terms of tier 1 to tier 3 phase?.

So, I will start with the last one. Store locations were about 8000 stores so that is top. I think the distribution of 40% in tier 1 and 60% in tier 2 and 3 is still pretty close. So that hasn’t changed.

Your first one is hedging of reconfigured, low cost [ph] hedging that is not as terribly liquid market on the LME and on the exchanges but we continue to look at it. And we have made no formal decisions. The second one was air purifiers.

Well I think the one comment we have made is that given the significant growth in water treatment and we think the potential for air purification, we are going to have to put some breath in water in China for those two businesses and we are kind of evaluating the options right now on what to do there. .

And I think Bill if your question was around the investment in terms of SG&A and advertising, etc we have been saying that we will lose about $4 million in the category, air purification category and we are comfortable with that. So we are in line with what we have been saying. .

And then once you John on the ERP implementation mentioned 17 million, how much has been spent year-to-date there and am I under the correct assumption of 5 million hitting the fourth quarter?.

Yeah, I think the fourth quarter is about $4 million or $5 million Bill, somewhere in that range is reasonable. So when you are 17 so we spend about 13 year-to-date. I mean we have been kind of running at that $4 million to $5 million range if you will. .

And that is exclusively in North America, correct. .

That is exclusively in North America. .

Great, thank you. .

Thank you and our next question comes from Kevin Maczka of BB&T Capital Markets. Your line is now open. Please go ahead. .

Thanks, good morning. .

Good morning. .

First question, just to make sure I am clear on the North American water heater forecast that the volumes will be flat this year, so we had a big pre-buy in late 2014, the price increases hit in early 2015, why is it again that is starting to materialize in the form of 20% volume declines in September and October, is that primarily a comp issue or I am just wondering why are we seeing such a severe decline now?.

I mean, it is a great question and obviously we did not certainly anticipate it when we took volumes out. But the best and I will use the word guess is lead times. If you go back to the first quarter they certainly wanted some of the -- our partners wanted some of the old products and we put them on allocation but they got them.

The new product came out and they certainly wanted some of that product and the lead times I think for the industry extended some. And because we were changing 80% of our SKUs, it was a significant undertaking. So, I think there was safety stock built up, etc, etc that is just again our estimate and that now lead times are back to more normal levels.

For us and we would guess for all of our competition and now there is some excess inventory in the channel. That is the best for lack of better word that we can come up with. .

And I think lot of just in times that some say they adjust upwards and lead times go out and they adjust downwards and lead times shorten. And I think it is an impact of that. But as John said, it surprised us too. It was higher than we anticipated but we don’t see any major market impact that is causing that other than inventory. .

And so we are right back as I said earlier to our original estimate where we thought there was about 100,000 of pre-buy, 100,000 to 150,000 pre-buy in the fourth quarter and we said completions were going to be up 100 to 150. And so we would watch and we kind of said the industry would be flat.

Now the thing to remember is the industry has grown pretty nicely over the last two years as replacement has become a bigger piece. So I think right now we’re staying flat as a reasonable expectation. .

Got it, it all makes sense and to get too flat what does that imply for the remaining months of the year. .

The remaining months of the year, for the fourth quarter we would expect it is going to be down and again part of that is a reflection of that pre-buy that happened last year, right, that’s 100,000 to 150,000 units. So it ends up with the industry being down I guess couple hundred thousand units or something. .

Okay, got it. And if I could just ask one more on China and I appreciate all the comments and the new ones on the resi side with the purchasing the heaters after the apartment purchase but, I am wondering if you can say a little bit more about what you are seeing on the commercial side.

It sounds like that was a little bit softer, is there some macro pressure on that side of the business there?.

Really it did have an effect on margins in the third quarter. We have about a $30 million business last year so it’s not a huge business but it’s a very profitable business. Year-to-date we saw that its down over 30% and it has specifically affected the third quarter by about 3 million sales being down 3 million and profit being down 2 million.

So, the bad news is that it had a significant effect, the good news is the business is only $30 million business and we have seen that in a couple of different parts. We saw that in our Lochinvar business to sell boilers through a distributor. Those sales were down in the third quarter also relatively significantly.

