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A.O. Smith Corporation (NYSE:AOS)

Q2 2008 Earnings Call

July 17, 2008 10:00 am ET

Executives

Paul W. Jones - Chairman of the Board, President and Chief Executive Officer

Terry M. Murphy - Chief Financial Officer, Executive Vice President

Craig Watson - Vice President of Investor Relations

Analyst

Paul Mammola - Sidoti & Company

Ned Borland - Next Generation Equity

Michael Schneider -Robert W. Baird & Co., Inc.

Matt Summerville - KeyBanc

Jonathon Louison - Anchorage Capital

James Gentile - Newland

Alan Mitrani - Sylvan Lake Asset Management

Presentation

Operator

Welcome to the second quarter 2008 earnings conference call. (Operator Instructions) I would now like to turn the conference to Craig Watson, Vice President of Investor Relations.

Craig Watson

Before we begin with Paul’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. Paul?

Paul Jones

This morning we are pleased to report record second quarter earnings. Our operating units are performing well in the most difficult economy in recent memory. Operating margins in both of our businesses exceeded 9% and we remain confident in our ability to manage the challenges associated with the weak housing market and relentlessly high raw material and energy costs.

Total sales in the second quarter increased slightly to $622 million from $612 million last year. Net earnings of $32 million increased 20% compared to a last year second quarter, while record second quarter earnings per share of a $6 increased 22% reflecting the additional benefit of our share repurchase program. Because of the strong performance in the second quarter we have increased our 2008 earnings forecast to $2.70 to $2.85 per share from our previous estimates of $2.60 to $2.80 per share. We still maintain our previous cautious view regarding the back half of the year.

Terry will now discuss the financials in a little more depth, and then I’ll come back and talk more about the outlook.

Terry Murphy

Sales were about $381 million and the Water Products business were 8% higher than sales of $354 million in the second quarter of last year. Sales growth in China more than 30% and pricing action is to of cover higher steel cost more than offset lower residential water heater unit volumes. Second quarter sales of $242.4 million at Electrical Products declined 6% compared with the same period of last year.

A sharp decline in unit volumes related to the soft housing market more than offset pricing initiatives related to higher costs for steel and copper. Overall second quarter operating profits increased $3.7 million as a result of the Electrical Products strong performance during the quarter. Water products second quarter operating earnings were 36.3 million slightly lower than the second quarter of 2007. Lower residential volume and higher steel costs more than offset the strong growth in China, the higher sales of commercial product and pricing action. Consequently, operating profit margin declined to 9.5% from 10.4% to a year ago.

In Electrical product, second quarter operating profit of $22.5 million increased 24% compared with the second quarter of 2007. In addition to ongoing costs reduction and activity, the increase in operating profit resulted from targeted efforts with certain product lines and customers consistent with profitability roadmap, improving commercial terms including terms for freight, increased pricing for raw materials and favorable manufacturing costs absorption of approximately $3 million.

In addition, the second quarter is almost always the most seasonably strong quarter. Operating profit margin was 9.3% compared to 7% in the second quarter of 2007. The third quarter will be adversely affected by unfavorable absorption, higher steel costs and lower volume, thus the cautionary language we have included in our press release.

We want to be cognize in fact, because of the seasonality of this business and the strong second quarter volumes relative to the rest of the year. The margins in the third and fourth quarters will normally be lower than the margin in the second quarter. Our earnings of $1.6 per share also included in non-recurring net benefit of $0.03 per share related to the restructuring in our motors business.

As planned, we’ve recorded a charge of approximately $2.6 million related to the closure of our plans in Mebane, North Carolina and Scottsville, Kentucky as we prepared to transfer hermetic motor production to Mexico. At the same time, we’ve reported a $2.6 million after-tax currency gain related to the closure of our operation in Budapest. As a result the expense and the gain offset each and the $1 million tax benefit from the U.S. restructuring flow to the bottom-line resulting in the $0.03 per share pick up.

