RESULTS OF OPERATIONS

THIRD QUARTER AND FIRST NINE MONTHS OF 2009 COMPARED TO 2008

Sales were $501.5 million in the third quarter of 2009 or 16.8 percent lower than sales of $602.7 million in last year's third quarter. Sales for the first nine months of 2009 were $1.48 billion or 17.5 percent lower than sales of $1.80 billion in the same period last year. The decline in sales for both the third quarter and first nine months of 2009 resulted from lower volume for residential and commercial water heaters in North America and declining market demand at Electrical Products. The decline in sales at both of our operating units reflects historically low levels of housing starts and reduced commercial construction activity caused by the global recession.

Net earnings for the third quarter of 2009 were $34.6 or $1.14 per diluted share, establishing a quarterly earnings record, and compared to reported net earnings of $5.8 million or $0.61 per diluted share in the third quarter of 2008. Our reported earnings per share under GAAP have been impacted by required accounting related to the company's transaction with Smith Investment Company (SICO), which closed on April 22, 2009 and is discussed in more detail in Note 1 of the Notes to Condensed Consolidated Financial Statements. For accounting purposes, the former controlling shareholder, SICO, is treated as the acquirer even though A. O. Smith Corporation (the company) is the surviving corporation from a legal standpoint. Prior year and current year-to-date earnings and earnings per share amounts reported by the company include SICO earnings and shares outstanding as adjusted for the exchange ratio of the merger transaction prior to the closing date.

The primary accounting impact of the SICO transaction is in the calculation of earnings per share because the accounting rules require the use of SICO adjusted average shares outstanding prior to closing. The 2009 third quarter earnings and per share amounts are unaffected by the SICO transaction. Eliminating the impact of the transaction as set forth in the table on the following page, non-GAAP net earnings were $21.4 million or $0.70 per diluted share in the third quarter of 2008 and compared to the previously mentioned net earnings of $34.6 million or $1.14 per share in the third quarter of 2009. Reported net earnings for the first nine months of 2009 were $58.6 million or $2.69 per diluted share and compared to net earnings of $21.7 million or $2.29 per share in the first nine months of 2008. Elimination of the impact of the transaction results in non-GAAP net earnings of $67.0 million or $2.21 per diluted share in the first nine months of 2009 as compared to non-GAAP net earnings of $75.2 million or $2.48 per share in the same period of 2008.

We believe that presenting non-GAAP financial information permits investors to compare the financial results of the business operations of the company for the current period to the historical financial results of the company for periods previously reported. Although future discrete quarterly financial information will not be affected by the transaction, 2009 year-to-date and full year earnings per share calculations will continue to be impacted. During 2009 and 2010, we will continue to present non-GAAP earnings per share information for purposes of comparing the financial results of the current period to the historical financial results of the company. Management also uses the non-GAAP information for all internal purposes of reporting results of operations including return on investment measures utilized in determining certain incentive-based compensation and employee profit sharing amounts. Below is a reconciliation of GAAP to non-GAAP earnings and earnings per share as discussed above.

                            A. O. SMITH CORPORATION

                        Reconciliation of Non-GAAP Data

                     In millions, except per share amounts



                                      Third Quarter Ended                  Nine Months Ended
                                         September 30                        September 30
                                    2009               2008              2009              2008
Net Earnings, as reported        $  34.6           $    5.8          $   58.6          $   21.7
Add: Non-GAAP adjustments
attributable to net earnings
of non-controlling interest
and SICO expenses                $     -           $   15.6          $    8.4          $   53.5
Adjusted Earnings                $  34.6           $   21.4          $   67.0          $   75.2
Average Common shares
outstanding, as reported(1)         30.4                9.5              21.8               9.5
Add: Non-GAAP adjustments to
weighted average Common
shares attributable to
non-controlling interest               -               20.9               8.5              20.8
Adjusted average Common
shares outstanding                  30.4               30.4              30.3              30.3

Earnings per Share, as
reported                         $  1.14           $   0.61          $   2.69          $   2.29

Adjusted Earnings per Share      $  1.14           $   0.70          $   2.21          $   2.48

The non-GAAP presentation of adjusted earnings per share should not be construed as an alternative to the results reported in accordance with U.S. GAAP. It is provided solely to assist in the investor's understanding of the impact of these items on the comparability of the company's operations.