So the bad news is yes, the commercial market is weak. The good news for us is that it is not a huge component of our sales by any means. .

And this is in line with again things we have been reading about China where infrastructure spending has come down and this is again as John said, small part of our business but it is being impacted by that. .

And I’ll jump off after this but that’s likely to continue, it sounds like if in fact that sort of China big picture macro pressure?.

Well in theory but again if we are down to some $20 million we would think at some level that kind of a baseline. So we are down from 30 to probably a little over 20 this year. I am not sure it will go much lower. And it really does mask how well China really did in the quarter because water heaters and water treatment were up very nicely.

You take out that $3 million decline in sales they were up 15% in all their other businesses. So they had a very good quarter. Margins were good. Again except for this effect of the commercial business as well the translation of their margins. And with that margin dollars if you will. So all in all I think China had a very good quarter. .

Okay, great. Thank you. .

Thank you and our next question comes from Mike Halloran of Robert W. Baird. Your line is now open. Please go ahead. .

Good morning everyone. So staying on the China side and staying on the margins specifically, you had the promotion cost that extended in the third quarter this year.

I think last year and maybe even the year before they were kind of flipped around with very minimal promotion oriented cost in the third quarter or more aggressively in the fourth quarter.

Maybe you could just talk about how that tracks as we move into the fourth quarter here and if you expect some revision?.

Well I think we would kind of expect that and I think we talked about that a little bit in previous calls. That last year we had higher margins in the first three quarters and then lower margins in the fourth quarter. And it was really as correctly what you said a distribution of some of the SG&A cost.

And I think we have kind of said that we expect this year is going to be more of a level type kind of margins for China if you will. .

Okay that makes sense there and then North America, not to beat a dead horse but another question on the residential side, is the implication then once you walk through September-October time period that the inventory levels are then about right size and you see some more normalized trends or do you think that the inventory build stretches a little bit longer in the next couple of months or the months we just had?.

I mean as we have talked to our partners we would say it is probably stretches through October and then we anticipationally send a level off. .

That makes sense, thanks guys. .

Thank you and our next question comes from Samuel Eisner of Goldman Sachs. Please go ahead. .

Yeah, thanks very much and good morning everyone. .

Good morning. .

Just going back to the North American resi comments, I want to understand, you mentioned in this talk is there a way to pass out, is there difference in the channel between your wholesaler customers as well as your retail customers?.

In what sense Sam. .

I mean I guess we know who your largest customer is on the retail side or the home center side but just curious if there is a -- the speed stocking is it across the Board destocking, is it more pronounced in one of those main channels, I just want to understand kind of more simple level?.

It is more pronounced in home side. I understand the question now. It is more pronounced in home side. .

Got it, that is helpful there.

And then on the margins, I thought I will ask it again, 700 basis points on a year-on-year basis is pretty phenomenal, you mentioned mix at least for Lochinvar, it is always in the back half of the year so that wouldn’t necessarily be a tailwind, so perhaps you can talk about mix on commercial as well as Lochinvar kind of absent of the normal 2H ramp that you would see far from Lochinvar?.

I am not exactly sure of the question, but I guess what I will confine is that we have said in the past that Lochinvar is about 60% of their earnings come in the last half of the year, 40% in the first half of the year. We are certainly seeing that and their commercial business is very strong which has given better margins for them.

So that is a contributor. We have also seen our commercial business up year-to-date and in the third quarter relatively significantly and again that is a big contributor because those two businesses are our highest margin businesses. .

Alright, I guess my point is though Lochinvar is always going to be stronger in the back half of the year, so on a year-on-year basis there shouldn’t be a change in the profitability unless your mix is dramatically improved on the other winning commercial water years, so that is….

Sam, their margin percentages were up very, very nicely for the quarter and year-to-date and part of that is what you alluded to. Commercial was up more and so that contributed to that. I hope that answers the question but yes, their margin percentage points was up very nicely year-to-date..

Understood. Sorry, didn’t mean to interrupt. And then I guess just lastly on the rest of the world growth rate, the roughly 9.5% that you guys grew I recognize there is some FX headwinds there.

Just wondering if you can put that growth rate that you saw in the quarter into the three main buckets that you guys had referred to as your overall kind of rest of world growth, thanks?.