The second quarter of 2007 included pre-tax restructuring expense in the motor business of approximately $100,000. Year-to-date operating cash flow declined to $23 million from $38 million last year. The year-over-year decline was the result of an increase in working capital primarily inventory at Electrical Products related to lower than expected sales volume and an increase in raw material inventory related to increase costs for steel, and improvement in the inventory days of water products offset the increased working capital in electrical products and as a consequence consolidated cash cycle days were flat compared to last year.

As a result of the up positive operating cash flow, our debt-to-total capital ratio decreased to 31.7% from 34.3% at the end of last year. During the second quarter, capital spending totaled $25 million compared with depreciation and amortization of $34 million. Capital spending for the year is still expected to range between $80 million and $90 million, while depreciation and amortization is expected to total approximately $70 million. We’re now projecting operating cash flow of approximately a $110 million to $120 million in 2008.

I’ll turn the call back over to Paul for concluding remarks.

Paul Jones

I just want to update you on some of our initiatives before I conclude with the outlook. First the roadmap at Electrical Products, we are making progress with the lien product initiative and expect to complete the lion share of this product standardization effort in our fractional horsepower motor business, by the end of the fourth quarter. We expect big benefits to flow through the manufacturing process from this standardization.

Terry talked about product in market optimization when he referred to improved pricing that targeted accounts. Over the last year, we have gone back to some of our customers, for products and contract profitability was really challenged, and we laid down new pricing that we believe would put these programs back in the block. In some cases, customers have taken their business elsewhere, while with others we’re not getting paid more fairly and finally our third roadmap initiative, asset optimization remains on scheduled with the closure of the Budapest, Hungary plant completed, and the closings of the plants in the Mebane, North Carolina and Scottsville, Kentucky to be completed by the end of the year.

We continue to expect related cost savings of $5 million in 2008, an annual savings of $20 million in 2009 and beyond. Furthermore, the asset optimization initiative will really benefit from the lien products initiative as cost savings and efficiencies cascade throughout the organization.

In the Water Products business, China sales grew 32% to $51 million and sales have grown almost 40% year-to-date. In addition to the strong growth in unit volume, the business is also benefiting from favorable currency adjustments. The current plant expansion project to double capacity in Nanjing by the end of next remains on scheduled.

For obvious reasons, we are very pleased with the fast growth in sales and profit, we are enjoying in China. As part of our strategy to extend our rapid growth in China to the larger Asian region, A.O. Smith began marketing residential water heaters in India, during the second quarter. Introducing glass-line products specifically designed for consumers in that large and fast growing market. We expect to begin manufacturing in Bangalore, India during 2010.

Now, let’s finish off up with the outlook. To no-ones surprise, weak construction markets continue to challenge us and just about everyone else, and though we enjoy higher commercial sales during the second quarter, we still believe that commercial market will weaken further during the second half of the year and this will have an adverse effect on sales mix and margin, but more importantly, the elevated steel costs we are enduring remain our biggest concern regarding our forecast for the balance of the year.

As depicted on this charts, steel costs are rising dramatically and are expected to remain at record levels for the balance of the year. Our ability to offset these higher costs with pricing will significantly affect our ability to make our forecasted earnings and we will continue to look to our customers to absorb the impact of these increases. Though they will help, our productivity programs will not be enough to offset these historic raw material cost increases.

To concluded, our operating units are performing very well in a difficult market, the performance during the first half of this year is the reflection of our ability to operate our plans efficiently, focus on costs containment and recovery increased raw material costs from our customers.

In addition to the full impact, to the sharply elevated steel costs during the second half of the year, the protracted weakness in the housing market and the likely sort of weaker commercial construction, we’ll make the next six months particularly challenging. Because of the sharply higher raw material costs and lower unit volumes in the second quarter, we expect third quarter earnings to significantly lower than the record $0.79 per share earned in third quarter of 2007, which included a non-recurring tax benefit of $0.10 per share.

Having said that, we are increasing and narrowing our full-year 2008 earnings forecast to $2.70 to $2.85 per share from our previous estimate of $2.60 to $2.80 per share to reflect our strong performance during the first half of 2008. This estimate continues to include approximately $0.25 per share of expense related to restructuring in our Electrical Products business. With that, we’ll now open the call for questions. Operator

Question-and-Answer Session

Operator

(Operator Instructions) Our first question is from the line of Paul Mammola from Sidoti & Company.

