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Letter To The Shareholders
A. O. Smith performed well in 2008 despite the financial market collapse
in the fourth quarter and the overall weakening of the economy. Sales of
$2.3 billion were roughly the same as the prior years. Net earnings of $81.9
million or $2.70 per share were approximately seven percent lower than
the record earnings commodity prices, and the onset of a global recession
in the fourth quarter. This performance represents a tremendous amount
of hard work on the part of all of our employees, and we are proud of this
accomplishment.
Equally as important, we enter 2009 with a strong balance sheet. Cash flow
operating activities, although lower than 2007, was a healthy $107 million
last year; and our debt-to-total-capital ratio remained steady at 34 percent.
We continue to preserve cash and reduce our overall cost structure to maintain
our financial flexibility in the future.
ELECTRICAL PRODUCTS
Electrical Products Company continued to be impacted by the housing recession
in 2008 as sales decreased approximately four percent to $858.1 million. We
took a number of pricing actions in response to higher raw material costs, however
they were unable to offset lower volumes. Reacting to weak market conditions,
many of our OEM customers pursued aggressive inventory reduction programs,
especially as 2008 drew to a close, further impacting motor sales
Operating earnings of $39.1 million were significantly higher than the $23.1 million
earned in 2007; however, earnings included $8.7 million of restructuring expense
in 2008 compared with $22.8 million in restructuring expense the prior year.
Electrical Products concluded its restructuring activities with the closing of the
Scottsville, Ky., and the Mebane, NC., manufacturing plants at the end of last
year. Last March, the company closed its plan in Budapest, Hungary. We expect
to benefit from incremental savings of $15 million in 2009 on top of the $5 million
in savings recorded in 2008. Later this quarter, we expect to open our new
manufacturing facility in Yueyang, China. This plant will produce large hermetic
motors and high-voltage products to serve the rapidly growing commercial hermetic
segment of our business.
SMITH INVESTMENT TRANSACTION
I am pleased to report that on December 9, the company signed a definitive merger
agreement with Smith Investment Company (PK:SMIC) under which Smith Investment
would become a wholly owed subsidiary of A. O. Smith. We have worked hard to
ensure this is a good deal for our shareholders and Smith Investment shareholders
scheduled for the second quarter.
OUTLOOK FOR 2009
Clearly, 2009 will be another challenging year. The housing industry, which experienced
its lowest sales in a generation, is not expected to recover this year. Commercial
construction, which helped to partially offset housing's weakness the last two years,
weakened at the end of 2008; and we not expect a recovery in that market segment
in 2009.
While A. O. Smith is not immune from the effects of this recession, we do have one
important mitigating factor on our side: the underlying non-cyclical replacement demand
in each of our business units. Over the last 10 years, for example, replacement
business has accounted electric motor industry, historical trends show replacement
demand makes up approximately 60 percent of the total market.
There are several other factors that we hope will allow us to ride this particularly rough
spot in the economy. First, we expect water heater pricing to have a positive impact
on the company's profitability in 2009. Second, we will expect growth from the China
market, albeit at a slower pace than the recent past. The final positive factor is that
we expect to enjoy a full year of benefits from the restructuring program Electrical
Products completed in 2008. The company remains on track to achieve $20 million
cost savings we identified when announcing this restructuring initiative.
There is one other factor that will help A. O. Smith tremendously in 2009, and that is
our employees. I am particularly proud of these men and women, who were able to
ignore the distractions caused by the economical melt-down and remain focused
on our customers and on completing a number of important strategic initiatives over
the course of the year. That ability to focus on the business at hand will be challenged
in 2009, thanks to the global recession, but I am confident the A. O. Smith team is
up to the task.
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