Well, so first of all remember that China was up about 13.5% not 9%. They were up about 13.5% in the quarter and local currency terms. And I guess if you ask me and I haven’t done it but I would say it was 5% or so for water treatment/air purification. We think the market was probably up 4% to 5%.

When you adjust for the -- I should say 6% to 7% and then you adjust for our 70% of the business. And we continue to gain share in water in the instantaneous side of the market and some price. So I mean, I think it was reasonably split between those three buckets for us to get the 13.5% in local currency terms. .

But I do want to caution that quarter-by-quarter that mix will change and frankly we are not really good at forecasting quarter-by-quarter. But from a longer term or an annual perspective we are very comfortable with those three buckets. And it so happens that this quarter they are about a third each.

But there are times when one will be growing faster than the other and compensating. So, I just want to caution that it is not always a third, a third, a third for the three buckets. .

Got it, that's very helpful. I will get back in queue. Thanks. .

Thank you and our next question comes from Robert McCarthy of Stifel, your line is now open. Please go ahead. .

Good morning everyone. .

Good morning. .

In terms of 2016 and going back to sustainability of the North American margins, given the very impressive performance, I think you alluded earlier in the call that given the factors that were kind of set you would expect a more normalized level of margin in the 2016 time frame could be 19% to 20%, what is the implication for pricing with respect to your North American product, is there disciplined pricing or would you expect tougher pricing incrementally particularly volumes continue to be weak going into 2016?.

You know one thing is that we don’t count and don’t speculate on what's going to happen to price going forward. It is just again we are the only public company and we are the only ones out here talking about plans and speculating on prices, something we just don’t do. .

Okay, fair enough and then I guess tumbling down the question thinking about the deval in China, did you think these steps hurt any of the movement secondly to kind of the high end of the market, it is kind of your bread and butter in terms of or has it hurt pricing in any large degree, how do you think about the deval in terms of the competitive dynamics for you in China?.

We have not seen any movement away from our product being on the high end. And in fact if we look at our short-term market shares in China again from a value perspective we have been inching up. So we have not seen any movement away from the higher end product. .

And I don’t think we would expect to see that we would. .

Okay and then moving on to, you talked about kind of disconnecting from the China GDP multiply which I think makes some sense and focusing on consumption trends but just looking at China overall, I guess obviously the commercial business was an area of weakness.

Are there any other parts of the business that you are just kind of watching I guess in the context of its looks like air purification or was a little late versus your expectation. Obviously these are small numbers but you got it initially about $10 million in resi this year.

It looks like it is going to be 8, can you speak to, are you seeing any areas of incremental weakness aside from the commercial side?.

Not really, I think overall I think like we said during my comments, we are comfortable with the 15% annual growth that we have been talking about.

And to your point we’ve used GDP as a convenient benchmark or reference point in the past but as GDP becomes more volatile I think that’s why we are trying to explain more in terms of what really drives our business and we get down to the three buckets that are impacted really by different components of GDP by consumption as opposed to the whole GDP measure by itself.

.

And air purification I think we have said in the past under $10 million and we were always in that 8 million to 9 million range so I think we are -- we really haven't adjusted that down. I will say that the air purification in the first half of the year, the markets did not grow as expected.

But we really didn’t have much effect on us if we’re just bringing our products into the market place at this point in time. .

The category grew phenomenally fast last year and for the first half of this year has been relatively flat if not down a little. This is the total category in the market. But yes, it’s so comfortable that it’s a great place to go into because we think overtime we’ll be able to bring some innovation and new things to that market. .

You know, okay, thank you for that and then just looking across the other parts of the portfolio, I guess ERP expense next year what is your expectation initially in terms of incremental expense or tailwind or expense coming down in 2016?.

It won't come down. We are going through the planning process right now. It will go up mainly because you end up expensing more during go lives and we will have more go lives next year.

So we are kind of looking at that right now and its probably could approach $25 million I guess next year but we are in the process of doing that when we get in the first quarter call, we’ll have finalized that. .

25 million in total not incremental expense right, okay to be clear right.

And that is very much a guess at this point. .