Paul Mammola - Sidoti & Company

I think obviously the biggest eye-opener on the page is the Electrical Products operating margin and Paul and Terry, you both went through a few reasons why that is up so big. I’m trying to get a sense of what is the biggest contributors, is it pricing, the restructuring efforts or the contract terms you have seen so far?

Paul Jones

Paul, it’s a lot of things and we’re not going to start going through the list on a priority basis, that will be giving too much information to our competitors, but yes we are benefiting from the mix adjustment relative to the targeted actions that we’ve said we were going to be doing and it’s now that that those actions are showing up on the income statement and I’m equally pleased with all the other things going on to -- with 9.3% margin, it is certainly better that what we’ve done in recent history, but that’s not an acceptable number to us long-term. So, we’re still working on all the pieces of the equation to get the margins up there for us and be able to sustain them.

Paul Mammola - Sidoti & Company

So, would you say that you’re ahead of schedule? In a low cost steel environment, are you ahead of schedule from the 200 basis points addition to the operating margin you forecasted for ’09?

Paul Jones

I don’t think we have a low cost steel environment. I think one in the future, but yeah if we could normalize for that. The team is exceeding the original plan.

Paul Mammola – Sidoti & Company

Okay, and do you have a motor sales growth number for China, I know you have putout the Water Products number?

Terry Murphy

Double-digit

Paul Jones

Its double-digits, continues to be. We are just in the interest of gravity we didn’t put all that in there, but we continue to be as excited about the motor business in China. Throughout the water heater business, it’s rapidly growing this is the commercial hermetic for people on the phone who that are not familiar with it. It’s continuing to grow and that’s a product that we sell around the world. I think the U.S. is now our number four market for that product, we sell more of it in Asia, Middle East and Europe that we do in the U.S.

Paul Mammola – Sidoti & Company

Have you put out a capacity expectation for the India plant? I know it’s early but just trying to get a sense.

Paul Jones

No, we haven’t, we are waiting for the bureaucracy there to sign the plot of land to us. We’ve already, have made a commitment to an industrial part as of other people and we’ve been told, we are going to get a part of land, we’ve haven’t been told what it look like. Whether it would be triangle or rectangle or wide, we are supposed to know that any day now.

We are ready for any contingency and ready to put up the facility, but all I can say is that we are marketing the product there, we are shipping it out of China, its not a China product, it was specifically designed, its been through full life cycle testing for the India market, and so far the order rate is running ahead of our expectations, but that’s all we can say so far.

Operator

Our next question is from the line of Ned Borland from Next Generation Equity.

Ned Borland – Next Generation Equity

Just on the Electrical Products side of the business, the revenue decline of 6%. How much of that was from, customers taking their business elsewhere, I mean can you give me sense for that?

Paul Jones

Well, I think the two biggest, Ned I can clarify it this way. Obviously, the housing market weakness is part of it, but the other part of it rather significant piece would be the customer actions, the targeted customer actions where. You said taking it elsewhere; we do have some customers that are paying to these much higher prices. So, it’s a combination of both things, but either way it helps our margin. If we can eliminate a piece of business that had negative margin or if we can get up enough to make it positive, both of those help

Ned Borland – Next Generation Equity

So, would be pricing adjustments basically net of that, some customers that took their business somewhere else, is what I’m hearing, right.

Paul Jones

Yes.

Ned Borland – Next Generation Equity

And then just on the materials and pricing in both businesses. I mean I think, we were sort of expecting that last quarter on the call there was discussion of, it takes sort of a while for the pricing to offset the costs increases, certainly we didn’t really -- it didn’t seen from these results that we saw that. I mean it looks like that’s going to be coming in the second half of the year. Is your pricing at a level where you think that you’re okay versus your raw material or do you think you would need further increases?