(1) Reported shares are calculated as the weighted average of SICO shares prior to the closing and A. O. Smith shares after the closing

Our gross profit margins are unaffected by the aforementioned transaction and in the third quarter of 2009 increased to 27.6 percent from 20.5 percent. Our gross profit margin for the first nine months of 2009 increased to 24.5 percent from 22.1 percent in 2008. The increased margins for both the third quarter and first nine months of 2009 were due to lower third quarter material costs, year over year pricing at Water Products, benefits from prior years restructuring activities at Electrical Products and ongoing cost containment activities at both operations.

Selling, general and administrative (SG&A) expenses were $92.3 million in the third quarter of 2009 or $5.1 million higher than the third quarter of 2008. The majority of the increased SG&A was incurred by Water Products and was associated with selling costs to support higher volume at its China operation. The remainder of the third quarter increase resulted from due diligence costs associated with our recently announced agreement to purchase a majority interest in a China water treatment business and higher corporate expenses. SG&A for the first nine months of 2009 was $265.6 million or $10.2 million less than the same period in 2008 due mostly to salaried personnel reduction activities and lower domestic selling costs. SICO related SG&A was $0.5 million and $1.2 million in the third quarter and first nine months of 2008, respectively, and was negligible in 2009.

In the third quarter of 2009, we had restructuring income of $3.0 million associated with the sale of our Shenzhen, China electric motor facility to the Chinese government, which exercised eminent domain relative to a road construction project. In the first nine months of 2009, restructuring income was $1.5 million as the above gain on the Shenzhen facility was partially offset by a $1.0 million loss on sale of a vacated facility from a previously owned business and $0.5 million of moving costs associated with certain Electrical Products plant closures. We recognized $2.4 million

and $8.1 million of restructuring charges in the third quarter and nine months of 2008, respectively. Included in these 2008 charges were expenses incurred by SICO relative to the merger transaction amounting to $0.3 million and $1.9 million in the third quarter and first nine months, respectively. The remainder of the 2008 charges consisted mostly of severance and asset impairment associated with plant closures initiated by Electrical Products in 2007 and completed in 2008.

Interest expense in 2009 decreased from 2008 by $2.1 million and $6.7 million for the third quarter and first nine months, respectively, due to lower interest rates and debt levels.

We have significant pension benefit costs and credits that are developed from actuarial valuations. The valuations reflect key assumptions regarding among other things, discount rates, expected return on assets, retirement ages, and years of service. Consideration is given to current market conditions, including changes in interest rates in making these assumptions. Our assumptions for the expected rate of return on plan assets is 8.75 percent in 2009, unchanged from 2008. The discount rate used to determine net periodic pension costs increased from 6.5 percent in 2008 to 6.6 percent in 2009. Pension expense for the first nine months of 2009 was $6.2 million or $3.2 million higher than the first nine months of 2008. Total pension expense for 2009 is expected to be $8.3 million compared to $4.0 million in 2008. Our pension costs are reflected in cost of products sold and SG&A.

Our effective tax rate for the third quarter was 24.7 percent and compares to 25.8 percent in the same period of 2008. The lower rate in the third quarter of 2009 was due to a $3.0 million non-taxable gain associated with the sale of a motor manufacturing plant in Shenzhen, China and a $1.5 million tax benefit for additional research tax credits and closure of a Federal tax audit. The 2009 year-to-date effective tax rate was 23.1 percent compared to 24.9 percent for the same period a year ago. In addition to the aforementioned third quarter tax benefits, a $1.9 million second quarter favorable adjustment in deferred taxes, primarily related to a retroactive reduction in the tax rate of our China water heater operation for achieving high technology status, resulted in the lower 2009 rate. The 2008 year-to-date effective rate benefited from a nontaxable $2.9 million favorable cumulative translation adjustment recognized upon closure of our Budapest, Hungary motor operation.