Now that will be refined down the road. Okay and then just on the M&A front. I mean, obviously you have spoken in the past, you are focused on the value, focused idea or deal in certain regions or geographies. I think you have spoken to the limited opportunity sort of properties.

I mean has anything changed given the macro, given the bid asked in terms of expectations and has it changed kind of your view of capital redeployment here in terms of perhaps doing other things, given that the M&A environment maybe particularly murky or volatile?.

No, first of all the answer is our strategy has not changed. So we have been very consistent with our strategy. There are opportunities out there, no question about it. The market is very expensive. People are paying -- companies who don’t have the organic growth we see are paying very high prices for growth.

And so it makes it a little more challenging type of market but we are sticking to our strategy and our stated objectives in terms of return to shareholders. .

Okay, and the last question is, I mean, without going into 2016 too much because I know you are going to do that later on, I mean just looking at the performance you have had year-to-date how we think about in terms of the relative comparison next year.

Is first half tougher next year or second half tougher next year just thinking about the walk?.

Again, I will give you some macro comments and John you want to add to it, but we don’t expect there to be too much difference in the cycle and the cyclicality of the business. And we are just going through our plans. So our plans are putting them together.

So they are by no means definite but again, longer term we are very comfortable with the 8% plus growth portfolio that we have talked about, organic growth portfolio that we have talked about, very comfortable with that. John, do you have anything to add. .

No, you obviously should incorporate price increases, etc in April so that….

So we have a partial year….

I think we add that but otherwise….

I will leave it there, thanks for your time. .

Thanks. .

Thank you and our next question comes from Ryan Connors of Boenning & Scattergood. Your line is now open. Please go ahead. .

Great, thanks for the time this morning.

I had a question, you talked a lot about the NAECA III situation in terms of the pricing and the tactical impact on channel inventories but I wondered if you could comment on that from the angle of competitive offerings and market share and I guess as the relative merits of everyone's compliant offerings become better understood in the marketplace, is that a situation where you and others will pretty cleanly just map over your respective customer bases to your new offerings or are there opportunities here to either pick up or I guess lose market share based on the relative merits of the different compliant offerings, without getting too technical obviously?.

I think everybody it appears have approached it pretty much the same way and so the offerings that have come out are relatively consistent. So, we would not, I don’t think expect much movement from a market share standpoint either way. .

Okay, and as you -- so is that the way it is being marketed kind of in the channel, or I mean I would imagine there is -- the products are being sold on some kind of relative superiority and there is some competitive dynamics at play there but you are saying that the reality is it is more or less commoditized and then which means it would kind of fall back to more or less a pricing game to some extent then?.

Well, I guess I would say is I don’t think it has really changed the dynamic change before or after in that thought from a product standpoint. But you still have all the things of your distribution channel. We have better distribution channels. We have all of those things that will come into play is not by any meaningful price gains. .

Right, so I think just to reinforce that, the competitive dynamics have not changed vis-à-vis NAECA coming in.

But your point in terms of if you segment the business into the commercial and residential, clearly the residential business is much more commoditized and the commercial business sounds much more in value and that is where frankly we come out on top..

Okay, that's helpful. Thanks so much. .

Thank you and our next question comes from Larry De Maria of William Blair. Your line is now open. Please go ahead. .

Okay, thank you.

In the first catalogue allocation you noted that strategy hasn’t changed so therefore should we assume that share repo policy would continue next year and be reauthorized when you complete the remaining 900,000 shares?.

Yes, I mean from the point of view of saying we are not going to be adding to our cash reserves, we are going to be buying back shares, yes. .

Okay, great, thanks. And then on China sales are obviously strong but below the 15% a quarter. I guess what do you see that gives you the confidence that accelerating to fourth quarter and you are already seeing that.

I am having all maybe the markets responded to the promotions and how are they referenced and maybe other new products in the fourth quarter that we’re talking about?.

So year-to-date we were at about 15% and we would expect the fourth quarter will be about 15% increase and that’s why we’re comfortable with that. And nothing out of the ordinary as I mentioned earlier, we had all of our SPUs [ph] did extremely well except the commercial side and the commercial side its only $30 million business in 2014 numbers.