Paul Jones

Ned, we get this question every call, it’s a legitimate question. There are so many moving parts right now, and the numbers are big. Let me give you an example, we expect that based on our feedback from the industry that the scrap index would go down this month and it went up a $105 on an annualized basis just that piece alone is $40 million in additional cost for our company. Our productivity plans don’t add up to that. So we are forced as our competitors to go to the customer base and do everything we can do to help recover those cost, and that’s essentially.

Yes, we are being conservative in our outlook, we always want to make sure we continue to be conservative, but there is some big numbers floating around right and big potential numbers out there and all I can tell you is that on the long-term, we are excited about what we’re going to able to do on having a larger value enhancing corporation here, and we are dealing with these bumps in the road in some cases mountains in the road as they come up and I think our teams are dealing with them pretty effectively.

Ned Borland – Next Generation Equity

Okay and then a couple of small once here, the voluntary headcount reduction. How is that tracking with your expectations?

Paul Jones

We actually had a little bit more benefit in that, but it was negligible.

Ned Borland – Next Generation Equity

Is there anything left on the Share Repurchase Authorization? What do you have outstanding on that?

Paul Jones

We have a one million shares authorization on that, and we are currently involved in the Smith Investment Company proposal for the company, so that means we are in a permanent no-trade periods so we’ve done nothing on that.

Operator

Our next question is from the line of Mike Schneider from Robert W. Baird.

Michael Schneider -Robert W. Baird & Co., Inc.

Maybe we cab start with water heaters, just a few questions. The pricing assumption for the second half, I am just curious what you’ve assume for retail pricing. I know that’s been the area of challenge for you. Have you assume that you do get midyear price increases before the anniversaries of early next year or even more conservative.

Terry Murphy

I can’t answer that Mike.

Michael Schneider -Robert W. Baird & Co., Inc.

And, just for competitive reason?

Terry Murphy

Yes.

Michael Schneider -Robert W. Baird & Co., Inc.

Okay, and then commercial water heaters they were flat or just slightly up even in the first quarter, but its sounds like they were down in units in the second quarter, is that on track with your estimates and have you extrapolated that into the second half.

Paul Jones

Mike its actually running ahead of what we expected and not a lot, a little bit in the second quarter. We have been predicting that would decline and we still are, but we still haven’t seen it.

Terry Murphy

I mean the business is remaining above what we thought it would be which a good thing is.

Michael Schneider -Robert W. Baird & Co., Inc.

Okay, but you still presumably embedded more caution for the second half?

Paul Jones

Yes, we did. Traditionally it does decline overtime for the after housing it does decline, but in our second quarter we did have growth over our last year and we are forecasting it will decline, but I can tell you we haven’t seen it yet. Its still hasn’t come.

Michael Schneider -Robert W. Baird & Co., Inc.

And in the residential portion of water heaters, did you see a pre-buy in the quarterly. We’ve heard from your competitor and distributors that people where trying to beat the July price increases. I presume you did and can you quantify it?

Terry Murphy

It was very small Mike. There probably was one but as the material costs keep going up this might be in every quarter event, as we continue to go the market to recover our costs.

Michael Schneider -Robert W. Baird & Co., Inc.

So, the increase this quarter organically in domestic water heater sales was than all due to price and units were actually down, is that the right way to characterize the quarter?

Terry Murphy

Units were down just very small amounts, so it’s the price.

Michael Schneider -Robert W. Baird & Co., Inc.

Okay and then in motors. I am curious to hear your comment about the $3 million more favorable overhead absorption; can you give us some more color on that and is that year-over-year or sequential?

Paul Jones

It’s a year-over-year comparison and it really just is a -- last year there was negative absorption, this year there is positive absorption. When you look at EPC’s inventories they are actually only up I think $4 million year-over-year. They are up a little bit; in some respects we are looking at -- you’ve got steel cost which is going to increase inventory costs, you’ve also got a situation where we are closing these facilities and there is a need to build some product and advance with the closing of the facilities, so its not something that we necessarily expect to continue, but when you look at it on a year-over-yea basis there is building of inventories, which created positive absorption.

Michael Schneider -Robert W. Baird & Co., Inc.

That’s even in the phase of the 6% revenue decline in motors?