For all periods presented, the net earnings attributable to noncontrolling interest are comprised of the portion of A. O. Smith Corporation's earnings not attributable to SICO shareholders through the closing of the SICO transaction on April 22, 2009.

Water Products

Third quarter sales for our Water Products segment were $336.7 million or $35.4 million less than 2008 third quarter sales of $372.1 million. Year-to-date sales in 2009 were $1.01 billion or $92.2 million lower than the same period in 2008. The sales declines in both the third quarter and first nine months of 2009 were due to lower residential and commercial water heater volume in North America, reflecting continuing softness in the domestic housing market and a slow down in the commercial water heater segment, which more than offset year over year pricing. The sales decline in the third quarter and first nine months of 2009 was partially offset by increased sales for our China water heater operation as a result of improved consumer confidence, success with new residential and commercial products, and expansion into new geographic markets.

Operating earnings for our Water Products segment were $38.7 million in the third quarter of 2009 or 18 percent higher than the same period in 2008. The increased third quarter earnings resulted from higher margin China volumes, continued cost reduction activities and lower raw material costs. Year-to-date earnings in 2009 were $104.3 million, similar to earnings of $105.1 million in the same period of 2008.

Electrical Products

Third quarter sales for our Electrical Products segment were $165.9 million or 28.5 percent lower than sales of $231.9 million in the same quarter of 2008. Year-to-date sales for this segment were $472.0 million or $222.9 million lower than sales of $694.9 million in the first nine months of 2008. The lower sales in both the third quarter and first nine months of 2009 resulted from weak residential and commercial construction markets due to the global recession.

Operating earnings for our Electrical Products segment in the third quarter of 2009 were $22.8 million or $12.2 million higher than 2008 third quarter earnings of $10.6 million which included $2.1 million in pre-tax restructuring charges. The higher third quarter 2009 earnings were due to continued benefits from the restructuring initiatives completed in 2008 as well as ongoing expense reduction actions and lower raw material costs. A $3.0 million net gain associated with the sale of the Shenzhen, China facility and $2.2 million of LIFO income which resulted from reduced inventory levels also contributed to the improved third quarter earnings. Operating earnings for the first nine months of 2009 were $27.4 million or $16.9 million lower than earnings in the same period of 2008. The lower earnings resulted from significantly lower volumes which more than offset the cost savings achieved as a result of the 2008 restructuring activities.

Outlook

Based on the company's performance through the first three quarters of this year, the company is increasing its 2009 guidance. The company now forecasts A. O. Smith's full-year earnings will be between $2.95 and $3.13 (see accompanying reconciliation) per share on a GAAP basis and $2.60 and $2.75 per share on a non-GAAP basis.

The company remains concerned about the economic recovery, particularly in the housing and commercial construction markets, and by recent significant increases in raw material costs. These factors will continue to present challenges to our operating units as we conclude the year.

                            A. O. SMITH CORPORATION

                     Reconciliation of full-year projection

                                GAAP to non-GAAP

                     in millions, except per share amounts



                                                                   low end       high end
Projected full-year net earnings - GAAP                           $    70.5     $    74.9
Add: Non-GAAP adjustments attributable to net earnings on non-
     controlling interest and SICO expenses                       $     8.4     $     8.4

Adjusted projected full-year earnings                             $    78.9     $    83.3

Projected average shares outstanding - GAAP (1)                        23.9          23.9
Add: Non-GAAP adjustments to weighted average Common shares
     attributable to non-controlling interest                           6.4           6.4

Adjusted projected average shares outstanding                          30.3          30.3

Projected full-year earnings per share - GAAP                     $    2.95     $   3.13(2)