So it did have an effect but the business is doing very well and we are comfortable with the 15% in the fourth quarter which would give us about 15% for the year. .

Okay and but has the market responded to promotions that you referenced across some earning in October?.

Yes, I think that the sell through would be in the holiday certainly. .

Okay and then one last question I guess, correct me if I am wrong when you are looking for a deceleration margins in the fourth quarter after obviously posting real good results this quarter, is there any reason for this besides in the headwind I don’t know if there is factory shutdowns for seasonal reasons or is there any other reason for deceleration that’s not normal?.

I wouldn’t say we are forecasting much in the way of deceleration of margins in the fourth quarter. We earned $0.82 in the third quarter. The midpoint of our range in the fourth quarter is I guess about $0.84 and so I don’t think we’re expecting much in the way of deceleration in margins by overall.

I mean there will be some on the margin because commercial and Lochinvar is a little bit lighter in the fourth quarter as in the third quarter which is traditional. They have been every year we owned them. In the commercial market we would expect it will be down a little bit but again nothing significant. .

Got it, alright, thanks very much. .

Thank you and our next question comes from Bhupinder Vohra [ph] of Jeffries. Your line is now open. Please go ahead. .

Hey, good morning guys. .

Good morning. .

Most of the questions have been answered. I just wanted to get a sense of we talked about and how we have been talking about your previous presentations in China in the water treatment market, the size of it, and I believe John actually mentioned something about the water treatment in India.

Can you just talk about that like size of the market like what growth rates we see for that category and how it goes over the next few years?.

CMM has estimated that the water treatment in China is going to grow 35% to 40% over the next three or four years. We are seeing this year we would expect probably above 40% growth in that category and that’s what we’ll have.

So we are very comfortable with that mainly because the penetration rate of water treatment equipment in China is very low compared to other developed countries. So I think that’s the basis why CMM is saying that it is going to continue to grow and grow dramatically over the next several years.

And we’re comfortable that the size of the market sorry it is a little hard to get your hands around but we would say that without the AT, etc it is probably a $2 billion market.

Half of it is distributed through our channel and half of it would be on the high end so our gap is probably a $500 million to $600 million market at this point in time but growing dramatically. .

Okay and do you have the same story on the India water treatment..

We do not have the same study in water treatment in India. We just brought that product to market late in the first quarter of 2015. We are really doing it in two cities in India as its heavily advertised product and we wanted to make sure that we were focused on a couple of cities and that’s where we are looking at right now. .

And I believe Ajita you mentioned something like a number you were comfortable investing in China Air Purifier, I believe it was $4 million next year on kind of advertising and marketing, is there a similar number for the other markets like India and if you are doing the same thing for Southeast Asia?.

No, just to clarify what I mentioned was that we expect the air purification number to be negative $4 million in 2015 this year. We have not said anything about next year.

Again these are new businesses we are getting into and we expect that we’ll have to invest behind them which is by the way again part of our strategy which we have been doing right through, that as different categories grow and then their growth stage we’ve always been investing in what's coming down the road and what's going to be our growth engines in the future.

So this is a continuation of that strategy that has been very successful for us in China and we hope in India going forward. .

Okay, that’s all I have. Thank you. .

Thank you and our next question comes from David Rose of Wedbush Securities. Your line is now open. Please go ahead. .

Good morning and thank you for sneaking me in this morning. I was wondering if you can just clarify something on North American margins first and then go into China. Just help me remember the impact of NAECA, you had the price increase so generally you have escalators or adjustments built in when steel prices move.

But because of NAECA you didn’t do that necessarily, does that mean now going forward that we would see adjustments because of steel prices and they could go down, your pricing could go down theoretically, help me understand that, if you don’t mind?.

We have no price adjustments on the wholesale side of the business and we have a few on the retail side of the business. So I don’t think necessarily automatically you can assume that. .

Okay, I was just [indiscernible] we might see something.

So we shouldn’t assume that at all?.

Again, we are not going to comment on future price but there is nothing setup if you will. .

Okay, that’s helpful. And then on China you call out the contribution to growth of water treatment business of being 4.5 points, that business grew 40%, that contribution was less to the growth rate last year so I am assuming roughly 3 points of growth.