Paul Jones

Yes, because when you keep in mind there is also raw material cost and obviously we’ve got steel costs that are higher and you’ve got building of some inventories as a result of the closing of the facility so…

Michael Schneider -Robert W. Baird & Co., Inc.

The motor margins in the second half, your comments there about sequentially lower margins is -- I guess can you give us some senses that in equal portion of lower production and an assumption around even further declines in volumes or is it one more than the other?

Paul Jones

I think that you’re right-on that we expect volume declines in the third quarters. Because of volume declines we are not going to absorb as much fixed costs which will cause margin pressures probably in the third quarter as well. So, I think that when we look ahead into the third quarter we are saying, we expect that volumes are going to be off, quarter-to-quarter and you are not going to have some of these things like we had this quarter relative to favorable absorption.

Michael Schneider -Robert W. Baird & Co., Inc.

Okay and then just stepping back a bit, you’re largest distributor in water heaters is having cash flow problems. They even cut the dividend yesterday, have you done any assessment around bad debts, are you seeing any interruptions in shipments.

Paul Jones

We’ve obviously -- giving the weakness in the economy and everything, we’ve had a couple of hits over the last year that report us on; both are meant to be motors customers, those happened last year, but we are very carefully monitoring things with our customer base and I think the incident which you are talking about is just a conservative customer of ours doing what they think is prudent.

Terry Murphy

I think things generally overtime Michel we just tighten the credit policy, so it’s something that we look at on a regular basis.

Paul Jones

Yes we mentioned a little bit about commercial terms and the EPC, Electrical Products Comments. That’s somehow that there’s a tightening of credit policies in addition to looking at things like great allowances and the like.

Michael Schneider -Robert W. Baird & Co., Inc.

The operating cash flow Terry, the guidance was reduced I believe by about 12%, could you give us some color on that as to why the CapEx and D&A did not change?

Terry Murphy

The biggest item there is that we did not have a pension contribution in the earlier cash flow numbers, we’re now looking to make a $10 million contribution to the pension plan and that’s the biggest single change from what’s you heard before.

Operator

Our next question is from the line of Matt Summerville from KeyBanc.

Matt Summerville – KeyBanc

A couple of questions; what’s the full year tax rate assumption we should be using Terry?

Terry Murphy

25%.

Matt Summerville – KeyBanc

Paul you mentioned the scrap index you tracked pricing up $105 is that increase what you’re calling the $40 million cost headwind and if so when does that headwind kind of hit and that with respect to the original question that I would think people are still trying to figure out is one, in the first half of the year, do you feel you were in parity with raw material costs and selling prices and based on what you know today, do you feel your imparity right now for the second half of the year?

Paul Jones

What I am trying to say and I’ll explain it. The scarp index is one of the indices we used relative to where we buy our steel and what we pay for it. It’s typically a quarterly average, so one point does not make the whole quarter, but we were expecting -- the spread this is the number two Bush links in Chicago or the Chicago Exchange. It was $430 of ton in April, its $890 of ton now; it’s gone up $460 of ton in three months.

Overtime that will be a significant impact on our cost. If all of our indices went up by 400,000 tons a year, so if all of our steel goes up $100 of ton and we have got a $40 million annual cost increase from that element. We have had several increases going back to the March, April, May, June timeframe.

I was just reacting to something that happened four days ago on Monday this week and again believe me I understand your issues, all I can say is we are doing everything we can to recover all of these increasing costs that are hitting our business and we will continue to do so, but I can not get into to making statements like really want me to make I just can’t do that for a competitive reasons. Just keep watching our margins, that’s the one way a answer I can give you. Keep watching our margins, keep looking of what we’re doing in the business, are we improving it or not, in spite of all these large moving parts that we have going on right now.

Matt Summerville – KeyBanc

How much of the sequential improvement in the motor business do you believe is due to seasonality? I am trying to look at kind of what the base level of margin should be kind of thinking about the back half of the year.

Paul Jones

Very little, very little of it is seasonal; our biggest issue there other than raw material cost is a weak housing market in the U.S.