Projected full-year earnings per share - non-GAAP                 $    2.60     $    2.75

(1) Shares are calculated as the weighted average of SICO shares as adjusted for the exchange ratio of the merger transaction prior to the closing and A. O. Smith shares after the closing

(2) Amount differs from the $3.10 high end guidance disclosed in the company's Form 8-K furnished on October 16, 2009 as the $3.13 was rounded down to maintain the same range ($0.15) as the non-GAAP guidance ($2.60 and $2.75)

Liquidity & Capital Resources

Our working capital was $261.2 million at September 30, 2009, compared with $280.1 million working capital associated with continuing operations at December 31, 2008. A reduction in inventory levels of $63.3 million, as a result of focused inventory reduction programs at both businesses, and higher accounts payable at our Water Products segment resulting from improved vendor terms were partially offset by a $67.5 million (non-cash) decline in our derivative contracts liability. Cash provided by operating activities during the first nine months of 2009 was $197.8 million compared with $75.0 million during the first nine months of 2008. A decline in the company's working capital needs this year compared with a significant increase last year more than offset lower earnings this year compared with the same period one year ago. For the total year, we expect cash provided by operating activities to be approximately $190 to $200 million.

Our capital expenditures totaled $37.9 million during the first nine months of 2009 compared with $44.3 million in the same period last year. We are projecting 2009 capital expenditures to be between $55 and $60 million, less than last year and less than our 2009 projected depreciation and amortization expense of approximately $70 million. A significant portion of the remaining capital spending projected for the fourth quarter is associated with the construction of the water heater manufacturing plant near Bangalore, India.

We have a $425 million multi-currency credit facility with eight banks. The facility has an accordion provision which allows it to be increased up to $500 million if certain conditions (including lender approval) are satisfied. Borrowing rates under the facility are determined by our leverage ratio. The facility requires us to maintain two financial covenants, a leverage ratio test and an interest coverage test, and we were in compliance with the covenants at the end of September, 2009.

The facility backs up commercial paper and credit line borrowings, and it expires on February 17, 2011. As a result of the long-term nature of this facility, our commercial paper and credit line borrowings, as well as drawings under the facility, are classified as long-term debt. At September 30, 2009, we had available borrowing capacity of $331.8 million under this facility. We believe the combination of available borrowing capacity and operating cash flow will provide sufficient funds to finance our existing operations for the foreseeable future, as well as the intended purchase of a majority interest in the water treatment business of Tianlong Holding Co. Ltd. of Hong Kong for $77.0 million announced in the third quarter of this year and disclosed in our Form 8-K filed with the SEC on October 16, 2009.

At this point in time, our liquidity has not been materially impacted by the current credit environment, and we do not expect that it will be materially impacted in the near future. There can be no assurance, however, that the cost of future borrowings on our credit facility will not be impacted by the ongoing capital market disruptions.

Our total debt declined $103.0 million from $334.8 million at December 31, 2008 to $231.7 million at September 30, 2009. Our leverage, as measured by the ratio of total debt to total capitalization, was 23.7 percent at the end of September, down from the 33.5 percent at the end of last year.

GSW operated a captive insurance company to provide product liability and general liability insurance to American. We decided to cover American's liability exposures with our existing insurance programs and operate the captive in runoff status effective July 1, 2006. The reinsurance company restricts the amount of capital which must be maintained by the captive. At September 30, 2009, the restricted amount was $17.3 million and is included in other non-current assets. The restricted assets are invested in short-term securities. During the first nine months of 2009, the captive sold approximately $8.9 million in marketable securities and paid us an $8.9 million dividend. The proceeds of this dividend were used to pay down debt.

Our pension plan continues to meet all funding requirements under ERISA regulations. We made voluntary contributions to the plan totaling $50.0 million during the first nine months of this year, even though we are not required to make a contribution in 2009.