If I strip that out of your growth rate that implies that your water heater business last year grew roughly 12%, if I am not mistaken 12% to 13%.

So this step down in growth rate in the water heater business, was there a particular market that was weaker for you, did you see that step down in growth in tier 1 on tier 1 markets, maybe you can break that out for us?.

From a China perspective where one water treatment growth is last year I think was about 5 point not 8 points for the total. This year it will probably be about 4.5 points so it is very close to the same number.

So there is not much of a difference there and as Ajita alluded to there is different buckets and different moving on three buckets year-over-year but nothing specific from a water heater standpoint.

We continue to do very, very well on the instantaneous gas with our new products and again the thing you have to build in there is commercial [indiscernible] and that’s kind of on the periphery is affecting some of the noise..

Okay, and then the DSOs declined nicely in the quarter and I am assuming most of that was that in China, was that North America?.

We have some inventory built for a variety of reasons but our DSOs were down and our account stable base were outside I think year-over-year. Our total days in cash cycle were down. .

Okay, so then on the China front can you just provide a little bit more clarity in terms of how you are monitoring the financial strength of the distributors in China, particularly the independence?.

You know a lot of the independents and the distributors that we have we get our cash up front. So really there isn't a whole bunch of AR type risk that we run in China. .

Okay and then there is strength in terms of being able to support the channel going forward, are you getting any sort of color?.

Well I think we have strong distribution partners because they are selling our product which is selling very well. So I mean we are comfortable with the strength of our distribution partners. And we have a lot of specialty stores. We have I think what 1800 or so specialty stores but those are concentrated.

It is not that we are dealing with 1800 different distributors those are concentrated in a group of distributors if you will. So we continue to do well and our partners are doing well. .

But also I think to answer your question is their concern about their financial strength and their ability to fund the growth that we expect going forward. No, and we do monitor that, we work with them and if we find that there are concerns about that we have a plan to switch them up. So that and that by the way is not anything new.

That’s something that’s been in place for sometime in the way we manage the business in China. .

Okay that’s helpful, thank you Ajita, thank you John..

Thank you and we have a follow up question from William Bremer of Maxim Group. Your line is now open. Please go ahead. .

Thank you for taking it.

One quick one, I was wondering if you could sort of give us a little granularity on Lochinvar, their commercial side specific fabrication orders versus more standard, now each say standard off the shelf products that they serve, can you give us a sense are you starting to see more specific fabricated orders there and then just a quick update on Canada.

.

Not much different in terms of the dynamics with Lochinvar. The condensing boiler segment is very strong. And like John mentioned there was some weakness in the product that non-condensing products that are sold in China through a distributor through the Lochinvar brand. But other than that the dynamics are not very different.

Does that answer your question Bill?.

Well I think Canada -– I mean I think the balance are relatively flat. Obviously there is an effect on the translation back to the U.S. Also much of the product is purchased from the U.S. by three of the four competitors there and that’s really what generated the price increases to maintain our reasonable level profitability. .

Thank you. On Lochinvar just really go into the fact that when we did visit the plants down in Tennessee we definitely saw the expansion occurring and anticipating more specific fabrication for corporate client.

I was wondering if that is what's powering these margins a little bit more at this time?.

As you saw and when we had our Analyst Day there, the expansion is happening and is going very well. That’s the combination of expanding manufacturing capacity and also expanding engineering and testing and lab capacity. And that’s all looking at the long-term.

And as we’ve indicated we think that there is a long runway for this business to continue to grow at 10%. And so what we are doing is just planning for that and that’s going well. So from a longer term perspective since the dynamics are in place and we are very comfortable with that and what's built into our guidance. .

Great, thank you Ajita. .

Thank you. And I'm showing no further questions at this time. I would now like to turn the call over to Ms. Patricia Ackerman for closing remarks..

Thank you for joining us today. Please take note that we will be at the Goldman Sachs Conference in Boston on November 3rd and the Baird Conference in Chicago on November 9th. A short video showcasing our China products and distribution can be found on our website, aosmith.com. Have a wonderful day..

Ladies and gentlemen, thank you for participating in today's conference. This concludes today's program. You may now all disconnect. Everyone have a great day..