Operator

Our next question is from the line of [Jonathon Louison] from Anchorage Capital.

Jonathon Louison - Anchorage Capital

First, how much of the revenue could be attributed to currency?

Terry Murphy

Not a significant amount; less than probably $7 million to $8 million.

Jonathon Louison - Anchorage Capital

$7 million to $8 million and do you hedge currency at all?

Terry Murphy

Yes, we certainly do hedge currency.

Jonathon Louison - Anchorage Capital

You do and then secondly on the pre-buy, you said that it was very small. I mean we have pre-buy issues before, I think most recently in the fourth quarter of ’07, how did it compare to that?

Paul Jones

Well, I think it’s safe to say that we have a lot of customers who would liked to have bought more but our terms or price and effect at the time of shipment and we tend to put some restrains on how much they can buy. It doesn’t do us any good to pump up second quarter revenue to expense it in the third quarter, so it was negligible; it was just a small amount.

Jonathon Louison - Anchorage Capital

And you don’t think it should have a real volume impact on the second quarter, on the third quarter then?

Paul Jones

No. It hasn’t so far. Our order rates are very good.

Jonathon Louison - Anchorage Capital

And then what about, in your water products I know your margins are about 9.5% less than the last quarter. In terms of your purchasing of steel, how much of the steel that you purchased this year, this quarter was bought earlier in the quarter than say same time last year?

Paul Jones

I think it’s safe to say, we will buy all of the steel we can find at any time. We are able to keep our supply and keep our plants fed with steel, which by the way a lot of companies can’t say but we’re really comfortable that we’re going to have a continuing supply but to sat that there is excess out there that we could load up on I think would be an overstatement.

Jonathon Louison - Anchorage Capital

Right, so I mean you’re buying -- as we’ve seen that price kind of run up this year. It’s been running up -- it ran up pretty heavily throughout the quarter and you were buying throughout the quarter?

Paul Jones

Yes, we are running our factories throughout the quarter.

Operator

Our next question is from the line of James Gentile from Newland.

James Gentile - Newland

I am looking at the second half guidance and you have been very forth coming in the weakness that you’re forecasting in your models etc. The street for the third quarter, in particular already has $0.60, which by any stretch of the imagination down from the 79 would be considered significant at 25%. I mean is there any reason to think that significant would mean more than that?

Paul Jones

Well, let me answer at this way, the 79 had $0.10 of tax, so we’re really comparing to a 69 and, we don’t give quarterly guidance, make our earnings as high as possible, the quarter, the year and next year and beyond. We feel good about how thing are going to go going forward. It’s just right now is you keep reusing the same old phrase. There is a lot of moving parts with a lot of big numbers in it. I am confident that we’re doing all the things that we can do to help maximize returns. We’ll be back in there months and see how well we do.

James Gentile - Newland

Exactly, the street clearly is already forecasting a very weak second half, so I think you are executing fantastically in this environment. Just one more question on pre-buy for water heaters. Just to confirm the last comment that you made Paul, is that -- you have not seen a significant pre-buy in the second quarter?

Paul Jones

No.

James Gentile - Newland

Okay good and then giving the underlying margin trends in motors, no reason to think we are not on track to yield that $20 million in cost of savings in 2009?

Paul Jones

We are still comfortable, that will occur in next year.

James Gentile - Newland

Fantastic and how much stock did you buyback in the quarter.

Paul Jones

None.

James Gentile - Newland

In the first half?

Terry Murphy

The reason for that James is that, SICO proposal, that company proposal, the time of that proposal was made from that point on we are restricted relative to it. For the company to buyback share we are following the same rules as individual relative to insider information. So we’re under a situation where we can’t -- we’ve been advised by counsels that we cannot be buying back shares.

James Gentile - Newland

Great and when is that listed approximately?

Paul Jones

When we get the two special committees. I still had the project; the Smith Investment Company’s special committee has made a proposal. We’ve formed a special committee, and as far as I know they’re still discussing the proposals, going back and forth at the point of time that we reached an agreement that will be disclosed at that time.

Operator

Your next question comes from Alan Mitrani from Sylvan Lake Asset Management.