On October 13, 2009, our board of directors declared a regular quarterly dividend on our common stock and Class A common stock to $.195 per share. The dividend is payable on November 16, 2009 to shareholders of record on October 30, 2009.

Critical Accounting Policies

The preparation of our consolidated financial statements is in conformity with accounting principles generally accepted in the United States which requires the use of estimates and assumptions about future events that affect the amounts reported in the financial statements and accompanying notes. Future events and their effects cannot be determined with absolute certainty. Therefore, the determination of estimates requires the exercise of judgment. Actual results inevitably will differ from those estimates, and such differences may be material to the financial statements. The critical accounting policies that we believe could have the most significant effect on our reported results or require complex judgment by management are contained in Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations, of our Annual Report on Form 10-K for the year ended December 31, 2008. We believe that at September 30, 2009 there has been no material change to this information.

Recent Accounting Pronouncements

In May 2009, the Financial Accounting Standards Board ("FASB") issued Accounting Codification Statement ("ASC") Sub-topic 855-10 (formerly Statement of Financial Accounting Standards ("SFAS") No. 165), "Subsequent Events". Sub-topic 855-10 addresses the types and timing of events that should be reported in the financial statements for events that occur between the balance sheet date and the date the financial statements are issued or available to be issued. Sub-topic 855-10 was effective for us on June 30, 2009 and we reviewed events for possible inclusion in the financial statements through October 30, 2009.

In March 2008, the FASB issued ASC Sub-topic 815-10, "Derivatives and Hedging". Sub-topic 815-10 (formerly SFAS No. 161, "Disclosures about Derivative Instruments and Hedging Activities, an Amendment of FASB No. 133"), is intended to improve transparency in financial reporting by requiring enhanced disclosures of an entity's derivative instruments and hedging activities and their effects on the entity's financial position, financial performance, and cash flows. ASC 815-10 applies to all derivative instruments within the scope of SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," ("SFAS 133"). It also applies to non-derivative hedging instruments and all hedged items designated and qualifying under SFAS 133 and is effective prospectively for financial statements issued for fiscal years and interim periods beginning after November 15, 2008, with early application encouraged. This pronouncement encourages, but does not require, comparative disclosures for periods prior to its initial adoption. We adopted ASC 815-10 on January 1, 2009. Adoption of this statement did not have a material impact on our consolidated financial condition, results of operations or cash flows. See Note 14 for further discussion.

In December 2007, the FASB issued ASC Sub-topic 810-10-65, "Consolidations", (formerly SFAS No. 160, "Noncontrolling Interests in Consolidated Financial Statements, an amendment of ARB No. 51"). This pronouncement changes the accounting and reporting for minority interests, which will be recharacterized as noncontrolling interests and classified as a component of equity. This new consolidation method changes the accounting for transactions with minority interest holders and is effective beginning in 2009. We adopted ASC 810-10-65 on January 1, 2009. Adoption of this statement has impacted our accounting for the SICO transaction and has been incorporated in the accompanying financial statements.

In December 2007, the FASB issued ASC Sub-topic 805-10, "Business Combinations", (formerly SFAS No. 141(R)). ASC 805-10 requires us to continue to follow prior guidance for certain aspects of business combinations, with additional guidance provided defining the acquirer, recognizing and measuring the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree, assets and liabilities arising from contingencies, defining a bargain purchase and recognizing and measuring goodwill or a gain from a bargain purchase. In addition, certain transaction costs previously capitalized as part of the purchase price will be expensed as incurred. Also, under ASC 805-10 adjustments associated with changes in tax contingencies that occur after the one year measurement period are recorded as adjustments to income. This statement is effective for all business combinations for which the acquisition date is on or after the beginning of an entity's first fiscal year that begins after December 15, 2008; however, the guidance in this standard regarding the treatment of income tax contingencies is retrospective to business combinations completed prior to January 1, 2009. We have adopted ASC 805-10 on January 1, 2009 and incorporated the impact of this statement in the accounting for the SICO transaction.