Alan Mitrani - Sylvan Lake Asset Management

Are your competitors going along with your price increases?

Paul Jones

I can’t comment on that.

Alan Mitrani - Sylvan Lake Asset Management

Well, why not; in terms of the electrical, how is that a competitors disadvantage if you comment on that?

Paul Jones

Well it’s a concentrated industry. We do not discuss publicly what we are doing. You folks pick it up from the marketplace and whatever is happening -- I think it’s the safe assumption that that anybody to buy steel is seeing increased cost and I think it’s a safe assumption that everybody is probably doing everything they can to cover.

Alan Mitrani - Sylvan Lake Asset Management

Okay and the $20 million of cost savings, it seems like a lot of that a physical plants being shutdown. Does that have anything to do? Does that assume that steel prices keep going up as some of the input costs because I know raw material are a pretty sizeable percentage of your COGS in that business?

Paul Jones

That didn’t affect our revenue. We are moving capacity to a lower cost location and a lot of that savings is from the fixed factory overhead we have as well as some labor savings and as I am moving, the product line capacity and capability will remain the same, we are not giving up any of that. It’s just a matter of lowering our variable cost and in some cases our fixed cost by shutting down these plants and consolidating into existing plants that we already have that can take that additional capacity and capability into them.

Alan Mitrani - Sylvan Lake Asset Management

Okay, can you also talk about any divestiture that you are looking to do?

Paul Jones

No.

Alan Mitrani - Sylvan Lake Asset Management

Do you have any strategic moves on the table or is that all part of the Smithfield too?

Paul Jones

Well, that the Smithfield’s doesn’t have anything do with A.O. Smith asset base at all and we are still going to keep going the way we are, but we are always looking at whatever we can do to improve shareholder returns in all elements of the portfolio we have.

Alan Mitrani - Sylvan Lake Asset Management

Any idea when we are going to here something on the Smith’s proposal?

Paul Jones

No.

Alan Mitrani - Sylvan Lake Asset Management

Is that a rate event?

Paul Jones

No, not on that special committee; we just had a board meeting and their report was nothing, we are still talking, so I do not know what’s going on there and neither is anybody else on our board other than the three members of the special committee and they are doing their job as they should.

Operator

You have a follow-up question from Mike Schneider from Robert W. Baird.

Michael Schneider- Robert W. Baird & Co., Inc

Can you just give us some color on the performance of the sub segments within motors that is just the range of increases and declines and problems in distribution, age factor, etc?

Paul Jones

Well I think it’s safe to say that we were primarily down in the housing related things. Our distribution which has been one of those 10% a year plus growers was probably flat and has been for a while and then on course of the -- as we’ve already mentioned we are up strong double-digits out of Asia. So, that’s about as much colors as I think I can give for competitive reasons Mike I am sure you understand.

Operator

You have a follow-up question from Paul Mammola from Sidoti & Company.

Paul Mammola - Sidoti & Company

There was some rumblings about a joint venture for the filtration products in Asia possibly, is there any update on that? Is that sort of a near term sort of catalyst we can expect?

Paul Jones

That’s an area that we’re reviewing of opportunity whether we do it on our own or with the joint venture or acquirer or whatever all those are open options, we don’t have any particular route that we are following to get to that, but we think water filtration is a potential market opportunity and we are looking at it is as maybe a place to deploy some capital to get some significant returns for our shareholders. A lot of company’s are looking at this right now, so we are being in our usual cautionary mode. We will be pretty darn sure if this thing is going to work and we decided to go a different route.

Paul Mammola - Sidoti & Company

Paul and if you could or not I am not sure would you classify that as near term or maybe I’m asking too much?

Paul Jones

Yes I get in trouble every time it’s scheduled that we are going to do an acquisition or joint venture, but it is still on the list of things that we’re pursing and we are continuing to have multiple discussions in that area.

Operator

Thank you and there are no further questions.

Paul Jones

We appreciate everybody’s attention. Thank you, very much.

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Source: A.O. Smith Corporation Q2 2008 Earnings Call Transcript
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